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NACPB Weekly Tax News
Presidential Advisory Report Weighs In On Tax Reform Debate With Shopping List Of Proposals Presidential Advisory Report Weighs In On Tax Reform Debate With Shopping List Of Proposals The President's Economic Recovery Advisory Board (PERAB) has delivered its long-awaited report on tax reform options, carrying a host of reform options for the Administration to consider in drafting tax policy. The Report covers a wide range of reform proposals in areas such as corporate and international taxation, retirement plan simplification, individual taxation, and small business simplification. Observation: PERAB is an outside advisory panel established by the President and is not part of the Administration. The Report, which doesn't represent Administration policy, may figure in the upcoming Congressional debate over EGTRRA sunsets and extenders. Corporate tax reform. The PERAB Report contains a number of proposals for reforming the U.S. corporate tax system, which experts have described as "deeply flawed and in need of reform." These range from reducing the statutory corporate tax rate (with reduction or elimination of preferential tax breaks, such as the Code Sec. 199 domestic production activities deduction) and allowing all businesses to expense all or a portion of new machinery and equipment purchases to limiting the deductibility of net interest (to provide a more level treatment of debt and equity). As a counterweight against the growth of noncorporate business forms (e.g. LLCs, S corporations) offering the legal benefits of limited liability but only one tax on earnings, one proposal would require firms with certain "corporate" characteristics (e.g., firms that are publicly traded, have a large number of shareholders, or meet certain income or asset sizes) to pay the corporate income tax. An alternative is to eliminate double taxation of corporate income and harmonizing tax rates on corporate and on-corporate income through integration with the individual income tax. International tax issues. The PERAB suggests that the U.S. consider making fundamental changes to the way it taxes its multinational corporations (MNCs). One option would be to adopt a territorial approach similar to those used by most other developed economies and exempt from U.S. tax the active foreign income earned by foreign subsidiaries or by the direct foreign operations of U.S. companies. (Transition rules might be imposed to limit the potential windfall from eliminating the tax that would have been paid when and if accumulated and deferred profits currently held abroad are repatriated.) Moving to a territorial system would eliminate the incentives of U.S. MNCs to keep income earned from foreign operations abroad rather than repatriating this income to the U.S. Another option would be to impose a pure worldwide tax system and end deferral (of overseas active income of foreign subs until it is repatriated) as part of a larger corporate tax reform that lowers the U.S. corporate tax rate to a level comparable to the average of other developed countries. Still another approach would be to limit or end deferral in exchange for reducing corporate rates. Simplification for families. To cut down on overlapping provisions with different rules, requirements, and phaseouts, one broad option is to simplify the tax rules for families. Ways of achieving this goal include: consolidating family credits and simplifying eligibility rules; replacing the personal and dependency exemptions, the child tax credit, and the dependent and child care credit with one uniform Family Credit and replacing the earned income tax credit (EITC) and refundable potion of the child tax credit with a Work Credit. Other broad options include simplifying and consolidating tax incentives for education (e.g., by replacing the multiple tax benefits now available with one or two alternatives), simplifying the kiddie tax, and simplifying rules for low-income credits, filing status, and divorced families. Simplifying savings and retirement incentives. The proposals to simplify and streamline the current 20 Code provisions that provide incentives to save for retirement and other purposes (e.g., education, medical expenses) include:
Capital gains simplification. Proposals include simplifying the capital gains structure by converting the separate rates into a 50% exclusion, taxing Code Sec. 1250 recapture and collectibles gain at ordinary income rates, using the average cost method for all shares in a particular mutual fund, and limiting or repealing Code Sec. 1231 exchanges. Other changes. Other options presented in the report include:
How Parent Treats Acquired Corporation's Qualified Research Expenses On Its Consolidated Return PLR 201034017 In a Technical Advice Memorandum (TAM), IRS has concluded that a parent corporation couldn't include in its computation of the research credit on its consolidated return a target's and target subsidiary's qualified research expenses (QREs) for a period before that in which they became members of its consolidated group. The parent must include the average annual gross receipts (AAGRs) for the target's and target subsidiaries' four tax years before the parent's tax year in its base amount when computing the research credit for its consolidated tax year, but the part of the base amount attributable to the target and target subsidiaries must be reduced because they were members of the parent's consolidated group for only a part of its tax year. Background. For amounts paid or incurred before 2010, Code Sec. 41(a) provides that the research credit for the tax year is an amount equal to the sum of 20% of the excess (if any) of the QREs for the tax year over the base amount. QREs are the sum of the in-house research expenses and contract research expenses that are paid or incurred by the taxpayer during the tax year in carrying on a trade or business. Code Sec. 41(c)(1) provides that the term "base amount" means the product of (a) the fixed-base percentage, and (b) the AAGRs of the taxpayer for the four tax years preceding the tax year for which the credit is being determined (the credit year). Under Reg. § 1.41-3(b)(1), if a credit year is a short tax year, then the base amount determined under Code Sec. 41(c)(1) is modified by multiplying that amount by the number of months in the short tax year and dividing the result by 12. All members of a controlled group are treated as a single taxpayer for purposes of computing the research credit. (Code Sec. 41(f)(1)(A), Reg. § 1.41-6(b)(1)) A controlled group is the same as defined in Code Sec. 1563(a), but with a more than 50% test substituted for the at least 80% test used for determining parent-sub control, and without regard to the rule that treats life insurance companies as a separate controlled group or the exception to the trust attribution rules for stocks held by a qualified plan trust. (Code Sec. 41(f)(5)) Under Reg. § 1.1502-76(b)(1)(i), a consolidated return must include the common parent's items of income, gain, deduction, loss, and credit for the entire consolidated return year, and each subsidiary's items for the portion of the year for which it is a member. If the consolidated return includes the items of a corporation for only a part of its tax year determined without taking this rule into account, items for the part of the year not included in the consolidated return must be included in a separate return (including the consolidated return of another group). These rules must be applied to prevent the duplication or elimination of the corporation's items. Under Reg. § 1.1502-76(b)(1)(ii)(A)(1), if a corporation (other than an S corporation) becomes or ceases to be a member during a consolidated return year, it becomes or ceases to be a member at the end of the day on which its status as a member changes, and its tax year ends for all federal income tax purposes at the end of that day. Facts. Parent is the common parent of a consolidated group filing its returns on a fiscal year basis. Target was the common parent of its own unrelated consolidated group that filed its returns on a calendar year basis. On Date B, Parent acquired the stock of Target in exchange for stock and cash in a transaction that wasn't a reverse acquisition under Reg. § 1.1502-75(d)(3), terminating the Target consolidated group. In its computation of the Parent group's research credit for its tax year beginning on Date A and ending on Date D, Parent included Target's and Target subsidiaries' QREs for the period Date A through Date B—i.e., the period in which Target was the common parent of its own consolidated group. Parent didn't include Month in its original computations, but did file an informal amended claim to include Month. Parent didn't deduct any QREs for the period Date A through Date B and isn't claiming any deduction for these QREs. In calculating the research credit for Parent's group for the tax year ending Date D, Parent included Target's and Target subsidiaries' gross receipts for the period Date A through Date B in the computation of Parent's base amount. Observation: Presumably, Month is Target's short tax year ending on Date B that was created when Parent acquired Target's stock and, as a result, the Target consolidated group was terminated. Target included the same QREs for the period Date A through the end of Year 4 and for Month in its computation of the Target group's research credit for the Year 4 tax year and the short tax year ending on Date B, respectively. However, because these years were both loss years for the Target group, none of the credits were utilized to offset Target group's income tax. Parent carried or intends to carry the credits forward to Parent's consolidated return years (subject to Code Sec. 383 limitations). Thus, Parent and Target both included Target's and Target subsidiaries' QREs for the period Date A through Date B in the computation of the research credit. TAM's conclusion. The TAM concluded that Target's and Target subsidiaries' QREs from the period Date A through Date B shouldn't be included in Parent's consolidated return for the tax year ending Date D because those QREs weren't paid or incurred during the part of Parent's tax year in which they were members of the Parent consolidated group. Rather, the QREs were paid or incurred during the part of the year in which Target was the common parent of its own group. Under the consolidated return regs, the QREs must be included only in the Target's group's consolidated return for the appropriate year. Under Reg. § 1.1502-76(b)(1)(ii)(A)(1), Target's consolidated group terminated at the end of the day on Date B (the date of Target's acquisition) and Target and its subsidiaries became members of the Parent consolidated group on Date C. Under Reg. § 1.1502-76(b)(1)(i), Target's and Target subsidiaries' QREs for the period Date A through the end of Year 4 and for Month must be included in the Target consolidated group's QREs for Year 4 and Target's short tax year ending on Date B, respectively. The Target consolidated group must use the short tax year provision of Code Sec. 1.41-3(b)(1) to compute its research credit for its short tax year ending on Date B. The TAM further concluded that Parent must include the AAGRs for Target's and Target subsidiaries' four tax years before Parent's tax year ending on Date D in Parent's base amount when computing the research credit for Parent's consolidated tax year ending on Date D. However, because Target and Target subsidiaries were members of the Parent consolidated group for only a part of Parent's tax year beginning on Date A and ending on Date D, the part of the base amount determined under Code Sec. 41(c)(1) attributable to Target and Target subsidiaries must be reduced by multiplying the amount by the number of months in the period from Date C through Date D and dividing the result by twelve. References: For computing the research credit for controlled groups, see FTC 2d/FIN ¶ L-15316; United States Tax Reporter ¶ 414.03; TaxDesk ¶ 384,006; TG ¶ 15103. Officers' Compensation Wasn't Subject To $1 Million Compensation Limit After Merger PLR 201033008 IRS has privately ruled that a corporation's officers weren't covered employees for purposes of the Code Sec. 162(m) $1 million compensation deduction limit where after a merger the compensation was no longer required to be reported to shareholders under the Securities Exchange Act of '34 (Exchange Act). Background. Subject to certain exceptions, Code Sec. 162(m) generally provides a deduction limit of $1 million for compensation paid by a publicly held corporation during any tax year to a covered employee. Under Code Sec. 162(m)(3), a covered employee is defined as any employee of the employer if (1) as of the close of the tax year, the employee is the employer's chief executive officer (CEO) or is an individual acting in such capacity; or (2) the total compensation of the employee for the tax year is required to be reported to shareholders under the Exchange Act by reason of the employee being among the four highest compensated officers for the tax year (other than the CEO). Reg. § 1.162-27(c)(2)(ii) generally provides that whether an individual is a covered employee under this definition is determined under the executive compensation disclosure rules of the Exchange Act in Item 402 of regulations S-K, 17 CRF 229.402. Under the Exchange Act disclosure rules (which were amended on Sept. 8, 2006), named executive officers subject to disclosure are: (1) all individuals serving as principal executive officer or acting in a similar capacity during the last completed fiscal year, regardless of compensation level; (2) all individuals serving as the principal financial officer or acting in a similar capacity during the last completed fiscal year, regardless of compensation level; and (3) the registrant's three most highly compensated executive officers other than the principal executive officer and the principal financial officer who were serving as executive officers at the end of the last completed fiscal year. In Notice 2007-49, 2007-25 IRB 1429, IRS said that to reflect amended Securities and Exchange Commission (SEC) disclosure rules, it would interpret the term covered employee for purposes of Code Sec. 162(m) to mean any employee of the corporation if, as of the close of the tax year, the employee is the corporation's principal executive officer or an individual acting in this capacity, or if the employee's total compensation for that tax year is required to be reported to shareholders under the Exchange Act because the employee is among the three highest compensated officers for the tax year (other than the principal executive officer or the principal financial officer—i.e., the chief financial officer (CFO)). Notice 2007-49 said that the term covered employee for purposes of Code Sec. 162(m) doesn't include those individuals for whom disclosure is required under the Exchange Act on account of their being the taxpayer's principal financial officer (within the meaning of the amended disclosure rules) or an individual acting in such a capacity. Facts. Corporation entered into a merger agreement with Acquiring and Acquiring's direct wholly-owned subsidiary Merger Subsidiary. Under the merger agreement, Corporation merged with and into Merger Subsidiary, which was the surviving corporation. The acquisition was completed on Date 1, before the end of Corporation's tax year, resulting in a short tax year ending on Date 1. On Date 2, Corporation terminated its registration of securities by filing a Form 15 with the SEC. Corporation represented that under the executive compensation disclosure rules under the Exchange Act, it wasn't required to disclose the compensation of its officers for the fiscal year ending on Date 3, or for any part of that year, including any part of Corporation's short tax year ending on Date 1. Not covered employees. In PLR 201033008, IRS ruled, based solely on the facts presented, that Corporation's officers weren't covered employees under Code Sec. 162(m) with respect to Corporation for its tax year ending on Date 1. References: For the deduction limit for compensation over $1 million paid to top officers, see FTC 2d/FIN ¶ H-3776; United States Tax Reporter ¶ 1624.009; TaxDesk ¶ 276,001.1; TG ¶ 7531. Guidance On Withholdable Payments To Foreign Financial Institutions And Others: Part II Notice 2010-60, 2010-37 IRB IRS has issued a Notice that provides preliminary guidance on implementing chapter 4, Subtitle A of the Code, which was added by the Hiring Incentives to Restore Employment Act of 2010 (HIRE Act, P.L. 111-147, 3/18/2010) (Code Sec. 1471 through Code Sec. 1474). IRS requests comments on this guidance, which will be incorporated into upcoming proposed regs. This article, the second of two parts, covers the collection of information and identification of persons by foreign financial institutions (FFIs), the information that FFIs must report to IRS under a Code Sec. 1471(b) FFI agreement with respect to their U.S. accounts, and the mandatory electronic filing requirement. For a discussion of other topics covered by the notice, including which obligations are exempt from chapter 4 withholding under the grandfathering provision, and the definition of a foreign financial institution (FFI), see ¶Â 17. Background. Under Code Sec. 1471, FFIs generally must enter into FFI Agreements to avoid withholding. An FFI Agreement provides that the participating FFI agrees, among other requirements, to: (1) obtain such information regarding each holder of each account maintained by the FFI as is necessary to determine which (if any) of the accounts are U.S. accounts; (2) comply with due diligence procedures that IRS may require for the identification of U.S. accounts; and (3) report certain information with respect to U.S. accounts maintained by the FFI. A participating FFI must also agree to withhold tax on certain payments made to non-participating FFIs and recalcitrant account holders (i.e., account holders that fail to comply with reasonable requests for information by a participating FFI or that fail to provide a waiver). For a more in-depth discussion of Code Sec. 1471 through Code Sec. 1474, see ¶Â 17. FFI's information collection and identification of persons. Notice 2010-60, Sec. III.B.1, provides that to facilitate compliance with the obligations imposed by chapter 4, participating FFIs will be allowed to rely on Forms W-9 (Request for Taxpayer Identification Number and Certification) that they collect for other U.S. tax purposes (i.e., for purposes of chapters 3 and 61 of the Code), and will generally be required to treat accounts of individuals that are so documented as U.S. accounts for purposes of chapter 4. They also must collect Form W-8BEN (Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding) or Form W-9 (or acceptable substitute forms) from certain of their account holders. This requirement will be limited in scope. Participating FFIs (as well as other withholding agents) will also be required to identify other FFIs as participating FFIs, deemed-compliant FFIs, or non-participating FFIs (or as entities described in Code Sec. 1471(f), i.e., foreign governments, international organizations, foreign central banks of issue). IRS contemplates that it will issue employer identification numbers (EINs) to participating FFIs (FFI EINs) and that they will use these to identify themselves to withholding agents. Until withholding agents are able to verify the status of FFIs with IRS, withholding agents and participating FFIs will be allowed to rely on certifications provided by FFIs as to their status as participating FFIs, unless the withholding agent or participating FFI knows or has reason to know that the certification provided is incorrect. To determine if any of the accounts maintained by a participating FFI held by individuals are U.S. accounts, future guidance will provide procedures that distinguish between (a) preexisting individual accounts (financial accounts held by individuals as of the date that a participating FFI's FFI Agreement becomes effective) and (b) new individual accounts (accounts opened by individuals after the date that a participating FFI's FFI Agreement becomes effective). New individual accounts will include new account relationships established by individuals holding preexisting individual financial accounts with the FFI. For example, it will include a custodial account opened after the effective date of the participating FFI's FFI Agreement by an individual that maintains a preexisting depository account at the FFI. For preexisting individual accounts, the participating FFI will be required to determine whether the accounts are to be treated as U.S. accounts, accounts of recalcitrant account holders, or other accounts under the steps in Notice 2010-60, Sec. III.B.2.a. For new individual accounts, the participating FFI will be required to determine whether the accounts are to be treated as U.S. accounts under the steps in Notice 2010-60, Sec. III.B.2.b. For financial accounts held by persons other than individuals, the participating FFI will be required to determine whether the accounts are to be treated as U.S. accounts, accounts of participating FFIs, accounts of deemed-compliant FFIs, accounts of non-participating FFIs, accounts of entities described in Code Sec. 1471(f), accounts of recalcitrant account holders, accounts of excepted or other non-financial foreign entities (NFFEs), or other accounts under the steps in Notice 2010-60, Sec. III.B.3. While the procedures for new entity accounts are similar to those for preexisting accounts, or new entity accounts, FFIs must determine how to treat the accounts using all information collected by the FFI (e.g., for purposes of opening and maintaining the account, corresponding with the account holder, and complying with regulatory requirements (including "anti-money laundering/know-your-customer" (AML/KYC) requirements), regardless of whether the information is available in electronically searchable files. (Notice 2010-60, Sec. III.B.3) To avoid duplicative documentation, a participating FFI must determine the treatment of its entity account holders under the procedures in Notice 2010-60, Sec. III.B.3, rather than the certification procedures described in Code Sec. 1472(b), for purposes of applying Code Sec. 1472 for a withholdable payment to an entity account holder. (Notice 2010-60, Sec. III.B.4) To comply with its obligations as a withholding agent under Code Sec. 1471 and Code Sec. 1472, a U.S. financial institution (USFI) must determine whether to treat entities to which it makes withholdable payments as U.S. persons, participating FFIs, deemed-compliant FFIs, non-participating FFIs, entities described in Code Sec. 1471(f), excepted NFFEs, or other NFFEs. Where the entities to which a USFI makes withholdable payments are account holders of the USFI, these determinations parallel the determinations that a participating FFI is required to make with respect to its entity account holders. IRS will require USFIs to determine whether their foreign entity account holders are NFFEs subject to reporting or withholding under Code Sec. 1472 or FFIs subject to withholding under Code Sec. 1471(a) by applying procedures similar to those described in Notice 2010-60, Sec. III.B.3. A USFI that performs such procedures will not be required to separately request certification under Code Sec. 1472(b) from its NFFE account holders. These procedures will apply only with respect to holders of financial accounts as defined in Code Sec. 1471(d)(2) to which the USFI makes withholdable payments. (Notice 2010-60, Sec. III.B.4) Reporting on U.S. accounts. IRS is developing a new form for reporting the information required by Code Sec. 1471(c). This form will be filed electronically. The account number to be reported for an account may be an actual account number, or, if no account number is used by the FFI, a serial number or other number the FFI assigns to the financial account that is unique and will distinguish the specific account. IRS intend to issue guidance that will require the account balance or value to be reported in U.S. dollars. Future guidance will provide the appropriate method for currency translation. For the account balance of deposit and custodial accounts, IRS is considering requiring reporting of the highest of the month-end balances during the year (or, if the balance is determined less frequently, the highest of the balances as determined for purposes of reporting to the account holder during the year). FFIs will be required to provide additional account-related information (e.g., copies of account statements including monthly or quarterly balances and daily receipts and withdrawals) on IRS's request. IRS also intends to issue guidance coordinating the reporting provisions of chapter 4 with other U.S. tax reporting obligations. (Notice 2010-60, Sec. IV) Electronic filing. IRS intends to issue regs that would require all or most financial institutions to electronically file their returns with respect to tax for which the institutions are liable under chapter 3 and chapter 4 of the Code beginning with returns filed for tax years ending after Dec. 31, 2012. IRS considers the receipt of electronic filings by financial institutions in lieu of paper filings to be critical to chapter 3 and chapter 4 compliance efforts. (Notice 2010-60, Sec. III.V.F) References: For withholdable payments to FFIs and other foreign entities, see FTC 2d/FIN ¶ O-13070 et seq.; United States Tax Reporter ¶ 14,714 Homeowner's Association Has UBTI From Restricted-Access Beach Club And Parking Lots Ocean Pines Association, 135 TC 13 The Tax Court has ruled that a Code Sec. 501(c)(4) homeowner's association had to treat as unrelated business taxable income (UBTI) the income it earned from a beach club and some of the income it earned from renting parking lots. The facilities weren't open to the general public and thus weren't related to the promotion of community welfare. The Tax Court also held that the parking lot income wasn't real property rent that was excluded from UBTI. Background. Civic leagues or organizations not organized for profit but operated exclusively for the promotion of social welfare are exempt under Code Sec. 501(c)(4). And under Reg. § 1.501(c)(4)-1(a)(2), an organization is operated exclusively for the promotion of social welfare if it is primarily engaged in promoting in some way the common good and general welfare of the people of the community. Code Sec. 501(c)(4) organizations must pay tax on their UBTI. Income is UBTI if it is derived from a regularly carried-on trade or business that is not substantially related to the purpose constituting the basis of the organization's exemption under Code Sec. 501. (Reg. § 1.513-1(a), Reg. § 1.513-1(d)) For the conduct of a trade or business to be substantially related to the purpose or purposes for which an organization was granted a tax exemption, performance of the services from which the gross income is derived must contribute importantly to the accomplishment of these purposes. (Reg. § 1.513-1(d)(2)) Under Code Sec. 512(b)(3)(A)(i), rents from real property are excluded from UBTI. Payments for the use or occupancy of rooms or other space where services are also provided to the occupant are not rents from real property for purposes of computing UBTI. Services are considered rendered to the occupant if they are primarily for his convenience, e.g., maid service, and are other than those usually or customarily rendered in connection with the rental of space for occupancy only, such as heat, light, cleaning of public areas, and trash collection. Thus, rents for hotels, boarding houses, parking lots, warehouses, or storage garages aren't rents from real property. (Reg. § 1.512(b)-1(c)(5)) Facts. Ocean Pines Association (OPA), exempt under Code Sec. 501(c)(4), is a homeowners association with numerous members in a Maryland community known as Ocean Pines. OPA owns beachfront property approximately eight miles from the Ocean Pines area in Ocean City, Maryland. The Ocean City property consists of two parking lots, containing 300 parking spaces in total, and an oceanfront beach club, known as the Ocean Pines Beach Club. OPA's members who use the parking lots and the beach club commute approximately 15 minutes by car from Ocean Pines to Ocean City. The beach club allows both OPA members and nonmembers to purchase food and beverage services and to use its restrooms for free. However, the swimming pool, gym lockers, and shower facilities are accessible only to OPA members. Only OPA members are eligible to purchase permits for the parking lots. The Association's members must pay a weekly or monthly fee depending on the period for which the permit is issued. The lots are also leased to third party businesses. During the summer, OPA employs a guard to open and close the lots and to check parking decals as cars enter the lots. OPA timely filed Form 990, Return of Organization Exempt From Income Tax, for 2003 and 2004, but did not file the form on which the unrelated business income tax is reported, Form 990-T, Exempt Organization Business Income Tax Return. The issue before the Tax Court was whether OPA's parking lot rental income (except for leasing to third parties during evenings and off-season) and beach club income were UBTI. Income not for promotion of community welfare. Siding with IRS, the Tax Court ruled that the beach club and the parking lots did not promote community welfare because they are not open to the non-member general public. The parking lots and the beach club are not accessible to the general public. Only OPA members and their guests may park in the parking lots. Although the beach club allows both OPA members and nonmembers to access its food and beverage services and its restrooms, its primary facilities (the swimming pool, gym lockers, and showers) are accessible only to OPA members. Thus, the Tax Court concluded that operation of the parking lots and the beach club is not substantially related to the purpose of promoting social welfare within the meaning of Code Sec. 501(c)(4) because they are not open to the general public. Parking lot income not excepted real estate income. The Tax Court agreed with IRS that the legislative history to the UBTI states or implies four times that the operation of a parking lot yields UBTI and not rent from real property. It also ruled that under Reg. § 1.512(b)-1(c)(5), the services provided by an operator of a parking lot (at least a typical parking lot) are primarily for the convenience of the customer and are other than those usually or customarily rendered in connection with the rental of rooms or space for occupancy only. (By contrast, the lease payments OPA received from third-party businesses were rent from real property under Reg. § 1.512(b)-1(c)(5), and thus were properly conceded by IRS to be excludable from UBTI.) References: For unrelated business taxable income, see FTC 2d/FIN ¶ V-3308; United States Tax Reporter ¶ 5134; TaxDesk ¶ 681,000; TG ¶ 20883. For services rendered in connection with rental for unrelated business income purposes, see FTC 2d/FIN ¶ D-6909; TaxDesk ¶ 681,008. ...The Swiss Finance Ministry said last week that it is past the half-way point in releasing data on 4,450 accounts held at banking giant UBS to IRS. The information is at the heart of a lawsuit and a subsequent U.S.-Swiss agreement to resolve the dispute involving accounts of U.S. citizens suspected of tax evasion. IRS was quick to respond to the Swiss announcement. "Based on information received to date and assurances by the Swiss government, we anticipate being in a position to withdraw the John Doe summons this fall," IRS said in a statement, referring to a summons that is part of the proceedings in a federal district court. ...The three largest commercial preparers of individual tax returns have joined forces to express their "strong opposition" to an IRS decision blocking their access to the agency's "debt indicator." (Aug. 11 letter to Treasury Secretary Timothy Geithner and IRS Commissioner Douglas Shulman) The debt indicator is information which is used as an underwriting tool for refund anticipation loans. The companies—Jackson Hewitt Tax Service, Inc., H&R; Block, and Liberty Tax Service—prepared more than 27.5 million tax returns in 2010. In their letter, they said the debt indicator "has been an integral, and necessary, part of the tax preparation and bank product application process since its inception" in 1989. The debt indicator has been an "important component" in the agency's effort to increase electronic filing, the letter noted. The companies questioned the wisdom of Treasury and IRS taking such unilateral action "absent extensive discussions with industry stakeholders and, most importantly, taxpayers." The letter cited a number of reasons the decision to eliminate the debt indicator is "misguided," including the following: the demand for refund anticipation loans is customer driven; the federal government has a vested interest in providing accurate, readily-available information; IRS has breached the spirit of trust and cooperation with the tax preparation industry; eliminating the debt indictor will increase costs to taxpayers; and the debt indicator provides immediate benefits to IRS and all taxpayers. ...While IRS has made important advancements in its oversight of the filing compliance of Code Sec. 527 tax-exempt political organizations, there is still room for improvement, the Treasury Inspector General for Tax Administration (TIGTA) said in an audit that just became publicly available. (Audit Report No. 2010-10-018) The agency has not "fully addressed" noncompliance, the audit said. For example, a sample review of Forms 8872 (Political Organization Report of Contributions and Expenditures) found that one in four had incomplete or missing contributor or recipient information. Although at some point these reports may be deemed acceptable, the agency is not scrutinizing these filings to determine if they are complete or if penalties are warranted, the audit said. It also noted that IRS is not always issuing timely and complete notices to 527 groups nor is the agency verifying compliance with its requests for additional information. "We believe [IRS] should focus on addressing noncompliance through increased enforcement actions," TIGTA said. "The assessment of taxes and penalties for incomplete filings, when appropriate, could lead to increased accountability and disclosure by political organizations," TIGTA said, adding that an improved notice process "could also assist political organizations in complying with their responsibilities." The audit can be found at http://www.treas.gov/tigta/auditreports/2010reports/201010018fr.pdf. Guidance On Withholdable Payments To Foreign Financial Institutions And Others: Part I Notice 2010-60, 2010-37 IRB IRS has issued a Notice that provides preliminary guidance on implementing chapter 4, Subtitle A of the Code, which was added by the Hiring Incentives to Restore Employment Act of 2010 (HIRE Act, P.L. 111-147, 3/18/2010) (Code Sec. 1471 through Code Sec. 1474). IRS requests comments on this guidance, which will be incorporated into upcoming proposed regs. This article, part one of two, covers which obligations are exempt from chapter 4 withholding under the grandfathering provision, and the definition of a foreign financial institution (FFI). For a discussion of other topics covered by the notice, including the collection of information and identification of persons by financial institutions, the information that FFIs must report to IRS under a Code Sec. 1471(b) FFI Agreement with respect to their U.S. accounts and electronic filing requirements, see ¶Â 18. Background. Generally effective for payments made after Dec. 31, 2012, the HIRE Act establishes rules for withholdable payments to FFIs and for withholdable payments to other foreign entities by adding a new chapter 4 to the Code (Code Sec. 1471 through Code Sec. 1474). The new rules provide for withholding taxes to enforce new reporting requirements on specified foreign accounts owned by specified U.S. persons or by U.S. owned foreign entities. These provisions don't apply to any obligation outstanding on Mar. 18, 2012 (the date that is two years after the enactment date), or from the gross proceeds from any disposition of the obligation. (Act Sec. 501(d)) Generally for payments made after Dec. 31, 2012, a withholding agent must deduct and withhold a tax equal to 30% of any withholdable payment made to a FFI that does not meet certain requirements. (Code Sec. 1471(a)) A "withholdable payment" is non-effectively connected (1) U.S. source fixed or determinable annual or periodical (FDAP) income (which includes interest and dividends but not gains on sales of property and on which nonresident withholding applied under pre-HIRE Act law), (2) gross proceeds from the sale of property that produces interest and dividend income (which have not previously been subject to nonresident withholding) and (3) interest on deposits with foreign branches of a domestic commercial bank (which is otherwise non-U.S. source income). (Code Sec. 1473(1)) To avoid this 30% withholding requirement, a FFI must either enter into a Code Sec. 1471(b) agreement with IRS and satisfy the requirements listed below, or satisfy one of several alternatives. (Code Sec. 1471(a)) Code Sec. 1471(b) Agreement. Withholding on withholdable payments is not required if a Code Sec. 1471(b) agreement is in effect between the FFI and IRS in which the institution agrees to:
Annual reporting is also required as to account balances and gross receipts and withdrawals from the account. (Code Sec. 1471(c)(1)) U.S. accounts. A U.S. account is any financial account which is held by one or more "specified U.S. persons" or a "U.S. owned foreign entity" (with an exception where all accounts held by a natural person do not exceed $50,000). (Code Sec. 1471(d)(1)) A specified U.S. person is any U.S. person other than (i) a corporation whose stock is regularly traded on an established securities market or members of its "expanded affiliated group" and (ii) certain entities that are exempt or have a special status and government bodies. (Code Sec. 1473(3)) A "U.S. owned foreign entity" is a foreign entity with one or more substantial U.S. owners, applying a more than 10% ownership of stock by vote or value test to a corporation; a more than 10% of capital or profits interests test to a partnership; any interest in a grantor trust; and under regs, any specified U.S. person with more than a 10% interest in a trust. (Code Sec. 1471(d)(1)) Payments to other foreign entities. Generally for payments made after Dec. 31, 2012, a withholding agent must deduct and withhold a tax equal to 30% of any withholdable payment made to a nonfinancial foreign entity if the beneficial owner of the payment is a nonfinancial foreign entity that does not meet specified requirements. (Code Sec. 1472(a)) Withholding is not required if the payee or the beneficial owner of the payment provides the withholding agent with either a certification that the foreign entity does not have a substantial U.S. owner, or provides the withholding agent with the name, address and TIN of each substantial U.S. owner. (Code Sec. 1472(b)) Withholding does not apply to any payment beneficially owned by a publicly traded corporation or a member of an expanded affiliated group of a publicly traded corporation. Nor does it apply to any payment beneficially owned by any: (1) entity organized under the laws of a U.S. possession, which is wholly owned by one or more bona fide residents of that possession; (2) foreign government, political subdivision thereof, or wholly owned agency or instrumentality of any foreign government or political subdivision thereof; (3) international organization or any wholly owned agency or instrumentality thereof; (4) foreign central bank of issue; (5) any other class of persons identified by IRS for these purposes; or (6) payments identified by IRS as posing a low risk of U.S. tax evasion. (Code Sec. 1472(c)) HIRE Act Sec. 501(d)(3) provides an increased grace period during which IRS does not have to pay interest on certain overpayments related to chapter 3 or 4 of the Code. Grandfathered obligations. In Notice 2010-60, IRS explains that any payment made pursuant to any obligation outstanding on Mar. 18, 2012 (or any gross proceeds from the disposition of such an obligation) will not be subject to withholding under chapter 4. IRS intends to issue regs providing that "obligation" for this purpose means any legal agreement that produces or could produce withholdable payments. A legal agreement that produces withholdable payments doesn't include brokerage, custodial and similar agreements to hold financial assets for the account of others and to make and receive payments of income and other amounts with respect to the assets. (Notice 2010-60, Sec. I) Under the regs, an obligation won't include any instrument treated as equity for U.S. tax purposes, or any legal agreement that lacks a definitive expiration or term. For example, savings deposits, demand deposits, and other similar accounts are not obligations for purposes of the effective date rule. IRS also intends to issue regs that provide that an obligation entered into on or before Mar. 18, 2012 will be treated as outstanding on Mar. 18, 2012 and that for purposes of the grandfather rule any material modification of an obligation will result in it being treated as newly issued as of the effective date of the modification. A material modification means any significant modification as defined in Code Sec. 1.1001-3 for an obligation that constitutes indebtedness for U.S. tax purposes. In all other cases, whether a modification of an obligation is material will be determined based on all relevant facts and circumstances. (Notice 2010-60, Sec. I) FFI defined. Under Code Sec. 1471(d)(5), except as otherwise provided by IRS, a "financial institution" means any entity that (1) accepts deposits in the ordinary course of a banking or similar business, (2) holds financial assets for the account of others as a substantial portion of its business, or (3) is engaged (or holds itself out as being engaged) primarily in the business of investing, reinvesting, or trading in securities (as defined in Code Sec. 475(c)(2) without regard to the last sentence), partnership interests, commodities, or any interest (including a futures or forward contract or option) in such securities, partnership interests, or commodities. IRS intends to issue regs on each of these three categories of financial institutions. Notice 2010-60, Sec. II.A.1, provides that the first category of financial institutions are entities that accept deposits in the ordinary course of a banking or similar business. They generally include, but are not limited to, entities that would qualify as banks under Code Sec. 585(a)(2) (including banks as defined in Code Sec. 581 and any corporation to that Code section would apply except for the fact that it is a foreign corporation), savings banks, commercial banks, savings and loan associations, thrifts, credit unions, building societies and other cooperative banking institutions. The fact that an entity is subject to the banking and credit laws of the United States, a State, a political subdivision thereof, or a foreign country, or to supervision and examination by agencies having regulatory oversight of banking or similar institutions, is relevant to but not necessarily determinative of whether that entity qualifies as a financial institution. Notice 2010-60, Sec. II.A.2, provides that the second category of financial institutions are entities that as a substantial portion of their business, hold financial assets for the account of others. These may include, for example, broker-dealers, clearing organizations, trust companies, custodial banks, and entities acting as custodians with respect to the assets of employee benefit plans. As in the case of institutions in the first category, the fact that an entity is subject to the banking and credit laws or broker-dealer regulations of the United States, a State, a political subdivision thereof, or a foreign country, or to supervision and examination by agencies having regulatory oversight of banking or similar institutions, is relevant to but not necessarily determinative of whether that entity qualifies as a financial institution. Notice 2010-60, Sec. II.A.3, provides that the third category of financial institutions are entities that are engaged (or hold themselves out as being engaged) primarily in the business of investing, reinvesting, or trading in securities (as defined in Code Sec. 475(c)(2) without regard to the last sentence), partnership interests, commodities (as defined in Code Sec. 475(e)(2)), or any interest (including a futures or forward contract or option) in such securities, partnership interests, or commodities. This category generally includes, but is not limited to, mutual funds (or their foreign equivalent), funds of funds (and other similar investments), exchange-traded funds, hedge funds, private equity and venture capital funds, other managed funds, commodity pools, and other investment vehicles. Although Code Sec. 1471(d)(5) refers to the business of investing, reinvesting, or trading in securities, etc., Notice 2010-60 notes that the concept of "business" as used in Code Sec. 1471(d)(5)(C) is different in scope and content from the concept of a "trade or business" as used in other Code sections. Isolated transactions that might not give rise to a trade or business for other purposes may cause an entity to be engaged primarily in the business of investing, reinvesting, or trading in securities, etc. IRS anticipates that regs will provide that whether an entity is engaged primarily in the business of investing, reinvesting, or trading in securities must be determined on the basis of all relevant facts and circumstances. (Notice 2010-60, Sec. II.A.3) Excluded institutions. Notice 2010-60, Sec. II.B, also identifies entities that IRS intends to exclude from the definition of FFI and exempt from the requirements of Code Sec. 1472. IRS intends to issue regs that generally will provide that a foreign entity that otherwise satisfies the definition of a financial institution solely because it is primarily engaged in investing, reinvesting or trading in securities will not be treated as a financial institution if it falls within one of the following classes of foreign entities:
In addition, IRS plans to issue regs treating entities whose business consists solely of issuing insurance or reinsurance contracts without cash value (i.e., most property and casualty insurance or reinsurance contracts or term life insurance contracts) as non-financial institutions for purposes of chapter 4. Regs will also exclude certain investment funds and other entities that may have only a small number of direct or indirect account holders, all of whom are individuals or non-financial foreign entities that would not be subject to withholding or reporting under Code Sec. 1471 or Code Sec. 1472 and certain financial institutions organized in U.S. Territories. Notice 2010-60, Sec. II.C, says that IRS intends to provide that certain foreign retirement plans pose a low risk of tax evasion for chapter 4 purposes, and so payments beneficially owned by the retirement plans will be exempt from withholding under Code Sec. 1471(a). IRS does not intend to exempt an FFI from the requirement to enter into an FFI Agreement, even if the FFI receives withholdable payments solely through its U.S. branch. Where a U.S. branch of an FFI receives withholdable payments that aren't eligible for the Code Sec. 1473(1)(B) exclusion from the definition of a withholdable payment for income taken into account under Code Sec. 871(b)(1) or Code Sec. 882(a)(1), the FFI generally will be required to execute an FFI Agreement to avoid being subjected to withholding under Code Sec. 1471(a). (Notice 2010-60, Sec. II.D) References: For withholdable payments to FFIs and other foreign entities, see FTC 2d/FIN ¶ O-13070 et seq.; United States Tax Reporter ¶ 14,714 et seq. IRS Will Correct Erroneous HIRE Act Failure To Deposit Penalty Assessments IRS SBSE Payroll E-mail, 8/27/10 E-mail from an IRS spokesperson reveals that IRS is currently correcting a problem with how the first quarter HIRE Act credit was applied to the second quarter Form 941, Employer's Quarterly Federal Tax Return. The problem is generating erroneous penalty notices. Background. Under Code Sec. 3111(d), as amended by the Hiring Incentives to Restore Employment (HIRE) Act (P.L. 111-147), qualified employers are exempted from paying the employer 6.2% share of Social Security (i.e., OASDI) employment taxes on wages paid in 2010 to a newly hired qualified individual. The payroll tax relief applies only for wages paid to qualified individuals after Mar. 18, 2010 and before Jan. 1, 2011. A qualified individual is one who:
The payroll tax exemption doesn't apply for wages paid during the first calendar quarter of 2010, more narrowly, it doesn't apply for wages paid from March 19 through March 31. Instead, the amount by which the qualified employer's OASDI tax for wages paid during the first calendar quarter of 2010 would have been reduced if the payroll tax exemption had been in effect for the first quarter is treated as a payment against the employer's OASDI tax for the second calendar quarter of 2010. (Code Sec. 3111(d)(5)) In May, IRS issued a revised Form 941 (Employer's Quarterly Federal Tax Return) for the second quarter of 2010 to reflect the payroll tax exemption for hiring unemployed workers. Calculation problem and a fix. An IRS spokesperson says there was a problem with how the credit for first quarter wages paid from March 19 through March 31 (Form 941, line 12e) was applied when computing the Failure to Deposit Penalty on the second quarter Form 941. The calculation problem caused IRS to send out erroneous CP 207 and CP 276B notices to some taxpayers. The IRS proposes a federal tax deposit penalty on CP 207. A CP 276B notice asks taxpayers to review their records to determine if they are paying their current payroll taxes on time. The IRS spokesperson says IRS has corrected the error and plans to revise any erroneous penalty assessments by September 6th. References: For the HIRE Act's payroll tax exemption, see FTC 2d/FIN ¶ H-4687.1; United States Tax Reporter ¶ 31,114; TaxDesk ¶ 541,002.1. Unsophisticated Investor Avoids Substantial Underpayment Penalty For Unreported Disguised Sale Shao, TC Memo 2010-189 The Tax Court has held that an inexperienced investor was not liable for the Code Sec. 6662(a) substantial underpayment penalty for not reporting gain on a purported loan transaction program that was in fact a disguised sale. She acted in good faith on an honest misunderstanding of the law, had legitimate, non-tax reasons for trying to structure the transaction as a loan and consistently treated the transaction as a loan. Observation: The new decision dealt with a transaction widely characterized as Ponzi scheme, one that the Tax Court previously held to be a disguised sale (Callloway, (2010) 135 TC No. 3). There, however, the Tax Court held that the taxpayer was liable for the accuracy related penalty under Code Sec. 6662. Background. Under Code Sec. 6662(a) and Code Sec. 6662(b)(2), a 20% penalty applies for any substantial underpayment of income tax. A substantial understatement of income tax exists for an individual if the amount of the understatement exceeds the greater of 10% of the tax required to be shown on the return, or $5,000. (Code Sec. 6662(d)(1)) The accuracy-related penalty under Code Sec. 6662(a) doesn't apply, however, to any portion of an underpayment if a taxpayer shows that there was reasonable cause for it, and that the taxpayer acted in good faith with respect to that portion. (Code Sec. 6664(c)(1), Reg. § 1.6664-4(a)) In determining reasonable cause, pertinent facts and circumstances include the taxpayer's efforts to assess his proper tax liability, the taxpayer's knowledge and experience and the reliance on the advice of a professional in determining whether the taxpayer acted with reasonable cause and in good faith. (Reg. § 1.6664-4(b)(1)) Facts. Cecelia Shao joined a software company called Veritas at the height of the dot-com boom and received shares in the company after each merit increase. Lacking experience with stocks, she opened an account with E*trade to administer her stock grants. Shao accumulated a large number of Veritas shares and saw them as a source of retirement funds, but she needed cash for immediate needs and began looking for ways to unlock the shares' value without selling. Her certified financial planner suggested a margin loan with E*trade, but she wanted other options to raise cash to buy a home. Shao's planner suggested that she enter into a loan program with a company called Derivium. The terms of the 2001 agreement characterized the transaction as a 3-year loan of 90% of the value of the stock pledged as collateral. The terms of the agreement allowed Derivium to sell the stock, which it did immediately upon receipt The loan's terms were as follows: nonrecourse as to borrower (recourse against collateral only); dividends to be received as cash payments against interest due, with balance of interest owed to accrue until maturity date; noncallable before maturity; no prepayment allowed before maturity; interest at 10.5% compounded annually; balloon payment at loan maturity equal to the loan principal plus accrued interest. Derivium, which engaged in some 1,700 similar transactions involving approximately $1 billion, boasted to its potential clients that it could make the loans because it had a sophisticated hedging strategy. Shao believe the only difference between Derivium's deal and her E*trade margin account was that she wasn't subject to margin calls with Derivium. Consistent with Shao's understanding of the transaction, her planner prepared Shao's 2001 tax return without reporting a sale of the Veritas stock. Shao never received a Form 1099-B, Proceeds from Broker and Barter Exchange Transactions, for the sale of the securities, nor a Form 1099-C, Cancellation of Debt, and didn't withhold any information from her planner. After a wave of lawsuits against it, and IRS's investigation of it as an abusive tax shelter, Derivium filed for bankruptcy in 2005. As the bankruptcy went forward, the trustee uncovered what he deemed a Ponzi scheme. In 2005, IRS contested Shao's characterization of the Derivium transaction as a loan and also hit her with a 20% substantial underpayment penalty under Code Sec. 6662. Earlier this year, the Tax Court held that a substantially similar Derivium transaction was a sale rather than a loan (Callloway, (2010) 135 TC No. 3). In that case, the Tax Court said the taxpayer was liable for the accuracy related penalty under Code Sec. 6662 because he didn't act with reasonable cause and in good faith because he didn't report the transaction on his returns consistent with his characterization of it. He couldn't avoid liability for the penalty by showing reliance on a competent professional adviser (i.e., his financial adviser) because he made no effort to establish that adviser's credentials or qualifications nor did he establish whether the adviser had any connection to Derivium. He also should not have relied on a memo about another transaction written by a person claiming to be a certified public accountant to Derivium's president. Tax Court's decision. The Tax Court held that Shao did sell her Veritas stock in 2001, triggering capital gain she should have reported. However, the Court said he wasn't liable for the Code Sec. 6662(a) accuracy-related penalty for not reporting the sale on her 2001 tax return. In deciding whether Shao acted with reasonable cause and in good faith under Reg. § 1.6664-4(a), the Tax Court said it had to consider all the facts and circumstances, including the experience, knowledge, and education of the taxpayer. Although Shao had a college degree, it was in cultural anthropology and she didn't have any investing experience before being hired at Veritas. When she entered into both of her stock transactions (the E*trade margin loan and the Derivium transaction) she did so only after consulting a certified financial planner. Shao herself began hiring tax professionals to prepare her returns as soon as she started getting stock options. When she entered the Derivium transaction the only stock loan she had ever entered into was her E*trade margin loan, which she believed was similar to the Derivium transaction and whose legitimacy had never been questioned. Under Reg. § 1.6664-4(a), to find good faith and reasonable cause "the most important factor is the extent of the taxpayer's effort to assess the taxpayer's proper tax liability." Shao sought financial advice from a trusted certified financial planner before entering the deal and also hired her to prepare the related tax returns. The returns were consistent with Shao's understanding of the transaction and consistent with the information returns she received from third parties because she didn't get a Form 1099-B or 1099-C showing a sale of the stock or cancellation of debt. The Tax Court also said it was inappropriate to penalize taxpayers where a mistake of law was in a complicated subject area without clear guidance. The Tax Court held Shao had legitimate, nontax motivations for wanting to structure her deal as a loan instead of a sale—she wanted to reduce risk and use some of the stocks' value without selling her nest egg. In essence, the Court said she may have been naïve, but not negligent. Unlike the taxpayer in Calloway, Shao treated her transaction like a loan throughout its existence, proving her good faith. As a result, the Tax Court held that Shao acted in good faith on an honest misunderstanding of the law that was reasonable in her circumstances. References: For accuracy related penalties, see FTC 2d/FIN ¶ V-2000; United States Tax Reporter ¶ 66,624; TaxDesk ¶ 863,005; TG ¶ 71626. More issues sought for IRS's Industry Resolution Program IR 2010-93 IRS is once again encouraging businesses, associations and other interested parties to submit to the Industry Issue Resolution (IIR) Program appropriate tax issues for resolution. The issues should involve a controversy, a dispute or an unnecessary burden on taxpayers. Purpose of IIR program. Since its inception in 2000, the IIR program has resulted in resolution of many different tax issues cumulatively affecting thousands of taxpayers in many different lines of business. For each issue selected, a multi-functional team gathers and analyzes the relevant facts and recommends guidance. At any time, business associations and taxpayers may submit tax issues that they believe could be resolved through the IIR program. IIR project selection criteria and submission procedures are outlined in Rev Proc 2003-36, 2003-1 CB 859. Recent submissions accepted into the IIR program include vendor mark down allowances for calculating inventory under the retail inventory method; network assets in the utilities industry (unit of property); network assets in the telecommunications industry (unit of property); and asset class determination under Rev Proc 87-56, 1987-2 CB 674 for wireless telecommunication assets. An example of guidance issued under the IIR program is Rev Proc 2008-23, 2008-12 IRB 664 providing guidance for auto wholesalers, manufacturers and dealers regarding the proper treatment of the dollar-value, LIFO inventory method for pooling purposes of crossover vehicles, which have characteristics of trucks and cars. References: For the Industry Issue Resolution program, see FTC 2d/FIN ¶ T-9974. First Circuit Affirms Tax Court's Validation Of "Check-The-Box" Regs Medical Practice Solutions LLC, Carolyn Britton, Sole Member, (CA 1 8/24/2010) 106 AFTR 2d ¶2010-5239 The First Circuit Court of Appeals has affirmed the Tax Court's rejection of an attempt to remove liens to satisfy unpaid employment taxes by claiming that the "check-the-box" regs were invalid. The taxpayer was the sole member of a limited liability company (LLC), which the "check-the-box" regs treated as a disregarded entity under its default rule. As a result, the taxpayer was responsible for the LLC's employment taxes. Background. Under the "check-the-box" system of classifying entities for tax purposes, eligible entities, i.e., unincorporated business entities that aren't trusts and that aren't mandatorily classified as corporations, may choose their federal tax classification. Multi-owner eligible entities may elect to be classified as corporations or partnerships, or to retain their default classifications in the absence of an election. Single-owner eligible entities may elect to be classified as corporations, or may choose to have their status as entities separate from their owners ignored. (Reg. § 301.7701-3(a)) A single member LLC that doesn't elect to be treated as a corporation under the "check-the-box" regs is considered a disregarded entity for federal tax purposes. As such, its activities are treated in the same manner as a sole proprietorship. (Reg. § 301.7701-3(b)(1)(ii)) As a result, the disregarded entity is ignored and its property and activities are treated as those of the owner of the entity. In 2005, IRS issued proposed regs that would treat single-owner entities that are disregarded as entities as separate entities for employment tax purposes. Final regs provide that for employment taxes related to wages paid on or after Jan. 1, 2009, a disregarded entity is treated as a corporation (i.e., as a separate entity) for purposes of employment tax reporting and liability. (Reg. § 301.7701-2(c)(2)(iv)) Facts. Medical Practice Solutions was a single-member LLC with Carolyn Britton as its sole member. She treated the LLC as her sole proprietorship on Schedule C, Profit or Loss From Business, on her return. She did not elect to have the LLC treated as a corporation for federal income tax purposes. After Medical Practice Solutions failed to pay employment taxes for several periods in 2006, notices of lien and intent to levy were sent to Britton. After a hearing under Code Sec. 6330, a notice of determination sustaining lien and proposed levy were sent to Britton, pursuant to Reg. § 301.7701-3(b) of the check-the-box regs. Taxpayer's argument. Britton contended that only the LLC, Medical Practice Solutions, was liable and that the check-the-box regs (as applicable to employment taxes related to wages paid before Jan. 1, 2009) were invalid. She asserted that the LLC was the employer liable for the taxes. She also argued that the amended regs, which reverse the effect of regs applicable to the periods at issue showed that the prior regs were unreasonable. Check the box regs valid. The Tax Court held that collection against Britton could proceed. Relying on Littriello v. U.S., (CA 6 4/13/2007) 99 AFTR 2d 2007-2210, cert denied 2/18/2008, and McNamee v. Dept. of the Treasury (CA 2 5/23/2007) 99 AFTR 2d 2007-2871, the Tax Court rejected the taxpayer's argument that the LLC had to be treated as the employer liable for the employment taxes and that the check-the-box regs were invalid. The Sixth Circuit in Littriello and the Second Circuit in McNamee rejected the argument that a LLC's separate existence under state law had to be recognized and that the proposed regs were evidence of the invalidity of the regs in issue. The Court found that Britton did not provide a valid reason to support a conclusion contrary to these cases and noted that she had not contested the underlying liabilities. TC affirmed. The First Circuit Court of Appeals has found that there was no error or abuse of discretion in the Tax Court's decision and has affirmed its decision. References: For the "check-the-box" regs, see FTC 2d/FIN ¶ D-1150 et seq.; United States Tax Reporter ¶ 77,014.15 et seq.; TaxDesk ¶ 580,500 et seq.; TG ¶ 4050 et seq. For disregarded entities and employment tax, see FTC 2d/FIN ¶ H-4223; TaxDesk ¶ 534,002. Federal External Review Guidelines & Model Notices Issued For Affordable Care Act Purposes EBSA, Availability of Interim Procedures for Federal External Review and Model Notices Relating to Internal Claims and Appeals and External Review under the Patient Protection and Affordable Care Act, 8/23/2010 IRS, DOL's Employee Benefits Security Administration (EBSA), and the Department of Health and Human Services (HHS) have published a joint notice announcing the availability of and providing links to guidance on the interim federal external review process provided for by interim final regs issued under the Patient Protection and Affordable Care Act (Affordable Care Act, P.L. 111-148). Model notices are carried on EBSA's website. Background. Under Public Health Service Act (PHSA) §2719—which has been incorporated into the Code and ERISA—a group health plan and a health insurance issuer offering group or individual health insurance coverage must have an effective process for appeals of coverage determinations, claims, and adverse benefit determinations. The plan or issuer must, at a minimum: (a) have in effect an internal claims process; (b) provide appropriate notice to enrollees of available internal and external appeals processes, and the availability of any assistance with the appeals process; (c) allow an enrollee to review his file, present evidence, and receive continued coverage pending the outcome of an appeal; and (d) include certain external review protections. IRS, EBSA, and HHS recently published interim final regs regarding the internal claims and review processes required of group health plans. In the preamble to the regs, IRS, EBSA, and HHS said they would issue additional guidance on the federal external review process, plus model notices that could be used to satisfy the regs' notice requirements. New notice. The new notice published by IRS, DOL, and HHS accordingly responds by addressing three key areas. (1) The notice announces the availability of EBSA Technical Release No. 2010-01, which provides an interim enforcement safe harbor for non-grandfathered self-insured group health plans that are not subject to a state external review process, and thus are subject to the Federal external review process. (2) The notice says that for issuers in the individual market and the small group and large group health insurance markets (including fully-insured group health plans), there will be an interim enforcement safe harbor applicable only for plan years (in the individual market, policy years) beginning on or after Sept. 23, 2010. This safe harbor will continue until it is superseded by future guidance on the federal external review process that is currently being developed. HHS is to develop an interim compliance method for these plans that will either involve use of a state external appeals process or a temporary process, and HHS will publish details of the method on the Office of Consumer Information and Insurance Oversight website (http://www.hhs.gov/ociio/). During the limited interim enforcement safe harbor period, HHS will not take any enforcement action against an issuer that complies with that method. HHS is to issue further guidance before July 1, 2011, as to which state external review laws satisfy the minimum standards of the National Association of Insurance Commissioners (NAIC) Uniform Model Act as identified under the interim final regs. IRS, DOL, and HHS will also issue guidance to replace the interim process no later than July 1, 2011. (3) The notice announces that model notices that can be used to satisfy the disclosure requirements of the interim final regs have been posted on DOL's website. In addition, the notice says that model language for the description of the internal claims and appeals and external review procedures that is to be provided in the summary plan description that must be given to participants and beneficiaries, is to be posted in the future. References: For treatment of PHSA group health plan and health insurance issuer provisions as if included in the Code, see FTC 2d/FIN ¶ H-1325.60; United States Tax Reporter ¶ 98,154. Disability Payments To Firefighter Under Union's Contract With City Weren't Excludable John T. Bayse, TC Summary Opinion 2010-118 The Tax Court has held that payments made by a city to a firefighter injured in the line of duty had to be included in his gross income. The payments, which were made under a collective bargaining agreement, weren't made under a workmen's compensation act as compensation for personal injuries or sickness, and so weren't excludable under Code Sec. 104(a)(1). Background. Payments qualifying as workers' compensation are excludable from gross income unless the compensation offsets previously deducted medical expenses. Not only must an injury or illness be job-related, but also the statute (under which payment is made) must restrict the benefit to injuries or sickness related to the job. Thus, amounts that are received (1) under a workers' compensation act (such as the Longshore and Harbor Workers Compensation Act, 33 USC 901), or under a statute "in the nature of a workers' compensation act," (2) as compensation for personal injuries or sickness, (3) where the personal injuries or sickness were related to the employee's occupation, are excluded from the employee's income. (Code Sec. 104(a)(1), Reg. § 1.104-1(b)) In Rev Rul 81-47, 1981-1 CB 55, IRS concluded that a collective bargaining agreement that was adopted and approved by a local (county) legislature and incorporated by reference into the local legislative code qualified as a statute in the nature of a worker's compensation act. The collective bargaining agreement involved had been entered into pursuant to a county statute which provided that all collective bargaining agreements entered into by the county had to be approved by "legislative acts" of the county council and incorporated by reference in the county code. Accordingly, IRS ruled that payments made to disabled county safety officials (e.g., firefighters and police officers) under the terms of the collective bargaining agreement were excludable under Code Sec. 104(a)(1). In Rev Rul 83-77, 1983-1 CB 37, IRS held that a collective bargaining agreement, even if it was consistent with a municipal code, wasn't itself a statute. Accordingly, IRS ruled that payments made to a police officer, who was injured in the line of duty and was determined to be unable to perform regular police duties, weren't excludable from his gross income. Facts. John T. Bayse, who worked as a firefighter for Cleveland, Ohio, was injured in the line of duty while responding to an automobile accident. For purposes of his firefighting duties, he was deemed to have suffered a "hazardous duty injury." From the day of the accident through his retirement from the fire department (with the exception of 2 days when he attempted to resume work), he was on hazardous duty injury status and was paid pursuant to the terms of a collective bargaining agreement between Cleveland and the union, Cleveland Fire Fighters, Local 93. Under the terms of the collective bargaining agreement, he eventually applied for and was granted a disability retirement pension. On audit of Bayse's return, IRS determined that the disability payments received from the City of Cleveland had to be included in his gross income because they weren't received under a workmen's compensation act as compensation for personal injuries or sickness under Code Sec. 104(a)(1). Not workers' compensation. The Tax Court concluded that the payments Bayse received while on hazardous duty injury status had to be included in his gross income because the disability payments weren't received under a worker's compensation act or a statute in the nature of a worker's compensation act. The Court reasoned that the collective bargaining agreement entered into between the City of Cleveland and the union was a labor contract which did not rise to the force and effect of law. When the language of a collective bargaining agreement is by legislative act incorporated by reference or otherwise into a municipal code, and so enacted into law, it meets the requirements of Code Sec. 104(a)(1). But mere approval by the mayor or the city council of a collective bargaining agreement negotiated by a city and a union doesn't meets the requirements, without explicit incorporation into the city's code. The Court concluded that although this collective bargaining agreement was presumably ratified by the Cleveland City council, even such ratification wouldn't convert the collective bargaining agreement into legislation because (1) the collective bargaining agreement was modifiable under its own terms, and (2) unlike the county statute in Rev Rul 81-47, there was no showing that the State of Ohio had a statute that required the collective bargaining agreement to be incorporated into the Cleveland City Code. References: For the exclusion for workers' compensation payments, see FTC 2d/FIN ¶ H-1351; United States Tax Reporter ¶ 1044.01; TaxDesk ¶ 133,049; TG ¶ 7314. Tax Saving Opportunities For Corporations In A Recovering Economy Author: Lewis Taub Lewis Taub, CPA, is a director at RSM McGladrey's commercial tax practice in New York City. In a recovering economy, it is essential to minimize a corporation's tax liability. The cash from taxes saved can be used to help ensure the economic stability and growth of the entity. This Practice Alert, which is excerpted from a more extensive article in the July/August 2010 issue of Corporate Taxation, discusses some tax rules that can have a significant impact in a recovering economic climate. New net operating loss carryback rules. A significant opportunity for recovering companies is found in the new provisions dealing with the carryback of net operating losses (NOLs). The Worker, Homeownership and Business Assistance Act of 2009 amended Code Sec. 172(b)(1)(H), which before the amendment provided for the liberal carryback of NOLs only for businesses with gross receipts of less than $15 million. Specifically, the amendment provides a carryback period of up to five years for losses incurred in tax years ending after 12/31/07 and beginning before 1/1/10. This can result in a much greater tax refund than would have resulted from the general carryback rule, which allows for only a two-year NOL carryback. Just about any business can take advantage of the expanded carryback provisions with the exception of recipients of TARP (Troubled Asset Relief Program) funds from the U.S. government. One key element of the election is that it can be made for only one year. A calendar year business may elect to carry back the NOL for either 2008 or 2009. A fiscal year business may elect to carry back the NOL from the fiscal year ending in 2008, its fiscal year beginning in 2008 and ending in 2009, or its fiscal year beginning in 2009. The election must be filed on or before the extended due date of the tax return for the business' last tax year beginning in 2009. This means that a calendar year business has until 9/15/10 to elect to make the election either for 2008 or 2009. Rev Proc 2009-52, 2009-49 IRB 744, details the procedures in making the NOL carryback election. If the decision is to make the election for 2008, a Form 1139 may still be filed by 9/15/10 to obtain a "quick refund." The additional time to determine whether or not to use the liberal carryback provisions for 2008 or 2009 is to allow the corporation time to compute the NOL for both years before making an irrevocable election. Under Code Sec. 172(b)(1)(H), a corporation may elect to carry back an NOL as far back as the fifth prior tax year. However, carrybacks to the fifth tax year are limited to 50% of taxable income of that year. Carrybacks to the prior four years can offset 100% of taxable income. Typically, an NOL can offset only 90% of alternative minimum taxable income. However, that limitation is suspended for carrybacks for which the corporation elects the new extended carryback period. Forgiveness of debt opportunities. As part of the recovery process for a business, it is not unusual for the entity to approach its creditors in an effort to restructure debt. Often a restructuring will result in forgiveness of debt income, also referred to as cancellation of debt income (COD income). This income comes at a very bad time and is often difficult to stomach. The company has managed to restructure debt to have more cash available for operations. On the other hand, the debt restructure has created a taxable event, and a portion of the cash savings will need to go towards paying the tax resulting from the forgiveness of debt income. Assistance in dealing with this matter was provided by The American Recovery and Reinvestment Act of 2009. The Act added Code Sec. 108(i), which allows for a deferral of income resulting from forgiveness of debt in 2009 and 2010. Specifically, Code Sec. 108(i) provides for an election to be made to defer the taxable income arising from COD income in 2009 and 2010. The deferral is until 2014, and the income is reported ratably for five years from 2014 through 2018. The election is made separately for each debt instrument that was modified in a transaction that resulted in COD income. Rev Proc 2009-37, 2009-36 IRB 309, contains many details regarding the election under Code Sec. 108(i). These details include:
In August 2010, IRS issued temporary and proposed regulations explaining the application of the Code Sec. 108(i) rules to C corporations (T.D. 9497) and to partnerships and S corporations (T.D. 9498). Minimizing estimated taxes. Corporations may even be able to use the provisions of the estimated tax rules to minimize tax payments during the year. One provision, which is often overlooked, is found in the annualized income installment method. Under this method, the amount of any required installment is the excess of the applicable percentage (25%, 50%, 75%, 100%) of the tax for the tax year based on the annualized taxable income and annualized alternative minimum taxable income over the aggregate amount of all prior estimated tax installments made for the tax year. (Code Sec. 6655(e)(2)) For the first and second installments, the taxable income and alternative minimum taxable income for the first three months of the tax year are determined and annualized. Similarly, for the third and fourth installments the first six and nine months, respectively, of the tax year are annualized. However, in lieu of this standard annualization method, the corporation can elect to use one of two other annualization periods. Under one alternative, taxable income and alternative minimum taxable income are annualized for the first two months to compute the first installment, for the first four months for the second installment, for the first seven months for the third installment and for the first ten months for the last installment. The other alternative method requires the annualization amounts to be the first three, five, eight, and eleven months, respectively. The corporation can elect either one of these alternative options by the due date of the first estimated tax payment. Once made, the election is irrevocable and must be used for each quarter in that year for which the "annualization" method is used. These elective annualization choices give a corporation an opportunity to conserve cash, which can be used in the business during the year. Careful projections of taxable income should be computed before the due date of the first quarterly estimate to determine if either of the elective options would benefit the corporation. For example, a corporation's income in the first two months of the year may be significantly less than the first three months, thereby suggesting that the first elective option might be beneficial. However, the analysis must include the projected income for all of the operative periods because the election is in force for the entire year. Code Sec. 382 and bankruptcy proceedings. In general, the rules of Code Sec. 382 limit a corporation's ability to use existing net operating loss carryovers once the corporation experiences an "ownership change." Generally, an ownership change occurs when, within a span of 36 months, there is an increase in the stock ownership by one or more shareholders of more than 50 percentage points. In general, the rules of Code Sec. 382 allow post-change corporations to use pre-change NOLs, but limit the amount that may be used annually to a percentage of the entity value of the corporation at the date of change of ownership. It is not uncommon in this recovering economy to deal with companies that are either presently in bankruptcy proceedings or have recently restructured in bankruptcy. Do the Code Sec. 382 loss limitations apply to such entities? The answer is a resounding "No"! Under certain circumstances, Code Sec. 382(l)(5)(A) excepts from the application of the Code Sec. 382 limitations a corporation that undergoes an ownership change through bankruptcy proceedings. There are two requirements that must be met to be exempt from the Section 382 limitation. Specifically:
The term "title 11 or similar case" includes cases under Title 11 of the U.S. Code and receiverships, foreclosures, and similar proceedings in federal or state courts. (Code Sec. 368(a)(3)(A)) Informal workouts are not included in the definition. With regard to the term "control," the shareholders and qualified creditors of the entity before bankruptcy must own at least 50% of the vote and value of the post bankruptcy corporation. (Code Sec. 382(l)(5)(A)(ii)) The creditors must exchange "qualified debt," which is indebtedness that was held by the same beneficial owner for at least 18 months before the filing of the title 11 case and is in the ordinary course of business of the debtor's business. (Reg. § 1.382-9(d)(2)) If a corporation qualifies under Code Sec. 382(l)(5), the entity's NOLs and excess credits must be reduced by interest on the debt that was converted into equity during the bankruptcy proceedings if the interest was paid or accrued during:
The use of Code Sec. 382(l)(5) is not mandatory and a corporation can elect-out of that provision. (Code Sec. 382(l)(5)(H)) An ordinary deduction for worthless stock of a subsidiary. Suppose a corporation has a wholly owned subsidiary, which becomes worthless in value in a particular year. What would be the nature of the loss, ordinary or capital? Code Sec. 165(g)(1) provides that if a security that is a capital asset becomes worthless, a capital loss is taken in the year of worthlessness. However, Code Sec. 165(g)(3) provides that a security of an affiliated entity is not treated as a capital asset to the holding entity. Therefore, an opportunity exists for a corporation to take an ordinary loss on the abandonment of the stock of an affiliated corporation. There are certain requirements in order to obtain such a beneficial deduction. First, for the worthless entity to be "affiliated," the stockholder must own stock representing at least 80% of the voting power and at least 80% of the value of the entity's stock. (Code Sec. 165(g)(3)(A)) Second, 90% of the subsidiary's aggregate gross receipts for all tax years during which the subsidiary has been in existence must be from sources other than: royalties, rents (except rents derived from rental of properties to the corporation's employees in the ordinary course of its operating business), dividends, interest, annuities, or gains from sales or exchanges of stock and securities. (Code Sec. 165(g)(3)(B)) This "active" income standard apparently applies over the entire period of the subsidiary's existence and not just the period of affiliation with the parent company. (Rev Rul 75-186, 1975-1 CB 72) New Regs Authorize Limited Release Of Return Information To Census Bureau Preamble to TD 9500, 08/26/2010; Reg. § 301.6103(j)(1)-1, Reg. § 301.6103(j)(1)-1T; Preamble to Prop Reg IRS has issued final, temporary and proposed regs authorizing IRS to release to the Census Bureau information relating to research and development expenses plus information relating to the use of contract workers. Background. Under Code Sec. 6103(j)(1), IRS may furnish, upon written request by the Secretary of Commerce, such return or return information as IRS may prescribe by regulation to officers and employees of the Bureau of the Census (Bureau) for the purpose of, but only to the extent necessary in, the structuring of censuses and conducting related statistical activities authorized by law. Reg. § 301.6103(j)(1)-1 further defines such purposes and provides an itemized description of the return information authorized to be disclosed for such purposes. New final regs. Reg. § 301.6103(j)(1)-1(b)(3)(xxv), authorizes the disclosure of information on total qualified research expenses in three ranges: greater than zero, but less than $1 million; greater than or equal to $1 million, but less than $3 million; and, greater than or equal to $3 million. The information is derived from Form 6765, Credit for Increasing Research Activities, when filed with corporate income tax returns. Temporary and proposed regs. Reg. § 301.6103(j)(1)-1T(b)(3)(xxix) and Reg. § 301.6103(j)(1)-1T(b)(3)(xxx), which also serve as the text of proposed regs, authorize the disclosure to the Bureau of the total number of documents and the total amount reported on Form 1096 (Annual Summary and Transmittal of U.S. Information Returns) transmitting Forms 1099-MISC (Miscellaneous Income). Effective date. Both of the above changes are effective for disclosure to the Bureau on or after Aug. 26, 2010. References: For disclosure safeguards for tax return information and reports to Congress, see FTC 2d/FIN ¶ S-2801; United States Tax Reporter ¶ 60,334; TaxDesk ¶ 688,001; TG ¶ 60703. Tax Court Has Jurisdiction To Consider S Corp Related Deficiency Winter, 135 TC No 12 The Tax Court has held that it has jurisdiction to consider IRS's adjustment relating to an S shareholder who used the entity's regulatory financial statement to prepare his return, instead of Schedule K-1. The Court held that IRS's failure to assess the amount of the deficiency attributable to the amount reported inconsistently with the Schedule K-1 before issuing the notice of deficiency did not exclude this amount of tax from the deficiency as defined in Code Sec. 6211. As a result, the Court held that it had jurisdiction to redetermine IRS's adjustment. Background. Under Code Sec. 6037(c), an S shareholder must treat a Subchapter S item on his own return in a manner that is consistent with the treatment of that item on the corporation's return, unless the shareholder files with IRS a statement identifying the inconsistency. Under Code Sec. 6037(c)(3), if a taxpayer treats an item inconsistently, and doesn't file a statement identifying the inconsistency, any IRS adjustment required to make the shareholder's treatment of the item consistent with the treatment of the item on the S corporation return is treated as resulting from a mathematical or clerical error. This means that IRS can collect any such deficiency without going through the normal deficiency procedures, such as the issuance of a 90-day letter. Under Code Sec. 6213(b), if a taxpayer is notified that, on account of a mathematical or clerical error appearing on the return, an amount of tax in excess of that shown on the return is due, and that an assessment of the tax has been or will be made on the basis of what would have been the correct amount of tax but for the mathematical or clerical error, the notice is not considered a notice of deficiency for various purposes, including the prohibition of assessment and collection until notice of the deficiency has been mailed, and the prohibition of credits or refunds after petition to the Tax Court. Additionally, the taxpayer has no right to file a petition with the Tax Court based on the notice. Facts. Michael Winter was a shareholder in BFC Inc., an S corporation. Instead of using the information on the Schedule K-1 to complete his 2002 return, he looked up BFC's regulatory financial statements, took the net loss reported there, and multiplied it by his percentage ownership at the end of 2001. On his 2002 return, Winter showed a total 2002 passthrough loss of about $1.2 million and not the passthrough income of about $820,000 that BFC had reported on Winter's Schedule K-1. Instead of summarily assessing the tax arising from the inconsistent reporting and issuing a notice of deficiency for the rest, IRS originally issued a single notice of deficiency for both the increase in tax due to inconsistent reporting and a much smaller increase in tax due to Winter's failure to report income listed on some Forms 1099. Winter disputed the entire amount of the deficiency, and IRS summarily assessed the tax caused by the inconsistent reporting only after the jurisdiction issue was raised in the docketed case before the Tax Court. The Tax Court had to decide whether it had jurisdiction before addressing the substantive issues in a subsequent opinion. The issue was whether the Tax Court has jurisdiction over the adjustment to Winter's distributive share of S corporation income or whether IRS had to assess the tax related to the adjustment as a math error under Code Sec. 6213(b)(1), precluding the inclusion in the notice of deficiency of the increase in tax relating to that adjustment. Tax Court rules it has jurisdiction. The Tax Court held that it had jurisdiction over all issues presented in Winter's case. It pointed out that Code Sec. 6212, which authorizes the mailing of a deficiency, contains no restrictions prohibiting the inclusion of mathematical or clerical adjustments. In Winter's case, a notice of deficiency was issued, which is the traditional "ticket to the Tax Court" under Code Sec. 6213(a). And under Code Sec. 6512(b), the Tax Court has jurisdiction to determine overpayments, which is what Winter was claiming. In order to determine whether there is an overpayment, the Tax Court must determine the correct tax that should have been paid. These jurisdictional provisions of Code Sec. 6512 give the Tax Court authority to decide all issues necessary to determine the correct amount of income tax for the taxable year in issue. Even if IRS made the adjustment based on the Schedule K-1 as a mathematical adjustment, as has now been done, the correctness of the adjustment can still be placed in issue, as can any other previously assessed tax in order to determine the correct amount of the deficiency or overpayment. Ten judges agreed with the majority, one concurred in the result only, and there was one strongly worded dissent. References: For Tax Court jurisdiction, see FTC 2d/FIN ¶ U-2101; United States Tax Reporter ¶ 62,134; TaxDesk ¶ 831,009; TG ¶ 70251. |
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