Taxpayer's Loss Generated Using a Family Limited Partnership Formed With Assets Contributed to S Corporation Lacked Economic Substance

An attempt to combine the concepts of valuation discounts for family limited partnership often used in estate planning with a short-lived S corporation to create an income tax benefit was not looked upon positively by the Tax Court in the case of Smith v. Commissioner, TC Memo 2017-218.

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IRS Issues QSEHRA Guidance in FAQ Format

Late in 2016, as part of the 21st Century Cures Act, Congress had created a program under which certain qualifying small employers could pay directly for medical costs of certain employees (generally private health care insurance) without running afoul of the provisions of the Affordable Care Act that could subject the employer to a $100 per employee per day penalty for offering a health plan that did not comply with the standards imposed under that law.

These programs are referred to as “Qualified Small Employer Health Reimbursement Arrangements” (QSEHRAs) authorized by IRC §9831(d).  In Notice 2017-67 the IRS issued a 59-page set of frequently asked questions (FAQs) regarding the operation of such plans to maintain compliance with the requirements of the law.

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Waiver of Repayment of Excess Pension Payment Not Taxable as Cancellation of Indebtedness

In Private Letter Ruling 201743011 a taxpayer sought clarification that he would not end up having to effectively report the same income twice despite receiving information returns in different years that reported what was the same income.

The taxpayer had received payments from a pension plan to which the taxpayer had made after-tax contributions for several years.  The taxpayer reported his payments using the simplified safe harbor method of reporting his income pursuant to Notice 88-118, determining the taxable portion of each payment and the amount that represented a nontaxable return of capital.

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Senate Finance Committee Chairman's Revisions to Tax Cuts and Jobs Act

Changes to the Tax Cuts and Jobs Act were released late on November 14 by Senator Orrin Hatch.  These changes are being made to the original Senate Finance Committee Chairman's mark of the bill.

Some of the changes bring the Senate bill into conformity with similar provisions in the House Bill, while others (such as the removal of the shared responsibility payment beginning in 2019 that has gotten much press coverage) are brand new provisions not seen in the House bill.  The revisions also serve to bring the Senate Bill into compliance with the Byrd rule.

The Joint Committee on taxation has released an explanation of these changes..

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JCT Description of Initial Senate Versions of Tax Cuts and Jobs Act Released

The U.S. Senate Finance Committee is set to unveil the Chairman's Mark of the Tax Cuts and Jobs Act November 10.  The mark has some significant differences from the bill currently moving through the Senate Finance Committee.

Some highlights of key differences include:

  • Seven tax brackets (10%, 12%, 22.5%, 25%, 32.5%, 35%, 38.5%)
  • Expand child credit to $1,650
  • Double the estate tax exemption (no repeal)
  • Home mortgage deduction remains at $1,000,000
  • Back to original framework standard deduction numbers
  • No change to carried interest
  • Medical expenses remain deductible
  • No state and local tax deductions (including real estate taxes)
  • Lower corporate rate to 20% but with one year delay
  • Changes passthrough income relief to a 17.4% deduction for such income

The Joint Committee on Taxation has released their summary of the Senate Finance Committee's Chairman's Mark.

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Ways and Means Chairman Offers More Amendments to Tax Cuts and Jobs Act

Chairman Brady added more proposed amendments to the Tax Cuts and Jobs Act that were released on Thursday.

Chairman’s Second Amendment Summary

  • Removed self-employment tax revisions (which includes S corporations)
  • Restores adoption credit
  • Require SSN for child in order to claim entire amount of the enhanced child credit
  • Can rollover from 529 to ABLE account
  • Floor plan financing interest fully deductible but no full expensing for such businesses
  • S corporation gets special 6 year rule if terminates status due to Act for
    • Accounting method changes
    • Also gets special rule for distributions to be pro-rata from E&P and AAA
  • Requirement to capitalize research and development are required to be capitalized and amortized over 5 years (15 years for foreign)
  • Immediate deduction for expenses of attorney in contingent fee litigation
  • Remove changes to deferred compensation
  • 83(b) election cannot be made on restricted stock units (RSU)
  • Raised rate on repatriated assets to
  • 7% on earnings held in illiquid investments
  • 14% on other earnings and profits

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Ways and Means Chairman Brady's Amendments to the Tax Cuts and Jobs Act

The process continues in D.C. as the Tax Cuts and Jobs Act faces hearings before the House Ways and Means Committee.

On Monday Chairman Brady released a set of amendments, adopted by the Committee, that made the following revisions to the bill.

  • Rules mandating proper net earnings from self-employment for earned income tax credit
  • Employers must give employees’ name and address on payroll tax returns
  • Three year holding period for carried interests to get long term capital gain treatment
  • 1.4% excise tax only applies to universities with endowments of more than $250,000 per student
  • Deferral up to five years for income from stock options or restricted stock units if corporation’s stock is not publicly traded
  • Restores ability to treat self-created musical works as capital assets
  • Continue employer exclusion of dependent care assistance of up to $5,000 through 2022

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HR1 Tax Cuts and Jobs Act as Introduced in the House

On November 2 the Tax Cuts and Jobs Act was introduced in the House with the language being made available.

We have prepared a summary of significant items in the bill that you can download below:

HR1 Tax Cuts and Jobs Act Major Items

A detailed look at the various provisions has been prepared by the Joint Committee on Taxation. This 307 page document is an excellent reference to the details of the bill.

JCX-50-17 Description Of H.R.1, The "Tax Cuts And Jobs Act"

A copy of the bill that was released can be downloaded from the House Ways and Means Committee site:

HR1 Tax Cuts and Jobs Act

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Loans from Related Corporations Did Not Shareholders Basis for Losses

The rules for obtaining basis for S corporation loans are often best viewed as emphasizing form over substance.  The fact that a shareholder might be economically “on the hook” for ultimate repayment of the debt will not generally impact whether that person will be able to claim the debt as basis.  The shareholders of an S corporation ran into this issue in the case Messina et ux. et al. v. Commissioner, TC Memo 2017-213.

In this situation, the controlling shareholders of an S corporation formed another S corporation that loaned funds to a qualified S corporation subsidiary (QSUB) of the first S corporation.  The shareholders then attempted to claim losses from the first S corporation by use those loans as additional basis in the corporation—a position the IRS and, ultimately, the Tax Court disagreed with.

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IRS Memo Addresses Prohibited Indirect Loans to Employer for 403(b) Plan

In Chief Counsel Advice 201742022 the IRS considered whether certain arrangements related to a church’s §403(b)(9) retirement plan amount to loans to the employer prohibited under Reg. §1.403(b)-9(a)(2)(i)(C).

Reg. §1.403(b)-9(a)(2)(i)(C)’s exclusive benefit rule provides the following requirement for a program to be considered a valid IRC §403(b)(9) retirement account:

(C) The assets held in the account cannot be used for, or diverted to, purposes other than for the exclusive benefit of plan participants or their beneficiaries (and for this purpose, assets are treated as diverted to the employer if there is a loan or other extension of credit from assets in the account to the employer).

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Expert's Testimony Cannot Substitute for Records Taxpayer Failed to Produce

In the case of Feinberg v. Commissioner, T.C. Memo 2017-211, a taxpayer attempted to use the expert opinion of a CPA whom was claimed to be an expert in cost accounting, with an emphasis in the marijuana industry.

The taxpayers were shareholders in an LLC that ran a marijuana dispensary in Colorado.  On the original tax return filed for their S corporation claimed several deductions as ordinary trade or business deductions that the IRS determined were costs of sales—and important issue, since under IRC §280E only costs of goods sold may be deducted by a business that traffics in controlled substances under federal law.  Despite being legalized in Colorado, marijuana remains a controlled substance under federal law.

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Taxpayer Penalized for Failing to Produce Adequate Evidence to Support Value Claimed for Theft Loss

The Tax Court found that, in the case of Partyka v. Commissioner, TC Summ. Op. 2017-79, that while the taxpayer had sustained a theft loss that was properly deductible in 2012, the taxpayer had not taken sufficient care to obtain proper values for the property stolen, assessing the accuracy related penalty of 20% under IRC §6662 in addition to the tax due.

This case involves a combination of the sale of household furnishing and the rental of a residence to a tenant who ended up giving the taxpayer a check that bounced to pay for the furnishings and initial rent.  The tenant did not make good on the amount due, so the taxpayers undertook proceedings to evict the tenant.

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Court Finds IRS Allowed to Enforce Summons to Obtain Information from State of Colorado to Show Business Sold Controlled Substances

A taxpayer seeking to quash a summons from the IRS to the Colorado Department of Revenue’s Marijuana Enforcement Division failed to obtain the requested relief in the case of Rifle Remedies, LLC v. United States, USDC Colorado, Case No. No. 1:17-mc-00062.

The taxpayer had claimed that this subpoena was “really” a front for conducting a criminal investigation into the taxpayer’s marijuana business and, if the court didn’t accept that objection, the taxpayer had a series of other objections. 

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Inflation Adjusted Numbers Issued by IRS for 2018 Including New Indexed Maximum Small Employer HRA Amounts

The IRS released inflation adjusted amounts for a number of tax related items for 2017 in Revenue Procedure 2017-58

Note that these numbers assume the tax law as it currently exists.  At the time this Revenue Procedure was released the Congress was developing a comprehensive tax reform program that, if passed, could eliminate the need for some of these numbers and could significantly change others.

A PDF summarizing the significant numbers for 2018 can be downloaded below:

Key 2018 Inflation Adjustment Figures

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IRS Will Require Taxpayers to Supply Health Care Coverage Information to Process 2017 Returns

With “repeal and replace” of the ACA unsuccessful to date, the IRS has announced that the agency will reject 2017 income tax returns that do not address the ACA health care requirements (The Affordable Care Act: What’s Trending, IRS Website).

The IRS had originally planned to reject 2016 returns that did not provide this information.  However, early in 2017 when it appeared that “repeal and replace” was imminent and that the individual shared responsibility payment would be retroactively repealed the IRS decided not to begin requiring that information before processing a return.  The IRS had not required that information in prior years, but the agency had gotten the systems ready to deal with this issue for 2016 returns.

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LB&I Division Issues Memorandum on Units of Property and Major Components for Mining Industry

The IRS Large Business & International Division has issued a memorandum (LB&I-04-0917-004) dealing with the classification of various types of mining equipment to determine units of property and major components under Reg. §1.263(a)-3(e).

The memo is meant to provide some consistently and eliminate confusion over what are units of property and major components of units of property for mining organizations.  However, since making use of definitions will likely change how an organization has been classifying items as units of property or major components, an entity wishing to make use of this provision will need to go through the procedures for a change of accounting method.

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IRS Withdraws Anti-Kerr Regulations

The IRS in FR Doc 2017-22776 made official the withdrawal of proposed regulations issued in August of 2016 (REG-163113-02) under IRC §2704 that would have effectively reversed the Kerr decision with regard to family limited partnerships.

The proposed regulations would have significantly changed the regulations under IRC §2704 in ways that would have rendered it much more difficult to create family limited partnerships that could give rise to significant transfer tax discounts.  The regulations specifically addressed issues that the Tax Court had noted in the Kerr decision when it decided for the taxpayer based on the IRS’s regulations for that section.

Most advisers considered these regulations dead following the elections in November of 2016.  The regulations were one of many studied by the IRS for possible withdrawal and, not surprisingly, were on the list of those the agency planned to withdraw when that study of regulations was completed.  This notice simply makes that withdraw official.

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Taxpayer Could Claim Earned Income Credit, But Apparently Not for Reason Tax Court Gave

There are some posts that bother me when I write them because Ithink there must be something I am missing.  But I've tried to find that in this case and haven't, so I'll take the risk (and keep your eyes open for a correction if I've actually missed something).

A married taxpayer generally can only claim an earned income credit if the taxpayer files a joint return per IRC §32(d).  As well, a taxpayer is not allowed to elect to file a joint return if the taxpayer has filed a separate return, has received a notice of deficiency and files a petition with the Tax Court per IRC §6013(b)(2)(B).

But what happens if the taxpayer in question had filed a return using a filing status other than married filing separately, in this case head of household?  Per the Tax Court in the case of Knez v. Commissioner, TC Memo 2017-205 that return did not constitute a “separate return” for these purposes and, thus, Ms. Knez could elect to file a joint return with her husband even after she had filed a Tax Court petition.

In the end it appears the Tax Court got to a “kind of” proper result (allowing the earned income tax credit) but likely via the wrong route, at least based on the facts given.

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IRS Does Not Agree S Corporation Restricted Stock Ownership Counts for Real Estate Professional

In a case discussed here in 2015 (Restricted Stock Interest Still Found to Constitute Ownership Interest for Qualifying as Real Estate Professional) an Arkansas U.S. District Court held that a taxpayer who held restricted stock that constituted greater than 5% of the stock of the corporation could count hours worked in that entity towards qualifying as a real estate professional.

As is discussed in the original article, so long as no Section 83(b) election is filed by the taxpayer, the restricted stock is treated for S corporation purposes as "not issued" and thus does not create second class of stock issues.  The IRS had argued that same provision meant that the stock had to be ignored for purposes of the 5% stock ownership rule for counting as real estate professional hours time spent working as an employee for the S corporation.  The court did not agree with the IRS and treated the individual as a real estate professional.

Now the IRS has announced the agency will not follow the result in this case in Action on Decision 2017-07.  In a footnote the agency described the specific issues the agency was disagreeing with.

Nonacquiescence relating to the holdings that: 1) mere possession of a stock certificate, disregarding other conditions, restrictions or limitations on the possessor’s rights regarding the stock, constitutes ownership for purposes of § 469(c)(7)(D)(ii); and 2) work performed by the taxpayer in a rental real estate activity for purposes of § 469(c)(7)(A) may also constitute work performed by the taxpayer in non-rental business activities of the taxpayer for other purposes of § 469.

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