Assessment for Disguised Compensation to S Corporation Shareholders Not a Worker Classification Issue Just Because PEO Was Used

The Tax Court is a court of limited jurisdiction, which means it can only hear cases that the Internal Revenue Code provides that it can hear.  In Chief Counsel Advice 201735021 the issue was whether a payroll tax examination was a worker classification exam, as the Tax Court has the right to hear cases regarding employee classification under IRC §7436(a), but does not have jurisdiction to hear a case where the issue is whether certain payments represented disguised compensation to employees.

In this case, the IRS was examining an S corporation which, for some years in question, had used a professional employer organization (PEO) for its payroll.  Under the agreement with the PEO, all individuals working for the taxpayer, including the officers of the corporation, were treated as employees of the PEO and received paychecks from that organization. 

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IRS Grants Relief to Certain Partnerships That Failed to Notice Change in Return Due Dates

Due dates for tax returns don’t change very often—so rarely that most taxpayers likely assume they simply won’t. But Congress in 2015 proved that such dates can be changed and that Congress is willing to do so, changing several dates. Matters are tougher when Congress moves the due date forward, as they did for partnerships.

Many partnerships, unaware of that requirement, either filed their Form 1065 or their request for an extension on Form 7004 after March 15, but on or before April 15, this year.  Notice 2017-47 provides relief from late filing penalties for partnerships in that situation who meet the requirements provided for in the notice.

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Loss from Competing in Pageants Reportable on Return of Minor Daughter, Not Parents

The daughter of the taxpayers in the case of Lopez v. Commissioner, TC Memo 2017-171 competed in several beauty pageants beginning at the age of nine.  She won several events and received cash prizes, totaling $1,325 and $1,850 in the two years at issue in the case and her parents deposited her winnings in a savings account for her future college education expenses.

Competing in such contests require incurring many expenses, as the parents discovered.  The taxpayers paid $21,732 and $15,445 of such expenses in the two years under examination.  The parents did not take reimbursement for any of the expenses from their daughter’s savings accounts.

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Taxpayer's Refund on Unfiled Return Falls Into “Black Hole” Based on Date IRS Issued Deficiency Notice

Taxpayers who fail to timely their tax returns will sometimes tell advisers that it doesn’t matter because they are sure they are overpaid.  That’s fine—except that any overpayment can be lost if the taxpayer waits too long to timely file the return.

In the case of Borenstein v. Commissioner, 149 TC No. 10, the taxpayer discovered a way to lose a refund that probably will be new to most readers.

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IRS Allows Retirement Plans to Allow Those Affected by Hurricane Harvey to Receive Loans and/or Hardship Distributions Under Simplified Procedures

In Announcement 2017-11 the IRS has provided special provisions to allow qualified employer retirement plans to make Hurricane Harvey related distributions and/or loans.

The general relief is described in the notice as follows:

…[A] qualified employer plan will not be treated as failing to satisfy any requirement under the Code or regulations merely because the plan makes a loan, or a hardship distribution for a need arising from Hurricane Harvey, to an employee or former employee whose principal residence on August 23, 2017, was located in one of the Texas counties identified for individual assistance by the Federal Emergency Management Agency (“FEMA”) because of the devastation caused by Hurricane Harvey or whose place of employment was located in one of these counties on that applicable date or whose lineal ascendant or descendant, dependent, or spouse had a principal residence or place of employment in one of these counties on that date.

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Taxpayer Unable to Establish Extension Request Timely Filed

One of the traditions of tax season for advisers is filing extensions for taxpayers on April 15.  The case of Laidlaw, et ux. et al v. Commissioner, TC Memo 2017-167 deals with a problem when the IRS claimed not to have received an extension that the taxpayer’s adviser claimed to have filed.

The taxpayers filed their tax returns for 2005 at the extended due date of October 16, 2006.  The taxpayers had filed Forms 4868 for each of the prior three years—but the IRS did not have a record of receiving one for 2005.  The forms were not sent by certified or registered mail, but rather the taxpayer’s adviser testified that he sent them in by regular mail.

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Taxpayer Had to Repay Excess Premium Credit Despite Exchange Not Reacting to Notice of Change in Income

The taxpayers in the case of McGuire v. Commissioner, 149 TC No. 9, were asking the Tax Court to find that they did not owe $7,805 in excess advance premium credit they had received under the Affordable Care Act (ACA). However, the Court found that it lacked the ability to grant the relief the taxpayers were requesting.

The taxpayer originally had obtained insurance from Covered California, an ACA health care exchange, for 2014.  Based on the household income reported, Covered California computed that the taxpayers were eligible for an advance premium credit of $591 per month, for a total credit of $7,092.  The taxpayers enrolled in a plan with a gross monthly premium of $1,181.97 per month.  Due to the credit, the net premium they paid each month was $590.97.

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Federal and Texas Tax Related Relief for Taxpayers Affected by Hurricane Harvey

The IRS and the Texas Comptroller have announced forms of due date and other relief for individuals impacted by Hurricane and Tropical Storm Harvey in Houston and surrounding areas.

The IRS has announced information related to relief provided under IRC §7508A for performing certain acts in News Release IR-2017-135.  IRC §7805A provides that the IRS may authorize a delay of up to one year to allow taxpayers to perform certain acts when the taxpayer is affected by a federally declared disaster or terroristic or military action.

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IRS Recognized Common Law Marriage Based on State Ruling

Federal tax law doesn’t itself contain a definition of what constitutes a marriage, rather deferring to state law.  As Reg. §301.7701-18(b)(1) provides:

(b) Persons who are lawfully married for federal tax purposes.

(1) In general.

Except as provided in paragraph (b)(2) of this section regarding marriages entered into under the laws of a foreign jurisdiction, a marriage of two individuals is recognized for federal tax purposes if the marriage is recognized by the state, possession, or territory of the United States in which the marriage is entered into, regardless of domicile.

(2) Foreign marriages.

Two individuals who enter into a relationship denominated as marriage under the laws of a foreign jurisdiction are recognized as married for federal tax purposes if the relationship would be recognized as marriage under the laws of at least one state, possession, or territory of the United States, regardless of domicile.

Technical Advice Memorandum 201734007 answers a question regarding whether the IRS had to recognize a “common law” marriage.

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Social Club Did Not Show Profit Motive for Sales to Nonmembers

In the arena of tax law, often minor differences in a situation may create major differences in how a situation is evaluated for tax purposes.  What a taxpayer must show to demonstrate an activity was entered into with an intention to make a profit is one of those areas where there are different tests depending on the situation.

Specifically, a not for profit organization seeking to offset unrelated business taxable income from one activity with losses from another unrelated business activity faces a very different hurdle to show that the second activity was entered into with the intent to make a profit.  This issue was discussed recently in the case of Losantiville Country Club v. Commissioner, TC Memo 2017-158.

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Estate Not Allowed a Deduction for Unpaid Gift Tax Related to a Net Gift

When a taxpayer has made a “net gift” within three years of the taxpayer’s death, how is that gift handled for purposes of the “gross up” rule for such gifts found in IRC §2035(a) and (b)?  In the case of Estate of Sommers v. Commissioner, 149 TC No. 8, the taxpayer argued that the estate should be allowed a deduction on the Form 706 for the gift tax that was paid by the donors.

There is a transfer tax advantage to making fully taxable gifts prior to the date a taxpayer dies and paying the gift tax.  Although the estate and gift taxes are now “unified” with the same rates being applied, the gift tax is not imposed on the amount that is actually used to pay the gift tax—rather that tax is removed from the pool of assets that will eventually be subject to the tax. 

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No Deduction Allowed for Premiums Paid to Related Entity in Microcaptive Structure

The IRS has recently indicated a level of “unhappiness” with the concept of a microcaptive insurance company, adding them to the agency’s “dirty dozen” tax scams list in 2015 and declaring them a transaction of interest in Notice 2016-66.  In the case of Avrahami, et al v. Commissioner, 149 TC No. 17 we have the first time the Tax Court scrutinized this particular structure.

Captive insurance companies have been recognized as legitimate insurance arrangements by the courts in several cases (see Rent-A-Center, Inc. v. Commissioner, 142 TC 1 and AMERCO & Subs. v. Commissioner, 96 TC 18) so long as certain criteria are met that distinguish the arrangement as insurance rather than merely establishing a “set aside” of funds for potential liabilities.  These cases have generally involved large entities with the resulting captive being itself a relatively large organization.

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Memorandum Disagrees With Observation That Certain Small Partnerships Effectively Have No Tax Return Filing Requirement

In Chief Counsel Advice 201733013 the IRS concluded there is not an exemption from filing a tax return for small partnerships under any of the below authorities:

  • IRC §6031;
  • IRC §6693; or
  • Revenue Procedure 84-35.

IRC §6031(a) imposes the requirement that each partnership must file an annual partnership return. IRC §6698 imposes a per month penalty when the partnership fails to file a return—and for 2017 returns that penalty amount is set at $200 per month.[1]  This penalty can be waived if the failure to file is due to reasonable cause. [2]

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ESOP Failed to Cover Employees of Related Corporation, Plan Disqualified

Qualified retirement plan provision in the IRC generally give controlling owner-employees a trade-off—they can benefit under the plan, but only to the extent that an appropriate benefit is offered to the “rank and file.” Not surprisingly, some owners, attempting to maximize their benefit and avoid the cost of funding for other individuals, have attempted to establish structures to “isolate” the rank and file outside of the organization whose employees are covered by the program while still obtaining their services. And, similarly not surprisingly, the law has provisions meant to address such structures.

This type of arrangement was challenged by the IRS in the case of Paza Staffing Services v. Commissioner, Docket No. 6881-12R and is the subject of an unpublished order and decision published on August 17, 2017.   The plan in question was an employee stock ownership plan (ESOP) established by a corporation controlled by Dr. Zapolanski.

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Tax Court Refuses to Take Birth Certificate Provided by Taxpayer as Proof of Age When Taxpayer Provided Issuing Agency with Date of Birth

Actress Helen Hayes is not often quoted in Tax Court proceedings, but this case the court referenced her statement that “age is not important unless you are a cheese” as an introduction to a case that dealt with a situation where age was important to more than cheese. The case of Omoloh v. Commissioner, T.C. Summ. Op. 2017-64.

The issue in this case arose because Mr. Omoloh had taken a distribution from an individual retirement account. The question was whether Mr. Omoloh was over age 59 ½ and thus not subject to the 10 percent additional tax on premature distributions from his IRA.

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Split Fifth Circuit Panel Finds a Limited Ability to Substitute Land Was Not Fatal to Conservation Easement Deduction

In a split decision, the Fifth Circuit Court of Appeals reversed and remanded the Tax Court’s 2015 opinion in the case of BC Ranch II, LP et al v. Commissioner, Case No. 16-60068 and 16-60069. All the judges on the panel agreed that the Tax Court had erred in deciding that the entire amount paid by limited partners for their interests represented disguised sales and in deciding that a valuation penalty applied. But the panel split on a key question of whether the partnership had complied with the requirements to obtain a charitable contribution for the donation of a conservation easement, with a majority finding the Tax Court had erred in determining the contribution did not qualify for a deduction.

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IRS Will Not Grant Any Additional Time for Colleges to Report Tuition Paid on Form 1098-T

Previously, we reported that the IRS had issued a second one-year extension of time for colleges and universities to comply with the requirement to report tuition actually paid, rather than the amount billed, on Form 1098-T.  (See Additional Penalty Relief Granted to Educational Institutions Who Continue to Reports Amoufnts Billed Rather Than Paid on Form 1098-T)  But it appears that the colleges request for yet another extension will fall on deaf ears.

Tax Analysts reported in an article dated Aug. 15, 2017 that the National Association of College and University Officers (NACUBO) had been told by IRS officials that the agency will not grant any additional time to the educational institutions to comply with the reporting requirement added by 2015’s Protecting Americans from Tax Hikes Act (PATH).

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No Deduction for Employee Who Failed to Submit Expenses for Reimbursement by Employer

Taxpayers who seek deductions for employee business expenses will find the deduction barred if the taxpayer cannot show that he/she was not entitled to reimbursement from his/her employer for the expenses shown on the Form 2106.  This was the issue that tripped up the taxpayer in the case of Howard v. Commissioner, T.C. Summ. Op. 2017-65.

Employees are considered to be in a trade or business and thus are allowed a deduction for expenses incurred in pursuit of that trade or business if the expenses are “ordinary and necessary” expenses.[1]  However, if the employer offers to reimburse the expenses (such as via an expense reimbursement policy), but the employee does not take the employer up on the offer no deduction is allowed.  The expense in that case would not be “necessary” as the taxpayer had a source of reimbursement.

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Employee Could Not Deduct Commissions Paid on Same Day Sale from Stock Option Exercise as Ordinary Loss

In the case of Hann v. United States, Court of Federal Claims Case No. 15-20T, the taxpayer in question was seeking to claim an ordinary loss from aportion of the underwriting commissions paid when he elected to participate an initial public offering (IPO) of his employer’s stock. 

Under the terms of participation, Mr. Hann had to agree to dispose of the same proportion of all stock and stock rights he held as the primary shareholders were selling, which required him to exercise his vested and exercisable stock options to comply with that requirement if he wanted to participate. 

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Moneylending Was a Business for Taxpayer, So Debt Was a Business Bad Debt

In the case of Owens v. Commissioner, TC Memo 2017-157, the issue to be decided involved a $9.5 million bad deduction claimed as a business bad debt an individual who took the position he was in the trade or business of lending money.  The IRS argued that he wasn’t in the business of lending money, that the debts in question were not actually debts and, even if they were, the loan did not become worthless in the year he claimed the loss.

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