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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Interest Due Back from 2002 When Tax Exempt Determined in 2013 to be Retroactively Lost

The Tax Court ruled that when an entity has its tax-exempt status retroactively revoked, interest is due on any underpaid tax for the years that the entity now has a tax liability from the date a return would have been originally due for an entity that did not have exempt status.  In CreditGuard of America, Inc. v. Commissioner, 149 TC No. 17 the Tax Court rejected the taxpayer’s view that interest should not begin to run until the date it was finally determined the entity was not tax exempt.

The issue of the retroactive loss of the organization’s exempt status back to 2002 had previously been decided in a stipulated Tax Court decision entered on November 30, 2012, based on an examination the IRS had begun in 2003 but not concluded until February of 2012.  The total tax determined to be due from the taxpayer was $216,547.

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Tax Court Rejects First Circuit's View of Limits on Need to Subordinate Mortgages for Conservation Easement

The Tax Court, in the case of Palmolive Building Investors LLC et al. v. Commissioner, 149 TC No. 18, refused to follow the holding of the First Circuit Court of Appeals in the case of Kaufman v. Commissioner.  The Court continued to very strictly apply the subordination requirement in Reg. §1.170A-14(g), finding that the taxpayer in this case had not managed to satisfy the perpetuity requirement of IRC §170(h)(5).

The First Circuit and the Tax Court had disagreed on the extent to which a mortgage must be subordinated to meet the requirements of Reg. §1.170A-14(g)(2).  That regulation provides:

(2) Protection of a conservation purpose in case of donation of property subject to a mortgage.

In the case of conservation contributions made after February 13, 1986, no deduction will be permitted under this section for an interest in property which is subject to a mortgage unless the mortgagee subordinates its rights in the property to the right of the qualified organization to enforce the conservation purposes of the gift in perpetuity.

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Exclusion from Income of Minister's Housing Allowance Found Unconstitutional

Back in 2014 the Seventh Circuit Court of Appeals sidestepped the question of whether the allowance of an exclusion for a housing allowance for a minister of the gospel under IRC §107(2) was barred by the U.S. Constitution.  But the method the panel used to sidestep left an obvious route for the issue to come back—and now it has returned to the Courts.

Originally in the case of Freedom from Religion Foundation, Inc. v. Lew, 114 AFTR 2d, ¶2014-5425 issued in November of 2014 the panel found that the organization suing to bar ministers from receiving an exclusion from income for housing allowances did not show any harm to the organization.  The panel noted that the organization had not attempted to receive a similar exclusion for its employees from the IRS.  So, it was the organization that voluntarily treated the payments as taxable to its employees rather than the IRS denying that treatment.

At the time I had noted that the obvious next step was for the organization to ask for such treatment and then come back to Court if the IRS did not allow the claim.  The case of Gaylor, et al v. Mnuchin, et al, W.D. Wisconsin, Case No. 3:16-cv-00215 brings the matter back to the courts.  And, in fact, the case is back before the very trial judge that, in the original case, had found that IRC §107(2) violated the U.S. Constitution.  Not surprisingly, since the Seventh Circuit never actually dealt with that question (disposing of the case on a standing issue), the judge came to the same conclusion this time.

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Signature No Longer Required When Making IRC §754 Election

Under proposed regulations on which taxpayers may rely upon immediately, elections made by partnerships under IRC §754 will no longer have to be signed by a partnership representative (REG-116256-17; 82 F.R. 47408-47409, October 12, 2017).  The current regulations require that the election be signed, which has created issues with electronically filed partnership income tax returns.

In certain situations, a partnership may elect to adjust the basis of partnership property upon the occurrence of certain actions, such as a transfer of a partnership interest (as provided for in IRC §743) or upon distributions of property (as provided for in IRC §734).

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Relief Provisions Enacted by Congress for Hurricanes Harvey, Irma and Maria

Special tax relief for victims of Hurricanes Harvey, Irma and Maria was enacted into law in the  Disaster Tax Relief and Airport and Airway Extension Act of 2017 (H.R. 3823).  Section V of the Act, which also reauthorized Airport and Airway Trust Fund, contains the provisions related to Hurricane Relief.  The bill was signed into law by President Trump on September 29, 2017.

The provisions offer relief targeted specifically to the three hurricanes rather than making broader revisions to the law.   Thus, unless indicated in the bulleted list, the provisions are limited to those living in the affected declared disaster areas.

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Comments on the Tax Reform Framework of the Big 6

On September 27, 2017 the “Big Six” released the “Unified Framework for Fixing Our Broken Tax Code” that contained some details on the proposal.  The framework, which runs for 9 pages, is a bit more detailed than earlier statements, but still omits many details necessary to determine the impact of the proposal on specific taxpayers.  The first three pages of the framework contain mainly a vague description of the goals and justifications for the program, with only the final six pages giving actual information about steps to be taken.

By contrast, the initial proposal issued by the Treasury Department during the Reagan Administration that began the process the resulted in the Tax Reform Act of 1986 ran for over 400 pages. 

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