Larry's Tax Law

I have yet again encountered another important development diverting me from my multi-part blog series on Subchapter S.  Earlier this week, the Corporate Transparency Act (“CTA”) hit a massive obstacle.  I feel compelled to report about it. 

On December 3, 2024, the U.S. District Court for the Eastern District of Texas, in Texas Top Cop Shop, Inc. et al v. Merrick Garland, Attorney General of the United States et al, issued a 79-page decision, including a preliminary injunction, creating a nationwide prohibition against government enforcement of the CTA.    

This decision has created a tsunami of banter among members of the legal profession, the media and the business community.  While the decision appears to have delivered an early holiday cheer to many, caution is advised.  As my late tax professor, James J. Freeland, would have advised his students after reading the decision, pause for cause!

On June 28, 2024, in Loper Bright Enterprises v. Raimondo,[1] the U.S. Supreme Court overruled the landmark case of Chevron U.S.A. v. Natural Resources Defense Council, Inc. et. al.[2]  Interestingly, the Loper decision was rendered exactly 40 years and three days after the U.S. Supreme Court had decided Chevron.

I expect there will be a slew of law review and other scholarly journal articles that will examine in detail the court’s decision and its impact on American jurisprudence.  This blog article is not designed to provide that type of commentary.  Rather, my aim is to provide readers with a succinct but clear understanding of the Loper ruling and its likely implications relative to the administration of our federal tax laws.  

Overview

I am taking a break from my multi-part blog series, A Journey Through Subchapter S / A Review of the Not So Obvious & The Traps That Exist For The Unwary, to provide another update on the Corporate Transparency Act (“CTA”).  The CTA continues to get a lot of media attention as there have been judicial and legislative efforts to obtain its repeal or to strike it down as unconstitutional.

As reported on June 7, 2023, the CTA is a new federal law that requires most U.S.-based companies, including corporations, partnerships and limited liability companies, to report information regarding their “beneficial owners” to the federal government through the Financial Crimes Enforcement Network (“FinCEN”) and a new FinCEN IT system known as the Beneficial Ownership Secure System (“BOSS”).  Lawmakers enacted the CTA to help the government combat money laundering, financing of terrorist activities, tax fraud and other illegal activities.

I am taking a short break between the third and fourth installment of my multi-part series on Subchapter S.  Before I publish the fourth installment on that topic, my colleague Steven Nofziger and I want to alert our readers to some recent developments relative to the Corporate Transparency Act (“CTA”).

CTA

As previously reported, the CTA is a new federal law that requires most U.S.-based companies, including corporations, partnerships and limited liability companies, to report information regarding their “beneficial owners” to the federal government through the Financial Crimes Enforcement Network (“FinCEN”) and a new FinCEN IT system known as the Beneficial Ownership Secure System (“BOSS”).  The intent of the CTA and the reporting to FinCEN is to combat money laundering, tax fraud and other illegal activities.

As you may be aware, the Corporate Transparency Act (the “CTA”) is a new federal law that requires most U.S.-based companies, including corporations, partnerships and limited liability companies, to report information regarding their “beneficial owners” to the federal government through the Financial Crimes Enforcement Network (“FinCEN”) and a new FinCEN IT system known as the Beneficial Ownership Secure System (“BOSS”).  The intent of the CTA and the reporting to FinCEN is to combat money laundering, tax fraud and other illegal activities.

The CTA reporting requirements will become effective on January 1, 2024, for newly formed companies (which do not otherwise qualify as exempt); provided, however, existing non-exempt companies have until January 1, 2025 to comply.

Introduction

More than two decades ago, the Service announced its intention to consider simplifying the entity classification rules in Notice 95-14.  It stated:

“The Internal Revenue Service and the Treasury Department are considering simplifying the classification regulations to allow taxpayers to treat domestic unincorporated business organizations as partnerships or as associations on an elective basis. The Service and Treasury also are considering adopting similar rules for foreign business organizations. Comments are requested regarding this and other possible approaches to simplifying the regulations.”

The Service asked for public comments on simplification of entity tax classification.  It scheduled a public hearing on the matter for July 20, 1995. 

In May 1996, proposed entity classification regulations were issued by Treasury.  About seven months later, on December 17, 1996, Treasury finalized the regulations.  The regulations are found in Treasury Regulation Section 301.7701.

The regulations were clearly designed to accomplish the IRS’s stated goal – simplifying entity tax classification.  The regulations, commonly referred to as the “Check-the-Box” regulations, successfully brought an end to much of the long existing battle between taxpayers and the Service over entity tax classification.  The regulations generally became effective on January 1, 1997.  In a little over a month from now, they will be 25-years old.  

The regulations, despite judicial challenge (e.g., Littriello v. United States, 2005-USTC ¶50,385 (WD Ky. 2005), aff’d, 484 F3d 372 (6^th Cir. 2007), cert. denied, 128 S. Ct. 1290 2008)), have persevered, making the entity classification landscape free of many tax authority challenges and providing taxpayers with some objectivity and more importantly, much needed certainty.  That said, despite the simplification brought into the world of entity tax classification by the Check-the-Box regulations, for which tax practitioners applauded the government, several new hazards were created.  Whether these new hazards were intentional or unintentional is subject to debate.  Unfortunately, not all of these hazards are obvious to taxpayers and their advisors.  If taxpayers and their advisors are not extremely careful in this area, disastrous unintended tax consequences may exist.  Accordingly, a good understanding of the regulations and the consequences of making, not making or changing an entity tax classification decision is paramount.

Last month, I presented a White Paper that I authored on the regulations at the NYU 81^st Institute on Federal Taxation in New York City, and I will be presenting it again for NYU in San Diego on November 17, 2022.  The paper provides exhaustive coverage of the regulations and covers numerous nuances and traps that exist for unwary taxpayers and their advisors.  An issue which is often overlooked by practitioners is whether using the regulations to change entity status for income tax purposes is always a good idea.  While I discuss the issue in some detail in the paper, the sub-issue of whether a taxpayer should use the regulations to change the tax status of a limited liability company (“LLC”) taxed as a partnership to a corporation taxed under Subchapter S needs discussion.  I explore that sub-issue below.

More than 25 years ago, effective January 1, 1997, Treasury issued what have been called the “Check-the-Box” regulations (the “Regulations”).¹  The Regulations ended decades of battles between taxpayers and the IRS over entity classification.  Further, the Regulations simplified entity classification and brought much needed certainty to most entity classification decisions.

Under the Regulations, a business entity with more than one owner is either classified for federal tax purposes as a corporation or a partnership.²  Likewise, a business entity with only one owner is either classified as a corporation or is disregarded for federal income tax purposes as being separate and apart from its owner.³ 

If a business entity is disregarded, its activities are generally treated for federal tax purposes as the activities of its owner.  There are five notable exceptions to that rule. 

On November 19, 2021, HR 5376, the 2,476-page bill, commonly known as the Build Back Better Act, was passed by the U.S. House of Representatives by a vote of 220-213.

The House’s vote on HR 5376 was held after the Congressional Budget Office released its cost estimates for the proposed legislation. It estimates HR 5376 will cost almost $1.7 trillion and add $367 billion to the federal deficit over 10 years. 

HR 5376 started out with robust changes to our tax laws, including large increases in the corporate, individual, trust and estate income tax rates, significant increases in the capital gains tax rates, taxation of unrealized gains of the ultra-wealthy, a huge reduction in the unified credit, a tax surcharge on high income individuals, trusts and estates, expansion of the application of the net investment income tax, elimination of gift and death transfer discounts, and additional limitations on the application of the qualified business income deduction. 

To the cheer of most U.S. taxpayers, HR 5376, as passed by the House, is a dwarf, in terms of the tax provisions, compared to its original form.  As tax legislation, at least in its current state, it is much ado about nothing.  

However, U.S. taxpayers should not get too joyful about the legislation in its current form.  It will likely be substantially altered by the Senate, regaining many of its original provisions (with or without modification).  In fact, Skopos Labs reports that the bill, as passed by the House, has a 10 percent chance of being in enacted into law.

HR 5376, at its heart, provides funding, establishes new programs and otherwise modifies current provisions of the law aimed at enhancing a broad array of programs, including education, childcare, healthcare and the environmental protections.

While it may not be worth spending too much time focusing on HR 5376, as its tax provisions will be drastically altered by the Senate, it is worth briefly noting what is in the bill and what may be missing.

As many readers have noticed, I have been silent for the past few months.  That is partly due to exhaustion from reporting on the flurry of tax events that have occurred since the COVID-19 pandemic commenced in 2020 and also partly due to the need to conserve energy to fully learn, digest and report on the highly anticipated, new broad-sweeping federal tax legislation we should see within the next few weeks.  While many commentators are publishing articles on what could be contained in final legislation and what taxpayers should be doing currently, I decided, especially since I do not possess a good crystal ball, to wait until the legislation is passed (or at least gets further along in the legislative process) before reporting on it and advising taxpayers on what they should be doing in anticipation of the legislation.  So, all has been calm on the Larry’s Tax Law blog front.  Once the legislation is passed, however, I expect a nasty storm to ensue.

I plan to provide you with a summary of the most salient provisions of the law and how those provisions may impact taxpayers.  In the interim, I wanted to share some interesting tax trivia just published by the Internal Revenue Service.

Background

During the COVID-19 pandemic, the federal government enacted three major pieces of legislation to provide financial relief to individuals and families.  The American Recovery Plan Act (“ARPA”), the most recent legislation, provides the third round of Economic Impact Payments (“EIPs”), also referred to as stimulus payments (and “recovery rebates” in the acts), to millions of Americans.