Larry's Tax Law

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.  

As reported last week, opponents of the Washington state capital gains tax, after ultimately losing in the courts to have the legislation stricken as unconstitutional, decided to take the matter to the voters.  They have proposed a ballot measure which if successful, among other things, will repeal the tax. 

As part of the presentation of the ballot measure in the voters’ pamphlet, the State of Washington election officials recently announced that the explanation of the ballot measure must include a disclosure of the revenue impact its passage would have on the state’s revenue – a drop of roughly $1 billion per year.  Proponents of the ballot measure promptly filed a lawsuit in the Superior Court of Washington for Thurston County (“Court”) to block the inclusion of the revenue impact in the voter packets.  A hearing in the case occurred on June 7, 2024.

Judge Allyson Zipp, appointed to the Court by Governor Jay Inslee in 2021, presided over the case.  The oral arguments were interesting.

I have reported in several prior blog posts the significant events impacting the newly enacted Washington state capital gains tax.  The turbulent ride of this legislation continues!

The Colorful Journey

The colorful journey of the Washington capital gains tax started with Senate Bill 5096 ("SB 5096"). The bill was originally introduced to the Washington State Senate on January 6, 2021.  It was passed by the Senate on March 6, 2021, after a hearing in the Senate Committee on Ways and Means, three readings and some floor amendments.  The bill's passage margin in the Senate was narrow, receiving 25 affirmative votes and 24 negative votes. 

SB 5096 continued its journey to the Washington State House of Representatives, where the bill was introduced on March 9, 2021.  After three readings and two separate votes, as well as some amendments, the bill was passed in the House on April 21, 2021.  As was the case in the Senate, its passage margin in the House was narrow, receiving 52 affirmative votes and 46 negative votes. 

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.

It is a rainy day in the Pacific Northwest with chances of snow showers.  For those taxpayers that reside in the state of Washington or own highly appreciated capital assets located in the state, their day just got a bit gloomier. 

Earlier today, the Washington Supreme Court, in a 7-2 opinion, overturned the Douglas County Superior Court decision that had ruled the state capital gains tax enacted by the legislature in 2021 violates the Washington State Constitution.  

Majority Opinion

In its 50-plus page opinion written by Justice Debra L. Stevens, the majority of the court concludes:

“The court below [the Douglas County Superior Court] concluded the tax is a property tax that violates article VII’s uniformity requirement. In light of this ruling, the court did not address Plaintiffs’ additional constitutional challenges. We accepted direct review and now reverse. The capital gains tax is appropriately characterized as an excise because it is levied on the sale or exchange of capital assets, not on capital assets or gains themselves. This understanding of the tax is consistent with a long line of precedent recognizing excise taxes as those levied on the exercise of rights associated with property ownership, such as the power to sell or exchange property, in contrast to property taxes levied on property itself. Because the capital gains tax is an excise tax under Washington law, it is not subject to the uniformity and levy requirements of article VII. We further hold the capital gains tax is consistent with our state constitution’s privileges and immunities clause and the federal dormant commerce clause. We therefore reject Plaintiffs’ facial challenge to the capital gains tax and remand to the trial court for further proceedings consistent with this opinion.”

By motion dated November 3, 2022, the Washington State Attorney General asked the Supreme Court of the State of Washington to allow the Washington Department of Revenue to implement and collect the capital gains tax struck down as unconstitutional by the Douglas County Superior Court, pending the high court’s ultimate ruling on the matter. 

As previously reported, the tax, which was set to go into effect on January 1, 2022 was struck down by the Douglas County Superior Court as unconstitutional.  The first tax payments under the new tax regime would be due on April 17, 2023.

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.

On August 23, 2022, the Regular Division of the Oregon Tax Court issued its opinion in Santa Fe Natural Tobacco Co. v. Department of Revenue, State of Oregon.  The court determined that the taxpayer in that case is subject to the corporate excise tax. 

The taxpayer, Santa Fe Natural Tobacco Co., required that its wholesale customers located in Oregon accept and process returned goods.  In addition, the taxpayer’s in-state sales representatives, who did not maintain inventory, routinely confirmed and processed purchase orders between Oregon retailers and wholesalers.