Larry's Tax Law

Basic Rules

IRC § 6501(a) generally requires the IRS to assess tax within three (3) years after a tax return is filed by the taxpayer. 

There are two (2) notable exceptions to this rule under IRC § 6501(c) and (e), namely:

1. Under IRC § 6501(c), an unlimited assessment period exists in the case of a false or fraudulent return where the taxpayer has the intent to evade tax; and
2. Under IRC § 6501(e), a six (6) year period for assessment exists in the case where the taxpayer understates gross income by more than 25 percent, unless there is adequate disclosure on the taxpayer’s original tax return.

In the case of a shareholder of an S corporation, the analysis is generally conducted at the shareholder level.  In other words, the focus is on the shareholder’s tax return, and the issue is whether there is a problem with that return that would extend the limitation period for assessment.

As we know from the basic rules, absent fraud or an undisclosed substantial understatement of gross income, the limitation period for assessment is three (3) years.  Likewise, absent fraud, an undisclosed substantial understatement of gross income extends the limitation period for assessment to six (6) years.

The Tax Reform Act of 1986 (the “TRA 86”) was signed into law by President Ronald Reagan on October 22, 1986, exactly 38 years ago today.  TRA 86 was sponsored by, among others, Representative Richard Gephardt (D-Missouri) in the U.S. House of Representatives and Senator Bill Bradley (D-New Jersey) in the U.S. Senate.  It was strongly supported by the Chairman of the House Ways and Means Committee, Dan Rostenkowski (D-Illinois) and the Chairman of the Senate Finance Committee, Bob Packwood (R-Oregon). 

TRA 86 is one of the most comprehensive pieces of tax reform legislation ever enacted in the United States.  It was the result of a collaborative effort by Democrats and Republicans that spanned three years.

In this Part XII of my multi-part series on some of the not-so-obvious aspects of S corporations, I explore a consistent theme – taxpayers lose fights with taxing authorities when they fail to maintain adequate records.  Keeping adequate records is vitally important to S corporations and their shareholders or, for that matter, all taxpayers. 

Background 

Time and time again, taxpayers lose their battles with the IRS and other taxing authorities for the same reason – failure to maintain adequate records.  One of the greatest services that tax advisers can provide their clients is preaching the virtues of maintaining good records.

In this Part XI of my multi-part series on some of the not-so-obvious aspects of S corporations, I explore a topic that should be obvious but which appears to be ignored by many taxpayers and their tax advisers – accurate computation of shareholder basis for purposes of taking losses flowing through from the S corporation is important.

Background

In 2005, the Internal Revenue Service launched a study to assess the reporting compliance of S corporations.  The study, carried out under the National Research Program (“NRP”), involved the examination of roughly 4,800 randomly selected S corporation returns from tax years 2003-2004.  Based upon the portions of the study disclosed by the Service to the public, six major areas of noncompliance in the S corporation arena were detected:

Introduction

When considering converting a C corporation to an S corporation, tax advisers and taxpayers need to pay careful attention to the many perils that exist.  Failure to pay close attention to the road in this area could result in a disaster.  This Part X of my multi-part series on Subchapter S is designed to illuminate some of the road hazards that exist along the roadway traveling from Subchapter C to Subchapter S. 

Before converting an existing C corporation to an S corporation, an analysis of several matters should be undertaken, including the impact of the election on the shareholders and the corporation.  These matters include, but are not limited to, the topics briefly discussed below.

Unlike the rules contained in Subchapter K surrounding partnership distributions, which tend to be somewhat complex, the distribution rules contained in Subchapter S are fairly straightforward.  Nevertheless, from time to time, taxpayers and tax advisers appear to experience difficulty navigating through the applicable S corporation distribution rules.  This Part IX of my multi-part blog series on S corporations is designed to take some of the mystery out of the S corporation distribution rules.  The following is a brief overview of the S corporation distribution rules.

Background

The purpose of pass-thru taxation under Subchapter S is to avoid the imposition of an entity-level tax.  Shareholders of S corporations are taxed on their proportionate share of the corporation’s income, regardless of whether it is actually received; therefore, distributions from S corporation income should not be taxed again, otherwise there would be a second tax on such income, undercutting the purpose of pass-thru taxation.  IRC §1368 allows for shareholder distributions in a manner that avoids double-taxation of S corporation income, but it still imposes an entity-level tax on the earnings and profits (“E&P”) remaining from any prior operations as a C corporation. Much of the complexity within the Subchapter S distribution rules is due to these latter rules, which are designed to prevent C corporations from avoiding double-taxation on C corporation earnings by simply electing S corporation status.

At a fundamental level, distributions from S corporations must be analyzed in one of two categories: S corporations without E&P and S corporations with E&P.

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

In the S corporation arena, tax advisors and taxpayers generally do not focus a lot of attention on the S corporation shareholder eligibility rules other than at the time the S election is made.  As we dive into shareholder eligibility rules in this Part VIII of my multi-part series on Subchapter S, it should become apparent that the eligibility rules can be complex and require that S corporations and their shareholders keep a close eye on shareholder eligibility after the S election is made. 

Instances where S corporations and their shareholders may find the S election in peril for violating the shareholder eligibility rules include: (i) when a shareholder sells or otherwise transfers shares to a person or entity other than an existing eligible shareholder; (ii) when the corporation issues shares to a new shareholder; and (iii) when an existing shareholder transfers shares to a vehicle intended to be used for estate planning and/or creditor protection purposes.  Failure to pay close attention to the eligibility rules can result in disastrous consequences to the S corporation and its shareholders.

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.