Larry's Tax Law

Faris Fink, Commissioner of the Small Business/Self-Employed Division of the Internal Revenue Service, announced at the AICPA National Tax Conference on November 5, 2013, that his division is moving its audit focus from corporations to pass-through entities (i.e., S corporations, partnerships and sole proprietorships).

Fink was candid when he said his employees do not currently have the skills and knowledge to conduct these examinations.  In anticipation of its new focus, however, the Service is developing pass-through entity examination strategies and is training its audit staff to conduct the exams.  Practitioners should expect to see significantly more pass-through entity examinations in 2014.  One would suspect these examinations, especially early on, will be challenging for taxpayers and their advisors.  

Looks Like Oregon Tax Laws are Changing Again

House Bill 3601 A (“HB 3601”) passed the Oregon House of Representatives and the Oregon Senate on October 2, 2013, during a special session.  Governor Kitzhaber signed the bill into law on October 8, 2013.  The new law is effective January 1, 2014.  This is good news for some Oregon taxpayers and bad news for others.

The most significant impact of HB 3601 is found in six provisions, namely:

I.  Corporate Excise Tax Rates.  The corporate excise tax rates are increased.  Effective for tax years beginning in 2013 or later, a 6.6% tax rate applies to the first $1,000,000 of taxable income and a tax rate of 7.6% applies to any excess taxable income.  Under current law, the 6.6% tax rate applies to the first $10,000,000 of taxable income and the 7.6% tax rate applies to any excess taxable income.  This change in current law represents a substantial increase in tax for many corporate taxpayers.

II.  IC-DISCs.  Except as expressly provided by Oregon law, DISCs are taxed in Oregon like corporations.  ORS 317.635(1).  HB 3601 exempts existing Interest Charge DISCs (i.e., IC-DISCs formed on or before the effective date of the act) from the Oregon corporate minimum tax under ORS 317.090.  HB 3601 also causes any commissions received by DISCs to be taxed at 2.5%, and allows a deduction for commission payments made to existing DISCs.

III.  Dividends Received from DISCs.  HB 3601 allows a personal income taxpayer to subtract from income any dividend received from a DISC formed under IRC § 992.

IV.  Personal Exemption Phase-Out.  HB 3601 denies personal income taxpayers from claiming the personal exemption credit(s) (current $90 per exemption) if federal adjusted gross income is $100,000 or more for a single taxpayer and $200,000 or more for a married filing joint taxpayer.

V.  Senior Health Care Costs.  HB 3601 provides a small deduction for “senior” health care expenses not compensated by insurance.  The bill, however, adds a phase-out for taxpayers with federal adjusted gross income over certain thresholds.  Likewise, the definition of a “senior” starts out at age 62 for the 2013 tax year and increases each year thereafter by one year until tax year 2020.

VI.  Reduced Tax Rates for Applicable Non-passive Income.  For tax years beginning in 2015 or later, applicable non-passive income attributable to certain partnerships and S corporations will be taxed as follows:

The Service Continues its Warm Approach to Taxpayers with S Corporation Inadvertent Terminations (PLR 201340001) 

As we know, in accordance with Code Section 1362(f) and the corresponding Treasury Regulations, a corporation will continue to be treated as a Subchapter S corporation during a period of termination, if:

1. 1. The election was terminated, either because the corporation was disqualified as an electing small business corporation, or as a result of running afoul of the passive investment income rule;
   2. The Service determines the termination as inadvertent;
   3. The corporation promptly takes steps to correct the defect after discovery; and
   4. The corporation and its shareholders acted as if the election was continuously in effect.

While the IRS is back in business following the recent government shutdown, it may not receive your requests for private letter rulings with open arms.  Before requesting a private letter ruling, tax practitioners need to review the Service’s recent no-ruling revenue procedures, namely Revenue Procedure 2013-32 and Revenue Procedure 2013-3.

While the new no-ruling revenue procedures are broad in scope, it is possible the Service may still issue rulings in areas that otherwise appear to be no-ruling topics.  So, you should consider a pre-submission meeting or conversation with the IRS to determine whether a ruling may be available and/or to discuss how you should tailor a ruling request in light of these new revenue procedures.

There are rumors circulating in the media that taxpayer filing and payment obligations are currently on hold pending the Federal shutdown.  WRONG!

The IRS announced last week, despite its limited resources during the shutdown, taxpayer obligations continue.  These obligations must be met in a timely manner.  There will be no extensions arising from the shutdown.

Individuals and businesses are required to file returns, pay taxes, make estimate tax payments, and make tax deposits in a timely manner as required by applicable law.  The shutdown does not impact these obligations or the time frame in which to fulfill them.  It does, however, create a few hiccups for tax advisors and their clients, including:

To qualify as an S Corporation for the current tax year, a corporation must make an election: (1) at any time during the entity’s preceding tax year; or (2) at any time before the 15th day of the 3rd month of the current tax year.  If a corporation fails to make a timely election, it is considered a “late S election” and it will not qualify as an S Corporation for the intended tax year.

The consequences of a late S election or failing to file an S election can be severe.  First, the corporation will be taxed as a C Corporation and subject to corporate income taxes.  Second, the corporation may be subject to late filing and payment penalties, and interest on unpaid taxes.  Finally, if the corporation filed IRS Forms 1120S as if it were an S Corporation, then all prior tax years would be subject to IRS examination because the tax years remain open.

People are often surprised by the long reach of Internal Revenue Service (“Service” or “IRS”) liens.¹  Plains Capital Corporation (“Plains”) recently learned this lesson.  Plains lost a fight with the Service in a case before the United States District Court for the Eastern District of Texas.  It appealed to Fifth Circuit Court of Appeals.  Losing again, Plains proceeded with an appeal to the United States Supreme Court.  Unfortunately, on June 24, 2013, the highest court in the nation refused to hear Plain’s appeal.²  The saga is over for Plains, but the case should be a loud warning to others.

In 2002 and 2003, the Service assessed taxpayer Gregory Rand (“Rand”) for tax liabilities arising from 2000 and 2002.  It eventually filed notices of federal tax liens totaling over $3 million (“Tax Liens”).

In 2005, Rand obtained a $200,000 line of credit from Plains.  Plains was aware of the Tax Liens.  To secure its credit extension, however, it took possession of the title to Rand’s 2005 Ferrari.  Plains thought taking possession of the vehicle title would put it in front of the IRS.  Wrong!

In 2007, Rand agreed with the IRS that he would deliver the Ferrari to Boardwalk Motor Sports, Ltd (“Boardwalk”).  Boardwalk agreed to sell the vehicle on consignment.

The Service and Plains could not agree upon the priority of their respective liens.  So, the IRS served a notice of levy on Boardwalk and instructed Boardwalk to deliver the sale proceeds to it.  Later, an IRS agent instructed Boardwalk not to release the sale proceeds until the IRS and Plains reached agreement on lien priorities.  If it was unsure whether an agreement was reached, Boardwalk was instructed to go to the local court and file an interpleader action.

Introduction

Section 336(e)1 expressly delegates authority to Treasury to issue regulations, allowing taxpayers to elect to treat the sale, exchange or distribution of corporate stock as a deemed sale of the corporation’s underlying assets.  On May 15, 2013, Treasury finalized regulations under Section 336(e).

What is the 336(e) Election?

A Section 336(e) election allows certain taxpayers to treat the sale, exchange or distribution of corporate stock as an asset sale.  The benefit of an asset sale is obvious—the basis of the target corporation’s assets is stepped up to fair market value.

If an election is made, “old target” is treated as selling all of its assets to “new target.”  New target is treated as purchasing those assets, resulting in a step-up in basis of the assets.  Old target recognizes the gain or loss from the deemed asset sale immediately before the close of the stock transaction.

Section 336(e) is intended to provide taxpayers relief from multiple levels of tax on the same economic gain—economic gain attributable to the appreciation of assets held in corporate solution.  Such multiple levels of tax can result from the taxable transfer of appreciated corporate stock where the assets in corporate solution do not receive a corresponding step-up in basis.

As many employers have painfully learned, misclassifying employees as independent contractors can be an expensive mistake. Worker misclassification may become even more costly in 2014, when a new potential trap for the unwary will exist. If a non-complying employer gets caught in this new trap, it could be faced with significant monetary penalties.

Beginning in 2014, as a result of the Patient Protection and Affordable Care Act, employers who misclassify employees as independent contractors may be subject to an additional penalty regime. Section 4980H(a) of the Internal Revenue Code (the “Code”) imposes a penalty on “large employers” who fail to offer full-time employees health insurance with a minimum level of coverage. Because employers generally do not provide health care coverage to independent contractors, reclassification of an independent contractor to a full-time employee could trigger this penalty.

According to a Bureau of Labor Statistics study conducted almost 8 years ago, approximately 10.3 million workers in the United States, or 7.4% of the workforce, are classified as independent contractors. Today that number, despite recessionary times, is likely dramatically larger.

The federal government, based upon recent case studies including federal and state income tax and unemployment tax audits, recently concluded many workers classified as independent contractors are actually employees. Consequently, worker classification is currently a hot topic for the Internal Revenue Service, the state departments of revenue, and other federal, state and local agencies.

Government focus on worker classification is not a new phenomenon. Due to current economic and political pressures, however, it has risen to the forefront of governmental attention. During the last few years, federal, state and local agencies have dramatically increased audit activity, targeting worker misclassification.