Larry's Tax Law

As reported in my November 2015 blog post, in accordance with Internal Revenue Code (“Code”) Section 280E, taxpayers (for purposes of computing federal taxable income) are prohibited from deducting expenses related to the production, processing or sale of illegal drugs, including marijuana.

A Bit of Welcome Relief?

Measure 91, officially called the Control, Regulation, and Taxation of Marijuana and Industrial Hemp Act, passed by Oregon voters, appears to have alleviated some of the impact of Code Section 280E as it relates to Oregon taxable income. Specifically:

As a general rule, in accordance with IRC § 162(a), taxpayers are allowed to deduct, for federal income tax purposes, all of the ordinary and necessary expenses they paid or incurred during the taxable year in carrying on a trade or business.  There are, however, numerous exceptions to this general rule.  One exception is found in IRC § 280E.  It provides:

“No deduction or credit shall be allowed for any payment paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances (within the meaning of schedule I and II of the Controlled Substances Act) which is prohibited by Federal law or the law of any state in which such trade or business is conducted.”

I would like to invite you to NYU 74^th Institute on Federal Taxation taking place in New York, New York on October 25-30, 2015, and in San Francisco, California on November 15-20, 2015.

The NYU Tax Institute is one of our country’s most pre-eminent tax conferences for CPAs and attorneys. I am proud to be a presenter on the closely-held business panel of the program on Oct. 29 and Nov. 19. This is my third time speaking at the Institute. This year, I will present a newly-written white paper on qualified subchapter S subsidiaries.

Barnes v. Commissioner, 712 F.3d 581 (D.C. Cir. 2013) aff’g T.C.M. 2012-80 (2012) is illustrative of the point that understanding the basis adjustment rules is vital.

If this case was made into a movie, the name of the movie would tell the entire story – S corporation shareholders are not allowed to just make up the basis adjustment rules!  Also, as I have repeatedly stated, poor records lead to disastrous results.  The DC Circuit affirmed the US Tax Court in April of 2013 to finally put an end to the case.

The IRS will strike down transactions among related parties that lack economic outlay. At least two recent US Tax Court cases are illustrative of the issue.

Kerzner

Kerzner v. Commissioner, T.C. Memo 2009-76 (April 6, 2009). The Service beat the taxpayers in this case by a nose. Mr. and Mrs. Kerzner were equal partners in a partnership that owned a building. The partnership leased the building to an S corporation which was owned equally by two shareholders, Mr. and Mrs. Kerzner. Over the years, the partnership loaned the Kerzners money. In turn, they loaned the money to their S corporation, which used the money to pay rent to the partnership.

At the end of each year, promissory notes were drafted to document the loans; some of the notes stated an interest rate, some did not. Even though the notes required payment of principal, virtually no payments were ever made because the notes each year were replaced with new notes before any payment was due.

The S corporation had large losses. The Kerzners claimed basis in the loans to the corporation and took the losses on their individual tax returns. Upon audit, the Service claimed the loans lacked economic substance and did not give the Kerzners basis to absorb the losses.