Let’s say in 2011, your accountant suggested it might be good to elect S Corporation treatment for your business which has been a C corporation for 5 years. You’ve got the hottest bar in town. Its worth $1 Million and you only invested $100,000 which is fully depreciated, but there are good years and bad years and you like the fact that you can deduct losses and avoid double taxation of income by using S. Fast forward to 2015. Porky comes by and wants to buy your name, assets. He’s offering $1.2 Million. You are so excited. Selling these assets would yield a gain at capital gains rates what could be better. Then you talk to your tax lawyer. He says wait. Under Section 1374 of the Internal Revenue Code there is a built in gains tax that looks back 10 years. Thus, if at the time of your S Election in 2011, your business was worth $1 Million, it must recognize that $1 Million at ordinary corporate rates. Thus, instead of the tax being $250,000 on the gain it is $565,000 give or take. A huge difference.
Suppose you own a corporation MYTABLES, Inc. that manufactures tables. Your company has an opportunity to go into the desk market, but wants to limit its exposure. So, it sets up a subsidiary, DESKO, LTD. MYTABLES, INC., owns all of the stock of DESKO. People love the desks. The Company needs capital to hire more people to make desks. The owners go on the Barracuda Tank and Cube Markan offers to give $1 Million for 18% of the Company, but wants DESKO separated from MYTABLES. So, how do you separate out DESKO from MYTABLES. Under Section 355 of the IRS Code you can do what is known as a spin-off and so long as the DESKO has a different line of business from MYTABLES (they do) and so long as the shareholders of MYTABLES still own 80% of the stock of DESKO, then you can spin off, so long as DESKO and MYTABLES continue in business. There are lots of technical rules under Section 355, but that is the gist of it.
Suppose you are a computer software consulting business with offices in Arlington, Virginia and Prince Georges County, Maryland. You have employees who move back and forth between the offices consulting with clients and making calls on clients. Both Maryland and Virginia have income taxes. How do you allocate the income for purposes of the Arlington County, Virginia Business Professional Occupational License Tax. The Supreme Court adopted a three part test to use to determine how you allocate that burden In Nielsen Company v. Arlington County last month.
First, you must allocate the tax based upon payroll percentages in each jurisdiction. Then you are permitted a deduction for income subject to income taxes in another state. It is this deduction that the Court is concerned with.
The Court went on to say:
“That is, “attributable” does not mandate or prohibit any particular
methodology to determine which receipts captured in the pool of
taxable gross receipts are subject to deduction.”
The means that your company can allocate sales receipts in any acceptable manner.
There is a safe harbor under Section 58.1-3732(B)(2) which the Court rules is to be interpreted in the following manner:
“The Tax Commissioner held that the following analysis
determines whether the Code § 58.1-3732(B)(2) deduction may be
taken by a taxpayer, and, if so, how to determine what receipts
are backed out from the pool of taxable gross receipts:
1. Ascertain whether any employees at the Virginia
definite place of business participated in interstate
transactions by, for example, shipping goods to
customers in other states, participating with
employees in other offices in transactions, etc. If
there has been no participation in interstate
transactions, then there is no deduction. If there
has been participation, then;
2. Ascertain whether any of the interstate
participation can be tied to specific receipts. If
so, then those receipts are deducted; however, if
payroll apportionment had to be used to assign
receipts to the definite place of business, then it is
very unlikely that any of those apportioned receipts
can be specifically linked to interstate
transactions. If not, or if only some of the
participation can be tied to specific receipts, then;
3. The payroll factor used for the Virginia definite
place of business would be applied to the gross
receipts assigned to definite places of business in
states in which the taxpayer filed an income tax
return. Note that payroll apportionment would
probably be needed to assign receipts to definite
places of business in other states.”
So, if for example the employees in the Virginia office don’t deal with any interstate business there is not additional deduction. If however, the Virginia employees handled Maryland sales, then you can trace the specific receipt. If that doesn’t work, then you can allocate those according to payroll percentages for the second deduction.
Remember the business can still allocate receipts according to any reasonable formula for allocating receipts, there is just no safe harbor if challenged as unreasonable.
When you gift investment or business property to someone and that person sells that property they owe tax on the gain. The basis in the property for gain purposes is what the basis was in the hands of the donor (the person making the gift). So, if the donor had a basis of $100 and the donee (recipient of the gift) sold the property for $110, there would be a $10 gain.
What is the basis for someone who receives a gift and sells it for a loss. In that circumstance the basis is the LOWER of the basis in the hands of the donor or fair market value at the time of the gift. So let’s say that Fred holds a mortgage note on Blackacre from Mona for $100,000. The mortgage is under-water and there is no way that Mona will ever be able to repay the loan. Fred gifts the note to his son, Bam. Bam immediately forecloses and the property sells for $50,000. Does Bam get a capital loss of $50,000 or a capital loss of zero. That goes to what was the market value of the note on the date of the gift. It would appear that it would no more than $50,000. However, if Bam could have gotten an appraiser or another lender to state that the fair market value of the note was an amount larger than $50,000, then Bam could perhaps take the loss equal to the appraised amount. This is found in Reg. 1015-1 of the IRS regulations.
Let’s say Sid hit it big with your new product, Spacebook and he went from a middle aged computer geek to a billionaire overnight and lives in California. His aging parents are not in great health. His basis in his dot.com stock is about $10,000. His unrealized gain on that stock is $2,999,990,000. He wants to know how to reduce taxes and liquidate some of his stock in the next ten years. Perhaps he should gift $10,000,000 worth of stock to his parents. When the last parent dies, the stock is stepped up to the date of death value. Thus, the $10,000,000 in stock would now have zero capital gains. But Sid is nervous that his parents might not hold onto the stock. So, he said can I create a trust for them. The answer is yes. There are a number of trust vehicles that will work, so long as the last living parent has when is known as a general power of appointment to appoint the assets to his or her estate or creditors. There are trusts known as intentionally defective grantor trusts in which Sid gets taxed on the income while giving his parents the use of that income. The net result to Sid is tax savings of $3,300,000. You can buy a lot of other things for $3,300,000 and he is able to give his parents an income from that stock for the rest of their lives.
There is a very big project going on in which the IRS, State Tax Departments, State Attorney’s General and the Justice Department are engaged. Medicaid fraud cases involving home health agencies. It usually starts with a home health agency owned by non-citizens. If the agency is located in a state with income taxes, the state then commences a net worth tax audit on the business owner. Usually, as with any American, there are problems with the return. Then commences a criminal tax filing alleging tax fraud and because the company is owned by a new or non-citizen with ties overseas, they ask for no bond and make statements about the medicaid fraud investigation that they are pursuing. Many times they will get the tax preparers involved as well with offers of immunity. At that point, the Government can force open the books of the home health provider. The other trick is to have the IRS pursue an indictment for failure to collect and pay over employment taxes. Usually this is a civil issue, but for these cases they use the criminal means to again force open the books of the company. While there is a ton of fraud in the home health industry, this particular program seems to be similar to the old mafia investigations where corruption could not be proved, so tax laws are used instead. So, to home health agencies out there a couple of words of warning. (1) Pay your withholding taxes, even if you don’t pay yourself, your rent or any other bill; (2) Make sure your personal tax returns are unassailable. Don’t simply trust your preparer. Review the returns carefully to ensure that all items of income and expense are properly taken. Remember you sign those returns under penalties of perjury. (3) If the FBI, IRS, or a state tax agent starts an audit engage a seasoned tax professional to get involved at the earliest possible time. This could mean the difference between an indictment and a civil penalty,. If you have returns out there that have problems and YOU HAVE NOT YET BEEN CONTACTED BY AUTHORITIES, consider voluntarily amending them and paying the taxes, interest and penalties now. (or at least starting a voluntary payment arrangement with the tax authority). If you are an immigrant and have family members overseas that you support, try to keep a log of what you send overseas and to whom. That way, when the Government comes calling you have a record of where the money went. Lastly, remember that if your gifts to any one person (anywhere in the world) exceed $13,500 you need to file a Federal Gift tax return. With these tips you might avoid a long spell in jail.
If you post them by midnight tonight you get to deduct them against your Federal taxes. Assuming of course you do not have alternative minimum tax issues.
Judge Crabb is apparently friendly to folks who take a broad view of the Establishment Clause. She declared the National Day of Prayer unconstitutional (and probably will decide that Thanksgiving and Christmas should not be federal holidays at some point if given the chance), and she was reversed by the 7th Circuit Court of Appeals. But if the standing of the FFRF individuals is upheld, then pastors will have a problem because Section 107 is clearly friendly to religion. However under the Supreme Court test she cited the O’Connor test, the concept of religious neutrality has come in. Under that test you can’t discriminate against religious participation in universal government benefits, like school vouchers and free lunches to needy kids as long as you don’t require indoctrination with the use of those funds. The question here like all tax cases is of course the ever present, this is a tax case. This is where it gets interesting. Going back to Justice Roberts decision concerning Obamacare, a tax is a tax. Apparently, the 16th Amendment allowing the Government to tax income pretty much allows it to tax anything it wants including not having insurance. So, what if it exempts from income housing allowances for clergy and disability payments to Veterans. If Congress can tax something, they can choose not to tax something. The 16th Amendment gives Congress the power to lay taxes on income from whatever sources derived. Thus, Congress can pick and choose which incomes it wishes to tax even those that may be religious. So, interestingly enough, if this case goes to the Supreme Court, it may well be that the Obamacare ruling gives the Justices an out.
In Freedom from Religion Foundation v. Lew (November 22, 2013, W.D. Wisc), Judge Crabb found that Section 107 of the Internal Revenue Service was unconstitutional. This follows on the heels of another case Freedom From Religion Foundation v. Geithner 715 F. Supp 2d 105(E.D. CA, 2010) in which the District Court found the Foundation to have standing to challenge Section 107 and found that the case should not be dismissed. Section 107 and its predecessors have been in the Code since 1921 when it declared that church provided parsonages or rectories were not income to the pastor. In 1954, Section 107(b) was added to permit churches to give Pastors’ a housing allowance to permit them to live somewhere other than a parsonage. In other words, this saved churches the cost of having to maintain parsonages and allowed states to tax the real estate lived in by the Pastor. Until this ruling no successful challenge has been mounted against Section 107. However most of those cases failed because the Courts ruled that the person bringing the suit did not have standing. See Warren v. CIR 302 F 3d 1012 (9th Cir., 2002); Kirk v. CIR 425 F 2d 492 (DC, 1970). In the Wisconsin case two officers of the FFRF the United States because they couldn’t exclude their specified housing allowance from income. Thus, they had standing because they suffered from this “discrimination” more than the general public. Judge Crabb did some handstands to find that they had standing since she did not deal with the Anti-injunction Act nor did she deal with the Declaratory Judgment Act issues in such a suit. Instead, these taxpayers standing should have been predicated upon whether or not they were owed a refund of tax for not permitting them a housing allowance. The Court did not address this, and that may be this case’s fatal flaw. Had the Court addressed that issue, it could have then moved to the Constitutional issues involved. Interestingly enough this law has been around for 90 years and this is the first Court to rule that the law is unconstitutional. Now the question becomes whether or not the Obama Administration and its Justice Department choose to defend the law on appeal as they refused to do in the DOMA case. If they do not, this ruling will stand, but it will only impact taxpayers in the Western District of Wisconsin. As a practical matter until the IRS comes out with guidance pastors will still be able to exclude such allowance since those pastors were not made parties to the lawsuit.
So, you get a bill from the IRS and the IRS is demanding payment from you. You don’t understand the bill, what is your next step? (1) Call IRS and ask for them to send or fax to you a copy of their calculation so that you can compare that to your records. There is an anecdotal story (which is legendary and may not be true) about a person who worked at one of the Service Centers and decided that if people received a small bill from the IRS, they’d just pay it and this would help balance the budget. A number of these bills by legend went out and were paid, but one citizen called and asked for a calculation. After much frustration, the discovery was that there no calculation and the bill was rescinded. The story goes that no one knows how many of those fake bills really went out. So, if you don’t understand a bill from the IRS call them and get a description of the reason for the bill. 9 out of 10 times it is correct. So, after you get the bill, and determine if its correct, what should you do. If they sent you a bill because you did not file a return, prepare a return and file it with correct information. Then wait tor the revised bill. Either way, if a bill comes, DON’T IGNORE IT. The IRS will not go away simply because you put your head in the sand, they will continue to seek payment. Your first option is to start making monthly payments to them voluntarily without a plan. Many times collections will not attempt sterner actions if they see a steady payment coming in. Another is to set up a payment plan with them. If you do that, you’ll find that they will actually leave you alone for a couple of years. If you are cash strapped and can’t even afford a payment plan, then you can ask them to put you in the currently non-collectible category. Normally this is not granted unless you are retired or living on a fixed income and your expenses reasonable and your assets near zero. Lastly, you can make an Offer in Compromise. They are difficult to get approved. We’ll talk about those.