Vince Nardone: Tax and Controversy

Update on Estate Taxes

Guest Author Pilar Puerto discusses Estate Taxes:

 

On December 3, 2009, the house approved H.R. 4154, which would make the current estate, gift, and generation skipping transfer (GST) tax laws permanent.  As background, under the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), the estatetax was scheduled to be gradually phased out by increasing the applicable exemption amount each year up to $3.5 million in 2009 and then repealing in 2010. It is now the end of 2009 and unless Congress passes another act, in 2011 the estate tax provisions will revert to pre-2001 law. This would mean decreasing the unified credit exemption amount for estate tax purposes from the current $3.5 million to $1 million. But, lately there has been much debate and action in Congress for the passing of an estate tax bill.  And, up to this point there has been much speculation and uncertainty as to what the estate tax laws would look like.  But, now with the house’s approval of H.R. 4154 we have a better picture of what the future holds.

 

H.R. 4154 would make permanent the current unified credit effective exemption amount of $3.5 million for estate tax purposes to apply to estates of decedents dying during 2010 and later years. As to gift taxes, the unified credit effective exemption amount would remain at $1 million. And, the highest estateand gift tax rate would be 45%. The GST tax exemption would equal the unified credit effective exemption amount for estate tax purposes and be determined using the highest estate and gift tax rate. 

Considering the high exemption amounts, H.R. 4154 would make it so that only a small percentage of Americans need to worry about paying federal estate tax.  In general, estates are only subject to federal estate tax if they exceed the applicable exclusion amount. For example, under 2009 law only if a decedent’s taxable estate is over $3.5 million—after taking into consideration the unlimited marital deduction—will the decedent’s estate be subject to federal estate tax. Since H.R. 4154 would maintain the applicable exemption amount at $3.5 million, only the most fortunate of Americans need to be concerned about the estate tax.

 

There have been discussions among policy makers, however, on the effects that the estate tax may have on small family businesses, in particular farms.  The argument among these policy makers is that since most of the value of these family businesses is held in illiquid assets, these businesses would be forced to liquidate vital assets just to pay the federal estate tax. But, these concerns are not applicable to most family businesses. A recent report by the Congressional Research Service (CRS) shows that only a small fraction of estates with small or family business interests have paid the estate tax—about 3.5% for businesses in general, and 5% for farmers, compared to 2% for all estates.  CRS also reports that less than ½ of 1% of family-owned businesses that are subject to the estate tax “do not have readily available resources to pay the tax.” Therefore, even if there is a considerable burden on small businesses, this burden only applies to small percentage of these businesses. (RL33070 - Estate Taxes and Family Businesses: Economic Issues)

In sum, it looks like the future will continue to be the same as it is today.  That is, we will have high unified credit exemption amounts that will in turn exclude most estates from having to pay estate tax.  In turn, many will not need to worry about utilizing complicated devices in their estate plan for purposes minimizing the impact of the estate tax on their estates.

See the CRS study attached and the bill.Download Estate Tax - December 2009

Download Legislation - CRS Report

Internal Revenue Service, Office of Professional Responsibility Announces Enforcement Actions

In Announcement 2009-68, the Office of Professional Responsibility (OPR) published its recent disciplinay sanctions involving attorneys and certified public accountants.  These individuals are subject to the regulations governing practice before the Internal Revenue Service (IRS), which are set out in Title 31, Code of Federal Regulations, Part 10, and which are published in pamphlet form as Treasury Department Circular No. 230. The regulations prescribe the duties and restrictions relating to such practice and prescribe the disciplinary sanctions for violating the regulations.  These announcements continue to emphasize the Internal Revenue Service’s commitment to the oversight of tax professionals.  Please see the announcement attached to this blog entry.

Download OPR - announcements

Intangibles - Some may be like-kind for Section 1031

In representing professional practices, the issue of treating goodwill and going-concern value of a practice as like-kind property for purposes of Section 1031 commonly comes up.  But, the IRS has consistently held that goodwill and going-concern value of one practice is not like-kind for purposes of another practice.  The IRS has, however, recently changed its mind when it comes to certain other intangibles, such as trade names.

In Chief counsel advice, CCA 200911006, the IRS concludes that intangibles such as trademarks, trade names, mastheads, and customer-based intangibles that can be separately described and valued apart from goodwill qualify as like-kind property under Section 1031 (assuming the other requirements of Section 1031, including the nature and character rules of Reg. 1.1031(a)-2(c)(1), are met).  Thus, an exchange of these intangible assets can qualify for deferral of gain. This determination supersedes an opposite conclusion in TAM 200602034.

See the CCA attached to this article.  Download Article - Intangibles and like-kind exchange

IRS - Announces Leading Scams for Taxpayers to Avoid

The Internal Revenue Service recently posted its yearly list of scams for taxpayers to avoid.  The IRS calls it their "Dirty Dozen."  I have attached the list below.  The IRS announced that "Taxpayers should be wary of scams to avoid paying taxes that seem too good to be true, especially during these challenging economic times."  This is good advice from the IRS.  I have dealt with a number of clients that come to me and say: my prior tax attorney or my current tax return preparer told me that I can do...  But, when you look at the advice given, you have the following thoughts: (i) the client is not giving you the full story as to the advice; (ii) the client did not give the person providing the advice the whole story; (iii) something in between (i) and (ii) is true; or finally (iv) the person providing the advice truly believes what was articulated to me by the client.  Most of the time, the truth falls somewhere between (i) and (iii).  But, there are those rare occasions where someone is trying to scam the IRS and the taxpayers must be aware of them, and use common sense.  As the IRS said, if it is too good to be true, then it is too good to be true.  Seek compentent advice from someone that other professionals advise you to use.

Download Beware of IRS’ 2009 “Dirty Dozen” Tax Scams - April 20, 2009

  

IRS Announces Voluntary Disclosure for Unreported Offshore Income

On March 26, 2009, the Internal Revenue Service announced a voluntary disclosure program for unreported offshore income.  Tax professionals have been calling for and asking the IRS to institute this program for some time.  In practice, you find two type of people that have this offshore income: (i) one that says I have it and I am not going to disclose it and (ii) the other that says I have it and I want to disclose it but I am very concerned about the penalties, interest, and criminal exposure.  This program will not help the first person, who is likely always willing to violate the law to better their financial situation.  But, for those people that want to come in from the cold and correct their prior misfilings, this program is a good option and something that we can certainly help them with.

The IRS has indicated that for those people that voluntarily come forward to get right with the government each of those people will get a fair settlement.  The IRS had indicated that it will set up a penalty framework that makes sense for everyone involved.  Now, to be clear, what the IRS sees as being fair and making sense, is not always consistent with what taxpayers believe is fair or make sense.  As an example, the IRS made clear that taxpayers that come forward will have to: (i) pay back taxes and interest for six years; (ii) pay either an accuracy or delinquency penalty on all six years; as well as (iii) a penalty of twenty percent of the amount in the foreign bank accounts in the year with the highest aggregate account or asset value.   The trade off for paying the taxes, interest, and significant penalties for the six years is you can avoid criminal prosecution.  Is this fair and does it make sense, it depends. 

From my perspective, it is a good deal.  Anytime you can pay a monetary penalty to avoid going to prison for your prior misdeeds, it is a good result.  But, you need to come forward and deal with it now.  For taxpayers who continue to hide their heads in the sand, the IRS will come down hard on them.

See the attached documents from the IRS regarding more details on the voluntary disclosure program.

Download Offshore voluntary disclosure program

IRS Continues its Assault on Questionable Return Preparers!

The IRS issued a new release today regarding tips to consider before choosing a tax-return preparer.  But, what this release really represents is the Service's request for taxpayers to turn in their tax-return preparers for suspected fraud issues.  They discuss what taxpayers should be looking for and then provide the links on how to make a fraud referral.  I ask you, whose interest are they concerned about?  Ultimately, as a tax-return preparer you must be very careful these days in representing clients.

See the attached news release.Download IRS - tax return preparer

Practices that Operate as a Single Member Limited Liability Company and Employment Taxes

I recently wrote the article below for Zimmerman Boltz & Co. as it relates to Dental Practices, but it certainly applies to other single member LLCs as well.

For wages paid on or after January 1, 2009, Single Member Limited Liability Companies (“SMLLCs”) that have not elected to be treated as corporations are required to change the way they report and pay federal employment taxes and wage payments.  SMLLCs that have employees, are disregarded for tax purposes, and that elected to report and pay employment taxes under the sole members taxpayer identification number must now report and pay all employment taxes under the SMLLCs employer identification number.

Background on Limited Liability Companies

A Limited Liability Company (LLC) is a relatively new business structure for dental practices.  Most states today allow professional practices, including dental practices, to operate as LLCs.  LLCs are popular because, similar to a corporation, owners have limited personal liability for the debts and actions of the LLC. Other features of the LLC are more like a partnership in that it provides management flexibility and the benefit of pass-through taxation.  Owners of an LLC are called members.  There is no maximum number of members. And, most states also permit SMLLCs.

Over the years, however, there has been some confusion regarding the taxation of SMLLCs as to how they report and pay employment taxes.  The main cause of the confusion, of course, is the IRS.  When the states created the LLC as a new form of business entity, the IRS did not create a new tax classification for the LLC.  Rather, the IRS used the tax entity classifications it has always had for business taxpayers: (i) corporations, (ii) partnerships, and (iii) sole proprietorships.  An LLC is always classified by the IRS as one of these types of taxable entities.

Tax Treatment of a Limited Liability Company

A SMLLC can be taxed as either a corporation or a single member disregarded entity.  A SMLLC cannot be a partnership because a partnership requires two or more members.  To be treated by the IRS as a corporation, the SMLLC has to file Form 8832 and elect to be classified as a corporation.  An SMLLC that does not elect to be a corporation will be classified by the IRS as a disregarded entity, which is taxed as a sole proprietor for income taxes.  That is, all the tax attributes such as income, loss, credits, and deductions flow up to and are reported on the single member’s federal income tax return.  As an example, if the single member is an individual, then the tax attributes of the SMLLC are reported on the individual member’s Form 1040 schedule C.  The individual owner is then treated as a sole proprietorship for federal income tax purposes, and the owner is subject to taxes under the Self-Employment Contributions Act (SECA).  The confusion in this area arises in determining how to report and pay the employment taxes for a SMLLC that is a disregarded entity.  In 1999, the IRS issued Notice 99-6, which is effective through December 31, 2008 and is obsolete as of January 1, 2008.  Notice 99-6 gave the SMLLC classified as a disregarded entity two options for reporting and paying employment taxes:

1.      Use the EIN assigned to the LLC, or

2.      Use the name and taxpayer identification number (“TIN”) of the single member owner, which is usually an individual and thus the individual’s social security account number.

Under Notice 99-6, even if the employment tax obligations are reported using the SMLLC’s EIN, the single member owner retains ultimate responsibility for collecting, reporting, and paying over the employment taxes.

Recent Employment Tax Law Changes

In August 2007, regulations were issued requiring SMLLCs to use the practice’s EIN—thereby eliminating the SMLLC’s option to use the single member owner’s TIN.  The SMLLC will continue to be disregarded for other federal tax purposes, including income tax.  This change will begin for employment taxes that accrue after January 1, 2009.  The new regulations state that the LLC, not its single owner, will be responsible for filing and paying all employment taxes on wages paid on or after January 1, 2009.  The regulation changes are not retroactive. The owner of a disregarded entity remains responsible for paying employment taxes on wages paid before January 1, 2009.

The examples in the regulations clarify the treatment of a disregarded entity for purposes of employment tax on wages paid on or after January 1, 2009.

1.      LLC A is an eligible entity owned by individual A and is generally disregarded as an entity separate from its owner for federal tax purposes.  But, effective January 1, 2009 LLC A is now to be treated as an entity separate from its owner for purposes of employment taxes. Thus, if LLC A has employees it must pay the employees’ wages, as defined in Internal Revenue Code (IRC) Sections 3121(a), 3306(b), and 3401(a) and withhold the required taxes.

2.      LLC A is an employer and is subject to all provisions of law and regulations, including penalties that apply to employers.  Thus, LLC A is liable for income tax withholding, Federal Insurance Contributions Act (FICA) taxes, and Federal Unemployment Tax Act (FUTA) taxes under IRC Sections 3402, 3403, 3102(b), 3111, and 3301, respectively. LLC A must file the applicable employment tax forms, such as Form 941, Employer’s Quarterly Employment Tax Return, Form 940, Employer’s Annual Federal Unemployment Tax Return; file Forms W-2 with the Social Security Administration and furnish them to LLCA’s employees, and make timely employment tax deposits.

3.      A is not, however, an employee of LLC A for purposes of employment tax because LLC A is treated as A’s sole proprietorship for income tax purposes.  A is self-employed for purposes of the tax on self-employment income. This means that A is subject to tax under IRC Section 1401 on his net earnings from self-employment with respect to LLC A’s activities. As a sole proprietor, A is entitled to deduct trade or business expenses paid or incurred through LLC A’s activities, including the employer’s share of employment taxes imposed under sections 3111 and 3301, on A’s Form 1040, Schedule C, Profit or Loss for Business (Sole Proprietorship).

These changes in the regulations do not change income tax treatment for a disregarded entity or other LLCs, or employment or excise tax treatment for LLCs classified as partnerships or corporations.

Required Action

1.      If your practice is impacted by the employment tax changes discussed above and you do not have an EIN, then the practice will need to obtain one.

2.      An LLC applies for an EIN by filing Form SS-4, Application for Employer Identification Number, and completing lines 8 a, b, and c.

3.      A SMLLC that is a disregarded entity and does not have or will not have employees does not need an EIN.  It should simply use the name and TIN of the single member owner for federal tax purposes.

If a SMLLC, whose taxable income and loss will be reported by the single member owner, desires to obtain an EIN even though the SMLLC has no employees, it will not use the EIN for any federal tax reporting purposes.

Theft Loss – Taxpayer Fails to Establish State Law Theft to Support Theft Loss Deduction

The case of Electronic Picture Solutions, Inc. v. Commissioner, (2008) TC Memo 2008-212, 2008 RIA TC Memo ¶2008-212 ) reminds taxpayers and their professionals that to obtain a theft loss under the Internal Revenue Code you must first establish that a theft occurred under the applicable state law.  In Electronic Picture, the Tax Court denied the taxpayer's claim for a theft loss deduction relating to a stock investment and alleged defrauding by a broker.  According to the court, the taxpayer's fraud allegations failed to meet the operative California law theft definition.  The court found that the alleged theft lacked any proof that the broker held some guilty knowledge or made false representations with intent to deceive the taxpayer. Further, regardless of the broker’s intent, the taxpayer failed to present the necessary evidence that the broker actually defrauded the taxpayer or actually misappropriated the taxpayer's property.

These findings were determinative of the case because under federal tax law the court reiterated that Section 165(a) permits a deduction against ordinary income for “any loss sustained during the taxable year and not compensated for by insurance or otherwise.”  The court went onto say that any loss arising from theft is treated as sustained during the taxable year in which the taxpayer discovers the loss. Sec. 165(e).  But, the taxpayer, has the burden of proving it has sustained a theft loss. 5 See Rule 142(a); Welch v. Helvering, 290 U.S. 111 (1933).  According to the court, whether a theft loss has been sustained depends upon the law of the State where the loss was sustained.  Bellis v. Commissioner, 540 F.2d 448, 449 (9th Cir. 1976), affg. 61 T.C. 354 (1973); Luman v. Commissioner, 79 T.C. 846, 860 (1982); Paine v. Commissioner, 63 T.C. 736, 740 (1975), affd. without published opinion 523 F.2d 1053 (5th Cir. 1975).

It is important for practitioners to plan ahead and ensure as part of filing a return that the taxpayer’s document the necessary facts to support a position taken on a return, in this instance, a theft loss deduction. 

Download electricpicture_theft_loss.pdf

IRS Loses another Case Dealing with Medical Residents and FICA Tax

In Center for Family Medicine v. U.S., 102 AFTR 2d ¶2008-5152 (DC SD 8/6/08), a district court ruled on summary judgment that stipends paid to medical residents were not subject to FICA tax under the Internal Revenue Code Section 3121(b)(10), which represents the FICA student exemption.  The district court also held, however, that head residents, who stayed on after completing their residency to administer the programs, were not eligible for the FICA student exemption.

It is important to note that the district court case does not impact the income tax aspects of medical residents' stipends, only the FICA taxes.  FICA refers to the Federal Insurance Contributions Act that imposes two taxes: (i) the Old Age, Survivors and Disability Insurance tax (OASDI) and (ii) the Medicare/Hospital Insurance tax (HI).  The taxes finance benefits under the Social Security Act.  The FICA taxes are based upon “wages” paid with respect to “employment,” OASDI is at 6.2% of wages with certain limitations and the HI is at 1.45%.  Section 3121(b)(10), however, provides an exemption from FICA taxes for services performed in the employ of a school, college, or university “if such service is performed by a student who is regularly enrolled and regularly attending classes at” such an institution.  For the years at issue in the Center for Family Medicine case, in a version of the regulations that have since been amended, treasury regulation section 31.3121(b)(10)-2(c) provided for an analysis of the facts and circumstances in a particular situation to determine whether an institution was a “school, college, or university” for purposes of the student FICA exemption.

For more detail, see the case below.  Download fica_tax_medical_resident_case.pdf