Vince Nardone: Tax and Controversy

How the Multistate Tax Commission’s Guidance on Public Law 86-272 in the Aftermath of South Dakota v. Wayfair Frustrates the Law’s Fundamental Purpose

Public Law 86-272—enacted by Congress more than 50 years ago—protects purely interstate businesses from net income taxes imposed by states where the interstate business’s only connection with the state is soliciting orders for tangible personal property. But in the aftermath of South Dakota v. Wayfair, 585 U.S. ___, 138 S. Ct. 2080 (2018)—a Supreme Court decision that applied only to the imposition of sales taxes on interstate businesses—the Multistate Tax Commission (the “Commission”) has given states the green light to aggressively pursue net income taxes from purely interstate businesses. And, in the process, ignore Public Law 86-272’s fundamental purpose.

1. The Multistate Tax Commission.

To better understand how to respond to state taxing authorities’ and the Commission’s attack on Public Law 86-272, it is helpful to understand the Commission’s history. The Commission is a multi-state agency that attempts to promote uniformity in state tax laws. The Commission was formed in 1966, and its formation was a response to the passage of Public Law 86-272. See U.S. Steel Corp. v. Multistate Tax Comm’n, 434 U.S. 452, 455 (1978).

In 1959, Congress passed Public Law 86-272 to set forth minimum standards for states’ exercise of their taxing power over interstate businesses. Following the passage of Public Law 86-272, the administrators of several state taxing authorities drafted the Multistate Tax Compact, which formed the Commission and charged the Commission with promoting uniformity and assisting states in implementing tax laws and collecting taxes. But, clearly, the Commission’s formation in response to the passage of Public Law 86-272 suggests a deep bias against interstate businesses that seek the law’s protection.

Importantly, the Commission’s actions are advisory only. And, the Commission’s guidance is only binding in states that expressly adopt the Commission’s guidance.

2. The Commission’s Guidance.

Public Law 86-272 insulates specific activities from interstate taxation, and in the wake of Wayfair, the Commission’s guidance provides a list of internet-based activities that it considers protected and unprotected by Public Law 86-272. See Multistate Tax Commission, Statement of Information Concerning Practices of Multistate Tax Commission and Supporting States Under Public Law 86-272, 4 (2021).

In the Commission’s view, if a business’s website presents static text or photos, the presentation does not in itself constitute a business activity within the states where customers are located because there is no interaction with customers in the taxing state. Id. at 8. Similarly, the Commission states that posting static FAQs does not defeat the Public Law 86-272 immunity. And, placing Internet “cookies” onto in-state customers’ computers does not defeat the business’s Public Law 86-272 immunity when the cookies are used to gather information that is used only for purposes entirely ancillary to the solicitation of orders. Id. at 9.

But, the Commission suggests, Public Law 86-272 immunity is defeated if a website places cookies onto in-state customers’ computers to gather customer search information that is used to adjust production schedules, develop new products, or identify new items to offer for sale. Id. Handling customer service requests via instant messenger and email, according to the Commission, also defeats Public Law 86-272 immunity. The Commission reasoned that instant messaging and email occur within the customer’s state because the seller’s website or email transmits software or code to the user’s computer to facilitate the interaction. See Summary of March 28, 2019 teleconference (Apr. 9, 2019) Memorandum of Members of P.L. 86-272 Work Group.

Basically, the Commission’s guidance says that any modern interstate business that conducts any business activities over the internet is not protected by Public Law 86-272. But the Commission’s guidance—which does not carry the force of law—loses track of Public Law 86-272’s fundamental purpose.

3. The Commission’s Guidance Frustrates Public Law 86-272’s Fundamental Purpose.

The fundamental purpose of Public Law 86-272 is creating certainty and predictability for interstate businesses and providing better outcomes for interstate consumers. Congress’s primary goal was to “define clearly the lower limit” of state taxing power, and “provide clarity that would remove the uncertainty” created by prior Supreme Court decisions. Wisconsin Dept. of Rev. v. Wm. Wrigley, Jr., Co., 505 U.S. 214, 221-23, 112 S. Ct. 2447 (1992) (citing Heublein, Inc. v. South Carolina Tax Comm’n, 409 U.S. 275, 280, 93 S. Ct. 483 (1972)).

The Commission’s guidance frustrates Public Law 86-272’s fundamental purpose because it reduces certainty about interstate income tax liability. And the reduced certainty may lead to worse outcomes for consumers of products produced and sold in interstate commerce because many interstate sellers will shut down online chat support and email functionality—which consumers now rely on—to insulate themselves from net income taxes in aggressive tax jurisdictions. Consumers will lose the benefits of technological progress and free markets that Public Law 86-272 was enacted to protect. The Commission’s guidance has lost sight of Public Law 86-272’s fundamental purpose and may produce worse outcomes for both businesses and consumers.

As aggressive state taxing authorities continue attempts to expand their taxing power at the expense of clarity and certainty, we will continue to work with businesses to protect themselves—and their consumers—from government overreach.

---

Vince Nardone

Vince serves as a business advisor to owners and executives of closely-held businesses by counseling them on business planning, tax planning and controversy, mergers and acquisitions, succession planning, and legal issues that may arise in business operations.

 

Mike Sorice

Mike advises middle-market business owners on matters of business and management succession. He provides corporate and partnership tax advice to business owners and in-house accounting departments about federal income tax, state and local income tax, sales taxes, and excise taxes. In addition, Mike has represented taxpayers before the Internal Revenue Service and Ohio Department of Taxation related to federal, state, and local tax obligations.

Vince Nardone Discusses Ethics in Tax Practice at The Ohio Society of CPAs MEGA Tax Conference

 

 

 

 

On Wednesday December 14th, Vince Nardone discussed ethics in Ohio tax practice at The Ohio Society of CPAs MEGA Tax Virtual Conference.

During his presentation, Vince tackled the numerous considerations for having an ethics discussion as a CPA, the importance of understanding yourself and understanding your clients, as well as statutory and regulatory requirements and environment as a tax-return preparer. He then focused on the importance of best practices and identifying pitfalls to minimize disruptions within a tax practice.

The Ohio Society of CPAs is the #1 provider of CPE for Ohio CPAs year after year, and the MEGA Tax Conference is always an excellent opportunity for CPAs to learn about the latest advancements on a variety of essential topics in the industry. We want to thank Amber McAuliffe and the rest of the team at The Ohio Society of CPAs for inviting Vince to participate. There is no better group to work with, talk with, or be involved with. As Vince always says: “you become who you hang around” and there is no better group to hang around.

 

Public Law 86-272 in the Aftermath of South Dakota v. Wayfair

The Interstate Income Act of 1959, 15 U.S.C. § 381, Pub. L. 86-272 (“Public Law 86-272”) prohibits states from imposing a net income tax on income derived from interstate commerce if the interstate business’s only business activity within the state is the solicitation of orders for tangible personal property. The orders must be sent outside the state for approval or rejection and, if accepted, the orders must be filled from a point of shipment outside the taxing state. If the interstate business does more than solicit orders, then Public Law 86-272’s protections do not apply.

Public Law 86-272 has long frustrated state taxing authorities’ desire to tax all aspects of interstate commerce. And, in the aftermath of South Dakota v. Wayfair, Inc., 585 U.S. ___, 138 S. Ct. 2080 (2018), state taxing authorities have become more aggressive in applying their taxing statutes to interstate businesses.

1. Public Law 86-272’s Fundamental Purpose.

Public Law 86-272’s fundamental purpose is creating certainty and predictability for interstate businesses, and providing better outcomes for interstate consumers. Public Law 86-272 was enacted soon after the U.S. Supreme Court’s decision in Northwestern States Portland Cement Co. v. Minnesota, 358 U.S. 450, 79 S. Ct. 357, 359 (1959), in which the Supreme Court concluded that a state could constitutionally tax the net income of an interstate business. The Supreme Court’s decision in Northwestern States raised concerns that its broad language might ultimately be read to suggest that a company—whose only contacts with a state consisted of sending salesmen into that state—could lawfully be subjected to income taxation based on the interstate sales the salesmen generated. Wisconsin Dept. of Rev. v. Wm. Wrigley, Jr. Co., 505 U.S. 214, 220, 112 S. Ct. 2447 (1992).

In response to the business community’s concerns about the uncertainty created by Northwestern States, Congress enacted Public Law 86-272. Wrigley, 505 U.S. at 221. Congress’s primary goal was to “define clearly the lower limit” of state taxing power and “provide clarity that would remove the uncertainty” created by Northwestern States. Id. at 221-223 (citing Heublein, Inc. v. South Carolina Tax Comm’n, 409 U.S. 275, 280, 93 S Ct. 483 (1972)).

2. The Wayfair Decision.

In prior decisions, the Supreme Court held that an out-of-state seller’s liability to collect and remit sales tax to the consumer’s state depended on whether the seller had a physical presence in the consumer’s state. See e.g., National Bellas Hess, Inc. v. Dept. of Rev. of Ill., 386 U.S. 753 (1967); Quill Corp. v. North Dakota, 504 U.S. 298 (1992).

In Wayfair, the Supreme Court overturned 50 years of settled precedent and held that an out-of-state seller’s obligation to collect sales tax liability does not require physical presence. In fact, the physical presence requirement became increasingly artificial as e-commerce developed. According to Wayfair, an out-of-state seller with a website accessible in a consumer’s state could reasonably be said to have physical presence in the consumer’s state because it leaves cookies—computer files that track consumers’ information—saved on consumers’ hard drives. Wayfair, Slip Op. at 15.

In any case, because of “dramatic technological and social changes” brought about by the internet, out-of-state sellers can be meaningfully connected to a consumer’s state even in the absence of physical presence. Id. Thus, under Wayfair, out-of-state sellers are liable to collect and remit sales tax to a consumer’s state as long as the seller is meaningfully connected to the state.

Importantly, the Wayfair decision concerned only the liability of out-of-state sellers to collect and remit sales tax to a consumer’s state. It did not address the liability of interstate businesses under any other kind of tax. It specifically did not address the application of a net income tax, and the protections of Public Law 86-272.

3. Multistate Tax Commission Guidance.

Following the U.S. Supreme Court’s decision in Wayfair, the Multistate Tax Commission (the “Commission”) issued guidance to its members about the Wayfair decision’s effect on Public Law 86-272 The Commission’s guidance interprets the Wayfair decision to narrow the scope of protection for interstate sellers under Public Law 86-272.

Even though the Wayfair decision does not apply to net income taxes and did not address Public Law 86-272, the Commission used Wayfair to justify narrowing the protections of Public Law 86-272. According to the Commission’s guidance, when a business interacts with customers via the business’s website or app, the business engages in a business activity within the customer’s state that goes beyond the solicitation of orders. And, therefore, the business is not protected by Public Law 86-272.

4. Actions of State Taxing Authorities.

Following the Wayfair decision and the Commission’s new guidance on Public Law 86-272, state taxing authorities—including the Ohio Department of Taxation—are aggressively pursuing interstate businesses for net income taxes. For example, Ohio imposes a net income tax on the owners of pass-through entities doing business in Ohio (the “Pass Through Entity Tax”). Under Public Law 86-272, Ohio could not legally impose the Pass Through Entity Tax on interstate businesses whose only business activities in Ohio are the solicitation of orders for tangible personal property. But, the Commission’s guidance has emboldened Ohio and other states to ignore the critical protections of Public Law 86-272 and improperly impose the Pass Through Entity Tax on protected interstate businesses.

As business and tax attorneys and advisors, we know the critical legal and public policy arguments that interstate businesses must make to protect themselves from aggressive state taxing authorities. And in an upcoming blog post, we will go deeper into the Multistate Tax Commission’s guidance and explain how the Commission’s guidance frustrates the fundamental purpose of Public Law 86-272.

The Commission’s guidance is available here.

---

Vince Nardone

Vince serves as a business advisor to owners and executives of closely-held businesses by counseling them on business planning, tax planning and controversy, mergers and acquisitions, succession planning, and legal issues that may arise in business operations.

 

Mike Sorice

Mike advises middle-market business owners on matters of business and management succession. He provides corporate and partnership tax advice to business owners and in-house accounting departments about federal income tax, state and local income tax, sales taxes, and excise taxes. In addition, Mike has represented taxpayers before the Internal Revenue Service and Ohio Department of Taxation related to federal, state, and local tax obligations.

An Ounce of Prevention: Keeping Up with Physicians’ and Dentists’ Use Tax Obligations

State and local taxing authorities are stepping up their enforcement of medical and dental professionals’ use tax obligations. Medical and dental practices that do not properly report and pay applicable use taxes—or keep proper records of payment—risk sales and use tax audits that can create significant tax liabilities, along with substantial penalties and interest. For physicians and dentists to meet their use tax obligations and avoid a sales and use tax audit, an ounce of prevention truly is worth a pound of cure.

1. Use Tax Obligations

Most states impose use taxes that create obligations for physicians and dentists. For example, the state of Ohio imposes a tax on the storage, use, consumption, or benefit received in Ohio of goods and taxable services (the “use tax”). The use tax does not apply if sales tax has already been paid in Ohio. And if sales tax has been paid in another state, then the use tax only applies to the extent the use tax is higher than the sales tax paid in the other state.

Use tax is ordinarily collected the same way as sales taxes. Buyers of goods or taxable services are ultimately responsible for paying applicable use tax. But, the sellers of goods and taxable services must register with the Department of Taxation (the “Department”) and collect, pay, and file use tax returns. Both buyers and sellers have use tax obligations. But what if the seller does not properly collect, report, and remit applicable use tax?

Of course, the use tax statutes and regulations provide the answer. The buyer of taxable goods and services is ultimately responsible for the applicable use tax. So, if the seller does not collect applicable use tax from a buyer, then the buyer must file a monthly use tax return and pay use tax to the Department. Buyers who fail to report and pay applicable use tax are liable for the tax, substantial penalties, and interest that accrues on the unpaid amount of the tax until the buyer pays the tax or the Department issues a tax assessment.

How do medical and dental practices run afoul of state taxing authorities? The practices purchase medical and dental supplies and equipment from suppliers and one of two things happens: (1) either the equipment supplier does not collect the applicable sales and use taxes—and the practice does not pay the tax, or (2) the supplier collects the sales and use taxes and the practice pays, but the practice does not keep good records of taxes it paid. Either way, the state taxing authorities audit the practice’s sales and use tax returns—or lack thereof—and assess significant use tax liabilities against the practices.

2. An Ounce of Prevention

How can medical and dental practices avoid these substantial tax liabilities? Keep meticulous records of every purchase, and work with experienced accountants to determine whether the practice paid the applicable sales and use taxes.

If the practice paid the applicable tax, then keep records of the payment and be ready to present those records to the state taxing authority when an audit happens. If the practice did not pay the applicable tax—for whatever reason—then file the monthly use tax return and pay the applicable use tax when due.

Physicians and dentists who do everything right can still find themselves on the wrong side of an audit. But keeping accurate records and filing and paying use tax returns when due puts medical and dental practices in the best position to get through a sales and use tax audit.

3. A Pound of Cure

Physicians and dentists must prioritize patient care. But in prioritizing patient care, medical and dental practices can overlook their use tax obligations. Overlooking use tax obligations can result in an audit and assessments of tax, penalties, and interest. If you find yourself in a sales and use tax audit, it is critical to have the right legal and accounting team on your side to get you through the audit process with as little disruption as possible.

---

Vince Nardone

Vince serves as a business advisor to owners and executives of closely-held businesses by counseling them on business planning, tax planning and controversy, mergers and acquisitions, succession planning, and legal issues that may arise in business operations.

 

Mike Sorice

Mike advises middle-market business owners on matters of business and management succession. He provides corporate and partnership tax advice to business owners and in-house accounting departments about federal income tax, state and local income tax, sales taxes, and excise taxes. In addition, Mike has represented taxpayers before the Internal Revenue Service and Ohio Department of Taxation related to federal, state, and local tax obligations.

Tax Planning Opportunities are Available in Almost Every Business Transaction, Including When a Dispute Arises

As a business advisor and tax attorney representing businesses, we inevitably run into circumstances where we are advising businesses on disputes with third parties. Although we do our best to minimize disruption within the business—to ensure that we maximize profits—disputes will arise. And, in some instances, those disputes require us to pursue court intervention, mediation, or arbitration. Thus, during the normal course of any business operation, a business may find itself the recipient or payer in a settlement or judgment as a result of that court intervention, mediation, or arbitration.

Unfortunately, the federal tax implications of that settlement or judgment are often overlooked by the business owner/executive and the litigation/controversy attorney handling that dispute. The business generally just wants its pound of flesh, and the attorney usually just wants to “win.” But, what does all of that really mean? For both the payer and the recipient, the terms of a settlement or judgment may affect whether a payment is deductible or nondeductible, taxable or nontaxable, and its character—i.e., capital or ordinary—all of which may impact the perception of whether or not the settlement or judgement was a “win.” That perception and determination will likely come down to an analysis related to the “origin of the claim.”  

Origin of the Claim

Under the origin of the claim doctrine, the tax consequences of settlement proceeds are determined by the nature of the claim and the actual basis of recovery. According to the U.S. Supreme Court, courts must ask: In lieu of, what were the damages awarded? That is the U.S. Supreme Court’s mandated concept of the origin of the claim analysis. In United States v. Gilmore, the Court used this analysis to distinguish between deductible and nondeductible litigation expenses. Since Gilmore, courts have utilized the doctrine to determine whether proceeds from a lawsuit or settlement are taxable as ordinary income or as capital gain. As an example, an award for lost profits may be taxable as ordinary income, while an award for damage to an asset may be considered a return of capital to the extent of the basis in the asset, with the excess amount over basis treated as gain. Again, what is the origin of the claim?

Considerations Regarding Each Dispute

When we consult with business owners and executives on a potential dispute, we ask them to take into consideration a number of thoughts, including:

• What is the big picture here, recognizing that your decision today will ultimately determine your final destination, both personally and for the business?

• What may be the unintended consequences of that decision and resolution of that dispute?

• What will the cost be, both from an actual dollar amount, that of a relationship, as well as the potential of opportunity cost?

• What are the hazards of that dispute and chances of success?

• Is this all about principle?

• What is the likely outcome, in terms of the settlement or judgment, including the terms?

• And, how can we ensure that the final outcome is structured in the most tax-efficient manner?

Conclusion

In sum, there is a lot to consider in every dispute. Taxes are only one aspect of that dispute, although many times overlooked. The time to consider the tax consequences, as well as all other consequences, is before the dispute arises through court intervention, mediation, or arbitration. That is, waiting until the final determination of that dispute to consider the tax consequences will be too late. The ground work for the “origin of the claim” analysis will have already been decided. Therefore, while tax consequences may not be the final determining factor of whether a dispute should be pursued, it should be one of the factors considered, before you decide to pursue that dispute.

US Government, including Department of Justice and the IRS, Take Further Steps to Shut-Down Syndicated Conservation Easements.

Many weeks ago, I posted a blog addressing the abusive nature of syndicated conservation easements being peddled by certain professionals. See blog here. The government made it clear then, and made it clear again, that the Department of Justice and the IRS does not take kindly to professionals promoting certain conservation easement transactions that, according to the Department of Justice and IRS, are "abusive tax shelters lacking in economic substance or business purpose.” 

Recently, a federal grand jury sitting in Atlanta, Georgia, returned a superseding indictment charging seven individuals with conspiracy to defraud the United States and other crimes arising out of their promotion of fraudulent tax shelters involving syndicated conservation easements.

Vince Nardone Comment: This indictment includes CPAs, an attorney, and appraisers. It is a big deal. Advisors and taxpayers should pay attention, and take notice.

In fact, the Department of Justice stated that the scheme dates back nearly two decades and involved the alleged sale of more than $1.3 billion in "false and fraudulent tax deductions." According to the government, the seven indicted "engaged in a conspiracy to design, market and sell false and fraudulent charitable contribution tax deductions to high-income clients."

Two of the people "allegedly caused partnerships to donate conservation easements over land owned by the partnership," according to the Department of Justice’s release. They then allegedly used "two hand-picked appraisers … to generate fraudulent and inflated appraisals of the conservation easements that frequently valued the easements at amounts at least 10 times higher than the price that was actually paid for the partnership." The partnerships then claimed a tax deduction for a charitable contribution in the inflated amount of the conservation easement, resulting in a fraudulent deduction flowing to the clients who bought units in the partnership, the DOJ added.

The indictment makes it clear that the government believes the conservation easement transactions were "abusive tax shelters lacking in economic substance or business purpose." According to the government, attempts were made to disguise the transactions as real estate deals, but the deals were merely the illegal sale of inflated tax deductions.

I would encourage clients to read the full version of the indictment, and form your own opinion. And, as I will always say: It is proper and legal to plan for and participate in transactions that involve tax avoidance—as long as the transactions are motivated by a legitimate and substantial business purpose that includes economic substance. But, it is never proper to pursue transactions that involve tax avoidance, when the primary motive is tax avoidance, and the transaction itself lacks business purpose and economic substance. Why? Because, as the indictment makes clear, those transactions represent tax evasion, not tax avoidance. It is this simple: If it seems too good to be true, then it is too good to be true. Use your spider senses and stay away.

The DOJ indictment is available here: Download Indictment (04051846x9EF3B). 

Good Habits for Business Owners as We Begin 2022 “Avoid the IRS”

As a business advisor, tax attorney, and consultant that works with closely-held businesses, including doctors and dentists, as well as other high-income earning individuals, we are always thinking about the idea of continuous improvement. So, recognizing that it is the beginning of the year, and we are all trying to focus in on our habits, I thought a discussion about business practices and creating good habits would be a great discussion. Hopefully you do as well.

Background and Introduction

The idea here is: let’s focus in on the good habits that we can create over time, one step at a time, without setting ourselves up for failure, and without focusing on the bad habits that we have already established. So, here we go. As business owners we sometimes are overwhelmed by life and the busyness that surrounds us. And, when that happens, things around us fail to get done or are simply ignored. In fact, we may be really good at taking care of our customers, clients, or patients, but we fail to take care of our own “house.” One area where that occurs is on the tax side with individual business owners failing to pay their estimated taxes, other tax liabilities, or filing their tax returns. Have you ever received a letter like this from the IRS?

What is the Bad Habit?

If you have received one of these IRS notices, it is really important not to procrastinate and ignore it. In fact, before we can focus on establishing good habits, we need to address the current circumstances related to the IRS notice. That is the first step towards creating the good habit. Here are my thoughts:  

1. First of all, and most importantly, we want to avoid any sort of criminal enforcement action by Criminal Investigation. Criminal Investigation refers to the Internal Revenue Service’s arm that investigates and prosecutes individuals and businesses for the failure to file and failure to pay their individual income tax liabilities. That should be goal number 1.

2. Recognize and acknowledge that you need help and then reach out for that help.

3. Identify and work with a well-qualified tax attorney that focuses their practice in the area of tax controversy. And, recognize that just because someone calls them self a tax attorney does not necessarily mean that they have the appropriate experience. Ask questions and make an informed decision as to that particular professional.

4. Also, identify a well-qualified CPA and bookkeeper to assist with whatever task may be necessary for the preparation of and filing of the relevant delinquent tax returns.

5. Then, work with that well-qualified tax attorney, CPA, and bookkeeper to get into compliance, both from a tax filing and tax payment perspective.

6. Then, as a business owner, identify and put into place your best practices to minimize the disruption going forward and to ensure timely payment of all taxes and timely filing of all relevant tax returns, as discussed below—the good habit.

The Good Habit and Best Practices

For Attending to Our Tax Obligations

Those best practices for our closely-held business owners that operate their businesses are the following:

1. First of all, determine what your strengths and weaknesses are, and surround yourself with folks that complement both your strengths and weaknesses.
   1. One of the areas that I have found very helpful in determining our strengths and weaknesses is the Working Genius by Patrick Lencioni. I would encourage you to take this assessment. Please see the website link, which I have listed at the bottom of this blog article.
2. Second, form and establish a team of professionals that you work with both internally and externally. That team of professionals will vary depending upon your individual and business circumstances. But, it would generally include a financial advisor, CPA, business and tax attorney, and, potentially, a business consultant or coach.
3. Third, meet with your CPA, financial advisor, or business consultant on a monthly basis to discuss your key performance indicators within your business and your overall financial circumstances, including your monthly business financials.
4. Fourth, calculate and pay your estimated federal and state tax liabilities monthly.
   1. To be clear, do not meet on a quarterly basis; do it on a monthly basis. I know that you will hear from many advisors about meeting on a quarterly basis and paying your estimated tax payments on a quarterly basis. But, after working with business owners for over 22 years, I have found that cash flow is king. Cash flow is very important for those businesses, and the individual owners on the personal side. So, if we are managing and paying our estimates on a monthly basis, the cash flow is more consistent and we avoid surprises at the end of the year, or early next year.
   2. Do you know how many times I have heard a business owner say: I had no idea I was going to owe this much? My CPA never told me. Is it the CPA’s obligation to tell you, or your obligation to stay on top of your business and personal matters?
   3. Do not attempt to blame, justify, or make excuses for your actions or inactions. We avoid surprises by calculating those tax liabilities on a regular and continuous basis and paying those liabilities on a regular and continuous basis. Think monthly, not quarterly.
5. Fifth, be self-aware and listen to your team and professional advisors.
   1. Listen does not mean follow. It simply means listen, consider all the facts and circumstances, and then make an informed decision from there.
   2. But, be willing to scrutinize yourself and truly be self-aware. The more humble you are and the more open you are, the better you will be, the better those around you will be, and the better your business will perform.
   3. And, as I like to say: The Path We Choose Will Determine Our Final Destination. So, take your time, listen, and respond accordingly.
6. Finally, ask questions and be well-informed about your business, while delegating, not abdicating, to the appropriate team member or outside professional. And, recognize that simply because you delegated a certain task to another does not mean you do not have to oversee and ensure that the task gets done. It is your responsibility.

If you take these very simple but powerful steps, and consistently apply them going forward, not only will you never find yourself receiving that IRS notice again, you will find yourself with more time to focus on both your personal life and business matters. So, think about making changes and forming good habits, “Poco a Poco,” little by little.

If you have questions, feel free to contact me. You can find additional information on the home page of my personal website here.

See the Working Genius assessment here. I would encourage you to take the assessment. It is a good one.

Capital Gain Rates and Increase in Marginal Tax Rates Will Impact Our Doctors, Dentists, and Other Closely-Held Business Owners, if It Is up to Biden?

As a business advisor and tax planning attorney that works with closely-held businesses, including doctors, dentists, and other high-income earning individuals, I am receiving many questions about Biden’s tax proposals, including capital gains rates. I wanted to provide you an update on those tax proposals. Overall, however, it is important to recognize that these are simply proposals. I certainly would not make a business decision or plan a purchase, sale, or restructuring of a business, solely based upon these proposals. Yes, we should consider them. But, they are not currently law. Please note, this summary is based mainly on the General Explanations of the Administration’s Fiscal Year 2022 Revenue Proposals issued by the Department of the Treasury—commonly referred to as the: Green Book. Also, it is not a summary of all proposed changes. Rather, I have listed those proposals that I believe are the most impactful on what you do. So, here you go.

28 Percent Corporate Tax Rate

    Current Law

Income of a business entity can be subject to federal income tax in a manner that varies depending upon the classification of the entity for federal income tax purposes. Most small businesses are owned by individuals and taxed as “pass-through” entities, meaning that their income is passed through to their owners who are taxed under the individual income tax system. Most large businesses, including substantially all publicly traded businesses, are classified as “C corporations” because these corporations are subject to the rules of subchapter C of chapter 1 of the Internal Revenue Code (Code) and pay an entity-level income tax.

Additionally, taxable shareholders of such corporations generally pay federal income tax on most distributions attributable to their ownership in the corporation. This is where the concept of double taxation comes into play. If you recall, the Tax Cuts and Jobs Act of 2017 replaced a graduated tax schedule—with most corporate income taxed at a marginal and average rate of 35 percent—with a flat tax of 21 percent applied to all C corporations.

    Proposal

The proposal would increase the income tax rate for C corporations from 21 percent to 28 percent. The proposal would be effective for taxable years beginning after December 31, 2021. For taxable years beginning after January 1, 2021, and before January 1, 2022, the tax rate would be equal to 21 percent plus 7 percent times the portion of the taxable year that occurs in 2022.

Increase the Top Marginal Tax Rate for Individual and Fiduciary Taxpayers

    Current Law 

For taxable years beginning after December 31, 2017, and before January 1, 2026, the top marginal tax rate for the individual income tax is 37 percent. For taxable years beginning after December 31, 2025, the top marginal tax rate for the individual income tax is 39.6 percent.

For 2021, the 37 percent marginal individual income tax rate applies to taxable income over $628,300 for married individuals filing a joint return and surviving spouses, $523,600 for unmarried individuals—other than surviving spouses—and head of household filers, and $314,150 for married individuals filing a separate return.

    Proposal

The proposal would increase the top marginal individual income tax rate to 39.6 percent. This rate would be applied to taxable income in excess of the 2017 top bracket threshold, adjusted for inflation. In taxable year 2022, the top marginal tax rate would apply to taxable income over $509,300 for married individuals filing a joint return, $452,700 for unmarried individuals—other than surviving spouses—$481,000 for head of household filers, and $254,650 for married individuals filing a separate return. After 2022, the thresholds would be indexed for inflation using the C-CPI-U, which is used for all current tax rate thresholds for the individual income tax.

The proposal would be effective for taxable years beginning after December 31, 2021.

Increase Tax Rate on Capital Gains

    Current Law

Most realized long-term capital gains and qualified dividends are taxed at graduated rates under the individual income tax, with 20 percent generally being the highest rate—23.8  percent including the net investment income tax, if applicable, based on the taxpayer’s modified adjusted gross income.

    Proposal

Tax capital income for high-income earners at ordinary rates. Long-term capital gains and qualified dividends of taxpayers with adjusted gross income of more than $1 million would be taxed at ordinary income tax rates, with 37 percent generally being the highest rate—40.8 percent including the net investment income tax—but only to the extent that the taxpayer’s income exceeds $1 million—$500,000 for married filing separately—indexed for inflation after 2022.

This proposal would be effective for gains required to be recognized after the date of announcement. It appears that the "date of announcement" is April 28, 2021, the date that the Administration first detailed this proposal.

Accelerate Capital Gains on Gifts by Treating Transfers of Appreciated Property by Gift or on Death as Realization Events

    Current Law

Capital gains are taxable only upon realization, such as the sale or other disposition of an appreciated asset. When a donor gives an appreciated asset to a donee during the donor’s life, the donee’s basis in the asset is the basis of the donor; in effect, the basis is “carried over” from the donor to the donee. There is no realization of capital gain by the donor at the time of the gift, and there is no recognition of capital gain (or loss) by the donee until the donee later disposes of that asset. When an appreciated asset is held by a decedent at death, the basis of the asset for the decedent’s heir is adjusted (usually “stepped up”) to the fair market value of the asset at the date of the decedent’s death. As a result, the amount of appreciation accruing during the decedent’s life on assets that are still held by the decedent at death completely avoids federal income tax.

    Proposal

Treat transfers of appreciated property by gift or on death as realization events. Under the proposal, the donor or deceased owner of an appreciated asset would realize a capital gain at the time of the transfer. For a donor, the amount of the gain realized would be the excess of the asset’s fair market value on the date of the gift over the donor’s basis in that asset. For a decedent, the amount of gain would be the excess of the asset’s fair market value on the decedent’s date of death over the decedent’s basis in that asset. That gain would be taxable income to the decedent on the Federal gift or estate tax return or on a separate capital gains return. The use of capital losses and carry-forwards from transfers at death would be allowed against capital gains income and up to $3,000 of ordinary income on the decedent’s final income tax return, and the tax imposed on gains deemed realized at death would be deductible on the estate tax return of the decedent’s estate—if any.

Importantly, the gain on unrealized appreciation also would be recognized by certain trusts, partnerships, or other non-corporate entities in limited circumstances. There are numerous changes in the law that would be required under this proposal, which would be incorporated by regulations issued by Treasury. There is a more detailed discussion of these anticipated changes in the Treasury’s Green Book.

The proposal would be effective for gains on property transferred by gift, and on property owned at death by decedents dying, after December 31, 2021, and on certain property owned by trusts, partnerships, and other non-corporate entities on January 1, 2022.

Rationalize Net Investment Income (NII) and Self-employment Contributions Act (SECA) Taxes

    Current Law

Individuals with incomes over a threshold amount are subject to a 3.8 percent tax on net investment income. The threshold is $200,000 for single and head of household returns and $250,000 for joint returns. Net investment income generally includes (i) interest, dividends, rents, annuities, and royalties, other than such income derived in the ordinary course of a trade or business; (ii) income derived from a trade or business in which the taxpayer does not materially participate; (iii) income from a business of trading in financial instruments or commodities; and (iv) net gain from the disposition of property other than property held in a trade or business in which the taxpayer materially participates. The net investment income tax (NIIT) does not apply to self-employment earnings.

Self-employment earnings and wages are subject to employment taxes under either the Self-Employment Contributions Act (SECA) or the Federal Insurance Contributions Act (FICA), respectively. Both SECA and FICA taxes apply at a rate of 12.4 percent for social security tax on employment earnings—capped at $142,800 in 2021—and at a rate of 2.9 percent for Medicare tax on all employment earnings—not subject to a cap. An additional 0.9 percent Medicare tax is imposed on self-employment earnings and wages of high-income taxpayers, above the same NIIT thresholds of $200,000 for single and head of household filers and $250,000 for joint filers.

General partners and sole proprietors pay SECA tax on the full amount of their net trade or business income, subject to certain exceptions. Section 1402(a)(13) of the Internal Revenue Code provides that limited partners are statutorily excluded from paying SECA tax with respect to their distributive shares of partnership income or loss, although they are subject to SECA tax on their section 707(c) guaranteed payments from the partnership that are for services they provide to, or on behalf of, the partnership. Because the statutory exclusion only refers to limited partners, questions have arisen as to the meaning of this term and whether the limited partner exclusion might be applicable to limited liability company (LLC) members. According to the Treasury, partners who might more accurately be considered general partners and some LLC members avoid SECA by claiming the treatment of limited partners.

S corporation shareholders are not subject to SECA tax. But, tax law requires that owner-employees pay themselves “reasonable compensation” for services provided, on which they pay FICA tax like any other employee. Nonwage distributions to shareholders of S corporations are not subject to either FICA or SECA taxes.

    Proposal

The proposal would (i) ensure that all pass-through business income of high-income taxpayers are subject to either the NIIT or SECA tax; (ii) make the application of SECA to partnership and LLC income more consistent for high-income taxpayers, and (iii) apply SECA to the ordinary business income of high-income non-passive S corporation owners.

First, the proposal would ensure that all trade or business income of high-income taxpayers is subject to the 3.8-percent Medicare tax, either through the NIIT or SECA tax. In particular, for taxpayers with adjusted gross income in excess of $400,000, the definition of net investment tax would be amended to include gross income and gain from any trade or business that is not otherwise subject to employment taxes.

Second, limited partners and LLC members who provide services and materially participate in their partnerships and LLCs would be subject to SECA tax on their distributive shares of partnership or LLC income to the extent that this income exceeds certain threshold amounts. The exemptions from SECA tax provided under current law for certain types of partnership income—e.g., rents, dividends, capital gains, and certain retired partner income—would continue to apply to these types of income.

Third, S corporation owners who materially participate in the trade or business would be subject to SECA taxes on their distributive shares of the business’s income to the extent that this income exceeds certain threshold amounts. The exemptions from SECA tax provided under current law for certain types of S corporation income—e.g., rents, dividends, and capital gains—would continue to apply to these types of income.

There is a more detailed discussion of this proposal in the Treasury Green Book, including how to determine the amount of partnership income and S corporation income that would be subject to SECA tax under the proposal.

The proposal would be effective for taxable years beginning after December 31, 2021.

Repeal Deferral of Gain From Like-Kind Exchanges

    Current Law

Currently, owners of appreciated real property used in a trade or business or held for investment can defer gain on the exchange of the property for real property of a “like-kind.” As a result, the tax on the gain is deferred until a later recognition event, provided that certain requirements are met.

    Proposal

The proposal would allow the deferral of gain up to an aggregate amount of $500,000 for each taxpayer—$1 million in the case of married individuals filing a joint return—each year for real property exchanges that are like-kind. Any gains from like-kind exchanges in excess of $500,000—or $1 million in the case of married individuals filing a joint return—during a taxable year would be recognized by the taxpayer in the year the taxpayer transfers the real property subject to the exchange.

The proposal would be effective for exchanges completed in taxable years beginning after December 31, 2021.

Permanently Extend Excess Business Loss Limitation of Non-Corporate Taxpayers

    Current Law

Section 461(l) of the Internal Revenue Code limits the extent to which pass-through business losses may be used to offset other income. In particular, for taxable years beginning after December 31, 2020, and before January 1, 2027, non-corporate taxpayers may not deduct an “excess business loss” from taxable income. Instead, these losses are carried forward to subsequent taxable years as net operating losses.

Excess business loss is defined as the excess of losses from business activities over the sum of (a) gains from business activities, and (b) a specified threshold amount. In 2021, these thresholds are $524,000 for married couples filing jointly and $262,000 for all other taxpayers; these amounts are indexed for inflation thereafter. The determination of excess business loss is made at the taxpayer level, aggregating across all business activities. But, gains or losses attributable to any trade or business of performing services as an employee are not considered.

    Proposal

The proposal would make permanent the section 461(l) excess business loss limitation on non-corporate taxpayers.

The proposal would be effective for taxable years beginning after December 31, 2026.

Conclusion

So, what do we do with this? You consider it, but that is it. Recognize that many things will change between now and what the actual tax law change may look like. Do not delay or accelerate a sale or purchase simply because the law may change. It is something to consider. But, there are likely many other business issues and terms that we need to consider as well.

Have a great day!

Why Do Problems Arise? Ethical Problems in the Practice of Tax

I recently had the pleasure of writing an article for the CPA Voice community. CPA Voice is a bimonthly magazine that gives members of The Ohio Society of CPAs (OSCPA) relevant information on trends in the tax profession. It is a great publication. My article covers why ethical problems arise in the practice of tax. When I was considering the topic, and the writing, I identified that there are really three reasons, and each are addressed in my article, Why did a problem arise, even though I thought I was doing everything right?

I want to thank The Ohio Society of CPAs for allowing me to write for CPA Voice and allowing me to post the article on social media. The article is an outline and summary of my annual discussion on ethics ahead of the MEGA Tax Virtual Conference, which will be held this year on December 14^th and 15^th 2021. I speak pretty regularly at the Ohio Society of CPA’s MEGA Tax Conference on ethics in taxation and a variety of other topics. OSCPA always does a great job on the content, and I am happy to be a part of it.  

To read my full ethics article, download the May/June 2021 issue of CPA Voice, or access the article directly here. And, be sure to catch me talk about ethics in tax practice in more detail at the MEGA Tax Virtual Conference in December.

IRS Provides Additional Guidance on Employee Retention Credit

As a business and tax attorney that routinely works with individuals and owners of closely-held businesses, we try to continuously stay on top of current trends and events, including those coming from the IRS. On January 26, 2021, the IRS issued some additional and welcomed guidance on tax law changes made on December 27, 2020, and specifically related to the newly-extended employee retention credit. I wanted to address this because it does impact many of the clients that I work with.

In the recent guidance, the IRS urged employers to take advantage of the employee retention credit, designed to make it easier for businesses that, despite challenges posed by COVID-19, choose to keep their employees on the payroll. We encourage everyone to review it and consider whether or not it may impact their business going forward.

Please see the discussion below:

The Taxpayer Certainty and Disaster Tax Relief Act of 2020, enacted December 27, 2020, made a number of changes to the employee retention tax credits previously made available under the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), including modifying and extending the Employee Retention Credit (ERC), for six months through June 30, 2021. Several of the changes apply only to 2021, while others apply to both 2020 and 2021.

As a result of the new legislation, eligible employers can now claim a refundable tax credit against the employer share of Social Security tax equal to 70% of the qualified wages they pay to employees after December 31, 2020, through June 30, 2021. Qualified wages are limited to $10,000 per employee per calendar quarter in 2021. Thus, the maximum ERC amount available is $7,000 per employee per calendar quarter, for a total of $14,000 in 2021.

Employers can access the ERC for the 1st and 2nd quarters of 2021 prior to filing their employment tax returns by reducing employment tax deposits. Small employers (i.e., employers with an average of 500 or fewer full-time employees in 2019) may request advance payment of the credit—subject to certain limits—on Form 7200, Advance of Employer Credits Due to Covid-19, after reducing deposits. In 2021, advances are not available for employers larger than this.

Effective January 1, 2021, employers are eligible if they operate a trade or business during January 1, 2021, through June 30, 2021, and experience either:

1. A full or partial suspension of the operation of their trade or business during this period because of governmental orders limiting commerce, travel, or group meetings due to COVID-19, or

2. A decline in gross receipts in a calendar quarter in 2021 where the gross receipts of that calendar quarter are less than 80% of the gross receipts in the same calendar quarter in 2019 (to be eligible based on a decline in gross receipts in 2020, the gross receipts were required to be less than 50%).

Employers that did not exist in 2019 can use the corresponding quarter in 2020 to measure the decline in their gross receipts. In addition, for the first and second calendar quarters in 2021, employers may elect in a manner provided in future IRS guidance to measure the decline in their gross receipts using the immediately preceding calendar quarter (i.e., the fourth calendar quarter of 2020 and first calendar quarter of 2021, respectively) compared to the same calendar quarter in 2019.

In addition, effective January 1, 2021, the definition of qualified wages was changed to provide:

• For an employer that averaged more than 500 full-time employees in 2019, qualified wages are generally those wages paid to employees that are not providing services because operations were fully or partially suspended or due to the decline in gross receipts. 
• For an employer that averaged 500 or fewer full-time employees in 2019, qualified wages are generally those wages paid to all employees during a period that operations were fully or partially suspended or during the quarter that the employer had a decline in gross receipts regardless of whether the employees are providing services. 

Retroactive to the March 27, 2020, enactment of the CARES Act, the law now allows employers who received Paycheck Protection Program (PPP) loans to claim the ERC for qualified wages that are not treated as payroll costs in obtaining forgiveness of the PPP loan.

If you have questions, feel free to contact me. You can find additional information on the home page of my personal website here.

How the Multistate Tax Commission’s Guidance on Public Law 86-272 in the Aftermath of South Dakota v. Wayfair Frustrates the Law’s Fundamental Purpose

Public Law 86-272—enacted by Congress more than 50 years ago—protects purely interstate businesses from net income taxes imposed by states where the interstate business’s only connection with the state is soliciting orders for tangible personal property. But in the aftermath of South Dakota v. Wayfair, 585 U.S. ___, 138 S. Ct. 2080 (2018)—a Supreme Court decision that applied only to the imposition of sales taxes on interstate businesses—the Multistate Tax Commission (the “Commission”) has given states the green light to aggressively pursue net income taxes from purely interstate businesses. And, in the process, ignore Public Law 86-272’s fundamental purpose. Read more →

Vince Nardone Discusses Ethics in Tax Practice at The Ohio Society of CPAs MEGA Tax Conference

On Wednesday December 14th, Vince Nardone discussed ethics in Ohio tax practice at The Ohio Society of CPAs MEGA Tax Virtual Conference. During his presentation, Vince tackled the numerous considerations for having an ethics discussion as a CPA, the importance... Read more →

Public Law 86-272 in the Aftermath of South Dakota v. Wayfair

The Interstate Income Act of 1959, 15 U.S.C. § 381, Pub. L. 86-272 (“Public Law 86-272”) prohibits states from imposing a net income tax on income derived from interstate commerce if the interstate business’s only business activity within the state... Read more →

An Ounce of Prevention: Keeping Up with Physicians’ and Dentists’ Use Tax Obligations

State and local taxing authorities are stepping up their enforcement of medical and dental professionals’ use tax obligations. Medical and dental practices that do not properly report and pay applicable use taxes—or keep proper records of payment—risk sales and use... Read more →

Tax Planning Opportunities are Available in Almost Every Business Transaction, Including When a Dispute Arises

As a business advisor and tax attorney representing businesses, we inevitably run into circumstances where we are advising businesses on disputes with third parties. Although we do our best to minimize disruption within the business—to ensure that we maximize profits—disputes... Read more →

US Government, including Department of Justice and the IRS, Take Further Steps to Shut-Down Syndicated Conservation Easements.

Many weeks ago, I posted a blog addressing the abusive nature of syndicated conservation easements being peddled by certain professionals. See blog here. The government made it clear then, and made it clear again, that the Department of Justice and... Read more →

Good Habits for Business Owners as We Begin 2022 “Avoid the IRS”

As a business advisor, tax attorney, and consultant that works with closely-held businesses, including doctors and dentists, as well as other high-income earning individuals, we are always thinking about the idea of continuous improvement. So, recognizing that it is the... Read more →

Capital Gain Rates and Increase in Marginal Tax Rates Will Impact Our Doctors, Dentists, and Other Closely-Held Business Owners, if It Is up to Biden?

As a business advisor and tax planning attorney that works with closely-held businesses, including doctors, dentists, and other high-income earning individuals, I am receiving many questions about Biden’s tax proposals, including capital gains rates. I wanted to provide you an... Read more →

Why Do Problems Arise? Ethical Problems in the Practice of Tax

I recently had the pleasure of writing an article for the CPA Voice community. CPA Voice is a bimonthly magazine that gives members of The Ohio Society of CPAs (OSCPA) relevant information on trends in the tax profession. It is... Read more →

IRS Provides Additional Guidance on Employee Retention Credit

As a business and tax attorney that routinely works with individuals and owners of closely-held businesses, we try to continuously stay on top of current trends and events, including those coming from the IRS. On January 26, 2021, the IRS... Read more →