July 06, 2021

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?

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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!

May 19, 2021

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

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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 14th and 15th 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.

January 28, 2021

IRS Provides Additional Guidance on Employee Retention Credit

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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
  1. 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.

December 17, 2020

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

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On Tuesday, December 15, 2020, Vince Nardone discussed ethics in Ohio tax practice at The Ohio Society of CPAs MEGA Tax Conference.

During his session, “Ethics in Tax Practice: Ohio,” Vince tackled the numerous considerations for having an ethics discussion as a CPA, the importance of understanding your client and understanding yourself, as well as state regulations, and best practices and pitfalls.

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. Despite this year’s virtual circumstances, the conference was a success. We want to thank Tiffany Crosby and the rest of the team at The Ohio Society of CPAs for inviting us to participate.

November 20, 2020

IRS Rules on Deductibility of Qualifying Expenses Related to the Paycheck Protection Program (PPP)

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Everyone, I just worked with one of our associates in my firm to issue a client alert on our firms’ website. The IRS recently ruled that if a business reasonably believes that a PPP loan will be forgiven in the future, expenses related to the loan are not deductible, whether the business has filed for forgiveness or not. I would encourage you to read the more detailed client alert, which you can access here.

October 30, 2020

IRS Voluntary Disclosure Program; Alive and Well, or Dormant?

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As a business and tax attorney that routinely works with individuals and owners of closely-held businesses on IRS tax delinquencies, we try to continuously stay on top of current trends and events. As many of us have experienced since the impact of COVID-19, the IRS has basically come to a screeching halt in terms of customer service and enforcement. From my perspective, however, there is no better time than the present in terms of pursuing and submitting a voluntary disclosure. Thus, we thought it would be helpful to provide an update as to the voluntary disclosure process.

Background

On November 20, 2018, the IRS released a memorandum to taxpayers, detailing the new process for voluntarily disclosing violations due to willful behavior. The new program titled the "Updated Voluntary Disclosure Practice" ("UVDP"), applies to both domestic and offshore matters, whereas the OVDP only applied to undisclosed offshore accounts. The purpose of the UVDP is to provide taxpayers—who are concerned that their conduct is willful or fraudulent—a way to come into compliance with the law and avoid potential criminal prosecution. The IRS set out the following procedures regarding the UVDP. I provided a detailed summary of that November 20, 2018 memorandum in a prior blog dated April 23, 2019.  

Update and Process

Since that April 23, 2019 blog, however, the IRS has been slow in terms of processing voluntary disclosure applications under the November 20, 2018 memorandum procedures. To be clear, the slow response is not related to the lack of the IRS personnel’s willingness to process the applications—I do not believe. Rather, it is the lack of resources, and now with COVID-19 in play, it is the lack of resources and the lack of personnel actually working in the various offices to process the applications. Overall, this is a difficult time. But, difficult times also provide us with opportunities. And, in this instance, if you are a taxpayer that has been in the dark for some time, and have either not filed tax returns, not reported income, or otherwise filed false returns in the past, the lack of the IRS enforcement activities provides you with an opportunity to come out of the cold, and get into compliance.

Now, if we look back at a number of our current voluntary disclosures that have been submitted, we can see that it is really taking upwards of six months for us to receive an initial response. The Voluntary Disclosure Practice Preclearance Request and Application consists of two parts. In Part I, the “Preclearance Request,” the taxpayer provides more general information in regards to their noncompliance. Part I does not specifically ask for any account valuations, nor does it ask for any specific detail in regards to the taxpayer’s noncompliance. This is the initial response I am referring to above. In Part II, the “Voluntary Disclosure,” the taxpayer goes into detail, fully disclosing their financial accounts, including offshore accounts. The taxpayer is also required to provide a full narrative, detailing the circumstances and motive behind their noncompliance.

Filing a Preclearance Request and a Voluntary Disclosure does not prevent the IRS from pursuing a criminal investigation, and it does not prevent the IRS from pursuing criminal charges related to a taxpayer’s noncompliance. But, to the extent a taxpayer meets the minimum qualifications of the voluntary disclosure program, it would be a rare instance where the IRS chose to pursue criminal charges against a taxpayer that has voluntarily and timely stepped forward. That is, rather than incurring the cost to investigate, prosecute, and collect from a non-compliant taxpayer, the Service would rather encourage the noncompliant taxpayer to step forward and pay their previously unreported tax liability. As such, the Voluntary Disclosure process can serve as an effective means to shield the taxpayer from potential prosecution. To do so, however, the taxpayer must be completely open and upfront in regards to their noncompliance. The taxpayer should strive to provide the most accurate information they can provide, and should provide as complete a picture as they can to the IRS.

Conclusion

 In sum, when we are working with our individual and our closely-held business clients, no matter the specific project, we always focus on the concept and idea of: minimizing disruption to maximize profit. In the context of a voluntary disclosure, we minimize disruption by timely submitting a voluntary disclosure, fully disclosing, and fully cooperating with the IRS. There is no better time than the present to do so. If you have questions, you can contact me at vnardone@walterhav.com. And, you can find additional information on the home page of my personal website here.

September 11, 2020

Financial Workouts and Distressed Companies; Beware of Trust Fund Liability in These Difficult Times

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As we all know, COVID-19 has thrown us into some difficult times, both individually and professionally. For some businesses, these difficult times, and the overall economic downturn, has made it difficult to meet their daily, weekly, and monthly obligations. Certainly, by working through a financial workout or restructuring with creditors and other third-parties, those companies may be able to obtain relief and weather the storm. For others, however, they will not recover and will need to close. As part of any closure or restructuring of a business because of difficult financial circumstances, we have to consider (i) the tax ramifications of that closure/restructuring and (ii) the personal liability for the owners of those businesses. One area of potential personal liability are trust fund liabilities related to sales tax and withholding tax at the state level, and the trust fund recovery penalty at the federal level. This specific blog post will discuss the trust fund recovery penalty and the statute of limitations for the IRS to assess that penalty.  

Background Regarding the Trust Fund Recovery Penalty

Internal Revenue Code (“Code”) Section 6672, commonly referred to as the trust fund recovery penalty, is one of the most invoked sections of the Code by the IRS. The statute creates a unique vehicle for the collection of what are referred to as “trust fund” taxes (i.e., those taxes collected from employees and “held … in trust for the United States”). In the context of employment taxes, the term trust fund taxes refers only to taxes withheld from employees—federal income tax and one-half of Federal Income Contributions Act (“FICA”)—not to the portion of employment taxes that the business itself owes, such as its matching share of FICA or the Federal Unemployment Tax Act (“FUTA”).

Now, it is important to note that regardless of whether the IRS attempts to collect the unpaid taxes from the business as the primary obligor, section 6672 empowers the IRS to collect the unpaid trust fund tax liabilities of business entities from the personal assets of those persons who were responsible for the nonpayment of the taxes, including the business owners. In effect, the statute enables the IRS to “pierce the veil of limited liability” and hold many individuals secondarily or vicariously liable.

Nardone Comment: Only those persons who are responsible for the nonpayment of taxes can have personal liability under section 6672. Further, an individual may only be held responsible if they were willful in the failure to collect or pay over the required taxes. This particular blog post does not discuss the elements of the statute itself and the potential defenses to the responsible person element or the willfulness element. Rather, it only focuses on the statute of limitations. For this blog post, we assume that the person may be responsible.

Are There Limitations on the IRS Assessing the Trust Fund Recovery Penalty?

In any case where the IRS invokes or threatens to invoke Section 6672, we have to consider the IRS’s authority to do so, under the statute of limitations. Whether the IRS can assess the trust fund recovery penalty against one of the owners or other responsible parties, may depend on this analysis. Generally, the IRS has three years from the date the tax return was filed to assess the trust fund recovery penalty. 

A defense based on a statute of limitations can be a wholesale victory for the taxpayer. For this reason, the underlying taxpayer should evaluate all limitation periods. Subject to a variety of exceptions, the statute of limitations for the Service to assess the section 6672 penalty is three years from the later of April 15th following the year in issue or from the date the return was actually filed. This is true for taxes relating to all quarters of the year, as the earlier quarters’ returns are deemed “early filed.”

The principal actions likely to extend the statute of limitations in Section 6672 cases include the failure of the business to timely file the employment tax return, the individual’s written consent to extend limitations, submission of an offer in compromise, commencement of a refund suit, or challenge of a third-party summons. Similar actions by the business do not affect the statute of limitations for individuals.

Nardone Comment: It is important to ensure that all tax returns, including all employment tax returns, are timely filed when closing or restructuring a business. Otherwise, if the returns are not filed, the statute of limitations do not begin to run.

Conclusion

In sum, there are a lot of things going on when a business is restructuring or closing. And, unfortunately, one of the areas that typically does not get addressed is the filing of timely tax returns and the payment of tax liabilities. Thus, many years later, former owners and other responsible persons may be exposed to liabilities that they never thought would be personal liabilities for them individually. Thus, it is important that the business take all prudent steps to shield the owners and other responsible parties from potential liability, including ensuring that the tax returns are filed so that the statute of limitations begins to run on those returns. Further, as we will discuss in an upcoming blog, it is important that, to the extent funds are available, the business should voluntarily pay and allocate those funds to the trust fund tax liabilities. By doing so, we minimize personal exposure for the owners and other responsible persons. Do not let your distressed business and the financial difficulties of that distressed business become your personal responsibility.

September 03, 2020

United States Senate Finance Committee Finds Syndicated Conservation Easements to be Nothing More than Abusive Tax Shelters

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The Senate Finance Committee recently concluded that certain syndicated conservation easements examined by the committee are nothing more than abusive tax shelters. As a tax attorney and business advisor, I work with many different clients and closely-held businesses. As part of the work that I do, I work with clients to lawfully minimize their federal and state tax liabilities by reviewing and implementing certain tax planning strategies. The difficulty that we run into when it comes to tax planning, however, is that clients sometimes contact us and tell us about the next great tax planning opportunity that they learned about at a cocktail party—although today it may be a “virtual bourbon happy hour.”  The conversation typically goes something like this:

Vince, I just met Jill Smith from Tax Cheat, LLC, and she advised me of this great opportunity to invest in a syndicated conservation easement partnership. The client then says: I did not really understand it. But, she told me if I invest $100,000.00, I will obtain a charitable deduction on this year’s tax return of $500,000, and will save about $200,000 in taxes this year. This is great.

The client then asks me why I did not bring this up to her, and why she is not investing in this already? Well, I say, there are several reasons. First, it is a tax shelter. Second, it lacks economic substance. Third, you may be opening yourself up to scrutiny by the Internal Revenue Service. Did you really mean to ask the IRS to examine your entire return, and scrutinize every aspect of it? Fourth, you are unlikely to find a well-qualified tax-return preparer that will stake her reputation and CPA license on it, simply to save you a few dollars. Fifth, have you ever heard of the smell test? Do you really think that you can purchase a partnership interest in a syndicated conservation easement for a $1 and receive a deduction of $5? And fifth, and maybe most importantly, have you ever received a knock on the door or a visit from a special agent with IRS CI, otherwise referred to as IRS Criminal Investigation? These individuals are arguably the best and brightest law enforcement officers out there in terms of tracking down money, scrutinizing fraud, pursuing tax evaders, and calling a duck a duck.

Vince Nardone Comment: And, as a former FBI agent, I do not say that lightly. 

Yet, we tell our clients everything I summarized above, and they still decide to invest. And, the tax promoters that brought them the deal find them an unscrupulous tax-return preparer that prepares the return, or, worse yet, the client’s long-time tax return preparer, who is concerned about losing a client, decides to take the risk and prepare the return. The difficulty clients have is that they do not know who to believe. Do they believe their long-time tax planning attorney and business advisor that they have worked with for a number of years? Or, do they believe the tax attorney and CPA that are flying in from the “big city” to sell them the next big tax planning strategy?

From my perspective, some may allow their desire to save money to cloud their judgment on what and who to believe. And, they likely fail to realize or simply disregard the fact that the tax promoting attorney and CPA that flew into town are benefiting monetarily from the investment that the client is getting ready to make. The tax promoter is generally throwing caution to the wind, ignoring all logic and common sense, and citing to us (and our clients) that they are relying on other well-qualified professionals in establishing the numbers that they are relying on, and all swear that the transactions are legitimate. Did we forget about the concept of trust but verify? And then, when you talk with your client, the client does not really understand any aspect of the transaction itself. They just see the tax savings. You then bring up the concept of, “it is too good to be true,” and they ignore that as well.  So, as a tax attorney and business advisor, what do you do?

Well, no answer just yet. The other difficulty that we have as tax attorneys is that we are also working with the IRS or other government folks, like the United States Department of Justice, and IRS CI, who generally have difficulty in pursuing criminal cases in these types of matters. The difficulty is based upon the “so-called” complexity of the transactions and the guidance of unscrupulous advisors out there that swear that the transactions are legitimate. When the government folks are confronted with these transactions, they begin to question themselves. Are we simply not understanding what is occurring? Is this too complicated for my background or experience? Am I simply not smart enough to fully understand? Is it just too difficult and there is other low hanging fruit out there that I can go after? So, rather than pushing forward and calling a duck a duck, they move onto the easier cases and leave the difficult ones for the next Eliot Ness. The tax promoters are hoping for that result. And so again, us tax and business advisors are left with answering the question of “why did you not tell me about this great investment and why have I not invested”?

So, what do we do? Well, what you do, and what you should do is advise your client that (i) because it is a fraudulent and abusive transaction, and (ii) you may be opening yourself to someone alleging that you are committing tax evasion by entering into this transaction, as well as (iii) exposing yourself to numerous draconian penalties, you should not do it. Let’s call a duck a duck, and a fraud a fraud. Fraud (or defrauding or scamming) is nothing more than a crime in which someone tricks somebody else (the IRS) to get unfair or unlawful gain (tax deductions that generate a refund). Frauds are almost always about money, either directly or indirectly. So, to my clients, why? That is all I have to ask you. Why cause yourself the pain and suffering or scrutiny of the IRS and the federal government? Do you really need that? And, I would tell my colleagues at the Justice Department, IRS, and IRS CI, you are smart enough, you do understand it, and you should not avoid it. You are the Eliot Ness. A fraud is a fraud, no matter how complicated one may suggest that it is. 

So, why do I say all of this? Well, it was not until the recent publication of Chairman Charles E. Grassley’s bipartisan investigative report from the Senate Finance Committee, and its conclusions on the abusive tax shelters, that we now have sufficient public information out there on the syndicated conservation easements. The US government has finally stepped up and concluded that these so-called syndicated conversation easement transactions are nothing more than “retail tax shelters” that let taxpayers buy tax deductions at the end of any given year, depending on how much those taxpayers would like to shelter from the IRS, with no economic risk. The general outcome is that for every dollar you invest, you receive approximately four to five dollars’ worth of tax deductions, which ultimately means that for every dollar paid to a tax-shelter promoter, the taxpayer saves two or two and a half dollars in taxes they did not pay. As the Senate concluded, these transactions are abusive in all respects. Clients and other tax professionals are now listening to us as to why you should not invest in certain syndicated conversation easements.  Why did it take so long? I really do not know. I can ask my 13-year-old son, or my two-year-old niece and they would reach the same conclusion. The fact is, just because you give something a different name, or precede it with a disclaimer, it does not change what it is. You can put lipstick on a pig, but it’s still a pig. In this instance, it is still an abusive tax shelter.

In sum, we would encourage our clients to read the full version of the Senates Syndicated Conservation Easement Transactions report, here, and form your own opinion. And, to the extent you have been approached by someone to make a similar investment, you are looking to unwind a similar investment, or you have been contacted by the IRS regarding settlement, and need to know how to handle that, let’s discuss. Finally, please note that there are absolutely legitimate conservation easement opportunities out there, including syndicated ones. The difficulty is determining which one is legitimate versus those that are not. Although I have my own opinion, I will leave the ultimate conclusion to the courts and to Congress.

August 28, 2020

Payroll Protection Program (PPP) – SBA Guidance on Payroll Costs and Rents

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As a business advisor and attorney that works with healthcare professionals, and other closely-held businesses, including home offices, we are working closely to stay on top of the Small Business Association’s (SBA) rules and regulations on the Paycheck Protection Program, commonly referred to as the PPP. This continues to be a fluid situation, ever-changing, and guidance continues to come out. Recently, the SBA issued an interim final rule addressing the ownership percentage that triggers the applicability of owner compensation rules for forgiveness purposes and also addresses limitations on the eligibility of certain non-payroll costs for forgiveness.

Background Information

On March 13, 2020, President Trump declared the ongoing Coronavirus Disease 2019 (COVID-19) pandemic of sufficient severity and magnitude to warrant an emergency declaration for all states, territories, and the District of Columbia. With the COVID-19 emergency, many small businesses nationwide are experiencing economic hardship as a direct result of the federal, state, tribal, and local public health measures that are being taken to minimize the public’s exposure to the virus. These measures, some of which are government-mandated, have been implemented nationwide and include the closures of restaurants, bars, and gyms. In addition, based on the advice of public health officials, other measures, such as keeping a safe distance from others or even stay-at-home orders, have been implemented, resulting in a dramatic decrease in economic activity as the public avoids malls, retail stores, and other businesses.

On March 27, 2020, the President signed the Coronavirus Aid, Relief, and Economic Security Act (the CARES Act) (Pub. L. 116-136) to provide emergency assistance and health care response for individuals, families, and businesses affected by the coronavirus pandemic. The SBA received funding and authority through the CARES Act to modify existing loan programs and establish a new loan program to assist small businesses nationwide adversely impacted by the COVID-19 emergency.

Section 1102 of the CARES Act temporarily permits SBA to guarantee 100 percent of 7(a) loans under a new program titled the “Paycheck Protection Program.” Section 1106 of the CARES Act provides for forgiveness of up to the full principal amount of qualifying loans guaranteed under the Paycheck Protection Program (PPP).

On April 24, 2020, the President signed the Paycheck Protection Program and Health Care Enhancement Act (Pub. L. 116-139), which provided additional funding and authority for the PPP. On June 5, 2020, the President signed the Paycheck Protection Program Flexibility Act of 2020 (Flexibility Act) (Pub. L. 116-142), which changed provisions of the PPP relating to the maturity of PPP loans, the deferral of PPP loan payments, and the forgiveness of PPP loans. On July 4, 2020, the President signed into law S. 4116, which reauthorized lending under the PPP through August 8, 2020 (Pub. L. 116-147).

Now that the PPP application window has closed, a time-sensitive issue for many of our clients, and other closely-held businesses across the country, are the forgiveness aspects of the PPP. Thus, the recent guidance from the SBA on the ownership percentage that triggers the applicability of owner compensation rules for forgiveness purposes and the limitations on the eligibility of certain non-payroll costs for forgiveness was certainly helpful. Here is a summary of that rule in a frequently- asked question format, directly from the SBA.

Frequently Asked Questions Regarding Ownership Percentage that Triggers the Applicability of the Ownership Compensation Rule for Forgiveness Purposes and Limitations on the Eligibility of Certain Non-Payroll Costs for Forgiveness

1. Owners

Are any individuals with an ownership stake in a PPP borrower exempt from application of the PPP owner-employee compensation rule when determining the amount of their compensation that is eligible for loan forgiveness?

Yes, owner-employees with less than a 5 percent ownership stake in a C- or S- Corporation are not subject to the owner-employee compensation rule. The First Loan Forgiveness Rule, as revised by the Revisions to Loan Forgiveness and Loan Review Procedures Interim Final Rules, 85 FR 38304, 38307 (June 26, 2020), caps the amount of loan forgiveness for payroll compensation attributable to an owner-employee.  There is no exception in the rule based on the owner-employee’s percentage of ownership. The Administrator, in consultation with the Secretary, has now determined that an owner-employee in a C- or S-Corporation who has less than a 5 percent ownership stake will not be subject to the owner-employee compensation rule. This exemption is intended to cover owner-employees who have no meaningful ability to influence decisions over how loan proceeds are allocated.

2. Eligibility of Certain Non-payroll Costs for Loan Forgiveness

a. Are amounts attributable to the business operation of a tenant or sub-tenant of the PPP borrower or, in the context of home-based businesses, household expenses, eligible for forgiveness?

No, the amount of loan forgiveness requested for non-payroll costs may not include any amount attributable to the business operation of a tenant or sub-tenant of the PPP borrower or, for home-based businesses, household expenses. The examples below illustrate this rule.

Example 1: A borrower rents an office building for $10,000 per month and sub-leases out a portion of the space to other businesses for $2,500 per month. Only $7,500 per month is eligible for loan forgiveness.

Example 2: A borrower has a mortgage on an office building it operates out of, and it leases out a portion of the space to other businesses. The portion of mortgage interest that is eligible for loan forgiveness is limited to the percent share of the fair market value of the space that is not leased out to other businesses. As an illustration, if the leased space represents 25% of the fair market value of the office building, then the borrower may only claim forgiveness on 75% of the mortgage interest.

Example 3: A borrower shares a rented space with another business. When determining the amount that is eligible for loan forgiveness, the borrower must prorate rent and utility payments in the same manner as on the borrower’s 2019 tax filings, or if a new business, the borrower’s expected 2020 tax filings.

Example 4: A borrower works out of his or her home. When determining the amount of non-payroll costs that are eligible for loan forgiveness, the borrower may include only the share of covered expenses that were deductible on the borrower’s 2019 tax filings, or if a new business, the borrower’s expected 2020 tax filings.

b. Are rent payments to a related party eligible for loan forgiveness?

Yes, as long as (1) the amount of loan forgiveness requested for rent or lease payments to a related party is no more than the amount of mortgage interest owed on the property during the Covered Period that is attributable to the space being rented by the business, and (2) the lease and the mortgage were entered into prior to February 15, 2020. Any ownership in common between the business and the property owner is a related party for these purposes. The borrower must provide its lender with mortgage interest documentation to substantiate these payments. While rent or lease payments to a related party may be eligible for forgiveness, mortgage interest payments to a related party are not eligible for forgiveness. PPP loans are intended to help businesses cover certain non-payroll obligations that are owed to third parties, not payments to a business’s owner that occur because of how the business is structured. This will maintain equitable treatment between a business owner that holds property in a separate entity and one that holds the property in the same entity as its business operations.

Nardone Recommendations and Thoughts

As we will discuss in our next blog, early next week, business owners and taxpayers have to remain vigilant on understanding the impact of the PPP on its 2020 and 2021 operations, including estimated tax liabilities. This SBA interim rule discussed above helps us do just that. We know what qualifies and what does not when it comes to owners and rents for related party entities. And, importantly, to the extent the loan proceeds related to the PPP are forgiven, we have to understand the tax impact of that forgiveness. That is, the use of that money does not give rise to an ordinary and necessary deduction under the Internal Revenue Code. Thus, our tax liabilities for the year will be higher. We will discuss that in our next blog.

June 08, 2020

Ohio Department of Taxation Plans to Establish a Tax Amnesty Program

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A common discussion we have with business clients and individuals comprises of tax planning and the impact of tax liabilities. For example, in some instances, clients may have failed to collect and pay over, or simply may have failed to pay over taxes to the Ohio Department of Taxation. Taxing authorities, including the Ohio Department of Taxation, recognize that this happens, and offer voluntary disclosure and tax amnesty programs. In light of these programs, clients have the opportunity to come out of the cold, and pay their tax liabilities, while minimizing the impact of penalties and interest, and most importantly, criminal tax exposure. The Ohio legislature has recently introduced a new tax amnesty program addressing these kinds of issues which is discussed below.

Background

Generally, tax amnesty is a limited-time opportunity for a specified group of taxpayers to pay a defined amount of money in exchange for forgiveness of a tax liability—including interest and penalties— relating to a previous tax period(s) without fear of criminal prosecution.

On April 16, 2020, the Ohio legislature introduced H.B. 609 Tax Amnesty (the “Tax Amnesty Bill”). It is currently under review by the Ohio Senate’s Ways and Means Committee. The Tax Amnesty Bill establishes a three-month amnesty period during which taxpayers owing past-due state taxes and certain fees, may discharge the debt by paying the delinquent tax or fee without having to pay the penalty and accrued interest normally due.

Nardone Comment: This is a big deal and opportunity for potential savings.

 Purpose of Tax Amnesty

There are many explanations about the purpose and public policy for the tax amnesty program. Tax amnesty is one type of voluntary compliance strategy implemented to increase tax base and tax revenue for a particular state. Tax amnesty is different from other voluntary disclosure programs, partially because the tax amnesty program may waive a portion of the taxpayers' tax liability. The idea is that the introduction of amnesty in any fiscal year helps the state treasury raise tax revenues by adding taxpayers that have not declared their assets previously to the tax revenue coffers. The main purpose is to encourage individuals and businesses to declare their wealth as it may arise, and pay their taxes. Under this scheme, the taxpayer has to pay some amount of tax while avoiding payment of penalties and interest and avoiding criminal prosecution. States introduce this scheme when they believe that individuals and businesses are not reporting their tax obligations, and when the states are in need of revenue.

Nardone Comment: I had the pleasure of discussing the Tax Amnesty Bill with Law360, please see the link here. I would certainly encourage folks to follow Law360 on this issue, as well as other issues and changes in the law. Law360 is a great resource.

Detailed Analysis

The Tax Amnesty Bill establishes a temporary, three-month tax “amnesty” from January 1, 2021, to March 31, 2021, concerning delinquent state taxes. It also covers delinquent state income tax withholding remittances by employers and certain fees administered by the Ohio Department of Taxation (A detailed list of taxes and fees covered under the amnesty is detailed in the “Covered Taxes and Fees” section below). The amnesty applies only to taxes that were due and payable as of the bill’s effective date and that were unreported or underreported. The amnesty does not apply to any tax for which a notice of assessment or audit has been issued, for which a bill has been issued, or for which an audit has been conducted or is pending.

If during the amnesty, a person pays the full amount of delinquent taxes or fees owed, the Tax Commissioner must waive all penalties and accrued interest that are normally charged. The Tax Amnesty Bill authorizes the Commissioner to require a person to file returns or reports, including amended returns or reports.

In addition to receiving a waiver of penalties and accrued interest, a person who pays the amount due is immune from criminal prosecution or any civil action with respect to the tax or fee paid, and no assessment may be issued against the person for that tax or fee.  The most recent general tax amnesty was conducted in 2018.

Covered Taxes and Fees

The taxes and fees covered under the amnesty are:

  1. Income tax;
  2. Commercial activity tax;
  3. State sales and use taxes;
  4. Financial institutions tax;
  5. Public utility excise taxes;
  6. Kilowatt-hour tax;
  7. MCF (natural gas) excise tax;
  8. Insurance premiums taxes;
  9. Cigarette/tobacco/vaping excise taxes;
  10. Alcoholic beverage taxes;
  11. Motor fuel excise tax;
  12. Fuel use tax;
  13. Petroleum activity tax;
  14. Casino wagering tax;
  15. Severance taxes;
  16. Wireless 9-1-1 charges;
  17. Tire fees; and
  18. Horse racing taxes.

Local taxes, including school district income taxes and county and transit authority sales and use taxes, are not covered by the amnesty.

Administration and Revenue Disposition

The Commissioner must issue forms and instructions for the amnesty, must publicize the amnesty to maximize public awareness and participation, and may take any other action necessary to implement the amnesty.

Summary and Recommendation

I frequently speak with clients about the importance of minimizing disruption and maximizing profits in regards to their business, as well as in their personal lives. We certainly do not recommend falling behind on taxes because that will absolutely cause disruption in both your personal life and your business. But, let’s also be practical, it happens. There are times, for one reason or another, where clients do fall behind on their tax liabilities. So, when that occurs, the goal remains the same, minimize the disruption of the current circumstances. And, in this instance, availing oneself of Ohio’s tax amnesty program in 2021 may be one primary way to do just that. So, if you find yourself in a situation where you have fallen behind on any of the taxes discussed above, let’s consider and analyze what the best strategy may be to minimize disruption, including availing yourself of the tax amnesty program in 2021.

July 06, 2021

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August 28, 2020

June 08, 2020

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