The Extender’s Bill impacts Subchapter S in at least two respects. It amends IRC Section 1374(d)(7) and IRC Section 1367(a)(2). Both of these amendments are temporary. Unless extended, they only live until the end of this year. Yes, they only apply to tax years beginning in 2014.
I. IRC Section 1374(d)(7).
In the last five (5) years, we have seen at least three temporary amendments to the built in gains tax recognition period.
- The first amendment is found in Section 1251 of the American Recovery and Reinvestment Tax Act of 2009. This provision shortened the ten (10) year recognition period for tax years 2009 and 2010 to seven (7) years.
- The second amendment is found in Section 2014 of the Small Business Jobs Act of 2010. This provision extended the built in gains tax relief to 2011 and further shortened the recognition period to five (5) years. For tax year 2012, it appeared we would be back to the old ten (10) year recognition period.
- With the passage of the Taxpayer Relief Act of 2012, however, a third amendment to Code Section 1374 was given life. As a result, the five (5) year recognition period was extended to the end of last year.
Unfortunately, it looked like we were back to the ten (10) year built in gains tax recognition period. Lawmakers saved the day one more time, at least temporarily, when both the Senate and the House passed the 2014 Tax Increase Prevention Act on December 16, 2014. President Obama signed the bill into law on December 19, 2014. So, for your clients that dispose of built in gains assets this year, they are subject to a five (5) year built in gains tax recognition rule. For dispositions of built in gains tax property next year, unless Congress acts for a fifth time, we are subject to the old ten (10) year recognition period rule.
II. IRC Section 1367(a)(2).
Section 1367(a)(2) was added to the Code in 2006. It was set to sunset at the end of 2011. Section 325 of the 2012 Taxpayer Relief Act, effective January 1, 2013, however, extended the life of Code Section 1367(a)(2) to the end of 2013. It appeared IRC Section 1367(a)(2) was no longer in existence for 2014. The 2014 Tax Increase Prevention Act gave this provision one more year of life.
So, at least for 2014, shareholders of a S Corporation get to reduce their stock basis by the adjusted basis of property contributed by the S Corporation to a charity, even though the full fair market value of the property passes through to the shareholder as a charitable contribution deduction on their IRS Form K-1.
If any of your S Corporation clients made charitable contributions this year, they may be able to take advantage of this law. Unless extended again, Section 1367(a)(2) will no longer be law on January 1, 2015.
Year end is almost here. For your S Corporation clients, it is worth looking to determine if either of these provisions, amended by the 2014 Tax Increase Prevention Act, apply. Time is running out!
While it is highly unlikely Santa’s little helpers will deliver to taxpayers a tax reform package by the end of 2014 that is acceptable to the Senate, the House of Representatives and the President, House Ways and Means Committee Chairman, Dave Camp, made one last attempt to move the ball forward. On December 11, 2014, shortly before Chairman Camp’s expected retirement, he formally introduced a bill in the House to adopt into law the Tax Reform Act of 2014 which he authored and circulated in proposed form to lawmakers back in February. Affixed with the label “Fixing Our Broken Tax Code So That It Works For American Families and Job Creators,” the proposal is now formally before Congress.
Our lawmakers uniformly agree that we need tax reform in this country. In fact, more than thirty (30) separate congressional hearings dedicated to tax reform have been held in recent times. There exist at least eleven (11) bipartisan working groups which are exploring tax reform. So, we appear to be headed in the right direction. The billion dollar question continues to be, will we get sufficient consensus among our lawmakers so the tax reform will become a reality?
At about the same time as Chairman Camp introduced his tax reform bill in the House, Senate Finance Committee republican staff released a report, “Comprehensive Tax Reform for 2015 and Beyond.” The report exams the history of tax development and the economic issues associated therewith. Senator Orrin Hatch, who is slated to become the Chair of the Senate Finance Committee in 2015, hopes the report will get the issues on the table and act as an invitation to both parties to roll up their shirt sleeves and work together on these tough and ever important issues.
These developments may be an indication that the impetus for tax reform is picking up steam. Hopefully, the momentum will carry into 2015 and will be strong enough to get the ball across the goal line.
Despite these developments, however, I fear tax reform is still far away from becoming a reality. Chairman Camp’s proposal spans almost 1000 pages and impacts some highly sensitive tax issues important to special interest groups. While his proposed legislation cuts both ways (i.e., has provisions that each party could support), the question continues to be whether adequate consensus can be achieved in Washington to pass comprehensive tax reform legislation. Time will tell.
I'm proud to announce that Larry’s Tax Law was featured in LexBlog’s Top 10 Law Blogs List in February, March and July of this year. I hope to keep publishing useful material for CPAs and Tax Professionals.
Your feedback and guidance are truly appreciated. Please let me know if there are any topics or issues that you would like me to address in future blog posts.
Thank you for your support this year! Best wishes for a wonderful holiday season and a terrific 2015.
I was recently interviewed by Ama Sarfo, a reporter for Law360 (a national legal publication of LexisNexis). I discussed some of the audit risks Subchapter S corporations and their shareholders face these days. Below is an excerpt of the Article.
Audit Risk: It's estimated that the U.S. has a $450 billion gap between taxes that are owed to the government and taxes that are actually paid on time. This staggering number, despite significant budgetary constraints, has put taxpayer compliance back in the forefront for the IRS. In the 1990s, the Service was forced to move its focus from the audit function to information and technology as its systems were terribly out of date. Taxpayers need to be on their game because the IRS is back in the audit business, and noncompliance penalties are stronger than they've ever been before.
Compensation Documentation: Subchapter S corporation exams often lead to a review of shareholder compensation. The focus is generally on whether the compensation is unreasonably low — an amorphous label that lacks a uniform standard within the courts and instead depends on questions of facts and circumstances. I advise S corporation clients, among other things, to annually document their compensation decisions and their rationale for establishing shareholder employee compensation. This would include developing a compensation methodology based on qualifications, nature of work and information about what other like companies pay similar employees. It's an art.
Loss Deductions: Shareholder basis calculations used for the purpose of absorbing losses passed through from the corporation are often reviewed in S corporation examinations. S corporations aren't required to track and report shareholder basis on IRS Form K-1 issued to shareholders each year. According to IRS studies, in a large number of cases, errors are made in this computation (it is usually user error). So, the IRS is closely scrutinizing this issue in its audits. Don’t be surprised if, in the future, S corporations are required to track and report basis calculations on IRS Form K-1, just like partnerships are required to track and report capital account changes.
The law governing S corporations is ever changing. As tax practitioners, we need to keep abreast of these developments. I try to report important developments in this area of tax law on the blog.
If you would like to read the complete Article, it is available at www.Law360.com.
Larry J. Brant is a Shareholder in Garvey Schubert Barer, a law firm based out of the Pacific Northwest, with offices in Seattle, Washington; Portland, Oregon; New York, New York; Washington, D.C.; and Beijing, China. Mr. Brant practices in the Portland office. His practice focuses on tax, tax controversy and transactions. Mr. Brant is a past Chair of the Oregon State Bar Taxation Section. He was the long term Chair of the Oregon Tax Institute, and is currently a member of the Board of Directors of the Portland Tax Forum. Mr. Brant has served as an adjunct professor, teaching corporate taxation, at Northwestern School of Law, Lewis and Clark College. He is an Expert Contributor to Thomson Reuters Checkpoint Catalyst. Mr. Brant is a Fellow in the American College of Tax Counsel. He publishes articles on numerous income tax issues, including Taxation of S Corporations, Reasonable Compensation, Circular 230, Worker Classification, IRC § 1031 Exchanges, Choice of Entity, Entity Tax Classification, and State and Local Taxation. Mr. Brant is a frequent lecturer at local, regional and national tax and business conferences for CPAs and attorneys. He was the 2015 Recipient of the Oregon State Bar Tax Section Award of Merit.
Upcoming Speaking Engagements
- "Evaluating the Built-in Gains Tax for C to S Conversions After TCJA," New York University Summer Institute in Taxation – Advanced Conference on Subchapter SNew York, NY, 7.26.18
- "S Corporation Distributions – The Ins and Outs," New York University 77th Institute on Federal TaxationNew York, NY, 10.21.18-10.26.18
- "The Tax Cuts and Jobs Act – What It May Mean to Your Clients," Estate Planning Council of Portland Mini-SeminarPortland, OR, 11.7.18
- "S Corporation Distributions – The Ins and Outs," New York University 77th Institute on Federal TaxationSan Diego, CA, 11.11.18-11.16.18