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disconnectedAs we have been discussing these past several weeks, the Tax Cuts and Jobs Act (“TCJA”) drastically changed the Federal income tax landscape. The TCJA also triggered a sea of change in the income tax laws of states like Oregon that partially base their own income tax regimes on the Federal tax regime. When the Federal tax laws change, some changes are automatically adopted by the states, while other changes may require local legislative action. In either case, state legislatures must decide which parts of the Federal law to adopt (in whole or part) and which parts to reject, all while keeping an eye on their fiscal purse.

INTRODUCTION[1]

M&A dealThe Tax Cuts and Jobs Act (“TCJA”) will significantly impact merger and acquisition (“M&A”) activity. Although billed as tax reform, the TCJA did not reform or simplify the Internal Revenue Code (“Code”).

Virtually none of the provisions of the TCJA directly impact M&A transactions. Rather, the TCJA added or modified several sections of the Code that indirectly impact transaction structuring, pricing, negotiations and due diligence. Making matters more complex, some of these provisions of the TCJA are temporary.

This blog post briefly highlights several key provisions of the TCJA and the impact on M&A.

INTRODUCTION

charitable givingCharitable organizations work hard to maintain exempt status. These organizations operate in a highly regulated landscape: In exchange for enjoying freedom from income taxes, they must comply with strict organizational and operational rules. Even before the Tax Cuts and Jobs Act (“TCJA”), adhering to these rules required constant oversight. The TCJA changes the rules, impacting both the operations and funding of these organizations.

On the operational side, we review below: Changes to the rules on unrelated business taxable income and employee fringe benefits, the new excise taxes imposed on executive compensation, and college and university endowments, and changes to substantiation requirements for certain donations.

On the funding side, we review below: How changes to the standard deduction (addressed in more detail in a prior blog post), cash contribution limits, deductions for payments to colleges and universities for the right to purchase athletic event tickets, and the estate tax may impact donors and charitable giving patterns.

INTRODUCTION

extended familyThe Tax Cuts and Jobs Act (“TCJA”) creates the need for tax planning with respect to several major life-changing activities individuals may encounter, including marriage, divorce, home ownership, casualty losses, medical expenses and parenting. More specifically, the TCJA makes major changes to the existing framework of personal exemptions and itemized deductions, the child tax credit, the tax treatment of alimony and spousal maintenance payments made as a result of divorce, and the alternative minimum tax (“AMT”).

The primary focus of this blog post is the provisions of the TCJA that significantly impact families and individuals. Many of these provisions have been exhaustively reviewed by other commentators in the past several weeks. In those instances, our discussion is brief. Rather, we decided to place the bulk of our discussion on the less obvious provisions of the TCJA that may have significant impact on families and individuals.

EntertainmentBACKGROUND

The Tax Cuts and Jobs Act (“TCJA”) creates, modifies or eliminates a number of employment and employee fringe benefit related provisions of the Code. Both employers and employees need to be aware of these changes. Accordingly, this installment of our ongoing review and analysis of the TCJA focuses on these employer and employee fringe benefit provisions.

“Neither a borrower nor a lender be…” or at least, if you insist on borrowing (and we understand the appeal), we are here to help you stay abreast of the new rules on deducting interest.

BACKGROUND/PRIOR LAW

IRCInterest on a business or investment related debt is, in most instances, a deductible expense of the borrower and taxed as income to the lender. With a few exceptions, such as mortgage interest on a personal residence, borrowers generally cannot deduct personal interest. A borrower’s deduction is subject to a number of limitations set forth in Code Section 163. The Tax Cuts and Jobs Act (“TCJA”) has changed some of these limitations.

Before the enactment of the TCJA, nondeductible interest included any interest on a taxpayer’s debt not arising from a trade or business, home mortgage, investment activity, or qualified student loans (in other words, interest arising from those debts was deductible).

BACKGROUND

Qualified business incomeThe Tax Cuts and Jobs Act (“TCJA”) adopted a new 20% deduction for non-corporate taxpayers. It only applies to “qualified business income.” The deduction, sometimes called the “pass-through deduction,” is found in IRC § 199A. There has been a significant amount of media coverage of this new deduction. Rather than repeat what you have undoubtedly already read or heard, we chose to focus this blog post on the not so obvious aspects of IRC § 199A—the numerous pitfalls and traps that exist for the unwary.

BACKGROUND/PRIOR LAW

PartnershipUnder IRC § 708(a), a partnership is considered as a continuing entity for income tax purposes unless it is terminated. Given the proliferation of state law entities taxed as partnerships today (e.g., limited liability companies and limited liability partnerships), a good understanding of the rules surrounding termination is ever important.

Prior to the Tax Cuts and Jobs Act (“TCJA”), IRC § 708(b)(1) provided that a partnership [1] was considered terminated if:  

1.  No part of any business, financial operation, or venture of the partnership continues to be carried on by any of the partners of the partnership; or

2.  Within any 12-month period, there is a sale of exchange of 50% or more of the total interests of the partnership’s capital and profits.

Jerald AugustPlease join me on June 29, 2017 in Portland, Oregon, for what will be a dynamic presentation on the new partnership audit rules by Jerald August.  Jerry is a Partner in the preeminent New York City-based boutique tax firm Kostelanetz & Fink, LLP.  He has served as a chair of NYU's Institute on Federal Taxation for a number of years and specializes in federal and state income taxation, including taxation of pass-thru entities and tax controversy.  Jerry is not only one of the brightest tax lawyers you will ever meet, he is an outstanding speaker.  We are very fortunate to have him present at the Portland Tax Forum on this important topic.  We all need to learn about the new partnership audit rules – they come into play on January 1, 2018.

As a general rule, in accordance with IRC § 162(a), taxpayers are allowed to deduct, for federal income tax purposes, all of the ordinary and necessary expenses they paid or incurred during the taxable year in carrying on a trade or business.  There are, however, numerous exceptions to this general rule.  One exception is found in IRC § 280E.  It provides:

“No deduction or credit shall be allowed for any payment paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances (within the meaning of schedule I and II of the Controlled Substances Act) which is prohibited by Federal law or the law of any state in which such trade or business is conducted.”

Marijuana-plant-300x200Congress enacted IRC § 280E as part of the Tax Equity and Fiscal Responsibility Act of 1982, in part, to support the government’s campaign to curb illegal drug trafficking.  Even though several states have now legalized medical and/or recreational marijuana, IRC § 280E may come into play.  The sale or distribution of marijuana is still a crime under federal law.  The impact of IRC § 280E is to limit the taxpayer’s business deductions to the cost of goods sold.

On October 22, 2015, the U.S. Tax Court issued its opinion in Canna Care, Inc. v. Commissioner, T.C. Memo 2015-206.  In that case, Judge Haines was presented with a California taxpayer that is in the business of selling medical marijuana, an activity that is legal under California law.

The facts of this case are interesting.  Bryan and Lanette Davies, facing significant financial setbacks and hefty educational costs for their six (6) children, turned to faith for a solution.  After “much prayer,” Mr. Davies concluded that God wanted him to start a medical marijuana business.  Unfortunately, it does not appear that he consulted with God or a qualified tax advisor about the tax implications of this new business before he and his wife embarked upon the activity.

The good news for the Davies is that their business blossomed.  In fact, they employ ten (10) people in the business and have enjoyed financial success.  They timely filed state and federal income tax returns, reported income and paid, what they believed, was the proper amount of taxes.  The bad news for the Davies is the fact that the IRS did not agree with their computation of the tax liability.

The IRS issued a notice of deficiency.  Not able to resolve the matter at IRS appeals, the Davies found themselves in the U.S. Tax Court.  The sole issue in the case was whether the taxpayers’ business deductions were properly disallowed by the Service under IRC § 280E.

To no avail, the Davies presented numerous arguments as to why marijuana should no longer be a controlled schedule I substance.  They also asserted that their new business created employment opportunities for others, cured their family’s financial woes, and allowed them to participate in civic and charitable activities.

Judge Haines quickly dismissed the Davies’ arguments, concluding the sale of marijuana is prohibited under federal law—marijuana is a schedule I controlled substance.  Accordingly, IRC § 280E prevents taxpayers from deducting the expenses incurred in connection with such activity (other than the cost of goods sold).

Faced with a tax assessment exceeding $800,000, the Davies argued that their business does more than sell marijuana.  In fact, it sells books, shirts and other items related to medical marijuana.  Citing other cases, they argued that their expenses should be apportioned among the various activities (i.e., the sale of medical marijuana and the sale of other items), and that they should be able to deduct the expenses related to the sale of the non-marijuana items.

The court explained that, where a taxpayer is involved in more than one distinct trade or business, it may be able to apportion its ordinary, necessary and reasonable expenses among the different trades or businesses.  Unfortunately for the Davies, they could not show that they operated two (2) or more trades or businesses.  In this case, the facts indicated that the sale of shirts, books and other items was merely incidental to the sale of medical marijuana.  There was not more than one (1) trade or business.

PRACTICE ALERT:  Whether more than one (1) trade or business exists is a question of facts and circumstances.  Under CHAMP v. Commissioner, 128 T.C. 182 (2007), if a taxpayer operates more than one (1) distinct trade or business, it may be allowed to apportion its expenses among the trades or businesses.  If only one (1) of the businesses is impacted by IRC § 280E, only the expenses relating thereto should be denied.  The key is establishing that more than one (1) trade or business exists, and reasonably be able to apportion the expenses among those trades or businesses.  Keeping separate books and records, and accounting for business expenses in a separate manner, is likely the best approach.  The more separation and distinction among the businesses the better the chances of showing more than one (1) trade or business exists.  Maintaining separate entities or business names for each activity may be warranted.

The Davies lost the case and are now faced with a hefty tax bill.  Unless IRC § 280E is amended, taxpayers involved in the sale of medical and/or recreational marijuana, despite state legalization, will be presented with the same dilemma faced by the Davies in Canna Care, Inc. v. Commissioner.

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Larry Brant
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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.

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