Larry's Tax Law

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.

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.

Dear Readers:

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.

Best,

Larry

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Service was forced to move its focus from the audit function to information and technology as its systems were terribly out of date.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.

Whether we will see tax reform in this country anytime soon is debatable.  When and if we see it, whether IRC § 1031 will survive has been a subject of discussion.

House Ways and Means Committee Chairman David Camp issued a discussion draft of the Tax Reform Act of 2014 earlier this year.  The proposed legislation spans almost 1,000 pages.*  One of its provisions repeals IRC § 1031 and taxpayers’ ability to participate in tax-deferred exchanges.  The Obama Administration responded to Chairman Camp’s proposal.  It wants to retain IRC § 1031, but limit its application to $1,000,000 of tax deferral per taxpayer in any tax year.  Based upon the precise wording of the White House’s response to Chairman Camp’s proposal, it appears the $1,000,000 limitation would only apply to real property exchanges.  So, personal property exchanges would be spared from the proposed limitation.  Of course, there is always the possibility that lawmakers, if they take this approach, would expand the White House’s proposed limitation to apply to personal property exchanges.  Only time will tell.

Thomas v. Commissioner, TC Memo 2013-60 (February 26, 2013)

The saga of Michael and Julie Thomas started in the early part of this decade.  Michael was the head of real estate acquisition for DBSI in Idaho.  There, he met fellow DBSI employee Don Steeves, who was a CPA with seven (7) years of experience, primarily working in the real estate investment industry.  When Michael started two real estate businesses, TIC Capital ("TIC") and TICC Property Management ("TICC"), he hired Steeves as an independent contractor to serve as CFO of TIC and as the managing partner of TICC.  His compensation was incentive based—he received compensation which was based on the financial success of the two businesses.  In good years, Steeves’ compensation was off the charts.  In addition to acting as CFO for the two businesses, Steeves prepared Michael’s and Julie’s income tax returns.  They relied upon him to oversee all aspects of accounting and tax compliance for both of the businesses and their personal affairs.  They let him take total control of these functions.

Barnes v. Commissioner, 712 F.3d 581 (D.C. Cir. 2013) aff’g T.C.M. 2012-80 (2012) is illustrative of the point that understanding the basis adjustment rules is vital.

If this case was made into a movie, the name of the movie would tell the entire story – S corporation shareholders are not allowed to just make up the basis adjustment rules!  Also, as I have repeatedly stated, poor records lead to disastrous results.  The DC Circuit affirmed the US Tax Court in April of 2013 to finally put an end to the case.

Trugman v. Commissioner, 138 T.C. 22 (2012) exemplifies one of many reasons why you do not put real estate in a corporation, especially your personal residence.

The Trugmans were the sole shareholders of Sanstu corporation, an S corporation. Over the years, the S corporation acquired rental real estate all across the country.  The Trugmans likely did not utilize professional tax advisors.

In 2009, for some reason, the Trugmans awoke from a deep sleep and started thinking about tax planning.  To avoid tax on the income from their stock portfolio, they moved to Nevada which has no state income tax.

That same year, the Trugmans caused Santsu to purchase a single family dwelling they could occupy as their home.  Santsu contributed about 98% of the purchase price; and the Trugmans put in the other 2% or about $7500 toward the purchase.   The deed to the property listed Santsu as the sole owner.

Since they had not been homeowners in over three years, the Trugmans claimed a first-time homebuyer credit on their 2009 joint individual tax return under now expired IRC Section 36.

S corporations and their shareholders must keep track of stock and debt basis.  Failure to do so can lead to disastrous results.  Nathel v. Commissioner, 105 AFTR 2d 2010-2699 (2d Cir 2010), illustrates this point.

In Nathel, the government and the taxpayer stipulated to the facts.  Two brothers and a friend formed three separate S corporations to operate food distribution businesses in New York, Florida and California.  All three shareholders made initial capital contributions to the corporations.  The brothers also made loans to two of the corporations.

In 2001, one corporation was liquidated.  In a reorganization of sorts, the friend ended up owning 100% of the second corporation and the two brothers ended up equally owning the third corporation.

In late 2000, before the reorganization, the brothers made loans to the corporations totaling around $1.3 million.  In 2001, they made capital contributions totaling approximately $1.4 million.  Also, in 2001, they received loan repayments combined in excess of $1.6 million.

Immediately before the repayment of the loans, the brothers had zero basis in their stock and only nominal basis in the loans.  Ouch!  To avoid the ordinary income tax hit on the delta between the $1.6 million in loan repayments and their nominal loan basis, the brothers, with the likely help of their handy dandy tax advisor, asserted the $1.4 million in capital contributions was really tax-exempt income to the corporation, excludable under IRC Section 118(a), but which, under IRC Section 1367(b)(2)(B), increased their loan basis.  Therefore, the ordinary income tax hit on the loan repayments was nominal.

Please join me for the NYU 73RD Institute on Federal Taxation.  This year’s Institute will be held in San Diego at the Hotel Del Coronado November 16 – 21, and in New York City at the Grand Hyatt New York October 19 – 24.  Please see the attached brochure.  The coverage of tax topics is both timely and broad.  This year’s presentations will cover topics in the areas of:  executive compensation and employee benefits; partnerships and LLCs; corporate tax; closely held businesses; and trusts and estates.  What is so terrific about the Institute, in addition to a wonderful faculty and the interesting current presentation topics, you can choose the presentations you want to attend.  In other words, you can pick and choose the topics that relate to your tax practice.

This is my second time speaking at the Institute.  My topic this year is: "Developments In The World Of S Corporations."  I plan to deliver a White Paper that will provide attendees with an historic overview of Subchapter S and a look through a crystal ball at the future of Subchapter S, including a review of the recent cases, rulings and legislative proposals impacting Subchapter S.

I hope to see you in either San Diego or New York.

Best,

Larry