For Want of a Nail? How Long-Term Capital Gain Eligibility Can Turn on a Single Piece of Paper

An old proverb teaches that the absence of a horseshoe nail can cause the downfall of a kingdom. A recent Tax Court cases suggest a real estate owner’s eligibility for long-term capital gain can turn on something just as trivial:  a single piece of paper.

The Sugar Land case involved real estate businesspersons who, though various entities, held some land for investment purposes and other land for development purposes. During 2008, they decided to abandon development plans for raw land they originally intended to develop. In 2008, they executed an owner resolution expressing their change of intent. Their land holding company subsequently sold most of the property to an unrelated homebuilder in three transactions in 2011 and 2012. The company then sold substantially all the remaining property to related entities in four transactions spanning 2012 through 2016. The related entities developed that land for resale.

The IRS asserted that the 2012 sales should have generated ordinary income instead of long-term capital gain. Despite several factors militating against capital gain eligibility—including nearby development activity by related entities–the Tax Court found that the sales qualified as long-term capital gain. The court identified the 2008 owner resolution as the critical factor showing their intent.

The Sugar Land opinion is a bookend to the Fargo case we discussed in 2015. In Fargo, the Tax Court held that a taxpayer who held land without developing it for over a decade recognized ordinary income on its sale. The court reasoned that the long holding period did not overcome the absence of an owner resolution or other documentation evidencing the abandonment of the owner’s original development plan. The taxpayer could not recognize long-term capital gain.

Lesson learned? Silly or not, documenting the non-development intent for holding raw land can make a big difference in the income tax bill when the property is sold. If you want long-term capital gain, take a few minutes to make sure the owners execute a contemporaneous resolution or governing documents expressing the intent to hold the property for investment, not development. Otherwise you might tell a tale of losing your own financial kingdom, for want of just one piece of paper.

Helpful Resources:

E. John Wagner, II
jwagner@williamsparker.com
941-536-2037

The Tax Act May Limit Resolutions of Sexual Harassment Complaints

One aspect of the new Tax Act (the Act) that has not been widely reported impacts employers that amicably resolve claims of sexual harassment. The provision denies tax deductions for any settlements, payouts, or attorneys’ fees related to sexual harassment or sexual abuse if such payments are subject to a non-disclosure or confidentiality agreement. Specifically, Section 162(q) to the Internal Revenue Code provides:

PAYMENTS RELATED TO SEXUAL HARASSMENT AND SEXUAL ABUSE.—No deduction shall be allowed under this chapter for—

(1) any settlement or payment related to sexual harassment or sexual abuse if such settlement or payment is subject to a nondisclosure agreement, or
(2) attorney’s fees related to such a settlement or payment.

The intent of this provision is to deter confidentiality provisions in settlements of harassment claims. It is unclear if this provision will actually have the desired impact. Companies may value the confidentiality provisions more than the tax deductions permitted in their absence, and thus continue to enter into confidential settlement agreements. Alternatively, this provision of the Act may end up hurting those bringing harassment claims. Alleged victims may want confidentiality provisions in order to avoid any publicity about their claims. However, by removing tax incentives for employers, an employer may reject a higher settlement amount or settlement of claims altogether.

Section 162(q) of the Act is bound to create confusion as to its applicability as it fails to define key terms. Namely, the Act fails to define “sexual harassment” or “sexual abuse,” both of which are pivotal to the application of the new provision. The Act also fails to contemplate how the provision is to be applied in settlement arrangements involving a variety of claims. Are the sex-based claims separable from a universal confidentiality covenant? Causing further confusion, the Act fails to explain what attorney’s fees are considered to be “related to such a settlement or payment.” Are these only the fees related to settlement negotiations, drafting the agreement, and execution or payment? Or does it extend to the claim’s inception and include the underlying investigation of the claims?

In light of the numerous questions raised by Section 162(q), employers should review their standard settlement agreements and practices and consider revising the breadth of any releases, nondisclosure provisions, or any representations or remedies.

This post was originally posted on the Williams Parker Labor & Employment Blog.

Ryan P. Portugal
rportugal@williamsparker.com
941-329-6626

Charitable Giving Under the New Tax Act – The Standard Deduction Bump

One of the more visible changes from the Tax Act will be the increase in the standard deduction. When completing an annual tax return, a taxpayer has the choice to either take a standard deduction or to itemize deductions. The standard deduction is a flat dollar amount which reduces your taxable income for the year, with the same standard deduction amount applying to every taxpayer who takes the standard deduction. The itemized deduction instead allows a taxpayer to deduct a number of different expenses from throughout the year, including certain medical expenses, mortgage interest, casualty and theft losses, state and local taxes paid, and charitable contributions. Whether a taxpayer uses the standard deduction or itemizes his or her deductions will depend on whether that taxpayer’s itemized deductions exceed the standard deduction amount.

In 2017, the standard deduction amount was $6,350 for single taxpayers and $12,700 for married taxpayers filing jointly. The Tax Act has nearly doubled these amounts for 2018, with the standard deduction increased to $12,000 for single taxpayers and $24,000 for married taxpayers filing jointly. Limitations have also been placed on deducting state and local taxes (capped at $10,000) and on mortgage interest (limited to new loans, capped at $750,000).

Taxpayers now have a higher standard deduction amount they need to pass before itemizing their deductions and they have more limited expenses available in order to get over that bar. Fewer people will be generating the expenses needed to make itemizing deductions worthwhile. The Tax Policy Center estimates that the percentage of taxpayers itemizing deductions will drop from 30% to only 6%.

If fewer taxpayers are itemizing their deductions, the tax benefits of charitable giving will be available to fewer taxpayers. The Tax Policy Center estimates charitable giving to drop anywhere from $12 billion to $20 billion in the next year. Taxpayers may instead bunch their charitable gifts into a single year, itemizing their deductions in such a year while using the standard deduction in subsequent years rather than spreading out these gifts over a stretch of years.

People charitably give to their favorite organizations out of a humanitarian desire to help less fortunate people and to benefit the wider community; a smaller tax incentive will not change this. But the smaller tax incentive is expected to have a negative impact both for a taxpayer’s ability to deduct charitable gifts and for the amount of gifts charitable organizations expect to receive.

Jamie E. Koepsel
jkoepsel@williamsparker.com
(941) 552-2562

When is a Rose Not a Rose? IRS Tries to Plug Carried Interest Loophole by Claiming Roses are Not Flowers

The sweeping tax law passed in December requires partners holding some “carried interests” (partnership interests disproportionately large as compared to the relative capital contributed) to recognize gain at ordinary income tax rates (up to 37%) if their holding periods do not exceed three years, as opposed to the one-year holding period normally required to qualify for 20%-tax-rate long-term capital gain. The idea is that these interests are associated with services — often performed by hedge fund and private equity managers — that don’t carry the investment risk associated with a normal capital asset, and therefore holders of these partnership interests should have to own the interests longer to qualify for a low tax rate.

The statute categorically exempts partnership interests held by “corporations” from the new rules. Without explanation, the IRS announced this week it will take the position that “S corporations” are not “corporations” for the purposes of the carried interest law, even though by definition the opposite is true throughout the Internal Revenue Code. Their interpretation is akin to claiming roses aren’t flowers.

There are common sense reasons why S corporations should not be exempt from the carried interest statute. Because S corporations are pass-through entities, there is no practical difference between an individual owning a carried interest directly, as opposed to owning it through an S corporation. Yet read literally, the statute produces different results in these practically comparable situations.

Still, statutes are supposed to mean what they say. S corporations are corporations, just like roses are flowers. Unless Congress changes the statute, the Internal Revenue Service may have a hard time defending its position in litigation.

See our prior discussion of the new carried interest law:

E. John Wagner, II
jwagner@williamsparker.com
941-536-2037

Accrual-Method Taxpayers with Audited Financials May Have to Recognize Income Sooner

Section 13221 of the 2017 Tax Cuts and Jobs Act amended IRC section 451 to link the all events test for accrual-method taxpayers to revenue recognition on the taxpayer’s audited and certain other financial statements. Specifically, new IRC section 451(b) (old 451(b) through (i) were redesignated as 451(d) through (k)) provides that for accrual-method taxpayers “the all events test with respect to any item of gross income (or portion thereof) shall not be treated as met any later than when such item (or portion thereof) is taken into account in revenue in” either (1) an applicable financial statement or (2) another financial statement specified by the IRS. In other words, taxpayers subject to this rule must include an item in income for tax purposes upon the earlier satisfaction of the all events test or the recognition of such item in revenue in the applicable or specified financial statement. For example, any unbilled receivables for partially performed services must be recognized for income tax purposes to the extent the amounts are taken into income for financial statement purposes, instead of when the services are complete or the taxpayer has the right to invoice the customer. The new rule does not apply to income from mortgage servicing rights.

The new rule defines an “applicable financial statement” as (1) a financial statement that is certified as being prepared in accordance with generally accepted accounting principles and that is (a) a 10-K or annual statement to shareholders required to be filed with the SEC, (b) an audited financial statement used for credit purposes, reporting to shareholders, partners, other proprietors, or beneficiaries, or for any other substantial nontax purpose, or (c) filed with any other federal agency for purposes other than federal tax purposes; (2) certain financial statements made on the basis of international financial reporting standards filed with certain agencies of a foreign government; or (3) a financial statement filed with any other regulatory or governmental body specified by the IRS. It appears that (1)(b) would capture accrual-method taxpayers that have audited GAAP financial statements as a requirement of their lender or as a requirement of their owners, such as a private equity fund owner.

This new rule should also be considered by affected taxpayers in relation to the relatively new and complex revenue recognition standards in ASC 606, Revenue from Contracts with Customers, which becomes applicable to nonpublic GAAP companies later this year (unless adopted earlier). For example, a taxpayer’s tax function and financial accounting function would need to coordinate to ensure that the sales price of contracts containing multiple performance obligations (i.e., bundles of goods and services, such as software sales agreements that include a software license, periodic software updates, and maintenance and support services) is allocated to the separate components in the same manner for financial statement and tax purposes.

The new tax rule is effective for tax years beginning after 2017.

Discussion of the new tax rule begins on page 272 of the new Tax Cuts and Jobs Act Conference Report.

Michael J. Wilson
mwilson@williamsparker.com
941-536-2043

Williams Parker to Participate in International Trade Symposium at Port Manatee

On Thursday, February 22, 2018, Williams Parker will be participating in an International Trade Symposium organized by the International Trade Hub at Port Manatee hosting an association of trade commissioners from Chile, Colombia, Costa Rica, Ecuador, Spain, Guatemala, Honduras, Mexico, Peru, Uruguay, Dominican Republic, Brazil, Argentina, and Canada. These trade commissioners cooperate to expand and facilitate the international commercial relations with Florida and are mainly based in Miami. Following the symposium at Port Manatee, a luncheon will take place at the Manatee Chamber of Commerce featuring a brief presentation by Williams Parker attorney Jamie Koepsel regarding the international aspects of the recent tax legislation.

If you are in the retail industry or simply interested in international trade and want to learn more about how you can expand your business to international markets, you may want to consider participating in the event. A great number of the trade commissioners have already confirmed their participation in the event. Establishing relationships with the trade commissioners will be valuable to your business growth plans. The trade commissioners will help you navigate the markets and cultures of the countries where you want to do business.

Please contact Williams Parker attorney Juliana Ferro for more information.

A Little Clarity for Non-U.S. Persons Selling Partnership Interests

A Spanish translation of this post appears below. La traducción al español de este artículo aparece a continuación.

The Tax Cuts and Jobs Act provided clarity to a question of how to treat gain or loss from the sale or exchange of a partnership interest held by a foreign person. The IRS, through Revenue Ruling 91-32, previously provided that “the gain realized by a foreign partner upon disposing of its interest in a U.S. partnership should be analyzed asset by asset and, to the extent any such asset would give rise to effectively connected income, the departing partner’s pro rata share of such gain should be treated as effectively connected income.” The Tax Court disagreed with the findings of Revenue Ruling 91-32 in Grecian Magnesite Mining, Industrial & Shipping Co., SA v. Commissioner of Internal Revenue and instead held that income, gain, or loss from the sale or exchange of a U.S. partnership interest by a foreign person will only be attributable to a U.S. office, and thus taxed as effectively connected income, if the U.S. office is a material factor in the production of such income, gain, or loss in the ordinary course of business of that U.S. office.

Rather than waiting for courts to come to a consensus as to how to treat gain or loss from a foreign person’s sale of a partnership interest, the Tax Cuts and Jobs Act amended the previous tax law and took the position of Revenue Ruling 91-32. Now if a partnership has a U.S. office and a foreign person sells an interest in such a partnership, then an asset-by-asset analysis will need to be conducted to determine how much of the gain or loss from such a sale will be subject to U.S. taxes.

For more information regarding the Tax Act, please see our recent related blog posts linked below:

Jamie E. Koepsel
jkoepsel@williamsparker.com
(941) 552-2562

Un poco de claridad para personas no estadounidenses que ofrecen a la venta su participación en una sociedad americana (también conocida como “U.S. Partnership”)

La ley de recortes fiscales y empleos de 2017, conocida como el “Tax Cuts and Jobs Act,” dió claridad a la cuestión de cómo tratar las ganancias o pérdidas de capital generadas después de la venta o intercambio de capital de una sociedad americana (“U.S. partnership”) en poder de una persona no estadounidense.

El IRS (Servicio de Impuestos Internos), a través de la Resolución de Impuestos 91-32, sostenía que las ganancias generadas por un socio extranjero al vender o transferir su parte en una sociedad americana debían ser analizadas activo por activo y, en la medida en que las ganancias de cualquier activo estuviesen vinculadas a una actividad realizada en los Estados Unidos, las ganancias de dicho socio (medidas en proporción a su participación en la sociedad) debían ser tratadas como ingresos efectivamente vinculados a una actividad realizada en los Estados Unidos.

El tribunal de impuestos no estuvo de acuerdo con la forma en que la Resolución de Impuestos 91-32 fue interpretada en el caso de Grecian Magnesite Mining, Industrial & Shipping Co., SA v. Commissioner of Internal Revenue. El tribunal sostuvo que los ingresos, ganancias, o pérdidas generadas en la venta o intercambio de la participación de una sociedad americana por una persona extranjera debían ser atribuibles solamente a una oficina ubicada en los Estados Unidos y ser tratadas como ingresos efectivamente vinculados, solamente si la oficina ubicada en los Estados Unidos era indispensable para la producción de dichos ingresos, ganancias, o pérdidas en el curso ordinario de los negocios de la oficina ubicada en los Estados Unidos.

En lugar de esperar a que los tribunales llegaran a un consenso en cuanto a cómo tratar las ganancias o pérdidas generadas en la venta de capital de una sociedad en propiedad de una persona extranjera, la reforma fiscal de 2017 modificó la ley tributaria anterior y asumió la regla establecida por la Resolución de Impuestos 91-32. Ahora, si una sociedad tiene una oficina ubicada en los Estados Unidos y una persona extranjera vende su participación en tal sociedad, un análisis de cada activo debe ser conducido para determinar el monto de las ganancias o pérdidas sujetas a impuestos en los Estados Unidos.

Traducción por Juliana Ferro, Abogada

Tax Savings Estimator: Qualified Business Income Deduction

If you own a business taxed as a sole proprietorship, partnership, or S corporation, the new Section 199A Qualified Business Income Deduction offers one of the biggest potential tax benefits under the recently-enacted Tax Cuts and Jobs Act. It allows you to deduct up to twenty percent of your business income. If your income exceeds $157,500 ($315,000 for a married joint filer), the deduction is limited by filters tied to your company’s employee payroll and depreciable property ownership. There are other restrictions, but for most business owners our calculator offers a useful, simplified estimate of tax savings from the new deduction.

Curious whether you should change the tax status of your company? Read our analysis here: Should You Reform Your Business for Tax Reform?

E. John Wagner, II
jwagner@williamsparker.com
941-536-2037

A Guide to the Toll Charge of the Tax Act

Shareholders in foreign businesses could find themselves hit with an immediate tax on offshore earnings under the recently passed “Tax Act,” officially known as “An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018.”  Before the Tax Act, most foreign income earned by US shareholders through foreign corporations would only be subject to US taxes when the foreign income was paid to those US shareholders as dividends. The Subpart F rules were a way for the United States to capture some of this offshore income in the US tax base, but careful planning meant many US shareholders with foreign companies could keep money offshore and out of the US tax system for years. Some estimates put the amount of this offshore money at nearly $3 trillion, so any change to how the United States treats foreign taxes would look into how best to address these offshore earnings.

The Tax Act will look to capture some of this offshore income through a one-time immediate increase in the Subpart F income of certain US persons investing in foreign corporations.  The amount of income immediately taxed by the United States will increase by the greater of (i) accumulated post-1986 deferred foreign income determined as of November 2, 2017, or (ii) the accumulated post-1986 deferred foreign income determined as of December 31, 2017.  The tax rate on this deferred foreign income will be 8 percent for non-cash E&P and 15.5 percent for cash E&P.  This one-time tax has been referred to as a “Toll Charge” for how it may allow offshore income to flow back into the United States.

The Toll Charge is not a routine E&P calculation for US shareholders of foreign corporations.  Year-by-year ownership percentages, whether E&P is cash or non-cash, and the availability of certain foreign tax credits will all affect the final tax due.  The Tax Act has allowed for the payment of the Toll Charge in installments if sufficient cash to make payments is unavailable.

For more information regarding the Tax Act, please see our recent related blog posts linked below:

Jamie E. Koepsel
jkoepsel@williamsparker.com
(941) 552-2562

Welcome the New Year With Our Updated Tax Reform Review

On December 22, 2017, President Trump signed into law the most important rewrite of the US tax code in decades. The federal law, which is entitled “An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution of the budget for the fiscal year 2018” (the Act), has no other name, as its short title, the Tax Cuts and Jobs Act, was stricken from the bill shortly before being signed.

We have prepared a summary of the Act as a non-exhaustive discussion of key changes to the tax code. We will continue to analyze the Act and will post updates and recommend planning strategies on this blog.

For more information regarding the Act, please see our previous related blog posts linked below:

On behalf of everyone at Williams Parker, we hope you and your family have a healthy and happy 2018.

Please note this post was co-authored by Elizabeth Diaz, Colton Castro, and Nicholas Gard. 

Elizabeth P. Diaz
ediaz@williamsparker.com
941-329-6631

Colton F. Castro
ccastro@williamsparker.com
(941) 329-6608

Nicholas A. Gard
ngard@williamsparker.com
(941) 552-2563