Monthly Archives: February 2015

Better to Abandon a Bad Investment Than to Sell It? Sometimes, if the Investment is Still Worth Something

Could it be better to abandon a bad investment and receive nothing in return, than to sell it and receive something in return? Sometimes the answer is “yes,” according to a recent federal appellate court decision. The reason is that you can take an ordinary business tax loss from abandonment even though a sale would produce a capital loss. The extra tax benefit from the ordinary business loss may be more valuable to you than the combined consideration and capital loss you receive from a sale.

Assume you bought an investment for $100, and its value has fallen to $2. If you sell the investment for $2 and the investment is a capital asset, you will recognize a $98 capital loss. Unless you have $98 of capital gains from other transactions available at that time, you can’t use the loss to offset other income, and you are left with the $2 of sale proceeds. Even if you have $98 of capital gains from other transactions, an individual might offset capital gains tax at a 23.8% tax rate, producing a $23.32 tax savings, and a total value of $25.32, including the $2 of sale proceeds. If you abandon the investment for no consideration, you may be able to take a business loss offsetting income otherwise taxable at a 43.4% tax rate, producing a $42.53 tax benefit. Bizarrely, the $42.53 tax benefit from the ordinary business deduction is worth substantially more than the $25.32 combined proceeds and capital loss tax benefit from a sale.

Even more bizarrely, thanks to a quirk in the Internal Revenue Code, this arbitrage is not possible when the investment is completely worthless. It is only possible when the investment has some remaining value.

This arbitrage only exists in limited circumstances, and does not work for all investments. It also has litigation risk. The Tax Court has held that it does not work. The Fifth Circuit Court of Appeals decision approving the strategy is only binding law to overturn the contrary Tax Court decision in Texas, Louisiana, and Mississippi. The IRS may still challenge the strategy for taxpayers in other states, and those taxpayers cannot be sure their own federal appellate court will agree with the Fifth Circuit. For those willing to take those risks, however, the strategy is compelling.

Here is a link to the Fifth Circuit Court of Appeals February 25, 2015, decision in Pilgrim’s Pride v. Commissioner, approving the strategy:

E. John Wagner, II

Applicable Federal Rates for March 2015

The Internal Revenue Code prescribes minimum imputed interest rates and time-value-of–money factors applicable to certain loan transactions and estate planning techniques. These rates are tied formulaically to market interest rates. The Internal Revenue Service updates these rates monthly.

These are commonly applicable rates in effect for March 2015:

Short Term AFR (Loans with Terms <= 3 Years)                                          0.40%

Mid Term AFR (Loans with Terms > 3 Years and <= 9 Years)                     1.47%

Long Term AFR (Loans with Terms >9 Years)                                              2.19%

7520 Rate (Used in many estate planning vehicles)                                     1.8%

Here is a link to the complete list of rates:

E. John Wagner, II

Update – Employer Reimbursements of Individual Health Policy Premiums Temporary Relief Issued for Small Employers – until June 2015 And IRS clarifies reimbursement rules for 2% Sub S shareholders and for Medicare & Medigap premiums & TRICARE uncovered expenses

Small Employer Relief Until June 30, 2015

In November we alerted you that employers that reimburse employees for the cost of purchasing individual health insurance policies risk being subject to ACA penalties of $36,500 per year per person.  Here is a link to our prior alert:

On February 18, 2015, the IRS issued temporary relief for small employers (those that don’t qualify under the ACA as an “applicable large employer”) from these enormous penalties.  The temporary relief ends June 30, 2015.

Under the soon to be published IRS notice (Notice 2015-17), small employers that aren’t classified as “applicable large employers” will not be hit with the ACA $36,500 per person penalty for either 2014 or for the period from January 1, 2015 through June 30, 2015.  Starting July 1, 2015, the penalties will apply, so almost all employers need to stop premium reimbursement policies to avoid penalties.

To be eligible for the temporary relief, an employer is considered a small employer if it does not employ an average of 50 or more full-time employees (including full-time equivalent employees) on business days during the preceding calendar year.  An employer’s small employer status is looked at separately for 2014 and 2015 for purposes of this temporary relief.

An employer that qualifies for the temporary relief does not need to file Form 8928 reporting failure to satisfy the mandates of providing ACA compliant coverage for the period that the employer is eligible for the relief.

Reimbursement of 2% Sub S Shareholders

The new IRS notice also provides relief or clarification for employer health premium reimbursements provided to 2% Sub S shareholders.  Until further guidance is published by the IRS, and in all events through the end of 2015, health insurance premium reimbursements to 2% Sub S shareholders will not trigger the $36,500 ACA penalties.

The exception for 2% Sub S shareholders does NOT apply to reimbursements provided to other employees of the Sub S employer.  As a result, reimbursements to the non-2% Sub S shareholder/employees will trigger the ACA penalties (but may be temporarily suspended until June 30, 2015 if the employer is not an applicable large employer – see above).

Reimbursement of Medicare, Medigap and/or TRICARE Premiums

The IRS notice also addresses employer arrangements that reimburse employees for Medicare, Medigap and TRICARE premiums.  The IRS notes that the reimbursement of Medicare premiums by an employer may violate the Medicare secondary payer rules which are not tax rules but impose severe penalties.  On the tax side, the IRS advises that an employer program that reimburses Medicare, Medigap or TRICARE premiums (or uncovered medical expenses) without the employer offering the employee coverage under an employer sponsored minimum value health plan will trigger the $36,500 per person per year penalty.  The exception that allows an employer to reimburse the Medicare, Medigap or TRICARE premiums (or medical expenses) without triggering the ACA $36,500 penalty requires the employer to offer employer health coverage and comply with a number of other very specific requirements.  For more information, give us a call or email.

Carol L. Myers

Your Last Opportunity to Reduce Your 3.8% Medicare Surtax For the Rest of Your Life

IRS has extended to 2014 individual income tax returns a one-time opportunity to potentially permanently reduce exposure to the 3.8% Medicare Surtax enacted with Obamacare. With apologies for melodramatic tone, if you didn’t make the election on your 2013 federal income tax return and you don’t make the election on your original 2014 return, you may pay more 3.8% Medicare Surtax than necessary for the rest of your life. IRS extended the opportunity to 2014 returns because the final 3.8% Medicare Surtax rules were published near the beginning of the 2013 tax return filing season. There is no impetus to further extend the opportunity into future years, and the election generally cannot be made on an amended return.

The planning opportunity relates to income from “passive” business activities. “Passive” business income is subject to the 3.8% Medicare Surtax. Non-passive income is exempt. Income from an activity is not passive if the taxpayer meets certain hourly participation thresholds. An election to “group” activities makes it easier to satisfy the hourly participation thresholds to avoid passive activity status. Even if separate activities do not individually satisfy the participation thresholds, the grouped activities may nevertheless qualify and therefore exempt all the activities from the 3.8% Medicare Surtax.

The one-time opportunity is to change an individual’s “grouping” elections so the individual may convert a collection of passive businesses subject to the 3.8% Medicare Surtax into a single non-passive business exempt from the 3.8% Medicare Surtax. If the election is not made on an individual’s 2014 federal income tax return and the individual is subject to the 3.8% Medicare surtax in 2014, the existing grouping elections—or lack thereof—usually apply forever, and the opportunity to freely reclassify passive activities is permanently lost.

For more information concerning 3.8% Medicare Surtax planning, as well as planning to avoid related taxes:Taking a Second Bite of the 3 8 percent Medicare Surtax

E. John Wagner, II