An LLC taxed as a partnership with 128 partners failed to file its partnership tax return electronically, resulting in the IRS asserting a penalty of $224,640 under IRC section 6698(a)(1). Partnerships with more than 100 partners are required to file their tax returns electronically under IRC section 6011(e). Williams Parker represented the partnership in connection with a penalty waiver request pursuant to IRS Announcement 2002-3, 2002-1 CB 305 (Jan. 14, 2002). Shareholder Mike Wilson at Williams Parker convinced the IRS that the partnership was entitled to a penalty waiver under the criteria of the Announcement, and therefore the IRS withdrew the entire $226,640 penalty. Information regarding the Announcement criteria and related guidance can be found at irs.gov.
If you run a small business (or even a large closely-held business) taxed as an S corporation or partnership, don’t get too excited about the tax rate reduction headlines in Congress’ latest tax reform proposals.
The House bill touts a 25% tax rate for business income from these entities. Passive investors would enjoy the 25% rate on all business income, which may encourage more investment and lower equity financing costs. But for an entrepreneur actively involved in the business, the lower rate only applies to 30% of annual income from the business, or to annual business income up to approximately eight percent of adjusted tax basis (roughly, the un-deducted investment amount) in the business assets. So the House bill is friendly to passive investors, and offers only limited benefits to traditional entrepreneurial small business operators.
The Senate proposal touts a 17.4% deduction against S corporation and partnership business income, but limits that deduction to 50% of the amount the individual taxpayer business owner receives in wages. In other words, you have to pick up a dollar of income tax at the full individual tax rate and pay employment taxes on that amount, to enjoy the reduced tax rate on fifty cents of non-wage income. This mix is not much different than the House’s 70% wage income-to-reduced-tax-rate business income ratio.
Like the House plan, the Senate small business tax rate proposal limits benefits to entrepreneurs. Unlike the House bill, the Senate does little for passive investors, who may have a hard time justifying high wages to bolster their deduction.
The proposed 20% tax rate for traditional C corporation income is more straightforward than the S corporation and partnership tax rate proposals. This may cause some small businesses to consider converting to C corporation status (the tax status of many larger companies and the vast majority of publicly-traded companies). But in so doing the businesses (including, especially, Florida businesses) may become subject to state income taxes they otherwise avoid. Further, any cash removed from the business will either be subject to the full individual tax rates or to a 23.4% dividend tax. Finally, when the business is sold, the seller may receive a lower price (because the buyer can’t depreciate the purchased assets) or pay tax at an effective tax rate significantly higher than received or paid by the seller of a business structured as a S corporation or partnership. So while taking advantage of the 20% C corporation tax rate may seem desirable to a growing business that reinvests its profits, the business owner may suffer a significant detriment upon a business sale and pay a higher tax rate on cash removed from the business in the meantime.
Conceivably, if you operate a small business, some flavor of the House and Senate proposals could reduce your tax liability. There are some clean wins. For example, both bills would allow many small businesses to immediately deduct much larger volumes of annual asset purchases, rather than take depreciation deductions over time. But if enacted, the tax rate proposals will not make life more simple or reduce difficult choices.
Changes to business tax rates are just the tip of the tax reform iceberg. The bills would make significant changes to many other areas of the tax law. More to come…
Here is a link to a summary of the House bill: https://waysandmeansforms.house.gov/uploadedfiles/tax_cuts_and_jobs_act_section_by_section_hr1.pdf
Here is link to a summary of the Senate bill: https://www.finance.senate.gov/imo/media/doc/11.9.17%20Chairman’s%20Mark.pdf
Our community is near multiple major ports, including Port Manatee and the Port of Tampa. Taxpayers that import goods through these ports should be aware of U.S. tax issues that can arise from their actions. U.S. taxpayers that import goods from related parties outside the United States have several tax rules to consider in setting their transfer prices and reporting income, including the transfer pricing regimes in both the importing and exporting jurisdictions. Among the U.S. tax rules that such importers must consider is a lesser-known Internal Revenue Code section, Section 1059A.
Section 1059A provides that the maximum amount a U.S. taxpayer may claim as basis in inventory goods imported from a related party is the amount that was determined for customs purposes when the goods were imported. The statute is designed to prevent taxpayers from claiming low values for customs purposes (reducing the amount of U.S. customs duties owed) and high values for transfer pricing purposes (reducing the amount of U.S. taxable income).
A trap for the unwary can occur when related parties retroactively modify their intercompany pricing after goods are imported. For example, a U.S. company may increase the amount paid for an imported good at the end of the year in order to satisfy the arm’s length standard for transfer pricing purposes. This additional amount is generally be subject to customs duties, but reporting additional customs duties can fall through the cracks if a company’s personnel responsible for tax and customs compliance do not communicate regarding the adjustment. In addition, even where additional amounts are reported for customs purposes, the timing of an upward adjustment in the customs price could prevent taxpayers from including the adjustment in the basis of the inventory for tax purposes if the adjustment is made after the customs value has been “finally-determined” (generally, 314 days after the date of entry). These issues may frequently arise when taxpayers retroactively adjust transfer prices in accordance with Advance Pricing Agreements.
In recent years, practitioners have called for better coordination between the Internal Revenue Service and U.S. Customs and Border Protection along with reforms to eliminate the potential whipsaw of Section 1059A. It remains to be seen whether current tax reform proposals will reach this issue.
Nicholas A. Gard
On November 2, 2017, House Republicans unveiled their widespread rewrite of the U.S. Tax Code. The tax plan, called the Tax Cuts and Jobs Act of 2017, is a 429-page bill that provides changes to many aspects of tax law including the corporate tax rate, individual tax rates, the taxes levied on pass-through businesses such as partnerships, and estate taxes. While the bill is unlikely to be signed into law in its present form, certain key provisions of the proposal highlight the direction Republicans hope to take the U.S. Tax Code.
A notable provision is the slashing of the corporate tax rate from its current 35 percent rate to a new 20 percent rate. While earlier proposals considered a temporary rate reduction, the current proposal would make this tax cut permanent. Another much-discussed change is the introduction of a 25 percent tax rate for pass-through businesses such as partnerships and S-corporations. Most items of active income being passed through a business to partners or shareholders would be taxed at a maximum 25 percent rate, rather than the current 39.6 percent minimum rate.
The new tax plan also provides significant changes to how individuals are taxed. Key provisions reduce the seven individual tax brackets to four brackets of 12 percent, 25 percent, 35 percent, and 39.6 percent. The 39.6 percent top bracket will only apply for married couples earning at least $1 million a year or individuals earning at least $500,000 a year. The estate tax exemption would be raised to $11.2 million from its current $5.6 million amount, with the estate tax repealed entirely by 2024.
This is only the beginning of tax reform. The bill must still pass the Senate and be approved by the President, a tall task even if Republicans control each aspect of the legislative process. The reaction of Senators, and more importantly the reaction of voters, will determine whether the tax plan is passed, amended, or rejected entirely.
The Treasury Department’s issuance of proposed regulations under Code Section 2704 were met with significant criticism and confusion. The §2704 proposed regulations were intended to provide the IRS with an additional sword to reduce and in some cases eliminate valuation discounts on family-controlled business entities.
After thousands of comments were received and a public hearing was held where numerous taxpayer advocacy groups, business advisors, and valuation experts provided their concerns, the IRS finally blinked. On October 20, 2017, the IRS published a withdrawal notice of proposed rulemaking, which removes the potential for these proposed regulations to be finalized. The elimination of the proposed regulations is fantastic news for all family-controlled business owners that would be subject to estate and gift taxes. More information regarding the withdrawal is available at federalregister.gov.
The Sarasota-Manatee area recently hosted the 2017 World Rowing Championships, bringing nearly a thousand athletes from seventy countries to the world class rowing facilities at Nathan Benderson Park. The tax consequences of such a visit were probably far from the thoughts of the rowers, coaches, support teams, and fans arriving from all over the world. At what point should someone consider how their visits to the United States could create tax problems? Could you owe tax to the United States just by visiting the country for a rowing competition?
The United States taxes the worldwide income of those who are United States citizens and residents. Generally, any person born or naturalized in the United States will be considered a United States citizen. A person will be considered a resident of the United States by receiving U.S. permanent resident status in the way of a green card or by meeting the substantial presence test. Frequent visitors to this country or those who stay in the country for extended periods must be aware of how the substantial presence test could affect their residency status.
The substantial presence test looks at the number of days a person has spent in the United States over the past three years. Seasonal visitors to the United States, those who make frequent trips to the country for business purposes, or those who vacation in the United States may all establish residency by spending too many days on U.S. soil.
Those in the United States competing in sports may have a slight glimmer of good news. Professional athletes receive a partial exception from counting days for the substantial presence test, but only for days where a professional athlete is temporarily in the United States to compete in a charitable sporting event that is organized to benefit a tax-exempt charity, contributes 100 percent of the proceeds to charity, and uses volunteers for substantially all the work needed to run the event.
If the 2017 World Rowing Championships was your first and only trip to the United States then you likely won’t run into residency problems. But those that have fallen in love with the Sarasota-Bradenton area and plan to return for more visits need to be aware of how your stay in the United States could create tax consequences.
In April, the last time tax reform bubbled into the news cycle, we discouraged readers from paying much attention. President Trump’s “proposal” was this single page of bullet points that told us too little to evaluate its merit.
Tax reform returned to headlines this week, with the President offering this nine-page proposal.
If we use the “number-of-pages” method to evaluate work product, we might expect the new plan to include nine times as much meaningful information. Even if we discount the new document three and one-half pages for including a cover page and five pages only half-full of text, we might hope the new plan offers five and one-half times the information we gathered from April’s one-page plan.
It doesn’t. The new plan largely replicates the prior plan’s bullet points, adding some additional nontechnical explanation and a more impressive presentation format. It adds little, if anything.
Our advice hasn’t changed. Don’t get excited. Don’t exert energy seeking substance about tax reform just yet.
The Internal Revenue Service has announced that tax relief will be available to individuals who live in, and businesses whose principal place of business is located in, 37 different Florida counties affected by Hurricane Irma, including Sarasota and Manatee counties. Taxpayers who live outside the disaster area may also qualify for relief if they have records necessary to meet a deadline located in the disaster area.
The tax relief offered includes additional time to file certain tax returns, additional time to make certain tax payments, and additional time to perform other time-sensitive actions. If an enumerated tax return, tax payment, or other action for which relief has been granted was previously due on or after September 4, 2017 and before January 31, 2018, taxpayers will now have until January 31, 2018 to perform that action without incurring penalties. This relief would apply to businesses with filing extensions until September 15 and individuals with filing extensions until October 16 for their 2016 income tax returns.
Affected taxpayers may also be entitled to claim disaster-related casualty losses and deduct personal property losses not covered by insurance or other reimbursements on either their current year or prior year tax returns. Taxpayers should include the Disaster Designation “Florida, Hurricane Irma” at the top of the relevant 2016 tax form(s).
The Internal Revenue Service will also waive certain fees for tax return copy requests and may consider appropriate relief in the event a tax collection or tax audit matter has been impacted by Hurricane Irma.
A full list of the counties whose residents and businesses may be entitled to tax relief can be accessed here: https://www.irs.gov/newsroom/tax-relief-for-victims-of-hurricane-irma-in-florida.
Nicholas A. Gard
Earlier this month, the Tax Court rejected an argument by the IRS that in order to establish good faith reliance on a tax advisor, for purposes of avoiding penalties, the taxpayer, a foreign corporation, needed to have (1) conducted an independent investigation into the tax advisor’s background and experience instead of merely relying upon the recommendation of the tax adviser by the taxpayer’s US legal counsel, and (2) hired a tax expert that specialized in international tax law or an attorney with an LL.M. degree. The Tax Court found that the IRS attempted to impose greater conditions on the taxpayer than what is required under existing law. The Tax Court ruled that the taxpayer reasonably relied upon the recommendation of its legal counsel in hiring the tax advisor. Furthermore, the standard is not whether the tax advisor was an expert in international tax law or an attorney with an LL.M. degree, but instead whether the tax advisor was “a competent professional who had sufficient expertise to justify reliance.”
The opinion in the case, Grecian Magnesite, Industrial & Shipping Co., S.A. v. Commissioner, 149 T.C. 3 (2017), can be found here.
On Wednesday, President Trump released his tax proposal.
Take a look. It won’t take long. That’s it. One page of bullet points.
For comparison, now look at this discussion of then-candidate Trump’s tax proposals during the presidential election campaign last fall.
Anything new? Not really.
While restating campaign promises may initiate the legislative discussion, doing so tells us little about what might actually appear in legislation hammered out by competing factions in Congress.
So whether you are excited or disappointed about lower corporate tax rates or estate tax repeal, we suggest re-averting your attention to other matters for the time being.
To that end, this missive also ends without further elaboration.