Pay me now, tax me later. A hospital in a poor county in Central Florida wanted to recruit an OB-GYN. Rural employers often have to do something extra to recruit good help, so the hospital offered him a $260,000 loan. It came with a sweetener: if certain goals were reached, the loan would be forgiven.
It’s well established that loans aren’t taxable income. That can be pretty sweet to have $260,000 to spend with no withholding and no tax bill. But there’s a catch. You either have to repay the loan (out of your after-tax income), or you have to pay tax on the loan amount if the debt is forgiven.
It’s natural to try to want to have your cake and eat it too — to not pay the loan, and not pay the taxes. That is the very trick behind the leveraged ESOP. But for the rest of us, it’s an elusive goal. It eluded the doctor in Tax Court yesterday.
The doctor met his goals, and $260,000 of debt was cancelled over four years. The doctor didn’t report the income, so the IRS assessed additional tax. The doctor objected. From the Tax Court opinion:
Although the amount that petitioner received from the hospital pursuant to the Revenue Guarantee/Repayment Forgiveness addendum represented a bona fide loan, petitioner contends that the loan was a nonrecourse loan, i.e., that he was not personally liable for its repayment, and that, as a consequence, he did not receive income when the loan was forgiven and canceled by the hospital. The Court disagrees with the premise of petitioner’s argument.
The court pointed out that the terms of the note did make the doctor liable, and added:
Further, although the Court does not accept the premise of petitioner’s contention regarding the nature of the loan, it bears mention that just because a taxpayer is not personally liable for a debt does not mean that cancellation of indebtedness cannot give rise to income…
Under these circumstances, forgiveness and cancellation of the loan gave rise to income.
The Court added in a footnote:
…petitioner argues that when debt is canceled, the creditor should issue a Form 1099-C, Cancellation of Debt, and not a Form 1099-MISC. Although this may be so, the fact of the matter is that a bookkeeping error does not serve to negate income arising from the forgiveness or cancellation of debt.
Apparently the hospital knew that there was income, but issued the wrong kind of 1099. But the 1099 doesn’t change the nature of the income.
The moral? Forgivable loans are nice — cash now, tax later. But later happens.
Megan McArdle, Obamacare’s Tax Day Mystery:
Meanwhile, Louise Radnofsky of the Wall Street Journal offers an example of Effect 3, which I confess hadn’t occurred to me: folks who were covered in 2014, got their refund docked to cover subsidy overpayments, and therefore decided to cancel their insurance for this year.
At first blush, this seems irrational. You don’t need to cancel your insurance to make sure that your tax refund remains intact; you just need to do a better job of estimating your income when you go to buy your insurance so that you don’t end up with overpayments. Of course, the taxpayer in question might not have bought the insurance if she’d known what it was actually going to cost her.
Complex systems have unintended consequences.
Hank Stern, The 4% Solution (Insureblog). “Only 4% of people who signed up for ObamaCare got the correct subsidy”
Christine Speidel, Penalty Relief and Premium Tax Credit Reconciliation (Procedurally Taxing). “This post will describe the penalty relief available under Notice 2015-09 and some of the barriers that may prevent low-income taxpayers from accessing the relief.
William Perez, Taxes When Hiring Household Help
Tony Nitti, IRS Seeks Record $2 Billion In Back Taxes From Prominent Businessman And Philanthropist Sam Wyly. Offshore trusts are involved.
Jason Dinesen, Breakeven Analysis for Small Businesses, Part 1
Kay Bell, IRS telephone tax help was a dismal 38.5% this filing season. Part of your Commissioner’s “Washington Monument Strategy” of making taxpayers suffer to boost his budget.
James Kennedy, Marijuana Dispensary Settles Case after IRS Suggests It Engage in Money Laundering (Tax Policy Blog):
Imagine running a small business and being assessed a penalty by the IRS. Then imagine being told by the IRS that the only way to avoid the penalty is to commit a serious felony, laundering money. This Kafkaesque nightmare actually became reality for a Colorado marijuana dispensary called Allgreens when it tried to pay its federal payroll taxes.
At some point this decade or next, marijuana will become more or less legal. I wonder if the tax law will be the last bastion of prohibition.
TaxProf, The IRS Scandal, Day 712. “The IRS Assures an Atheist Group It Will Monitor Churches.” What could go wrong?
Joseph Thorndike, Republicans Want to Repeal the Estate Tax Because Too Much Is Never Enough (Tax Analysts Blog).
For my money – and admittedly, it’s not my money, since I don’t expect the tax to be an issue for my heirs – repeal is a bad idea under any circumstances. But it’s an especially bad idea when paired with a continuation of stepped-up basis.
If there is a good argument for the estate tax, it’s to allow basis step up. The “breaking up dynasties” thing is silly. From what I’ve seen in practice, all you need to break up inherited wealth is a second generation.
Eric Toder, Corporate Tax Reform and Small Business (TaxVox).
Sebastian Johnson, State Rundown 4/20: State Houses Consider Cuts (Tax Justice Blog).
Career Corner. The Non-Golfing Accountant’s Guide To Hitting the Links (Leona May, Going Concern)