When you fund an employee stock ownership plan, be sure you have an employee. Another strange ESOP failure out of Kansas emerged from the Tax Court yesterday. A Wichita doctor, whom we will call Dr. F, funded an ESOP for his practice with over $400,000 in 2004, supposedly rolled over from his IRA. But, according to the tax court, the doctor wasn’t qualified to participate, and there was no evidence of a rollover. From the Tax Court (emphasis added, citations omitted, doctor’s name shortened by me):
Dr. F. received no compensation from, and was not employed by, petitioner in 2004 or 2005. A total of 53.06 shares of petitioner’s stock was allocated to his account in these years. Respondent determined that these contributions exceeded the section 415(c) limitation because Dr. F. received no compensation from petitioner in 2004 or 2005. Petitioner alleges that the amounts in Dr. F.’s accounts were rollover contributions from Dr. F.’s individual retirement account and should not be considered for purposes of section 415(c).
In order for a distribution to be considered a rollover contribution, the entire amount received must be paid into a qualified trust for the distributee’s benefit no later than the 60th day after the day that the distribution is received. Petitioner has not provided evidence that a valid rollover took place. Further, because the ESOP trust did not have a bank or brokerage account from May 13, 2004, through December 31, 2009, it was not possible for the distribution from Dr. F.’s individual retirement account to have been paid into an account held by the ESOP trust.
Details, details. But details are everything. The IRS cited multiple reasons for the ESOP revocation, and as the court notes, “Any one of the reasons cited in the final revocation letter would be sufficient alone to cause the ESOP and the ESOP trust to fail…” The ESOP also failed to get a qualified appraisal.
This is the second physician ESOP out of Kansas to fail this year in Tax Court. Iowa has long been the capital of flaky ESOPs, but Kansas seems ready to challenge our dubious supremacy. In fairness, though, the trustee of both ESOPs appears to operate out of Northeast Iowa, so we’re keeping our hand in the game.
The Moral? ESOPs are useful for limited purposes, primarily as a succession vehicle for a closely-held business, but they are complex and dangerous, requiring meticulous compliance to avoid catastrophe. They are a poor tax shelter for a closely-held business when the owner wants to maintain control.
Joseph Thorndike, Tax Credits Are Easy – And a Loser’s Game for Liberals (Tax Analysts Blog):
Hilary Clinton’s presidential campaign is still churning out tax proposals at a furious pace. Over the weekend, she proposed a new credit for caretakers—intended, according to her campaign, to “provide support for the millions of families paying for, coordinating, or providing care for aging or disabled family members.”
That sounds great – just like every other tax break Clinton has suggested in the past several months. After all, caring for family members can be hard, and it’s often expensive. Caretakers could definitely use a hand.
But is the tax system the best way to provide it? Probably not.
Home caregivers are wonderful people. But Mr. Thorndike notes the problems with such feel-good credits:
Using tax incentives as a form of hidden spending merely serves to further erode support for more direct forms of government action. Small-bore tax breaks breed more small-bore tax breaks. But they don’t foster any serious rethinking of the role of government.
Nor do they produce meaningful results, even for the narrow problems they target.
There’s another argument that the tax-credits-for-everything crowd glosses over. Each feel-good credit throws another social program to an IRS that is collapsing under its current workload. They can’t really want IRS agents evaluating at-home care, yet it’s baked into that cake. If you don’t audit a lucrative tax credit, it becomes a fraud magnet. So IRS, meet Grandma.
Howard Gleckman, Clinton’s Caregiver Credit Adds To Her List of Tax Breaks, Sharpens Her Contrast With The GOP. “The likely Democratic presidential nominee, Hillary Clinton, would aggressively use the tax code to achieve social and economic goals, cut taxes on many middle-income people, and raise taxes on high-income households. Every Republican presidential hopeful would eliminate most existing tax subsidies, lower rates, and give big tax cuts to those with high-incomes.”
Robert D. Flach has fresh Tuesday Buzz! Lots of links, and spicy observations on the use of the tax law to run social programs.
Tony Nitti, Tax Geek Tuesday: Reminding You That The Gain On That Sale Of Stock May Be Tax Free. “C corporations are like pit bulls and prostate exams — they carry quite the stigma, but they’re not nearly as bad as they’re made out to be.”
TaxGrrrl, Guilty On Tax & Conspiracy Counts, Couple Faces New Charges For Revenge. Violating the first rule of holes.
Farley Katz, Joseph Perera, Katy David, Important New Partnership Audit Rules Change Taxation of Partnerships (Procedurally Taxing)
Not only can the partnership owe income tax, the tax will not be based on the income for the year in question, but instead on one or more prior years’ income. Consequently, the economic burden of the tax could be borne by partners who had no interest in the partnership when the income was generated. Conversely, if a partnership overstated its income in a prior year, the benefit of correcting that overstatement will accrue to the current partners, not those who were partners in the earlier year. Finally, if a partnership elects out of the new provisions (assuming it is eligible), the IRS will no longer be able to conduct a centralized audit controlling each partner’s distributive share, but will instead have to audit each partner individually,
Excellent article. These new rules will change the dynamics of partnership exams a great deal when they take effect for 2017 filings.
Tyler Cowen, Against a financial transactions tax. He cites a paper documenting that such taxes are unwise: “This is consistent with earlier findings on Sweden’s transactions tax, and that proposal continues to be one of the more overrated ideas in American Progressive political discourse.”
TaxProf, The IRS Scandal, Day 929
Career Corner. Let’s Discuss: Non-Equity Partners in Accounting Firms (Caleb Newquist, Going Concern)