Posts Tagged ‘Judge Halpern’

Tax Roundup, 9/10/2013: If your S corporation numbers aren’t perfect, zero isn’t good enough. And Wonka accounting!

Tuesday, September 10th, 2013 by Joe Kristan

20120511-2As we approach the October 15 extended deadline for 1040s, some taxpayers face a tough call: they still haven’t received all of their K-1s.  Yes, the extended K-1 deadline is normally September 15, but sometimes failure to file on time is an option for partnerships and S corporations, and the K-1s just aren’t done on time.  The tax law tells you to report the income as best you can, and amend if you get better information.  The IRS usually will understand.

Except when you control the S corporation with the delinquent K-1s.

A Californian, Dr. Sampson, owned two S corporations. His preparer hit a wall preparing the S corporation returns, according to the Tax Court (my emphasis):

Mr. Araradian has been preparing returns for Dr. Sampson and the corporations for many years. He receives the information necessary to prepare the corporations’ tax returns from Dr. Sampson’s administrator, who keeps general ledgers for both corporations using a computer program, QuickBooks, which is available to Mr. Araradian electronically. He also receives copies of the actual documents, such as bank statements and payroll reports, underlying the entries in QuickBooks (source documents), which he believes are necessary to verify the data in QuickBooks.  before he will prepare a tax return. For neither of the years in issue did either corporation provide source documents to Mr. Araradian before the respective dates on which their Forms 1120S for those years were due. The corporations’ Forms 1120S for those years were delinquent because, without source documents Mr. Araradian would not prepare those returns. 

Well, he still had the Quickbooks files, so he should be able to throw together a tentative taxable income number for the doctor, right?  Apparently not:

     And since he had not prepared the corporations’ returns by the dates on which petitioners’ 2008 and 2009 Forms 1040, U.S. Individual Income Tax Return (together, original returns), were due, Mr. Araradian did not have the corporations’ Schedules K-1, Shareholder’s Share of Income, Deductions, Credits, etc., from which to enter pass-through items from the corporations on the original returns.

Consequently, Mr. Araradian prepared the original returns omitting any income or losses passed through to petitioners from the corporations. He told Dr. Sampson in each case that he was making a statement on the return saying that pass-through items from the corporations were not being included. The statement that he made on each return is as follows:

      THE ENCLOSED TAX RETURN FOR REGINALD AND GERVEL SAMPSON DOES NOT INCLUDE THE K-1′S FROM MONTEBELLO MEDICAL CENTER, INC. * * * AND REGINALD SAMSPN [sic] MD A PROF CORP * * *. THE * * * [2008/2009] PERSONAL INCOME TAX RETURN FOR REGINALD AND GERVEL SAMPSON WILL BE AMENDED ONCE THE TAXPAYER RECEIVES THE * * * [2008/2009] K-1′S.

So he had the Quickbooks files, but he just used zeros.  For two years.   That turned out to be  less than the income that should have been reported, leading to over $130,000 in additional tax.  The IRS didn’t think that was reasonable and assessed penalties.

The taxpayers argued they filed a “qualified amended returns” for the two years.  The judge pointed out that the amended returns were filed after the IRS had contacted the taxpayers, so they didn’t work.

It seems strange to me that the preparer wouldn’t file a return based on the Quickbooks file alone, though maybe he felt the doctor’s bookkeeping wasn’t to be trusted without support.  Given the penalties for filing late S corporation returns, it’s surprising that the doctor didn’t turn over the “underlying documents.”  Considering that he had quite a bit of information in the Quickbooks files about the K-1 income, it’s surprising that they used zeros on the doctor’s 1040, instead of an estimate based on Quickbooks numbers.  But the tax law can be full of surprises.

The moral?  If you don’t have perfect information, the zero option may not be your next best option.  If you can’t file perfect, it’s better to file something, and to try to make it as close as you can.

Cite: Sampson, T.C. Memo 2013-212.

 

Richard Borean and Kyle Pomerleau,  Monday Map: Top Marginal Tax Rates on Sole Proprietorships and S-corporations (Tax Policy Blog).  Today, S corporations:

20130910-1

Yes, increasing rates on the wealthy also increases tax rates on businesses.

Don Boudreaux,  It’s Not Really a Taxingly Difficult Subject (Cafe Hayek): “Among the most economically naive calculations that people (including government officials) make is to estimate the growth in tax revenues based on the assumption that nothing changes beyond a hike in the tax.”

 

TaxGrrrl,  Back To School: Taking Advantage Of The Tuition & Fees Deduction 

Peter Reilly,  Sixth Circuit Highlights S Corporation Perils In Broz Decision  “Don’t rely on your accountant to straighten every thing out with journal entries.”

Russ Fox,  California to Require Annual Reporting of Like-Kind Exchanges for Out-of-State Property

Trish McIntire, Tip or Service Charge?

Robert D. Flach, When to contact your tax pro.  It’s amazing all the different things your average guy might need a tax pro for.  Robert also has fresh Buzz today!

Joseph Henchman, Wisconsin Offers Constructive Tax Filing Guidance for Same-Sex Couples

Jason Dinesen, Wisconsin State Tax Guidance for Same-Sex Married Couples   

William Perez, Statute of Limitations on Tax Refunds.  “Did you know that you can claim a tax refund for up to three years after the original deadline?”

Clint Stretch, Healthcare and Tax Reform:  “Repealing the employer-provided healthcare exclusion might make sense in economic theory, but in the practical world, it would accelerate a day of reckoning on healthcare for which we are unprepared.”

Jack Townsend, On Harmless Error

Brian Mahany, FBAR Basics – Foreign Reporting 101

TaxProf,  The IRS Scandal, Day 124

Me, Iowa’s “economic development” policy: bipartisan follies.

 

Kay Bell, Pennsylvania school tax protester pays $7,143 bill with $1 bills

News from the profession: Oh Dear Lord, Grant Thornton’s Belfast Office Has a Willy Wonka Room (Going Concern)

 

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Tax Roundup, 8/22/2013: Is your passport worth your business? And a prodigal mom!

Thursday, August 22nd, 2013 by Joe Kristan


passport
A great post by Phil Hodgen, Why people renounce U.S. citizenship for estate tax reasons.  It’s an issue often overlooked in cheap talk of “tax cheats,” but not by those who face a tremendous hit to their family businesses from the  U.S. Estate tax:

The senior members of these families are pressuring the younger generation give up U.S. citizenship to protect against these problems. I have heard the ultimatum from the father to the son: “The business or your U.S. passport. You choose.”

I want to emphasize that I do not hear political rants from my clients, or from the other family members who must deal with having a U.S. citizen shareholder thrust upon them. Everyone I talk to is eager to travel to the United States, enjoys meeting Americans, and bears no ill will to anyone.

But faced with the prospect of destroying the family business or giving up the U.S. passport, it is no contest. The passport has to go.

40% of the value of your business, as second-guessed by the IRS, can be a high price for a passport.

 

Sorry, “Mom.”  The Tax Court yesterday found a problem with a claim for a dependent exemption:

Petitioner has failed to show that she is entitled to the dependency exemption deduction for Mr. Salako. Petitioner claimed on her 2008 return that Mr. Salako was her son. Mr. Salako was born on January 12, 1961, and was thus 47 years old at the close of 2008. Petitioner, born in 1959, is only two years older than Mr. Salako. Thus, he cannot be her biological son, and we do not find credible petitioner’s unsubstantiated testimony that Mr. Salako is her adopted son.

Decision for IRS, not surprisingly.

Cite: Golit, T.C. Memo 2013-191.

 

Scott Hodge,  Why Shouldn’t the Tax Foundation Pay Taxes?  (Tax Policy Blog):

Just 3 percent (or 6,508) of all non-profits have assets of $50 million or more. However, these organizations took in 73 percent of all non-profit revenues and commanded 81 percent of all assets held by non-profits.  

Inequality!

 

TaxGrrrl, Michael Jackson’s Estate To IRS: Beat It.  Prompting a whole generation to ask, “who’s Michael Jackson?”

 

Cara Griffith, Textbooks with Borders (Tax Analysts Blog):

Most of us have heard of doctors without borders, but has anyone heard of textbooks with borders? It’s a reality for those using Amazon’s textbook rental service. The reason for this is very likely related to Amazon’s recurring sales tax issues.

Taxes often explain seemingly bizarre behavior.

 

Kay Bell, Maryland Rep. Van Hollen sues IRS over its application of 501(c)(4) political nonprofit rules.  Good luck with that.

 

TaxProf, TIGTA: IRS May Be Violating Copyright Law on 89% of its Software.  I don’t suppose copyright violations will invalidate an assessment.

 

Missouri Tax Guy,  DOMAs Death, There Are Questions

Trish McIntire,  Rant- Keep Your Return Safe.  Certainly never send it as an unencrypted pdf attachment to an email.

Peter Reilly,  Group Claiming To Teach True Meaning Of Islam Denied Exempt Status. 

TaxProf,  The IRS Scandal, Day 105

 

The Critical Question:  WHAT DO HERNIAS AND STATE TAXES HAVE IN COMMON? (Brian Strahle)

Personal advice section: Someone Who Has Never Dated an Accountant Came Up With 15 Reasons to Date an Accountant (Going Concern)  Someone who has dated one might come up with fewer.

 

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Tax Court: even if you lose money, your S corporation needs to pay “reasonable” compensation.

Thursday, August 8th, 2013 by Joe Kristan

20120801-2One thing I like about S corporations is that while corporation income is taxed on shareholder’s 1040s, income on the K-1 isn’t subject to payroll or self-employment tax.

Except when it is.

Mr. Blodgett had an S corporation called Glass Blocks Unlimited, which “sold and distributed ‘glass blocks’ for the real estate market in North America.”  He was the sole shareholder and president of the company.

The Tax Court lays out some key facts (my emphasis, footnotes omitted):

 He worked full time for petitioner, which had no other full-time employees. He was responsible for all operational and financial decisions of the company, and he performed nearly all of the work necessary to run the business. Petitioner additionally used an unspecified number of day laborers, whom it paid totals of $39,733 and $41,453 in 2007 and 2008, respectively.

Petitioner did not on its 2007 and 2008 Forms 1120S report paying Mr. Blodgett a salary or wages. It did, however, distribute money to him as cash was available and he asked for it. Petitioner distributed not less than $30,844 to Mr. Blodgett over the course of 2007. During 2008, petitioner made distributions to Mr. Blodgett totaling not less than $31,644.

The IRS treated the distributions as taxable wages to the taxpayer and assessed FICA and Medicare taxes.  The taxpayer disagreed, saying that the his “reasonable” compensation was lower than that assessed by the IRS.  The judge sided with the IRS:

As president of the company, Mr. Blodgett was petitioner’s only officer. Mr. Blodgett was also petitioner’s sole full-time worker in 2007 and 2008. He performed substantially all of the work necessary to operate the business, including processing orders, collecting payments, arranging shipment of goods, managing inventory, and handling customer relations. His services generated all of petitioner’s income.

     Because Mr. Blodgett was petitioner’s employee for the periods at issue and performed substantial services for it yet it did not pay him a salary, its distributions to him are deemed wages and thus are subject to Federal employment taxes.

The taxpayer also said some of the distributions were repayment of loans to the company.  Here the taxpayer was the victim of informal bookkeeping:

There were no written agreements or promissory notes supporting Mr. Blodgett’s testimony that the transfers were loans. While it is true that a portion of the transfers was reported as loans from shareholders on petitioner’s Forms 1120S, that entry is of little value without the support of other objective criteria. Indeed, petitioner did not even report the $10,000 transfer as a shareholder loan on its 2008 return. The absence of notes or other instruments, plus petitioner’s failure to treat the $10,000 transfer as a loan at all, indicates that the transfers were not loans.

To make things worse, the court upheld late payment penalties on the payroll taxes.

I think the taxpayer gets a raw deal here.  The IRS imposed $30,844 of wages on the taxpayer in 2007, even though the corporation’s net taxable income for the year was only $877, not counting the “wages.”  It hit him with another $31,644 if wages for 2008, when pre-wage income was only $8,950.  In other words, the Tax Court expected the corporation to incur a taxable loss just to generate some payroll taxes for the IRS.  That’s ridiculous, and a worse result than the same taxpayer would have had running the business on a Schedule C.

Furthermore, the Tax Court was too cavalier in disregarding the loans and repayments.  It’s wrong to expect a one-man corporation to generate prissy paperwork when the shareholder advances funds.   Yet because he didn’t have pieces of paper with the magic words, he got stuck with payroll taxes — and penalties.

The Moral?  When advancing and withdrawing funds from an S corporation, be sure to generate the appropriate prissy paperwork.  And if a wholly-owned S corporation generates enough cash to distribute to an owner working in the business, set a salary and pay the payroll taxes on at least a “reasonable” amount, or the IRS might impose payroll taxes on all of it.  You have to protect yourself from an unreasonable IRS assessment, because it looks like the Tax Court won’t.

Cite: Glass Blocks Unlimited, T.C. Memo. 2013-180

 

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Tax Court keeps taxpayer mistake from triggering the “self-rental” passive income rule.

Wednesday, November 14th, 2012 by Joe Kristan

Cell tower image courtesy Wikpedia Commons

The tax law “passive activity” rules were written to shut down real estate shelters by making rental losses “passive,” deductible only to the extent of “passive” income.  About 3 seconds after the rules were enacted, taxpayers began thinking of ways to generate passive income so they could deduct their passive losses by renting land or by renting property to a controlled business activity.  Rules treating “land rent” or “self-rental” net income as non-passive were issued quickly to stop that.

The new Obamacare 3.8% tax on “investment income” will apply to “passive income” as determined under the passive loss rules, so a  Tax Court decision issued yesterday exploring these issues takes on added importance.

The taxpayer leased land with cell-phone towers to his wholly-owned S corporation.  The S corporation in turn leased the towers to phone companies.  The taxpayer also leased land to his S corporation.

The S corporation mistakenly reported the income from its leases to the phone companies as ordinary income, rather than rental income, lumping the tower rental with the S corporation’s other business income.  The taxpayer treated the income as non-passive.

The towers leased to the S corporation were reported as passive leases on the taxpayer’s 1040, as were the land rents.  Some tower leases were profitable while others generated losses, but because they were all reported as “passive,” the losses and income offset.

The IRS had other ideas. The IRS left the K-1 income as non-passive, saying that the leases to the phone company wasn’t really “rental,” and in any case the taxpayer was stuck with the way the income was reported.  The IRS split the income from “self-rental” of the towers to the controlled corporation,  with the losses treated as passive and the income reclassified as non-passive under the self-rental rules.   The bottom line: a lot of non-passive income that couldn’t be offset by the now non-deductible passive losses.

The Tax Court said the IRS was being too cute.  The IRS said that the taxpayer was bound by his treatment of the S corporation tower income as non-passive because he had already grouped it with his other activities.   Judge Halpern said the IRS regulations didn’t have to cause such a harsh result.  While the taxpayer might be stuck with its return reporting for determining whether to report income from the K-1 as passive, that didn’t extend to the self-rental rules. so the taxpayer didn’t have to split up the cell-tower rental to the S corporation between profitable (non-passive) and loss-generating (passive):

We recognize that, because ICE erroneously reported all of its income as ordinary business (non-passive-activity) income, nonapplication of the self-rental rule of section 1.469-2(f)(6), Income Tax Regs., to ICE’s rental payments to petitioner, in effect, results in the reduction of what was reported as “active business income” and the offsetting creation of “passive income” in seeming contravention of the congressional conferees’ directive to issue regulations preventing that result. See H.R. Conf. Rept. No. 99-841 (Vol. II), at II-147 (1986), 1986-3 C.B. (Vol. 4) 1, 147. We do not believe, however, that ICE’s tax return mischaracterization of its tower access rental income from third parties should control the application of the self-rental rule where, as here, it is, by its terms, inapplicable, i.e., where petitioner’s towers were not, in fact, used in a trade or business. Moreover, we are not persuaded that the result we reach herein violates the conferees’ directive as it does not, in fact, permit “passive income” to offset “active business income”.

The Tax Court upheld the IRS in treating the land-rental as non-passive.

The Moral?  The Tax Court reached a fair result, even though it had to stretch around the regulations to do so.  Had the towers been rented to the S corporation for use in its non-passive business, the judge would probably have given the IRS its “heads I win, tails you lose” treatment — the income would have been non-passive, and the losses would have been passive and non-deductible.  The result was different because the S corporation in turn leased the properties to third parties, instead of using them in its non-passive business.

The result is fair because the taxpayer isn’t really generating improper passive income that wouldn’t be there if it had reported the income on the K-1 properly in the first place.

This case reminds us how important it is to identify your passive activities and group them properly.   With the 3.8% tax on passive income taking effect in January, this is even more important.

Cite: Dirico, 139 T.C. No. 16.

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How adding IRS agents increases tax revenues

Wednesday, June 29th, 2011 by Joe Kristan

The executor files an estate tax return valuing a 15% interest in an LLC at $34,936,000.
The IRS audits the estate tax return. They value the interest at $49,500,000, assiessing a deficiency of $6,990,720.
The Tax Court yesterday rules the correct value is $32,601,640. At the 48% estate tax rate that applies for 2004, that gives the estate a refund of $861,422.
It’s a good thing they audited that return, because that will help Commissioner Shulman pay to regulate more preparers.
Cite: Estate of Louise Paxton Gallagher, T.C. Memo. 2011-148

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