This week, Joe Kristan (CPA & Shareholder, Roth & Company (Des Moines, Iowa); Editor, Tax Update Blog) discusses a recent Tax Court case highlighting the difficulty S corporation shareholders face in overcoming the way an item is characterized on a K-1.
Don’t let the K-1 hit you on the way out the door.
Sometimes people become shareholders of S corporations without really understanding what they are getting into. Yesterday the Tax Court dealt with an S corporation shareholder who apparently didn’t understand just what he was getting out of.
The taxpayer owned 50% of Resort Builders, a construction company, with his brother, John. They operated as an S corporation, with the corporate earnings being taxed on the owner 1040s based on Forms K-1 allocating the corporation income.
Over time the brothers had a falling out. Judge Vasquez explains:
In 2007 petitioner told John that he wanted to resign from Resort Builders and turn in his stock. Consequently, relations between the brothers became acrimonious. John changed the locks to the corporation’s offices and withheld Resort Builders’ books and records from petitioner. In 2008 petitioner filed a lawsuit against John and Resort Builders in Florida State court seeking, among other relief, dissolution of the corporation and an accounting.
After participating in mediation, the brothers agreed to settle the lawsuit. In a written “Mediation Settlement Agreement” (mediation agreement), petitioner agreed to transfer his Resort Builders shares to John…
So how was the final return handled?
Resort Builders subsequently filed a final Form 1120S, U.S. Income Tax Return for an S Corporation, for its short taxable year beginning January 1, 2008, and ending July 24, 2008. Resort Builders reported $903,063 of ordinary income and indicated that it was using the completed contract method of accounting. Resort Builders issued a Schedule K-1, Shareholder’s Share of Income, Deductions, Credits, etc., to petitioner (Resort Builders K-1). The Resort Builders K-1 reported petitioner’s share of ordinary business income as $451,531.
You would think that with the lawsuit, mediation and so on that this would not have been a surprise. The taxpayer had the same accounting firm that prepared the 1120S for Resort Builders prepare his 1040 for 2008. For some reason it wasn’t filed until October 2010 — perhaps because he didn’t like the result, which:
…included a Schedule E, Supplemental Income and Loss, reporting $451,531 of passthrough income from Resort Builders. On line 17 of the Form 1040 petitioner reported Schedule E income of $323,777.4 Several lines below line 17, petitioner wrote: “(LINE 17 IS INCORRECT * * * WILL FILE AMENDED RETURN)”.
No amended return was filed, but the taxpayer apparently didn’t pay the amount shown, as the IRS assessed the amount shown on the return in February 2011, along with late filing penalties. Things ended up in Tax Court. The dispute:
Petitioner argues that he should not have to report the income shown on the final corporate return and the Resort Builders K-1 because he did not receive a distribution and was not otherwise enriched by Resort Builders in 2008.
The Tax Court explained that’s not how it works:
Petitioner was a 50% shareholder of Resort Builders until July 24, 2008, the last day of Resort Builders’ short taxable year. Accordingly, 50% of Resort Builders’ income for its short taxable year ending July 24, 2008, flowed through to petitioner. Petitioner was required to report this income on his 2008 Form 1040 even if he did not receive a distribution that year.
Decision for IRS.
The moral? If you disagree with your K-1, you have a steep climb. It doesn’t matter whether you get money from the S corporation. If it’s on the K-1, it’s supposed to be on your return. If you are leaving the S corporation, you want to make sure you understand what’s going to be on the K-1 on your way out, and make any distribution arrangements. If you mess it up there, the Tax Court isn’t going to fix it for you.m
Cite: Dalton v. Commissioner, T.C. Memo. 2017-43 (Mar. 13, 2017)
Related: Lew Taishoff, ANTI-FREEZE. “Takeaway- When negotiating a buyout, break-up, shareholder’s agreement, operating agreement, partnership agreement or any other deal that gives rise to passthrough tax, require distribution of cash sufficient to pay tax for all passcatchers.”
Monday, March 13, 2017
Howard Gleckman, The House GOP’s Proposals To Repeal ACA Taxes Would Largely Benefit High-Income Households. That’s because those taxes apply, by design, to only high-income households. The ACA architects tried to fund a mass benefit with a class tax.
Jack Townsend, Sixth Circuit Rejects Argument that False Statement to CI Agent Should be Sentenced as Obstruction Rather than Tax Offense.
Jason Dinesen, Glossary: Audit Technique Guides. “Audit Technique Guides are IRS guidebooks that give detailed insight into various industries IRS auditors may encounter.”
Jim Maule, Here’s Your Tax Refund, Oops, Wait, No, It’s Not There. In Massachusetts, “…shortly after generating the refund deposits, the software used by the Department of Revenue reversed the deposits and pulled the refund amounts back out of the taxpayers’ accounts.” Oops!
Kay Bell, DST: time change or tax saving trust? Both!
Keith Fogg, Tax Court Calendar Call Program (Procedurally Taxing):
Karen Hawkins, who is the chair elect of the Tax Section, got the calendar call program started in the early 1990s in San Francisco. She had a tax controversy practice in that area that regularly brought her to Tax Court calendar calls. At those calendar calls she observed that unrepresented taxpayers appeared who had no idea what to do. So, she began trying to assist them by giving them advice on a quick, informal and pro bono basis.
As a CPA who doesn’t pretend to be a Tax Court lawyer, this was new and interesting to me.
Kristine Tidgren, Iowa Supreme Court: Single Grazing Horse Did Not Establish a Farm Tenancy (Ag Docket). “Last year, many of us were surprised by an Iowa Court of Appeals decision that held that a single grazing horse was sufficient to establish a farm tenancy. Why did this matter? Because under the court’s ruling, the owners of the horse (and arguably anyone with backyard chickens or a pet emu) were entitled to the protection of the Iowa farm tenancy termination statute.”
Leandra Lederman, When a Tax Strategy Benefits a Subnational Government. “We may not think as often about a subnational government bolstering its tax revenues at the expense of the national government, particularly via a cooperating private party’s transaction structure. But that’s what happened a few years ago in Spain.”
Lew Taishoff, THE ENVELOPE, PLEASE. If you are cutting and pasting for your Tax Court position, and you are a her, make sure what you cut and pasted doesn’t refer to you as as him.
News from the Profession. Accounting News Roundup: Pandering to Millennials and Phony Revenue (Caleb Newquist, Going Concern).
Roger McEowen, Drainage Activities on Farmland and the USDA. “The original intent of Swampbuster was to deny federal farm program benefits to persons planting agricultural commodities for harvest on converted wetlands.”
Russ Fox, Even Minor Celebrities Should Pay their Taxes:
I never saw Discovery’s “American Guns” reality show. The former owner of a store called “Gunsmoke” ran into trouble with both gun selling laws and filing tax returns. He’s likely heading to ClubFed.
Richard Wyatt is the former owner of a gun store called Gunsmoke in Wheat Ridge, Colorado. Getting your store on television is a good way to increase sales; he appeared on 26 episodes of American Guns. Of course, you might want to make sure you follow the law. As the Department of Justice press release notes, “On Feb. 17, 2012, Wyatt conspired with others to deal in firearms without a license. In April 2012, the defendant surrendered his Federal Firearms License (FFL) due to his violations of federal laws and regulations.”
Federal agents apparently watch television, too.
Stuart Gibson, Can We Have Frictionless Tax Compliance? (Tax Analysts Blog). “Frictionless retailing connects businesses and customers quickly, while seamlessly handling every element of the interaction from search to research, purchase, payment, and delivery.”
TaxGrrrl, You Spring Forward For Daylight Saving Time Because Of Energy Policy, Not Farmers. “The idea is that extending daylight hours will cut energy consumption. If the day seems longer because it’s light out longer, it should follow that there would be less demand for electricity in the evenings.”
Tax Justice Blog, Tax Justice Digest: New Eight-Year Data Reveals Corporations Aren’t Paying Their Fair Share.
TaxPlus Blog, If U.K. taxes affect you, you may want to check out Alison Palmer, Spring Budget 2017 – Offshore matters and Michael Lapham, Spring Budget 2017 – New tax on transfer to overseas pension schemes at the TaxPlus Blog.
TaxProf, The IRS Scandal, Day 1402, Day 1403, Day 1404.
Tuesday, March 14, 2017
Des Moines Register, Iowa could expand tax credit program that benefits private schools. “If passed into law it would allow thousands of more students to receive state-supported tuition scholarships.”
Jack Townsend, Taxpayer with Israeli Bank Accounts Sentenced to 24 Months.
Kay Bell, Security concerns prompt U.S. and Canadian tax officials to temporarily take down some online systems. “The United States and Canada share more than the world’s longest undefended border. They also share attacks by cyber criminals on their online tax systems.”
Len Burman, ACA and the perils of reconciliation (TaxVox):
I intended to write a completely different post about how repealing the Affordable Care Act (ACA) would undermine Medicare’s finances. My story was half right: repealing the 0.9 percent additional Medicare payroll tax on high-income taxpayers would cost the Medicare trust fund about $145 billion over the next decade, enough to accelerate the date of insolvency by a few years—to 2028 according to the latest Trustees Report. But I was surprised to learn that repealing the “additional Medicare contribution”—a 3.8 percent levy on net investment income of high-income households that is projected to raise even more —would have no effect at all on the Medicare trust fund. That’s because the additional Medicare contribution doesn’t go in the Medicare trust fund.
Instead of a story about the future of Medicare, this turns out to be a cautionary tale about the dangers of rushing a major change in health and tax laws through a legislative short cut—one that may prove timely in the current debate over the ACA.
They hastily rammed through the ACA and blew up the individual insurance market, leaving destruction and disaster in in their wake. Haste may not be helpful in fixing it.
Leslie Book, Taxpayer Rights and Declining Budgets (Procedurally Taxing). “Deep cuts in IRS budgets as may be on the horizon are likely to create continued complaints both about declining direct measures of compliance and on measures of IRS service like answering the phone and making employees available to meet in person with taxpayers.”
Megan McArdle, Voters Won’t Ignore This CBO Score. “Regardless of what you think of Obamacare, or the new Republican bill, the politics of this are dreadful.”
Morgan Scarboro, Facts & Figures 2017: How Does Your State Compare? (Tax Policy Blog). The Tax Foundation’s John Buhl provided a summary of Iowa’s results:
In this year’s version, you’ll see that the latest data ranks Iowa 31st in state and local tax burden as a percentage of state income. Also, Iowa currently ranks 40th on the Tax Foundation’s State Business Tax Climate Index, which measures how well each state’s tax code is structured. In addition, the report shows how much each state relies on different revenue sources for their total revenue collections.
Key rankings for Iowa:
Federal aid as a percentage of state general revenue: 26th (accounts for 32.6 percent of Maine’s budget, above the U.S. average of 30 percent)
State individual income tax collections per capita: 21st ($1111; national average: $967)
State corporate income tax collections per capita: 25th ($148; national average: $144)
Iowa ranked in the middle for per-capita collections despite having a high individual tax rate and the highest corporation rate in the nation. That’s because Iowa’s tax system is full of special interests breaks, allowing some taxpayers to actually make money from the tax system while others get battered.
News from the Profession. Is PwC on the Ropes in the MF Global Trial? (Caleb Newquist, Going Concern). I just hope the jurors keep the envelopes straight.
Robert Wood, IRS Payroll Taxes Can Close A Business, Mean Personal Liability, Even Jail. “If you are in business, it can be tempting to figure that you have to keep the rent paid and supplies ordered, and that the IRS won’t miss the payroll tax money if you just divert it temporarily. But, no matter how good the reason, the practice is downright dangerous.” Stiff everyone before you fall behind on payroll taxes.
Tony Nitti, GOP Health Care Bill Will Result In A Huge Tax Cut For The Rich, 24 Million Without Insurance
Wednesday, March 15, 2017
Carl Smith, Tax Court Won’t Certify Battat for Interlocutory Appeal (Procedurally Taxing). “In Battat v. Commissioner, 148 T.C. No. 2 (Feb. 2, 2017), on which we blogged here and here, the Tax Court (Judge Colvin) held that there is no constitutional separation of powers problem in the President’s holding a removal power under section 7443(f) with respect to its judges.”
Jack Townsend, Third Circuit Affirms Contempt on Foreign Bank Account Records Subpoena.
Jim Maule, If At First You Don’t Succeed With a Tax Rule, . . .. “Sometimes persistence pays dividends. Sometimes it does not.”
Kay Bell, Donald Trump’s 2005 Form 1040 offers some info, raises more questions and explains why he hates the AMT. “Trump’s effective tax rate of around 25 percent on more than $150 million is 10 percent higher than what the prior GOP presidential candidate, billionaire Mitt Romney, paid according to the much more complete 2011 return that Romney released during the 2012 campaign.” That’s because Trump’s income is mostly operating income, rather than tax-favored capital gains and dividends.
News from the Profession. Man, This EY Auditor Made Some Bad Choices (Caleb Newquist, Going Concern)
Peter Reilly, No, President Trump Didn’t Escape Income Taxes For 18 Years. “It does seem a little odd, though that Trump passed up a fairly plain vanilla technique that might have save over a a million in tax.”
Robert Wood, Tax Return Disclosures That Aren’t IRS Audit Triggers. “You are required to disclose enough detail to tell the IRS what you are doing. But keep it short and succinct.”
Roger McEowen, What is a “Separate Person” For Payment Limitation Purposes? The more “persons” you have, the more farm subsidies you can get.
Sam Brunson, Did Rachel Maddow Break the Law? #TrumpTaxReturns (Surly Subgroup). “Under this standard, Johnson and Maddow probably didn’t violate the law by publishing the returns. My understanding is that they don’t know who leaked the return, so it is hard for them to know that it was leaked in violation of the law.”
Stephen J. Entin, Repealing Affordable Care Act Taxes on Upper-Income Workers and Savers (Tax Policy Blog):
The House Republican proposal to repeal and replace the Affordable Care Act would eliminate several taxes imposed under the Act. Among these is the Net Investment Income Tax that imposes a 3.8 percent surtax on income from investments. It applies to investment income of married couples with more than $250,000 of adjusted gross income, and single filers with more than $200,000 of adjusted gross income. This tax, in effect, extended the Medicare portion of the payroll tax to investment earnings for the first time. Critics complain that the repeal would benefit the rich, and cost the Treasury substantial revenue. They are looking only at the static “distribution tables” and ignoring the widespread economic benefits of repeal.
The “distribution tables” get may more attention than they deserve. Bad policy doesn’t become good policy just because it only affects the rich. Beheading random taxpayers wouldn’t be a good idea even if it only applied to the top .1% of the income distribution.
TaxProf, Donald Trump’s 2005 Tax Return (Form 1040). With a roundup of big media coverage.
Yifan Zhang, Would Bill Gates’s proposed robot tax help workers? (TaxVox). “For those left permanently behind by the technological revolution, these facts will understandably be of little comfort. Taxing robots and other technical advances, however, will not make the human consequences of automation and robotics go away.”
Thursday, March 16, 2017
David Henderson, When You Lose Something You Don’t Want, Is that Really a Loss? (Econlog). “In any case, notice that presumably a few million of the 14 million who would lose health insurance are people who would want to lose health insurance even if the premiums weren’t higher. So for people who value the well-being of those people, this counts as a win, not a loss.”
Howard Gleckman, Lessons From Donald Trump’s Tax Return And The AMT. “But the AMT is a crude last-ditch safety net. The real problem is a revenue code riddled with special breaks that make it possible for some people to dramatically reduce their taxable income and avoid paying large amounts of tax.”
James Q. Lynch, Pat Grassley proposes capping Iowa tax credits (thegazette.com). “House Study Bill 187 would cap 'contingent liabilities' tax credits at $400 million in the fiscal year beginning July, then lower them $10 million a year to $370 million.”
Janet Novack, How Trump’s 2005 Tax Bite Compares To Other Billionaires’ And To Yours. “In fact, as CPA and Forbes contributor Peter Reilly observes here, after comparing Trump’s AGI to his $36.6 million federal income tax bill, a ‘Trump apologist might argue that he really got hosed in 2005.'”
Jason Dinesen, Addition By Subtraction: Reducing Your Business’s Service Area. “In our conversation about selling or shutting down his business, I discovered that he didn’t really want to quit, he was just burned out.”
Jennifer Crull, Tax Credits: Yea or Nay? (Caffeinated Thoughts). “Since 90 percent of the tax credits are going to 19 business, wouldn’t it make more sense to cut the tax rate for corporations so that all can benefit from this tax savings?”
John Buhl, The Case Against Soda Taxes (Tax Policy Blog):
Besides being depicted as a way to improve public health, soda taxes are also now being looked at as a way to shore up state and local budgets and expand important services such as education. Although it might be more politically expedient to tax a demonized product like soda to pay for popular services, this represents bad fiscal policy. Ideally, public services should be funded by taxes with a broad base and low rate. Soda taxes are the opposite, subjecting a narrow tax base to very high tax rates.
Like traffic cameras, it’s a cash grab pretending to protect you.
Joyce Russell, Tax Receipts Fall Short Again; Farm Economy Languishes (Iowa Public Radio). “Officials with the Branstad administration say they expect to tap cash reserves this time rather than making more budget cuts.”
Kay Bell, March Madness expected to generate $10.4 billion in bets. “The Internal Revenue Service is painfully aware of all the winning bets that slip through its collection fingers. Still, the agency reminds us that all gambling winnings, be they paid out at a Vegas, baby, casino or by a street corner mook, are taxable income.”
Lew Taishoff, DO NOT ANNOY THE JUDGE – PART DEUX. “In short, William, y’all had your chance, and you blew it.”
Meg Wiehe, State Rundown 3/15: Responses to Revenue Shortfalls Vary Widely (Tax Justice Blog).
News from the Profession. Judge Didn’t Buy PwC’s Story, Rejects Call for Mistrial (Caleb Newquist, Going Concern).
Paul Neiffer, Social Security – Discounts and Premiums. “Farmers many times wonder if they should collect social security at age 62. We are giving you a chart as a reference that may help your decision.”
Robert Nassau, Using a Refund Suit to Remedy Identity Theft of Return Preparer Fraud (Procedurally Taxing). “While we would certainly recommend fully exhausting one’s administrative avenues of relief first, where those have proven unsuccessful, we would encourage taxpayers to file refund suits to get the result they deserve.”
Russ Fox, The Other March 15th Deadlines.
TaxGrrrl, IRS Offers Additional Time For Some Taxpayers Due To Winter Storm Stella.
TaxProf, The IRS Scandal, Day 1406: NY Post Editorial, Fire The IRS Chief Already, Mr. President.
Tony Nitti, President Trump’s Tax Returns: What Can They Really Tell Us?. “To listen to Maddow’s introduction, one would think that Trump’s return would neatly lay out his Russian connections, abusive tax shelters, and the fate of Atlantis. But that’s not how tax returns work. Even a basic return only reveals limited useful information, and as a general rule, the more complex the return grows, the less transparency it offers.”
Friday, March 17, 2017
Free Webinar! I am presenting a webinar next Wednesday on Iowa’s non-conformity for the ISU Center on Agricultural Law and Taxation. Sign up today! You can’t beat the price.
Prior Tax Update coverage:
Iowa’s guidance on 2016 return uncoupling: Section 179 and bonus depreciation.
Iowa guidance on 2016 return uncoupling: IRA charitable distributions
Iowa guidance on 2016 return uncoupling: S corporation built-in gains and contributions
Second thoughts on Iowa pass-through Sec. 179 guidance?
Superseded version of Iowa pass-through guidance
Annette Nellen, Obamacare repeal-replace proposal and insurance company compensation. “Given that the ACA aimed to make health insurance more affordable, the rationale for the compensation deduction limitation was to perhaps discourage such amounts by increasing taxes for the employer.”
Career Corner. How Should You Handle a Partner’s Facebook Friend Request? (Megan Lewczyk, Going Concern).
Howard Gleckman, Asking the IRS To Do More With Less, Again (TaxVox). “The White House promises to have a full budget in May, which could fill in many of the blanks. But no one should expect the IRS to do the increasingly complex job Congress demands with a budget that is nearly one-fifth smaller than it was in 2010.”
Jim Maule, So What Would YOU Do to Avoid Taxes? “When asked whom they liked more than the IRS, respondents paraded out a litany of individuals, including Barack Obama, the Pope, several members of the Trump family, Vladimir Putin, and OJ Simpson.”
Kay Bell, Tax cheats rejoice as Trump’s inaugural budget calls for continued IRS funding cuts
Keith Fogg, What is a Taxpayer Assistance Order? (Procedurally Taxing). “Taxpayer representatives benefit from understanding TAOs because having the authorized TAS employee issue a TAO on behalf of your client can go a long way toward resolving a case in which the IRS has taken an incorrect or unreasonable position that you cannot otherwise convince it to reverse.”
Kyle Pomerleau, CBO Report Compares U.S. Corporate Tax to G20 (Tax Policy Blog):
While important, the statutory rate isn’t the only thing that matters with respect to corporate taxation. The U.S. corporate tax and corporate tax codes throughout the world are filled with credits and deductions that impact both corporate investment behavior and how much corporations end up remitting in tax. And just as the statutory rate varies across the world, these deductions and credits vary.
It turns out that even when one accounts for the various credits and deductions available in the United States and elsewhere, the U.S. places an above-average burden on corporations.
It’s hard to give away enough with special tax breaks to make up for having the highest rate around. Take note, Iowa.
Lew Taishoff, AT HOME ABROAD – PART DEUX. “This case is an anomaly for several reasons. The deficiencies are three-figure amounts (under $200 each); each petitioner (there are three of them) seems to have his or her own lawyer, against only one for IRS; and the fact pattern sounds like a joke: A Finn, a Russian and an Irishman walk into Tax Court….”
Robert D. Flach, THIS JUST IN. The Winter Storm Stella deadline extension.
Robert Wood, Despite Trump Tax Returns, He Is Right To Repeal AMT.
Roger McEowen, Should Purchased Livestock Be Depreciated or Inventoried?:
The key question for a farmer/rancher is whether livestock should be depreciated or included in inventory. The depreciation of livestock is beneficial to the producer for many reasons. First, depreciation is an ordinary deduction and thus reduces the farmer’s net income and self-employment income. Second, although the depreciation taken on the livestock must be recaptured under I.R.C. §1245, this recapture is not subject to self-employment tax for Schedule F and farmers operating in the partnership form. Third, the amount of gain in excess of original cost, if held for the applicable period, is taxed at favorable capital gains rates under I.R.C. §1231.
The answer isn’t always obvious.
TaxGrrrl, Taxes From A To Z (2017): A Is For Affordable Care Act Reporting. “It’s clear that things are changing and that will impact your tax return eventually. But for now?”
TaxProf, The IRS Scandal, Day 1408: Why Won’t The Media Cover It?