Paul L. Caron
Dean




Friday, March 31, 2017

Weekly Tax Highlight And Roundup

This week, Joe Kristan (CPA & Shareholder, Roth & Company (Des Moines, Iowa); Editor, Tax Update Blog) discusses the Tax Court's recent reminder about the limits of management fees in shifting income for tax planning purposes.

KristanManagement fees mismanaged.

In the misty dawn of time — well, in my early days in public accounting — I knew an old-school practitioner who used “management fees” between related companies as a tax planning cure-all. Too much taxable income? Pay a management fee to the commonly-controlled company that’s running a loss, or to the relative who needs some cash and who doesn’t have much income. Problems solved!

Like many bad tax ideas, that works fine if the IRS never finds out. A Tax Court case yesterday shows what happens when they do.

A home health care company operated as a C corporation. It was acquired by another corporation named Sacer Cor, but apparently never filed a consolidated return with its 100% owner. Whether that is because Sacer Cor might be an S corporation is never spelled out in the case. Either way, Sacer Cor and Home Team, the subsidiary, filed separate returns.

The holding company, Sacer Cor, didn’t have its own employees, though its owners drew paychecks from the subsidiary. That might have been a bad fact. From the opinion by Judge Gerber (my emphasis)

Petitioner deducted $120,000, $36,000, and $42,000, claiming that it had paid those deductions to Sacer Cor for management services for the 2011, 2012, and 2013 taxable years, respectively. Respondent disallowed these deductions in full. On its corporate returns Sacer Cor reported the management fees from petitioner as income.

The $120,000 petitioner deducted as management fees for 2011 had initially been classified on its books as loans and was reclassified at the end of the year during the preparation of its return. Likewise, during the year 2011 petitioner made transfers to Sacer Cor totaling $76,000 that initially were classified on petitioner’s books as intercompany loans; later, a portion was reclassified as management fees. At the end of the 2011 year journal entries were made on petitioner’s books to reduce the balance of the intercompany loans account to $63,149.

To be sure, there is such a thing as legitimate management fees. When you have related business entities that file their own tax returns, it’s common for the bookkeeping and administrative functions to be in one entity, with the other entities paying that entity for the services. Usually those are billed on an hourly basis, or based on a formula related to number of employees, assets, or some other reasonable standard. They are billed and paid among the companies, with checks written from the operating entities to the management entity.

This case looks more old-school cowboy practitioner. The fees weren’t paid as fees. It appears that cash was kicked upstairs as available, and the amount to be called management fees was determined as part of the tax return process and “collected” through journal entries:

The management fee deduction for funds transferred to Sacer Cor was primarily determined according to the amount of cash Sacer Cor needed to make outside loan repayments and also to the amount of fiscal year operating profits of petitioner and Sacer Cor.

arguing that Sacer Cor’s board meeting minutes reflect that management fees were intended and voted by the board for each of the years at issue. Petitioner also argues that the amount of management fees varied each year because there was no way of knowing, in advance, the amount of time needed to manage petitioner.

The lack of holding company employees to actually render management services was not helpful:

None of the four shareholders were employees of Sacer Cor, and no one, including the four shareholders, was paid a salary for any services rendered to or on behalf of Sacer Cor. Periodically, the four shareholders of Sacer Cor were paid equal amounts as director’s fees. There is no credible evidence showing that any management services were performed by the shareholders or other employees of Sacer Cor for petitioner.

There were other problems:

Exacerbating those circumstances are the facts that the alleged management fees were originally booked as loan payments and that the amounts corresponded to petitioner’s ability to pay; i.e., they varied depending on petitioner’s revenues. We accordingly hold that respondent’s disallowance of the management fee deductions that petitioner claimed for 2011, 2012, and 2013 is not in error and is sustained.

The Moral?  There is a lot to learn here. The first and obvious lesson is that management fees aren’t magic fees to move income around as needed for tax planning. There has to be some management, and the fees charged have to have some relationship to services actually rendered.

The entire structure of the business might also be profitably revisited. If the holding company is also a C corporation (Lew Taishoff says it is), it is puzzling that they didn’t file a consolidated return, eliminating all of the income allocation problems. If it is an S corporation, then the owners may have been trying to be too cute in leaving just enough taxable income in the operating subsidiary to make the best use of the C corporation brackets by manipulating management fees. The result here, including penalties, shows the drawbacks of this approach.m

Cite:  Home Team Transition Management, T.C. Summ. Op. 2017-51 (Mar. 28, 2017)

Monday, March 27, 2017

Alex Taborrok, Supply Side Health Care Reform (Marginal Revolution). “We fight over health care policy because we focus on demand and redistribution. We could reach greater agreement if we focused on supply and innovation. What are the key areas where agreement is likely?”

Andrew Mitchel, Section 911 Housing Cost Amounts Updated for 2017. For taxpayers living abroad.’

Annette Nellen, AI, Apps, FinTech and More:

I’m working on an article for State Tax Notes on how we need to make far better use of today’s technology for income tax compliance, which is still too tied to paper filing. Basically, we just moved the paper to e-files.  You still manually enter a lot of information even though much of it exists electronically.

In theory we could automate a lot more tax compliance, but I lack faith in the ability of the IRS to do so competently.

Arnold Kling, The Cultural Roots of America’s Health Care Policy Mess. “Put together these cultural traits and you end up, in Josh Barro’s words, with an economy that spends 1/6th of GDP on health care with nobody wanting to spend 1/6th of their income on it.”

Jack Townsend, TIGTA Report on Criminal Enforcement Against Employment Tax Noncompliance. “Employment taxes withheld from employee compensation and remitted to the IRS are the backbone of our tax and FICA system.  There must be robust incentives to encourage compliance by employers and those within the employer organization responsible for employment tax withhold and payment to the IRS.”

Jared Walczak, A Capital Gains Tax Would Be More Volatile than Washington State Revenue Projections Suggest (Tax Policy Blog). “There is little one can say with confidence about capital gains tax revenue. The only thing we can be reasonably sure of is that it won’t look anything like this.”

Jim Maule, When Tax Revenues Continue to Be Less Than Required. “The [soda] tax, in place now for two months after years of disagreement, has fallen short of what it needs to generate in revenue.”

Kay Bell, W&M chair sees tax reform retroactive to start of 2017. “That will make tax moves this year, uh, exciting.”

Leslie Book, Tax Court Holds that Points Paid on Interest Only Refinancing Not Deductible. “I suspect there is a great deal of confusion and error in this area of the tax law.”

Lew Taishoff, STAMP OUT STAMPS, IRS. “So IRS has the aforesaid ‘splainin’ to do.”

Megan McArdle, The Republican Health Plan’s Quick Death Spiral. “I certainly can’t advance a rational explanation of why Republicans are so committed to pushing through a hastily drafted bill that no one likes.”

Misha Hill, What to Watch in the States: State Earned Income Tax Credits (EITC) on the Move (Tax Justice Blog). “State EITCs generally match a portion of the federal credit–ranging from 3.5 percent of the federal credit in Louisiana to 40 percent in Washington, D.C.”

News from the Profession. The “New” Arthur Andersen Was Just Kidding About Holding a Press Conference to Explain WTF Is Going On (Caleb Newquist, Going Concern)

Peter Reilly, The Devil And Lois Lerner. “So Judicial Watch’s disparate treatment claim is entirely unfounded. Unless they can find some conservative or Christian groups that have had different results from using the expedited process established in 2014 in order to avoid a repeat of Teapartygate, there is nothing to complain about.”

Robert D. Flach interrupts his busy-season blog hiatus for A VERY, VERY IMPORTANT MESSAGE. “If you receive any correspondence from any federal or state tax agency about a tax return give it to your tax preparer immediately!”

Roger McEowen, Charitable Contributions Via Trust. Sometimes trusts are a good giving vehicle, but you need to make sure that the trust document allows it.

TaxGrrrl, Taxes From A To Z (2017): I Is For Investment Income Expense

TaxProf, The IRS Scandal, Day 1417:  Satan, Tea Parties, and the IRS. Links to Sam Brunson’s Surly Subgroup post.

 

Tuesday, March 28, 2017

Career Corner. How to Get Ahead: Learn to Deal With the Critical Voice Inside Your Head (Caleb Newquist, Going Concern). First: don’t tell HR that you are hearing voices in your head.

Hank Stern, PCIP v2.0?. “We were long-time fans of the PCIP (Pre-Existing Condition Insurance Plan), the one part of ObamaCare that actually seemed to make sense. So of course it was designed to sunset after a time, leaving a lot of folks with few choices and less care.”

Howard Gleckman, No, Tax Reform Is Not Easier Than Rewriting the Health Law (TaxVox). “There is a good reason why a major rewrite of the tax code has not happened for more than three decades.” Eight, actually, according to the post.

Jack Townsend, Sixth Circuit Affirms Preparer’s Convictions Including Tax Perjury. “Essentially, Williams’ argument was a variation of the argument for 2004 — that there was no falsehood on the return he filed — Forms 1040EZ for each year.  Of course, the Form 1040EZ is an inappropriate return if the taxpayer had, as he had here, income from sources other than allowed on the Form 1040EZ, such as S Corporation return.”

Jared Walczak, Evaluating Soda Tax Proposals in West Virginia (Tax Policy Blog). A view from a confessed Mountain Dew junkie.

Joseph Thorndike, Tax Day Is a Drag. Should We Keep It That Way? (Tax Analysts Blog):

Actually, I think there’s a good case to be made that fans of big government should also be wary of making taxes less visible. For most of the last 40 years, liberals have been unwilling (or unable) to make a persuasive, straightforward case for adequate taxation. On the defensive since Reagan recast American politics in 1980, they’ve tried to build activist government on the sly, using tax expenditures or narrowly targeted tax hikes on the rich. 

That’s fine, as long as you harbor narrow, Clintonian notions of what constitutes progressive government. But grander ambitions require broader, more visible forms of taxation.

The ACA is an example of trying to fund a mass benefit with a class tax, leading to what is looking like a slow-motion collapse. I think that’s an argument against big social programs in the first place, but if you accept the premise that those are a good idea, you should listen to Joseph Thorndike.

Kay Bell, 5 FAQs about RMDs. “But some older taxpayers, specifically that first big batch of Baby Boomers who turned 70½ last year, are facing a key April 1 tax deadline.”

Keith Fogg, More Fallout from Chai (Procedurally Taxing). No, not flavored tea. It’s about the sign-offs required before IRS can impose penalties.

Leandra Lederman, ACTC Letter Requesting a Variance for Tax Guidance (Surly Subgroup). “As the ACTC’s letter states, even while simplification efforts are underway, ‘it is critical for taxpayers and their advisors to have the guidance needed to comply with the tax law as currently in effect.'”

Lew Taishoff, FIVE-OH. “Today is the fiftieth anniversary of my admission to the Bar of Our Fair State.” Wow. Congratulations, Mr. T!

Renu Zaretsky, Good things come to those who wait… and work. “Then there is this: Who will drive the tax train?”

Robert Wood, Shorten IRS Tax Audit Disputes Through New Program. “Fast Track Settlement can resolve audit disagreements in as little as sixty days, rather than possibly years.”

TaxGrrrl,Taxes From A To Z (2017): I Is For Investment Income Expense

If you borrowed funds for business and personal use, you must allocate the debt accordingly. That’s because only the interest expense on the part of the debt used for investment purposes is deductible: you cannot deduct any interest on money borrowed for personal reasons.

Generally, your deduction for investment interest expense is limited to your net investment income. You may be able to carry over amounts you could not deduct to the next tax year.

Determining the treatment of investment income expenses, including interest, can be surprisingly difficult.

 

Wednesday, March 29, 2017

Howard Gleckman, Does Learning About Taxes Change People’s Views About Fairness? (TaxVox). “When it came to their views about the rich, Vanessa found much more modest effects. Those who answered questions suggesting that the rich take advantage of special tax breaks and overseas shelters were a bit more likely to say that the rich don’t pay their fair share, but their views moved by only 4 percentage points, much less than among those who were asked similar questions about low-income people.”

Jason Dinesen, Iowa Tuition and Textbook Credit: Dealing with Private School Expenses. Jason explains how the credit applies to religious private schools.

Jim Maule, Tax Deduction for Donating Clothing. “Used clothing, unless it is something once owned by a celebrity, is like a used car. Its value diminishes from the moment it is purchased, and continues to do so as it is worn”

Kay Bell, 5 tax-saving investment options. 401(k), IRA, Sec. 529, HSA and one more.

Keith Fogg, Innocent Spouse Injured by Using the Wrong Form (Procedurally Taxing). “The case illustrates something that regularly happens in innocent spouse case – the innocent spouse’s refunds get offset by the IRS to satisfy the liability of the ‘liable’ spouse – and getting them back can prove very difficult for the innocent spouse.”

Lew Taishoff, THE SECRET SHARER. “So, just as in Józef Teodor Konrad Korzeniowski’s story, the secret sharers go overboard.”

News from the Profession. We Finally Found a Service That a Big 4 Firm Won’t Provide (Caleb Newquist, Going Concern)

Nicole Kaeding, The Return of Gross Receipts Taxes (Tax Policy Blog):

The flaws of gross receipts taxes are well documented. Gross receipts taxes lead to higher consumer prices, lower wages, and fewer job opportunities, as the tax pyramids throughout the production cycle. Unlike a retail sales tax that is assessed only on the final consumer purchase of a product, a gross receipts tax is assessed at every stage of production. (Many retail sales taxes do not fully exempt business inputs, and do have a small, but notable, amount of pyramiding.)

Why are states considering a gross receipts tax, given the noted flaws?

Because revenue.

Richard Phillips, The $767 Billion Money Pot Driving Tax Reform (Tax Justice Blog). “At the heart of this debate is the problem of corporations shifting their profits to foreign tax havens to avoid U.S. income taxes.”

Robert Goulder, Tax Reform Will Be Easy, Just Like Healthcare (Tax Analysts Blog). “From where I sit, the legacy issues presented by Obamacare pale when compared with the sheer vastness of our tax system.”

Robert Wood, With IRS, Ask Forgiveness Not Permission. On the problems of getting IRS advance rulings, and the alternatives.

Roger McEowen, Qualified Farm Indebtedness – A Special Rule for Income Exclusion of Forgiven Debt. “Farmers often have favorable tax rules.  The qualified farm indebtedness rule is one of those”

Sam Brunson, Chuck Berry, Cash, and Taxes (Surly Subgroup):

Multiple accounts report that he demanded cash from concert promoters before he’d go onstage. There’s a lot of evidence that taxpayers who receive cash are much less likely to report it than taxpayers who receive payment by credit card, or even by check.

Of course, it may well be that receiving cash didn’t cause Berry to evade taxes; he may well have demanded cash in order to facilitate his tax evasion. Either way, though, his receipt of cash was a red flag; the IRS went after him and, days after performing for President Carter in the White House, he spent four months in federal prison.

Getting paid in cash doesn’t make it tax-free.

TaxGrrrl, Taxes From A To Z (2017): K Is For Strike Price. “When you receive stock options as an employee, you have the right but not the obligation to buy up to a specific number of shares of company stock at a fixed price (the strike price) during a specific time period (the exercise period).”

TaxProf, The IRS Scandal, Day 1420.

 

Thursday, March 30, 2017

Jack Townsend, Motion to Dismiss Superseding Indictment Denied Because Taint Review Proper. “The case has a further wrinkle in that, prior to delivery to the taint team, two IRS agents involved in the execution of the search warrant had reviewed the notebook in question, marked ‘attorney-client privilege.'”

Jason Dinesen, Glossary: Lifetime Learning Credit. “This credit is similar to the American Opportunity Credit, but there are some key differences.”

Kay Bell, Democrats strike out on 3rd attempt to get Trump’s taxes. I think this may become a white whale for some in the current out-of-power party, like the birth certificate was for the last president.

Kristine Tidgren, New Law Limits Ag Nuisance Damages (Ag Docket). “The law states that an animal feeding operation found to be a public or private nuisance would conclusively be a ‘permanent nuisance,’ thereby foreclosing future lawsuits for additional damages.”

Leslie Book, Good Fortune (for the IRS) (Procedurally Taxing). “Good Fortune shows how in the absence of statutory detail on implementation, agencies have considerable discretion in promulgating rules, especially true when the rules relate to exemptions, which as the Tax Court noted here, are to be interpreted narrowly.”

Lew Taishoff, RESTITUTION, ASSESSMENT. “As for not filing the 4089-B, it’s easy to play Monday morning quarterback. So I’ll let it go at that.”

Meg Wiehe, State Rundown 3/29: More States Looking to Raise or Protect Revenues Amid Fiscal and Federal Uncertainty (Tax Justice Blog). “This week we see West Virginia, Georgia, Minnesota, and Nebraska continue to deliberate regressive tax cut proposals, as the District of Columbia considers cancelling tax cut triggers it put in place in prior years, and lawmakers in Hawaii, Washington, Kansas, and Delaware ponder raising revenues to shore up their budgets.”

News from the Profession. PwC Keeps The Oscars Gig (Caleb Newquist, Going Concern)

Nicole Kaeding, Is Tax Reform Coming to Louisiana? (Tax Policy Blog)

Individual Income Taxes:The plan would lower the current individual income tax rates from 2, 4, and 6 percent to 1, 3, and 5 percent. It would also repeal the deduction for federal taxes paid.

Corporate Income Taxes: The plan would consolidate the state’s five income tax brackets of 4, 5, 6, 7, and 8 percent into three brackets of 3, 5, and 7 percent. The deduction for federal taxes paid would also be eliminated for corporations in the state.

That would leave Iowa even more isoloated with its federal tax deduction, and correspondingly high rates – 8.98% for individuals, and the highest-in-the-nation 12% rate.

Paul Neiffer, Why Use An LLC?. “Many farm operations operate as corporations. In most cases, an LLC may have been the better option.”

Shu-Yi Oei, PROMESAs, PROMESAs? (Surly Subgroup). “Recall that unlike U.S. municipalities (such as Detroit), Puerto Rico bodies and utilities aren’t considered debtors for purposes of Chapter 9 of the U.S. Bankruptcy Code and therefore don’t have access to the municipal bankruptcy process.”

TaxGrrrl, Where Have All Of The Taxpayers Gone?

When early filing numbers were down, it seemed to follow that taxpayers who would have otherwise filed early in order to claim a refund were simply waiting for the deadline (even though the IRS emphasized that it would process tax returns normally before that date). But February 15 came and went – and numbers were still down. There was no mad stampede to file following the February 15 date. So what gives?

The results are odd. Here are the latest stats as of March 24:

TaxProf, The IRS Scandal, Day 1421: More On A Hidden Cause Of The IRS Scandal

William Gale, The Republicans Will Struggle to ‘Win’ on Tax Reform (TaxVox). “So the DBCFT is likely to be a non-starter.  But there’s no Plan B for tax reform on the horizon, and the health care reform experience shows how hard it is to gin up a comprehensive policy on the fly.”

 

Friday, March 31, 2017

Andrew Mitchel, Blind Guesses Are Not Good Faith Estimates. But they are easier and cheaper.

Howard Gleckman, The Theological Battle Over Tax Credits Versus Tax Deductions (TaxVox). “That brings us back to the core argument: that a refundable credit is an entitlement (thus bad) while a deduction is a tax cut (thus good).”

Jared Walczak, West Virginia Would Have 10th Best Business Tax Climate Under HB 2933 (Tax Policy Blog). ” It converts the current five-bracket graduated rate individual income tax, which has a top rate of 6.5 percent, into a 5.1 percent single rate income tax with a generous $10,000 standard deduction for filers with adjusted gross incomes of $50,000 or less.”

Jason Dinesen, Do I Prorate Income from a Fiscal Year K-1?

Jim Maule, Kansas As a Role Model for Tax Policy? Mr. Bad Example, maybe.

Kay Bell, IRS bringing in more tax money despite budget cuts. “The Internal Revenue Service collected more than $3.3 trillion during the 2016 fiscal year.”

Keith Fogg, Update on Aging Offers into Acceptance (Procedurally Taxing). “I wrote a post almost two years ago about the provision placed into IRC 7122(f) as part of the Tax Increase Prevention and Reconciliation Act of 2005, which deems a doubt as to liability and doubt as to collectability offers received by the IRS on or after July 16, 2006, accepted if the IRS does not act on the offer within two years.”

Lew Taishoff, TACITO E NASCOSTO. Mr. T discusses a sad Tax Court case involving a serial wife-beater and his attempt to make the battered wife jointly liable for the beater’s taxes. “He’s lucky I wasn’t the judge.”

News from the Profession. Would Neuralink Solve All of Accounting’s Problems? (Megan Lewczyk). “For accountants, I see the real potential in the capacity to store large amounts of data and then quickly be able to access it. Who needs a photographic memory? Implant one of these puppies and you’re good for life.” I hope they come out with NeuraGoodJudgement at the same time.

Paul Neiffer, S Corporation Liquidation. “We had done several posts about how to not recognize gain on land trapped in a C corporation via using an S corporation as the reader rightfully points out.  However, this does not apply to ordinary income assets such as grain and equipment.”

Richard Phillips, A Comparative Analysis: Tax Rates Paid by Companies for and Against the Border Adjustment Tax (Tax Justice Blog). “A close examination of average tax rates paid by companies in each coalition reveals the counterintuitive reality that those supporting the border adjustment tax are generally already paying low corporate tax rates, while those opposing the proposal are generally paying higher rates.”

Roger McEowen, Livestock Indemnity Payments – What They Are and Tax Reporting Options. “Given that the wildfires occurred in the early part of 2017, it is likely that any LIP payments will also be received in 2017.”

TaxProf, Trade Group: IRS Wastes 22% Of Its Budget ($2.76 Billion) On Information Technology. The post inks to a report by the “International Association of IT Asset Managers,” which says:

This should give those of us who think the IRS needs more funding pause. Yes, the IRS needs a bigger budget, but it needs much more than that. Without better management and systematic administrative reform, it will just be sending money down a big hole.

TaxGrrrl, Taxes From A To Z (2017): M Is For Marginal Tax Rate. “It is the tax rate you’ll pay on the next dollar of taxable income.”

Tony Nitti, Tax Reform: Five Headlines You’re Sure To Read. “Sure, these rare moments serve as career validation for people who have made the ill-advised choice to spend their lives in the bowels of the tax law, but debates over reform of those laws shouldn’t be preserved solely for us.”

https://taxprof.typepad.com/taxprof_blog/2017/03/weekly-tax-highlight-and-roundup-3.html

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