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2012 Year-End Income Tax Update
 

2012 Year-End Income Tax Update

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Agenda: Tax Updates for Individuals; Tax Update for Businesses; Fiscall Cliff; Disposition of Assets or Business Interests; Depreciation; Basis Issues; Business Income and Deductions; Estate Planning; ...

Agenda: Tax Updates for Individuals; Tax Update for Businesses; Fiscall Cliff; Disposition of Assets or Business Interests; Depreciation; Basis Issues; Business Income and Deductions; Estate Planning; Other Cases and Rulings.

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    2012 Year-End Income Tax Update 2012 Year-End Income Tax Update Presentation Transcript

    • The 2012 Year-End Income Tax Update &What is ComingMira J. FinéJanuary 29, 2013 1
    • ―Tax Code Confusing!‖• News flash from IRS Ombudsman.• 5,000 changes since 2001 – more than 1 a day on average• 6.1 billion estimated hours that individuals and businesses spend complying with tax filing requirements. Equivalent of 3 million full-time workers!• 90% of taxpayers who pay for professional preparers or commercial software to file taxes. 2 © 2013 Hein & Associates, LLP. All rights reserved.
    • So, short of it, taxes are going up!• Even though Bush tax cuts extended for 98% of taxpayers, 77% of Americans will pay higher taxes in 2013. – Payroll tax reduction not extended.• If you earn between $250,000 and $450,000, you may not receive the reprieve you think you did. – AMT will get you. 3 © 2013 Hein & Associates, LLP. All rights reserved.
    • Tax Changes – Individuals• Fiscal cliff changes impact• Overall estimate of the budgetary effects of the bill over 10 years is negative $3.63 trillion in revenues• Without the act, individual tax rates on all income groups would have increased, taxpayer-friendly treatment of capital gains and dividends would have completely disappeared, the child tax credit would have plummeted to $500, enhancements to education tax incentives would have ended, the federal estate tax would have reverted to a maximum rate of 55%, and many other popular, but temporary, incentives would no longer be available. 4 © 2013 Hein & Associates, LLP. All rights reserved.
    • Tax Changes – Individuals (cont‘d)1. Individual Tax Rates – 10%, 15%, 25%, 28%, 33% remain the same; 35% up to 400x or 450x; so over 450x 39.6% – Impact – Only a relatively small sliver of what had constituted the upper income range – Still benefited from longer rates and there is still an inflation adjustment – ―C‖ Corporation rates are still at 35%. – Extends all existing marriage penalty relief. So standard deduction would be 200% of deduction for singles. 5 © 2013 Hein & Associates, LLP. All rights reserved.
    • Tax Changes – Individuals (cont‘d)2. Capital Gains/Dividends Sunsets – Top bracket increased to 20%. The top rate will apply to the extent that a taxpayer‘s income exceeds 400x/450x. – Other recapture items unchanged – Impact/Caution – Installment payments received after 2012 are subject to rates for year of the payment, not sale. • The 3.8% threshold amount still stands at 200/250. 6 © 2013 Hein & Associates, LLP. All rights reserved.
    • Tax Changes – Individuals (cont‘d)3. Pease Limitation – Revises the limitation on itemized deductions but increases the applicable threshold level 300x MFJ adjusted for inflations – Adjusted by 3% by amount by which taxpayer‘s AGI > threshold 7 © 2013 Hein & Associates, LLP. All rights reserved.
    • Tax Changes – Individuals (cont‘d)4. Sales Tax – Deduction for state and local sales taxes paid (in lieu of state and local income taxes paid) – Useful in states that have little or no income taxes 8 © 2013 Hein & Associates, LLP. All rights reserved.
    • Tax Changes – Individuals (cont‘d)5. Permanent AMT relief – Increased exemption amounts and allows non-refundable credits to the full amount of the individual regular tax and AMT with inflation adjustment – Will be considered later as a potential adjustment to taxes 9 © 2013 Hein & Associates, LLP. All rights reserved.
    • Tax Changes – Individuals (cont‘d)6. Federal Estate Tax – Permanently provides for a maximum federal estate tax of 40% with inflation adjustment of $5M – Permanent – portability – Gifts – same – GST – allocations/values 10 © 2013 Hein & Associates, LLP. All rights reserved.
    • The most unfair tax of all!• COD – Cancellation of Debt• Bank forgives your debt• You think you‘re home free• Then comes the 1099-C 11 © 2013 Hein & Associates, LLP. All rights reserved.
    • Cancellation of Debt Extended thru 12/31/13• Loans forgiven as gifts aren‘t taxable.• Exception for the mortgage on your home.• Up to $2M (per couple) in mortgage debt on a principal home forgiven from originally from 2007-2012. Now extended to 12/31/13.• Bankruptcy discharges aren‘t taxable.• If you‘re insolvent, you get a pass.• Certain forgiven student loans aren‘t income.• Account for all 1099-C.• Price adjustment isn‘t income. 12 © 2013 Hein & Associates, LLP. All rights reserved.
    • Net Investment Income & Additional MedicareTaxes (for tax years beginning after 12/31/12)• Net investment income on individuals equals 3.8% of the lesser of: 1. Net investment income, or 2. The excess of the individuals adjusted gross income over the threshold amount ($250) not indexed for inflation. 13 © 2013 Hein & Associates, LLP. All rights reserved.
    • Net Investment Income & Additional MedicareTaxes (for tax years beginning after 12/31/12)• What is net investment income: – Category I – Interest, dividends, annuities, royalties, rents, other than such derived in the ordinary course of a trade or business. – Category II – Other described from a trade or business – under §1411(c)(2) passive or business of trading in – Category III – Net gain attributable to the disposition of property other than property in a T/B. – All this is over deductions allocable to gross income. – WOW – Gain from sale of principle residence 14 © 2013 Hein & Associates, LLP. All rights reserved.
    • Net Investment Income & Additional MedicareTaxes (for tax years beginning after 12/31/12) – Category IV: • Includes annuities • Royalties • Not pension – Excluding any items taken into account in determining S/E from a partnership is Category II PP – as if sold assets 15 © 2013 Hein & Associates, LLP. All rights reserved.
    • IRA Charitable Rollover• Congress retroactively reinstated the provision that allows people >70 ½ to transfer up to $100,000 tax free from their IRAs directly to charity.• For 2012 and 2013• Allows eligible gifts made during January 2013 to be treated as 2012 donations.• Permits IRS distributions made to the taxpayer in December 2012 to be transferred to charity in January 2013.• Taxpayers have the month of January to take advantage of these opportunities for 2012 income tax purpose. 16 © 2013 Hein & Associates, LLP. All rights reserved.
    • Tax Changes Effective in 2012 – Business• Reduced bonus depreciation (NOPE)• For qualified property acquired and placed in service after 2011 and before 2013, a 50% (down from 100%) bonus first-year depreciation allowance applies under §168(k) – (After 2012 and before 2014 for aircraft and certain long- production period property)• Fiscal cliff bill extended the 50% bonus depreciation through 2013 17 © 2013 Hein & Associates, LLP. All rights reserved.
    • Tax Changes Effective in 2012 – Business• Reduced §179 expensing (not now)• For tax years beginning in 2012, the §179 expensing election is $500,000 with a $2,000,000 investment- based ceiling. This was changed from the potential reduction to $139,000, with a $560,000 investment- based ceiling. 18 © 2013 Hein & Associates, LLP. All rights reserved.
    • Fiscal Cliff – The Avoidance of Tax Armageddon?• R&D credit – extended through 2013• WOTC – extended through 2013• Energy credits – extended• Payroll tax cuts – not extended• The temporary reduction in the employee portion of the FICA rate expired 12/31/12.• The employee share is now 6.2%, up from 4.2%. Wage limit is $113,700.• The self-employment income tax is 12.4%, up from 10.4%. 19 © 2013 Hein & Associates, LLP. All rights reserved.
    • Business Provisions that Expired on 12/31/11Extended to 2013• Research credit• Indian employment tax credit• New markets tax credit• Railroad track maintenance credit• Mine rescue team training credit• Employer wage credit for activated reservists• 15-year recovery period for leasehold improvements, restaurant property and retail improvements 20 © 2013 Hein & Associates, LLP. All rights reserved.
    • Business Provisions that Expired on 12/31/11Extended to 2013 (cont‘d)• Accelerated depreciation for Indian reservation property• Special rule for contributions of food and book inventories• Deduction for domestic production activities in Puerto Rico• Reduction in S corporation recognition period for built-in gains tax-5 years for 2012 and 2013• Shareholder basis adjustment for stock of S corporations making charitable contributions• 100% exclusion for gain on small business stock 21 © 2013 Hein & Associates, LLP. All rights reserved.
    • Corporate Tax Credits Included in Fiscal Cliff Bill• Actually crafted back in August 2012• By the Senate Finance Committee• Packed 50 tax credit extensions into the bill• Committee passed 19 to 5.• Then stalled. And sat ignored.• Sat dormant until White House insisted• Not a case of lobbyists sneaking last minute provisions• Corporate lobbyists, ―planted their seeds over the summer. They‘ll enjoy the fruit in the new year‖. 22 © 2013 Hein & Associates, LLP. All rights reserved.
    • Curious Provisions in ―Fiscal Cliff‖ Bill• Curious Provisions or ―Loopholes‖ or Corporate Credits – Help build racetracks – super accelerated depreciation – Coal as ―alternative energy‖ – subsidizing coal produced on Native American lands – Plug-in electric scooters – credit for 2 or 3 wheeled plug-in electric vehicles – Subsidize Hollywood films – special expensing rules for certain film and TV production – Rum tax for Puerto Rico – levies an excise tax 23 © 2013 Hein & Associates, LLP. All rights reserved.
    • Sequestration Delayed• As a result of the Budget Control Act of 2011 debt ceiling negotiations across the board spending cuts were set to begin 1/1/13.• Sequester which would impose steep, across- the-board cuts to domestic and defense will be delayed for 2 months.• Now set to begin as of 3/1/13? 24 © 2013 Hein & Associates, LLP. All rights reserved.
    • U.S. Debt Ceiling• Congress did not include an increase to the current debt ceiling.• On 12/31/12, Treasury Secretary Geithner noted U.S. had reached its $16.4 Trillion debt ceiling.• Treasury will now implement ―extraordinary measures‖ to avoid a default as long as possible.• Congress will need to propose additional legislation to raise the current debt ceiling.• Last time the negotiations resulted in a downgrade of U.S. credit rating and a whipsaw month in the markets. 25 © 2013 Hein & Associates, LLP. All rights reserved.
    • So what did this bill do?• Not great example of compromise• Averted short-term issues• Did not address country‘s long-term fiscal issues in this bill• Namely – Complicated tax code – Rising entitlement spending 26 © 2013 Hein & Associates, LLP. All rights reserved.
    • AICPA• Total Tax Insights: – Complete picture of estimated Federal, State and Local tax obligation – Most Americans don‘t know what their total bill is – Users can select a location and only four or five are required. – http://www.totaltaxinsights.org/ 27 © 2013 Hein & Associates, LLP. All rights reserved.
    • Awards & Taxes 28 © 2013 Hein & Associates, LLP. All rights reserved.
    • Amazon and Sales Tax• Amazon began collecting sales tax September 2012 in California! – Starting to collect sales tax in more states. – States started to say no to Amazon, took to court. Court agreed. – Amazon could stand firm and fight or accept the inevitable. – So Amazon will start collecting sales tax and now building more centers—faster delivery! 29 © 2013 Hein & Associates, LLP. All rights reserved.
    • $104 Million!• IRS awarded former UBS banker Bradley Birkenfield $104 million under the whistleblower program.• Largest amount ever given.• Birkenfield disclosed U.S. citizens with accounts in Switzerland.• He did spend 2 ½ years in jail for fraud for withholding crucial information. 30 © 2013 Hein & Associates, LLP. All rights reserved.
    • Biggest Tax Fraud Prosecution Ever• Attorney takes plea in biggest tax fraud prosecution ever!• Defendants in case Daugerdas and Guerin.• One of Jurors was a pathological liar brought case down. Ordered new trial.• Guerin plead guilty sentenced to 10 years.• Daugerdas and others await retrial. Trial took 3 months, 9,200 pages of testimony from 21 witnesses and 22,000,000 documents! 31 © 2013 Hein & Associates, LLP. All rights reserved.
    • Americans say ―No‖ to banks• 8.2% of middle-class American households, or 12 million, no longer use a bank.• Another 24 million households are ―underbanked‖ and only sometimes use bank services.• Others turn to payday loans or prepaid cards. 32 © 2013 Hein & Associates, LLP. All rights reserved.
    • Hit me with your best shot!• Martinez, former IRS agent turned private tax preparer, was arrested in March 2012.• Accused of trying to hire a hit man to kill witnesses.• Some of them allegedly former clients, in a case against him.• Allegedly stole $11 million by lying about amount owed.• Convinced them to write checks to his trust account.• He pocketed the difference! 33 © 2013 Hein & Associates, LLP. All rights reserved.
    • CPA gets 4.5-year prison sentence• CPA Castillo was sentenced to: – 4.5-year prison sentence – Additional 3 years of supervised release – Ordered to pay $43,582,699 in forfeiture• For his role in app. $500,000,000 fraud scheme affecting more than 3,500 victims• Castillo conspired with President of PCI to prepare false audited financial statements: – Personally created the statements – Never preformed an audit – Received approximately $84,000 in audit fees from 2004 – 2010• President sentenced to 60 years in prison. 34 © 2013 Hein & Associates, LLP. All rights reserved.
    • Compensation 35 © 2013 Hein & Associates, LLP. All rights reserved.
    • Watson, P.C. v. U.S., (CA 8 2/12) 109 AFTR 2d2012-483Summary of Facts:1. The taxpayer is an S corporation CPA firm.2. The sole shareholder received a $24K salary each year that was approved by a formal vote.3. The sole shareholder received distributions in excess of $175K in 2002 and 2003. 36 © 2013 Hein & Associates, LLP. All rights reserved.
    • Watson, P.C. v. U.S., (CA 8 2/12) 109 AFTR 2d2012-483Results confirmed by the Appeals Court:1. Based on services rendered and a compensation analysis – salary increased to $91K.2. Tax assessment – $48K for 2002 and 2003.3. Supreme Court will not review decision (10/1/12). 37 © 2013 Hein & Associates, LLP. All rights reserved.
    • Hot Topic – Worker ReclassificationVoluntary Classification Settlement ProgramTo be eligible, a taxpayer: a) Must have consistently treated the workers as nonemployees; b) Must have filed all required Forms 1099 for the workers for the previous three years; and c) Cannot currently be under audit by IRS, or currently under audit concerning the classification of the workers by the Department of Labor (DOL) or by a state government agency. A taxpayer that was previously audited by IRS or DOL about the classification of the workers will only be eligible if it has complied with the results of that audit. 38 © 2013 Hein & Associates, LLP. All rights reserved.
    • Hot Topic – Worker ReclassificationVoluntary Classification Settlement ProgramA taxpayer who applies for and is accepted into the VCSP will agree toprospectively treat the class of workers as employees for future tax periodsand in exchange: a) Will pay 10% of the employment tax liability that may have been due on compensation paid to the workers for the most recent tax year, determined under the reduced rates of Code Sec. 3509; b) Will not be liable for any interest and penalties on the liability; c) Will not be subject to an employment tax audit for the worker classification of the workers for prior years; and d) Will agree to extend the period of limitations on assessment of employment taxes for three years for the first, second and third calendar years beginning after the date on which the taxpayer has agreed under the VCSP closing agreement to begin treating the workers as employees. 39 © 2013 Hein & Associates, LLP. All rights reserved.
    • Hot Topic – Worker ReclassificationVoluntary Classification Settlement Program• Apply with Form 8952• Other considerations: – Impact on employee – State compliance issues – Workers‘ Compensation Insurance 40 © 2013 Hein & Associates, LLP. All rights reserved.
    • Hot Topic – Worker ReclassificationSection 530 of the Revenue Act of „78, as amendedA taxpayer that incorrectly treats an employee as anindependent contractor is nevertheless exempt fromemployment tax liability if it meets three requirements: – The taxpayer does not treat any other individual holding a substantially similar position as an employee for purposes of employment taxes for any period; – All required federal tax returns are filed by the taxpayer on a basis consistent with its treatment of the individual as a nonemployee; and – The taxpayer has a reasonable basis for not treating the individual as an employee. 41 © 2013 Hein & Associates, LLP. All rights reserved.
    • Masonry workers were employees, notindependent contractorsAtlantic Coast Masonry, Inc., TC Memo 2012-233• The Tax Court has held that a S corporation operating a masonry subcontracting business failed to properly treat its workers as employees. Although the workers were hired by the job and were free to work for others, a factor indicating independent contractor status, almost all of the other factors weighed in favor of employee status. For example, they were controlled by the subcontractor when they were on the job, and they had no significant investment in facilities.• No relief from Section 530 of the Revenue Act of „78 – Did not file 1099s 42 © 2013 Hein & Associates, LLP. All rights reserved.
    • Masonry workers were employees, notindependent contractorsAtlantic Coast Masonry, Inc., TC Memo 2012-233• Background. Code Sec. 3121(d)1(2) defines an ―employee‖ as an individual who, under common law (case law) rules, has the status of an employee. The courts have found that whether an individual is a common law employee is a question of fact to be determined by applying the following factors: – The degree of control exercised by the principal; – Which party invests in work facilities used by the individual; – The opportunity of the individual to realize a profit or loss; – Whether the principal can discharge the individual; – Whether the work is part of the principal‘s regular business; – The permanency of the relationship; and – The relationship the parties believed they were creating. 43 © 2013 Hein & Associates, LLP. All rights reserved.
    • Mortgage loan officer was independent contractorentitled to claim Schedule C deductionsCibotti, TC Summary Opinion 2012-21The Tax Court has held that a mortgage loan officerwas an independent contractor entitled to deductbusiness expenses on Schedule C, even though hewas issued a Form W-2 for his work, owned part of thestock of the company, and was its president. 44 © 2013 Hein & Associates, LLP. All rights reserved.
    • Mortgage loan officer was independent contractorentitled to claim Schedule C deductionsCibotti, TC Summary Opinion 2012-21The factors used to determine worker status weighed in favor of independentcontractor status, and the mortgage loan officer was president in name only. 1) The degree of control exercised by the principal; 2) which party invests in work facilities used by the individual 3) the opportunity of the individual for profit or loss 4) whether the principal can discharge the individual 5) whether the work is part of the principals regular business 6) the permanency of the relationship 7) the relationship the parties believed they were creating; and 8) the provision of employee benefits. 45 © 2013 Hein & Associates, LLP. All rights reserved.
    • Wages Disguised as NontaxableReimbursements• Revenue Ruling 2012-25, 2012-37 IRB 337 clarifies that an arrangement that re-characterizes taxable wages as nontaxable reimbursements or allowances, for example, to provide a tool reimbursement for employees, does not satisfy the business connection requirement of the §62(c) accountable plan rules. – Thus, the reimbursements are treated as made under a non-accountable plan and are taxable. 46 © 2013 Hein & Associates, LLP. All rights reserved.
    • Disposition of Assetsor Business Interests 47 © 2013 Hein & Associates, LLP. All rights reserved.
    • Sole shareholder‘s goodwill wasn‘t corporateasset taken into account on sale of businessH&M, Inc., TC Memo 2012-290• The Tax Court has concluded that where a corporation sold its insurance brokerage business to its competitor and its sole shareholder entered into employment with that buyer, the compensation under the employment agreement wasnt a disguised purchase price payment to the selling corporation.• In reaching this conclusion, the Court determined that the shareholders personal ability and other individualistic qualities werent a corporate asset (goodwill) that should be taken into account as part of the purchase price. 48 © 2013 Hein & Associates, LLP. All rights reserved.
    • IRS Oks reverse like-kind exchange where tworelated parties used the same swap facilitatorPLR 201242003• A new PLR deals with the unique situation of two related parties each vying to acquire the same property using a reverse like-kind exchange under Code Sec. 1031 and Rev Proc 2000-37, 2000-2 CB 308. IRS ruled that the party successfully consummating the reverse like-kind exchange could defer tax under Code Sec. 1031 even though it used the same exchange accommodation titleholder (i.e., the same swap facilitator) as the other party. 49 © 2013 Hein & Associates, LLP. All rights reserved.
    • Parent uses gifts and redemption to transferbusiness to children in tax-efficient wayPLR 201228012• IRS has privately ruled that a fathers transfer of a corporate business to his children through gifts and a redemption will achieve favorable tax consequences for all of the parties.• For example, IRS concluded that the fathers gain on the redemption will be capital gain reportable on the installment basis, the corporation wont have any gain from partially paying for the redemption with a note, interest on the note will be deductible by the corporation, and the redemption wont cause any dividend income to be constructively received by the children. 50 © 2013 Hein & Associates, LLP. All rights reserved.
    • Depreciation 51 © 2013 Hein & Associates, LLP. All rights reserved.
    • Taxpayer couldn‘t modify purchase priceallocations after cost segregation studyPeco Foods Inc. et al., TC Memo 2012-18• The Tax Court has concluded that a taxpayer could not modify purchase price allocations that it agreed to in connection with two asset acquisitions. The taxpayer made the modifications in an attempt to secure quicker depreciation deductions following a cost segregation analysis.• The Court concluded that IRS did not abuse its discretion in prohibiting the taxpayer from determining useful lives of assets in a manner that was inconsistent with the original allocation schedule. 52 © 2013 Hein & Associates, LLP. All rights reserved.
    • Basis Issues 53 © 2013 Hein & Associates, LLP. All rights reserved.
    • When a taxpayer cannot document basis thenthey have no basisScott P. Lysford, v. Commr, TC Memo 2012-41)• IRS‘s determination that the taxpayers were required to recognize gain on the full amount received from the sale of a real estate investment partnership interest was upheld as modified: although taxpayers offered various loan documents, deposit receipts and bank statements, along with copies of their Schedules K-1.• None of these documents, save photocopy of signed check from corp. to partnership for stated amount, were adequate to substantiate their basis in partnership where documents were unsigned, failed to identify source of funds and/or identify partnership as borrower. 54 © 2013 Hein & Associates, LLP. All rights reserved.
    • Shareholders‘ basis in S corp stock increased bycontribution of related S corp‘s receivablesMaguire, TC Memo 2012-160• The Tax Court has determined that a distribution of one S corporation‘s accounts receivable to its shareholders, followed by their contribution of the receivables to a related S corporation, increased the shareholders‘ basis in the second S corporation‘s stock and allowed them to deduct its losses.• The Court rejected IRS‘s argument that the transaction didnt amount to their making an economic outlay, finding that the financial positions of both the shareholders and the companies were altered by the shareholders‘ actions. 55 © 2013 Hein & Associates, LLP. All rights reserved.
    • Past basis miscalculations eliminate Sshareholders‘ pass-through loss deductionBarnes, TC Memo 2012- 80• The Tax Court has concluded that S corporation shareholders weren‘t entitled to deduct pass-through losses because they didn‘t have sufficient basis in their stock. The taxpayers‘ errors in their basis computation in previous years—in one year increasing their basis by ―phantom‖ gain, and in another failing to take into account suspended losses that became available—limited their ability to claim the pass-through losses in the year at issue. 56 © 2013 Hein & Associates, LLP. All rights reserved.
    • Proposed regs provide that only bona fideshareholder loans to S corporation create basisProp Reg § 1.1366-2, Prop Reg § 1.1366-5• IRS has issued proposed regs that would provide that S corporation shareholders increase their adjusted basis in any indebtedness of the S corporation to them—and so allow them to deduct their pass-through deductions and losses—only if the indebtedness is bona fide.• The proposed regs would apply to loan transactions entered into on or after final regs are published. 57 © 2013 Hein & Associates, LLP. All rights reserved.
    • Proposed PAL regs ease definition of limitedpartnership interest and extend it to LLC interests• The proposed regs that would provide a new definition of limited partnership interest for the purposes of IRC Sec. 469(h)(2).• IRC Sec 469 (h)(2) – A limited partnership interests is a passive interests for passive activity loss purposes except as proved by regulations.• Under the new definition, more partnership interests could escape treatment as passive interests.• The proposed regs would make it clear that an interest in an LLC could be treated as a limited partnership interest for PAL purposes. 58 © 2013 Hein & Associates, LLP. All rights reserved.
    • Proposed PAL regs ease definition of limitedpartnership interest and extend it to LLC interestsProp. Reg. 1.469-5T(e)(3)(i) provides that a partnershipinterest is treated as a limited partnership interest if:• The entity in which the interest is held is classified as a partnership for Federal income tax purposes; and• The holder of the interest does not have rights to manage the entity at all times during the entitys tax year under the law of the jurisdiction in which the entity was organized and under the governing agreement.• Access to management as a member of LLC.• Eliminated financial commitment SIDA. 59 © 2013 Hein & Associates, LLP. All rights reserved.
    • Proposed PAL regs ease definition of limitedpartnership interest and extend it to LLC interests• However, under Prop. Reg. 1.469-5T(e)(3)(ii), a partnership interest isn‘t treated as a limited partnership interest for the individual‘s tax year if he is a general partner as well as a limited partner in the partnership during its tax year ending with or within the individual‘s tax year.• Therefore, the individual can use all seven material participation tests.• Keep in mind, if the activity is not passive, then the LLC member is subject to SE tax. 60 © 2013 Hein & Associates, LLP. All rights reserved.
    • Business Income &Deductions 61 © 2013 Hein & Associates, LLP. All rights reserved.
    • New temp regs rewrite the rules on deduction vs.capitalization of tangible property costs – effective 1/1/14• The IRS has issued temporary regulations (TD 9564, 12/27/11) and identical proposed regulations (REG- 168745-03, 12/27/11) that provide guidance to taxpayers on the treatment of amounts paid to acquire, produce, or improve tangible property and on the accounting for, or dispositions of, property subject to depreciation.• The IRS recognizes the highly factual nature of deciding whether expenditures are for capital improvements or for ordinary repairs and the problems with applying the standard in practice. 62 © 2013 Hein & Associates, LLP. All rights reserved.
    • New temp regs rewrite the rules on deduction vs.capitalization of tangible property costs – effective 1/1/14• The regulations provide objective standards and bright-line rules (e.g., a de minimis rule for specific acquisitions) intended to simplify compliance with Section 263(a)‘s capitalization procedures.• The temporary regulations are generally effective for expenditures made after 12/31/13, which means they do not affect taxpayers‘ 2012 returns. Notice: 2012-73, 1/1/14 – effective date – NEW.• The IRS anticipates publishing additional guidance advising taxpayers about how to obtain automatic consent to change to a method of accounting provided in the temporary regulations. These requests can be filed only beginning with taxpayers‘ 2014 returns. 63 © 2013 Hein & Associates, LLP. All rights reserved.
    • New rules for repair-related automatic accountingmethod changes under recent regulationsRev. Proc. 2012-19, 2012-14 IRB• A new Revenue Procedure explains the procedures by which a taxpayer may obtain IRSs automatic consent to change to the accounting methods provided in recently issued Reg. 1.162-3T, Reg. 1.162-4T, Reg. 1.263(a)-1T, Reg. 1.263(a)-2T, and Reg. 1.263(a)-3T for tax years beginning on or after Jan. 1, 2014. (changed).• The Revenue Procedure addresses the changes with regard to the treatment of repair & maintenance, and materials & supplies as a result of the tangible property temporary regs. 64 © 2013 Hein & Associates, LLP. All rights reserved.
    • Deduction disallowed because medicalmarijuana dispensary engaged in ―trafficking‖Olive, (2012) 139 TC No. 2• In Olive, the Tax Court held that Section 280E precluded a taxpayer who operated a medical marijuana business (the Vapor Room) pursuant to California law from deducting expenses related to the business. Section 280E prohibits taxpayers from deducting any amount for a trade or business when the trade or business (or the activities that comprise the trade or business) consist of trafficking in controlled substances prohibited by federal law, even if legal under state law. This includes medical marijuana.• Does not apply to Cost of Goods Sold.• 1.263A-(4)(b)(l)(i) – Growing of plants is a production activity. 65 © 2013 Hein & Associates, LLP. All rights reserved.
    • Deduction disallowed because medicalmarijuana dispensary engaged in ―trafficking‖Olive, (2012) 139 TC No. 2• The court distinguished this case from Californians Helping to Alleviate Medical Problems, Inc., 128 TC 172 (2007) (CHAMP), in which the court allowed the taxpayer to deduct expenses. According to the court, CHAMP had two businesses (one the dispensing of medical marijuana and the other providing caregiving services), and CHAMP was allowed to deduct expenses related to caregiving.• In contrast, the Vapor Room‘s sole business was to dispense medical marijuana, and all other services it provided were part of that business. 66 © 2013 Hein & Associates, LLP. All rights reserved.
    • Sole proprietors, partners, and 2% S corpshareholders can deduct Medicare premiumsChief Counsel Advice 201228037• In Chief Counsel Advice (CCA), IRS has provided guidance on the requirements for a sole proprietor, partner, or 2% shareholder of an S corporation to deduct Medicare premiums as medical care insurance under Code Sec. 162(l).• Further, the CCA concludes that all Medicare parts, and not just the supplemental medical insurance of Medicare Part B, are insurance constituting medical care under Code Sec. 162(l).• Potential amended return - §162(l). 67 © 2013 Hein & Associates, LLP. All rights reserved.
    • CEO couldn‘t claim bad debt deduction for―loans‖ to troubled corporationRamig v. Comm., (CA 9 10/24/2012) 110 AFTR 2d ¶2012-5396• The Court of Appeals for the Ninth Circuit, affirming the Tax Court in an unpublished opinion, has concluded that a chief executive officer (CEO), who was also a board member and minority shareholder, couldn‘t take a bad debt deductions for advances he made to his corporation and other payments he made on the company‘s behalf.• No bona fide debtor-creditor relationship.• Ability to repay was in question. Collateral should be present. Have to have payment. Other potential lenders. 68 © 2013 Hein & Associates, LLP. All rights reserved.
    • Tax Court denies bad debt deduction for unpaidadvances from related entityHerrera, TC Memo 2012-308• The Tax Court has sustained a deficiency asserted against a married couple who reported pass-through bad debt deductions from a limited liability company (LLC). The deductions were claimed to have resulted from unpaid debt owed by a related entity.• However, the Tax Court found that the advances from the LLC to the related company were not debt and thus denied the claimed deductions.• No bona fide debtor-creditor relationship 69 © 2013 Hein & Associates, LLP. All rights reserved.
    • Estate Planning 70 © 2013 Hein & Associates, LLP. All rights reserved.
    • Estate of Beatrice Kelly, T.C. Memo 2012-73Facts:• In 1990, Mrs. Kelly inherited significant business & non-business assets from her husband – She was not involved in any businesses before his death• In 1998, Mrs. Kelly was diagnosed with Alzheimers. Several steps were taken to avoid litigation among the family.• In 2002, her children were appointed co-guardians, therefore all issues regarding Mrs. Kelly‘s care and property were subject to approval of the probate court.• Due to the nature of assets, there were some significant liability concerns.• In 2003, the children hired an attorney to review the family settlement agreement and address their liability concerns. 71 © 2013 Hein & Associates, LLP. All rights reserved.
    • Estate of Beatrice Kelly, T.C. Memo 2012-73• Facts: – The attorney created the following plan that was approved the by the state court. The court noted that she would save $2.9M in estate taxes.• Step 1 – Formed one LP to hold two operating quarries (Kel-Tex) – Formed three LPs to hold the majority of other assets – One corporation (KWC) that served has the general partner• Step 2 – Mrs. Kelly transferred assets to each LP in exchange for a 99% Ltd. partner interest and a 1% general partner interest, which was transferred to KWC 72 © 2013 Hein & Associates, LLP. All rights reserved.
    • Estate of Beatrice Kelly, T.C. Memo 2012-73• Step 3 – Mrs. Kelly made gifts of the LPs to her children from 2003 until 2005 and filed gift tax returns. – Mrs. Kelly retained $1.1M in her own name.• Composition of Estate – At the time of her death in 2005, she owned 99% of Kel- Tex, 100% of KWC ,about 33% of two LPs, 0% of the other LP and over $1M in liquid assets. 73 © 2013 Hein & Associates, LLP. All rights reserved.
    • Estate of Beatrice Kelly, T.C. Memo 2012-73• Decision of the Court – The Tax Court engaged in a two-part analysis, first of Mrs. Kellys transfer of property to the LPs then of the transfer of partnership interests to her heirs, and found that neither transfer triggered inclusion in her estate under IRC Sec. 2036(a).• Non-Tax Factors – Limited liability protection – Ensure equal distribution of assets – Consolidate management of assets – Established management compensation agreement – Mrs. Kelly received LP interest equal to the value of the assets she contributed – Mrs. Kelly retained sufficient assets to maintain herself 74 © 2013 Hein & Associates, LLP. All rights reserved.
    • Estate of Joanne H. Stone, TC Memo 2012-48Facts:• In 1990s, the Stone family developed some real estate, including the construction of a dam to form a lake.• After the project was completed, Mr. & Mrs. Stone decided the property should become a family asset and would like to begin gifting an interest in the property to their many children and their families.• In 1997, they consulted an attorney who recommend the establishing a Ltd. Partnership which would simplify the gifting process and guard against partition suits.• The Stone Family Ltd. Partnership (SFLP) was formed and an operating agreement was executed. 75 © 2013 Hein & Associates, LLP. All rights reserved.
    • Estate of Joanne H. Stone, TC Memo 2012-48Facts:• On 12/30/97, Mr. & Mrs. Stone contributed the real estate, which was valued at $1,575,600, to SFLP, in exchange for a 1% general partnership interest and a 49% LP interest.• From 12/31/97 through 12/31/2000 Mr. & Mrs. Stone gifted all of their LP interest (98%) to the family. The interest were valued in 1% increments at $15,756 each.• No valuation discount was applied. 76 © 2013 Hein & Associates, LLP. All rights reserved.
    • Estate of Joanne H. Stone, TC Memo 2012-48• IRS‟s Position: – The IRS determined that, pursuant to IRC Sec. 2036(a), Mrs. Stone retained an interest in the transferred assets, – the transfers were not bona fide sales for adequate consideration, – and the decedent retained an interest in the property, therefore the value of the transferred assets is includable in her gross estate.• Proposed deficiency – $2.5 M 77 © 2013 Hein & Associates, LLP. All rights reserved.
    • Estate of Joanne H. Stone, TC Memo 2012-48• Decision of the Court: – The Tax Court concluded that the transfer was for adequate & full consideration, therefore IRC Sec 2036 is not applicable. The property should not be included in her estate.• Non-Tax Factors – Mrs. Stone received LP interest equal to the value of the assets she contributed. – To create a family asset that may be developed in the future. – To protect against partition suits. – Mr. & Mrs. Stone retained sufficient other assets for themselves. – Mr. and Mrs. Stone were in good health when SFLP was formed. – No valuation discounts were applied. 78 © 2013 Hein & Associates, LLP. All rights reserved.
    • Court finds FLP was formed despite incompletedocuments and awards big refund to estateThomas Lane Keller et al. v. U.S., (CA 5 09/25/2012)110AFTR 2d ¶2012-5312• The Court of Appeals for the Fifth Circuit, affirming a district court, has determined that a decedent capitalized a family limited partnership (FLP) before her death, notwithstanding that she hadnt completed certain documents.• This resulted in an over $115 million refund to the estate, which initially reported the assets to be owned outright, rather than in the FLP. The refund arose from a valuation discount for the FLP interest and because the Court also allowed the estate a deduction for interest on a retroactively structured loan from the FLP that was used to pay estate tax.• State law is the determination of entity status. 79 © 2013 Hein & Associates, LLP. All rights reserved.
    • Gifts of limited partnership interests qualified forgift tax annual exclusionsEstate of George H. Wimmer, TC Memo 2012-157• In a case involving an asserted estate tax deficiency of over a quarter of a million dollars, the Tax Court has held that gifts of limited partnership interests made by the decedent during life were gifts of present interests that qualified for annual exclusions.• While the donees did not receive unrestricted and non- contingent rights to immediate use, possession or enjoyment of the limited partnership interests themselves, the gifts nonetheless qualified as present interests because the donees received such rights in the income from the limited partnership interests. 80 © 2013 Hein & Associates, LLP. All rights reserved.
    • Marital deduction not increased by transferredassets brought back into estateEstate of Clyde Turner, Sr., (2012) 138 TC No. 14• In a prior case involving the same estate, the Tax Court held that, under Code Sec. 2036, the estate had to include assets that had been transferred by the decedent to a family limited partnership (FLP).• The Tax Court has now modified the prior holding to reject the estate‘s contention that the included assets operated to increase the marital deduction. The Court reached this result after first refusing to reconsider its prior holding that inclusion was required under Code Sec. 2036.• Highlights danger of ignoring Code Sec. 2036 81 © 2013 Hein & Associates, LLP. All rights reserved.
    • Louise P. Gallager v. Comm. TC Memo 2011-148Issue: Minority Interest Valuation• In case the court considered all of the factors and arrived at their own valuation (pretty much in the middle) – Used financial data produced after valuation date – Use of guideline public company data – Allowed a 23% minority interest discount – Allowed a 31% marketability discount, based on restricted stock studies 82 © 2013 Hein & Associates, LLP. All rights reserved.
    • Other Cases, Rulings, Etc. 83 © 2013 Hein & Associates, LLP. All rights reserved.
    • Supreme Court: basis overstatement isn‘t incomeomission for 6-year limitations periodHome Concrete & Supply, LLC, (Sup Ct 4/25/2012) 109AFTR 2d ¶2012-661• The Supreme Court, resolving a split among various Circuit Courts and the Tax Court, has determined that an overstatement of basis isn‘t an omission of gross income for purposes of Code Sec. 6501(e)(1)(A)‘s 6-year limitations period.• The Court found that the ‗58 Colony decision, in which it construed the nearly identical language of Code Sec. 6501(e)(1)(A)‘s predecessor statute as referring only to items left out, controlled the outcome of this case. 84 © 2013 Hein & Associates, LLP. All rights reserved.
    • Fraudulent S return didn‘t extend assessmentperiod for innocent shareholderChief Counsel Advice 201238026• In Chief Counsel Advice (CCA), IRS has concluded that a fraudulent S corporation return (Form 1120-S) does not extend the period of limitations under Code Sec. 6501(c) for the personal tax liability of a shareholder who did not take part in the fraud. 85 © 2013 Hein & Associates, LLP. All rights reserved.
    • Roy Zeluck v. Commissioner, TC Memo 2012-98At-Risk Income Recapture• Tax Court determined for IRC Sec. 465 purposes that oil and gas partnership investor‘s liability on subscription note, used to partially fund his partnership investment, became “non-genuine” by end of tax year at issue, when the partnership terminated and there were no payments of required interest and principal through withholding or otherwise and no attempts to take possession of collateral or to take any enforcement action. 86 © 2013 Hein & Associates, LLP. All rights reserved.
    • Roy Zeluck v. Commissioner, TC Memo 2012-98At-Risk Income Recapture• Therefore, because the taxpayer‘s at-risk amount had already been reduced to zero as result of flow through losses and distributions, the invalidation of the note resulted in further reduction of at-risk amount to negative amount and gain recognition in accord with IRC Sec. 465(e).• See Form 6198 87 © 2013 Hein & Associates, LLP. All rights reserved.
    • Conversion of partnership to corporation treatedas Code Sec. 351 exchange – PLR 201214014• Conversion transaction will be treated as if the partnership had transferred all of its assets to taxpayer solely in exchange for taxpayer‘s stock and assumption by taxpayer of partnerships liabilities (―exchange‖)• and the partnership liquidated, distributing taxpayer stock to its partners.• the exchange will be treated as an exchange to which IRC Sec 351(a) applies, with partnership recognizing gain under IRC Sec. 357(c) equal to excess of sum of liabilities assumed by taxpayer in exchange over sum of basis of properties transferred by partnership to taxpayer in exchange 88 © 2013 Hein & Associates, LLP. All rights reserved.
    • Tax-Dodging Schemes• I am no human. The IRS has rejected claims from taxpayer who don‘t consider themselves to be a ―person.‖• It‘s against my religion. One man said his First Amendment rights exempt him from paying taxes because of his religious objections to the government‘s military spending. The case was dismissed. The man was fined $5,000. 89 © 2013 Hein & Associates, LLP. All rights reserved.
    • Conclusion• Watch for revenue raisers: – S Corp-Self-employment income – Tax on carried interest-investment services Partnership interest – Repeal of LIFO and LCM• Rethink choice of entity = individual rates > corporate rates – Even with double tax rates, may be better off as a C Corp – United States is #1 on its tax rate on corporations, so focus on reducing rates to make U.S. more competitive – Watch for potential extension/renewal may come back and in effect eliminating the double tax effect when liquidate C Corp. 90 © 2013 Hein & Associates, LLP. All rights reserved.
    • Questions 91 © 2013 Hein & Associates, LLP. All rights reserved.