2012 Year-End Income Tax Update

The 2012 Year-End Income Tax Update &
What is Coming
Mira J. Finé
January 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

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

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


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


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


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


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


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

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

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

Net Investment Income & Additional Medicare
Taxes (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


• 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


– 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

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

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

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

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

Business Provisions that Expired on 12/31/11
Extended 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

Business Provisions that Expired on 12/31/11
Extended 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

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

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

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

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

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

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

Awards & Taxes

28

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

$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

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

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

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

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

Compensation

35

Watson, P.C. v. U.S., (CA 8 2/12) 109 AFTR 2d
2012-483

Summary 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

Watson, P.C. v. U.S., (CA 8 2/12) 109 AFTR 2d
2012-483

Results 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

Hot Topic – Worker Reclassification
Voluntary Classification Settlement Program
To 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

A taxpayer who applies for and is accepted into the VCSP will agree to
prospectively treat the class of workers as employees for future tax periods
and 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


• Apply with Form 8952
• Other considerations:
– Impact on employee
– State compliance issues
– Workers‘ Compensation Insurance

40

Section 530 of the Revenue Act of „78, as amended
A taxpayer that incorrectly treats an employee as an
independent contractor is nevertheless exempt from
employment 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

Masonry workers were employees, not
independent contractors
Atlantic 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

Masonry workers were employees, not
independent contractors
Atlantic 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

Mortgage loan officer was independent contractor
entitled to claim Schedule C deductions

Cibotti, TC Summary Opinion 2012-21
The Tax Court has held that a mortgage loan officer
was an independent contractor entitled to deduct
business expenses on Schedule C, even though he
was issued a Form W-2 for his work, owned part of the
stock of the company, and was its president.

44

Mortgage loan officer was independent contractor
entitled to claim Schedule C deductions

Cibotti, TC Summary Opinion 2012-21
The factors used to determine worker status weighed in favor of independent
contractor 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 principal's 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

Wages Disguised as Nontaxable
Reimbursements

• 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

Disposition of Assets
or Business Interests

47

Sole shareholder‘s goodwill wasn‘t corporate
asset taken into account on sale of business

H&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 wasn't a disguised purchase price payment to
the selling corporation.
• In reaching this conclusion, the Court determined that the
shareholder's personal ability and other individualistic
qualities weren't a corporate asset (goodwill) that should
be taken into account as part of the purchase price.

48

IRS Oks reverse like-kind exchange where two
related parties used the same swap facilitator

PLR 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

Parent uses gifts and redemption to transfer
business to children in tax-efficient way
PLR 201228012
• IRS has privately ruled that a father's 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 father's gain on the
redemption will be capital gain reportable on the
installment basis, the corporation won't 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 won't cause any dividend income to
be constructively received by the children.

50

Depreciation

51

Taxpayer couldn‘t modify purchase price
allocations after cost segregation study

Peco 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

Basis Issues

53

When a taxpayer cannot document basis then
they have no basis

Scott 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

Shareholders‘ basis in S corp stock increased by
contribution of related S corp‘s receivables

Maguire, 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
didn't 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

Past basis miscalculations eliminate S
shareholders‘ pass-through loss deduction

Barnes, 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

Proposed regs provide that only bona fide
shareholder loans to S corporation create basis

Prop 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

Proposed PAL regs ease definition of limited
partnership 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


Prop. Reg. 1.469-5T(e)(3)(i) provides that a partnership
interest 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 entity's 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


• 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

Business Income &
Deductions

61

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

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

New rules for repair-related automatic accounting
method changes under recent regulations

Rev. Proc. 2012-19, 2012-14 IRB
• A new Revenue Procedure explains the procedures by
which a taxpayer may obtain IRS's 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

Deduction disallowed because medical
marijuana 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

Deduction disallowed because medical
marijuana 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

Sole proprietors, partners, and 2% S corp
shareholders can deduct Medicare premiums

Chief 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

CEO couldn‘t claim bad debt deduction for
―loans‖ to troubled corporation

Ramig 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

Tax Court denies bad debt deduction for unpaid
advances from related entity

Herrera, 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

Estate Planning

70

Estate of Beatrice Kelly, T.C. Memo 2012-73
Facts:
• 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 Alzheimer's. 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

• 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


• 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

• Decision of the Court
– The Tax Court engaged in a two-part analysis, first of Mrs. Kelly's 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

Estate of Joanne H. Stone, TC Memo 2012-48
Facts:
• 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


Facts:
• 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


• 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

• 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

Court finds FLP was formed despite incomplete
documents and awards big refund to estate
Thomas Lane Keller et al. v. U.S., (CA 5 09/25/2012)110
AFTR 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 hadn't 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

Gifts of limited partnership interests qualified for
gift tax annual exclusions

Estate 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

Marital deduction not increased by transferred
assets brought back into estate
Estate 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

Louise P. Gallager v. Comm. TC Memo 2011-148

Issue: 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

Other Cases, Rulings, Etc.

83

Supreme Court: basis overstatement isn‘t income
omission for 6-year limitations period

Home Concrete & Supply, LLC, (Sup Ct 4/25/2012) 109
AFTR 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

Fraudulent S return didn‘t extend assessment
period for innocent shareholder

Chief 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

Roy Zeluck v. Commissioner, TC Memo 2012-98

At-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

Roy Zeluck v. Commissioner, TC Memo 2012-98

At-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

Conversion of partnership to corporation treated
as 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

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

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

Questions

91

2012 Year-End Income Tax Update

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