Larry's Tax Law

In the case of John D. Moore, et al. v. Commissioner, TC Memo 2013-249 (October 30, 2013), the US Tax Court was presented with the saga of John Moore.

Mr. Moore was a CPA.  He left the world of public accounting to embark on a career in a new industry.  In 1992, he became the Operations Manager of the Dallas, Texas Peterbilt truck distributor.  By 1995, Mr. Moore had climbed the corporate ladder and was appointed president of the company.

In 1992, the company granted Mr. Moore an option, good through December 31, 1999, to purchase five percent (5%) of the shares of the company, an S corporation.  In 1997, the company merged with another company.  As a result of the merger, Mr. Gary Baker entered the picture.  Mr. Baker ended up with 1,477,859 shares of the merged entity.  On December 30, 1999, Mr. Moore entered into an agreement to purchase all of Mr. Baker’s shares for $5,842,606.  The next day, on December 31, 1999, Mr. Moore timely exercised his option and purchased 500,000 shares of the company for $212,334.

As part of the purchase of the Baker shares, Mr. Moore signed a promissory note for the full purchase price of an amount just shy of $6,000,000.  It was all due and payable on May 5, 2000.  After signing the note, however, the parties revised it so that $3,000,000 would be due on June 14, 2000, and the balance would be paid in three equal annual installments.

In Peter Knappe v. U.S., 713 F3d 1164 (9^th Cir., April 4, 2013), the United States Court of Appeals for the Ninth Circuit was presented with the question whether reliance upon a tax professional may excuse the late filing of a tax return.

Peter Knappe was the personal representative of the Estate of Ingborg Pattee.  He was also trustee of her testamentary trust.

Mrs. Pattee died in 2005, leaving a large estate.  Mr. Knappe was her long-time friend.  Although he had business experience, Mr. Knappe had no experience serving as a personal representative or preparing estate tax returns.  So, he engaged the services of Mr. Francis Burns, CPA.  Burns had been his company’s outside accountant for several years.  Mr. Knapp was always satisfied with his work.

Burns told Knappe that a Form 706 for the estate of would need to be filed by August 30, 2006.  Knappe had trouble obtaining the needed appraisals on or before the filing deadline.  Burns advised Knappe that he could obtain an extension of one (1) year for both the filing and the payment of the taxes due.

Burns filed a Form 4786, seeking both an extension for filing and for payment of the taxes due. The extension sought was one year.

As we know, the filing extension, unless the personal representative is out of the country, is only six (6) months.  The payment extension, however, in the discretion of the Service, may be up to one year.  Burns, however, believed both extensions were automatically one (1) year.  OOPS!

The United States Sixth Circuit Court of Appeals was actually presented earlier this year with the “$64,000 Question.”  In Robert W. Stocker, II and Laurel A. Stocker v. U.S., 111 AFTR 2d 2013-556 (705 F3d 225) (6^th Cir., January 17, 2013), the court examined what sort of evidence a taxpayer must introduce in order to support the timely filing of a tax return in which a $64,000 refund was claimed.

In this case, Bob and Laurel Stocker filed an amended 2003 return, seeking a $64,000 refund.  The Service denied the claim on the ground that they did not file the return within the 3-year statutory period.

The Stockers filed suit in District Court.  The court quickly dismissed the case for lack of subject matter jurisdiction—the Stockers could not establish the jurisdictional prerequisite of timely filing the return by methods recognized by the Service or the courts.

The taxpayers argued that testimony and circumstantial evidence may support the timely filing requirement.  Mr. Stocker and his office manager, Karrin Fennell, testified that the return was timely deposited at a United States post office, postage prepaid.  They forgot, however, to attach the registered mail customer return receipt.  The taxpayers were, however, able to produce evidence that the Department of Revenue timely received the amended return.  So, they argued the IRS must have likewise received the federal return on time.  Unfortunately, the IRS’ records showed the return was postmarked 4 days after its due date.

Thank you for your support and friendship.  I wish you a wonderful holiday season and terrific 2014.

- Larry

Earlier this year, the First Circuit United States Court of Appeals issued its decision in United States v. Albania Deleon, 704 F.3d 189 (1st Cir., January 11, 2013).   This case illustrates that worker misclassification may, in addition to the imposition of taxes and civil penalties, lead to criminal sanctions, including imprisonment.

Albania Deleon owned and operated two businesses:  an asbestos abatement training school (“ECT”) and a temporary employment agency (“MSI”).  This case focuses on Ms. Deleon and MSI.  MSI supplied temporary workers to asbestos abatement contractors. 

MSI maintained two separate payrolls for its workforce.  One payroll reported a minority of the workers as employees, proper withholding of payroll and income taxes was done, and Form W-2s were issued to the employees.  MSI reported in writing to both its customers (including governmental entities) and the occupational safety division of local government that it was responsible for and was complying with all employee withholding tax obligations. 

The second payroll, which encompassed most of MSI’s workers, treated the workers as independent contractors—no withholding was done.  Rather, IRS Form 1099s were issued to the workers.  MSI told its accountants that these workers were independent contractors.  Evidence in the trial record indicated Ms. Deleon had absolutely no factual basis for that conclusion.

In late 2006, as a result of an anonymous tip to the government that MSI was violating immigration laws and was involved in fraudulent payroll activity, state and federal investigators raided the offices of both companies.  Based upon the information gathered in the raid, including computer records, the IRS concluded MSI had fraudulently avoided paying over $1,000,000 in payroll taxes.

In the circumstance where substantially all of the assets of a closely-held C corporation are being sold, the shareholder of the seller may desire to receive part of the purchase price directly from the buyer for his or her personal goodwill. The result is beneficial to both the buyer and the selling shareholder. The buyer gets to amortize the amount paid for the goodwill ratably over fifteen (15) years, and the shareholder enjoys two tax advantages, namely he or she gets capital gain treatment on the amount received for the goodwill and he or she avoids the corporate level tax. This approach works provided certain facts exist:

• • The selling shareholder has created personal goodwill;

• • The selling shareholder has the ability to take the personal goodwill with him or her to another company and has the ability to compete with the corporation;

• • There is no contractual arrangement limiting the selling shareholder’s ability to use the personal goodwill in the pursuit of work for a business competitor or the ability to sell it to a business competitor; and

• • The amount of the sale proceeds allocated to the personal goodwill is reasonable.

The Timely Filing Requirement Imposed by Oregon DOR in Order for Taxpayers to be Able to use the "Prior Year Tax Safe Harbor" Stricken by the Oregon Tax Court 

On September 13, 2013, in Finley v. Oregon Department of Revenue, the Oregon Tax Court granted taxpayer’s Motion for Summary Judgment, and held Oregon Administrative Rule 150-316.587(8)-(A) is invalid to the extent it requires taxpayers to have timely filed their prior year’s Oregon income tax return to be eligible for the “Prior Year Tax Safe Harbor.”

I represented the taxpayer in this matter.  The facts were straightforward.  The tax years at issue were 2008 and 2009.  The taxpayer was a resident of Oregon during these years.

For tax year 2008, the taxpayer paid his taxes in a timely manner.  Unfortunately, he filed his Oregon individual income tax return late. 

For tax year 2009, the taxpayer had a substantial increase in his income due to a capital gain-generating transaction.  To avoid an estimated tax payment penalty, on December 31, 2009, thinking he qualified for the “Prior Year Tax Safe Harbor,” he made an Oregon estimated tax payment of 100% of his 2008 Oregon income tax liability.  Then, he timely filed his 2009 Oregon income tax return, and he paid the additional taxes shown due on the return.  Thereafter, the Oregon Department of Revenue sent the taxpayer a nice letter, thanking him for his generous tax payment, but requesting he pay an additional large sum, representing an estimated tax (late payment) penalty.  Not being able to resolve the matter with the Department, we filed a complaint in the Oregon Tax Court.  The case was ultimately heard by Judge Henry Breithaupt in the Regular Division of the Oregon Tax Court.

Faris Fink, Commissioner of the Small Business/Self-Employed Division of the Internal Revenue Service, announced at the AICPA National Tax Conference on November 5, 2013, that his division is moving its audit focus from corporations to pass-through entities (i.e., S corporations, partnerships and sole proprietorships).

Fink was candid when he said his employees do not currently have the skills and knowledge to conduct these examinations.  In anticipation of its new focus, however, the Service is developing pass-through entity examination strategies and is training its audit staff to conduct the exams.  Practitioners should expect to see significantly more pass-through entity examinations in 2014.  One would suspect these examinations, especially early on, will be challenging for taxpayers and their advisors.  

Looks Like Oregon Tax Laws are Changing Again

House Bill 3601 A (“HB 3601”) passed the Oregon House of Representatives and the Oregon Senate on October 2, 2013, during a special session.  Governor Kitzhaber signed the bill into law on October 8, 2013.  The new law is effective January 1, 2014.  This is good news for some Oregon taxpayers and bad news for others.

The most significant impact of HB 3601 is found in six provisions, namely:

I.  Corporate Excise Tax Rates.  The corporate excise tax rates are increased.  Effective for tax years beginning in 2013 or later, a 6.6% tax rate applies to the first $1,000,000 of taxable income and a tax rate of 7.6% applies to any excess taxable income.  Under current law, the 6.6% tax rate applies to the first $10,000,000 of taxable income and the 7.6% tax rate applies to any excess taxable income.  This change in current law represents a substantial increase in tax for many corporate taxpayers.

II.  IC-DISCs.  Except as expressly provided by Oregon law, DISCs are taxed in Oregon like corporations.  ORS 317.635(1).  HB 3601 exempts existing Interest Charge DISCs (i.e., IC-DISCs formed on or before the effective date of the act) from the Oregon corporate minimum tax under ORS 317.090.  HB 3601 also causes any commissions received by DISCs to be taxed at 2.5%, and allows a deduction for commission payments made to existing DISCs.

III.  Dividends Received from DISCs.  HB 3601 allows a personal income taxpayer to subtract from income any dividend received from a DISC formed under IRC § 992.

IV.  Personal Exemption Phase-Out.  HB 3601 denies personal income taxpayers from claiming the personal exemption credit(s) (current $90 per exemption) if federal adjusted gross income is $100,000 or more for a single taxpayer and $200,000 or more for a married filing joint taxpayer.

V.  Senior Health Care Costs.  HB 3601 provides a small deduction for “senior” health care expenses not compensated by insurance.  The bill, however, adds a phase-out for taxpayers with federal adjusted gross income over certain thresholds.  Likewise, the definition of a “senior” starts out at age 62 for the 2013 tax year and increases each year thereafter by one year until tax year 2020.

VI.  Reduced Tax Rates for Applicable Non-passive Income.  For tax years beginning in 2015 or later, applicable non-passive income attributable to certain partnerships and S corporations will be taxed as follows:

The Service Continues its Warm Approach to Taxpayers with S Corporation Inadvertent Terminations (PLR 201340001) 

As we know, in accordance with Code Section 1362(f) and the corresponding Treasury Regulations, a corporation will continue to be treated as a Subchapter S corporation during a period of termination, if:

1. 1. The election was terminated, either because the corporation was disqualified as an electing small business corporation, or as a result of running afoul of the passive investment income rule;
   2. The Service determines the termination as inadvertent;
   3. The corporation promptly takes steps to correct the defect after discovery; and
   4. The corporation and its shareholders acted as if the election was continuously in effect.