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1 Tax Alerts August 2018 Phase Two Tax Reform Outline is Expected to Come Soon A "phase two" tax reform outline could be unveiled by House GOP tax writers soon. Republicans have started to increase their tax meetings related to the effort, House Ways and Means Committee Chairman Kevin Brady, R-Tex. said. Individual Tax Cuts Brady reiterated to reporters that "phase two" will focus on the individual side of the tax code. Moreover, making permanent the individual tax cuts enacted under the Tax Cuts and Jobs Act (TCJA) (P.L ) will be the "centerpiece" of a "phase two" bill, Brady reportedly said. Additionally, Republican tax writers are considering proposals that would streamline the retirement savings process. Phase Two Fate Uncertain The next major tax bill s fate in the Senate remains uncertain. At least nine Democratic votes will be needed to reach the Senate s 60-vote threshold. Brady has said he is hopeful for Democratic support. However, Democratic lawmakers in the House and Senate remain largely opposed to the TCJA. Democrats have criticized the TCJA for primarily benefiting corporations. However, House Republicans are hopeful for bipartisan support on a new measure that focuses primarily on individual tax cuts. For more information about this article, please contact our tax professionals at taxalerts@windes.com or Shareholder Could Not Claim S Corporation s FICA Tip Credits An individual shareholder of an S corporation restaurant operator was not allowed to claim FICA tip credits under Internal Revenue Code (IRC) Section 45B that the S corporation did not claim. The shareholder could not unilaterally and retroactively nullify the S corporation s election to deduct FICA tip taxes. Background The restaurants owned by the S corporation had hired tipped employees whose earnings came partly from customer tips. The S corporation was required to pay taxes on these tips as part of its FICA tax payments. For the two tax years at issue, the S corporation did not claim any FICA tip credits. Instead, 1

2 Shareholder Could Not Claim S Corporation s FICA Tip Credits (continued) the S corporation deducted its payments of the FICA tip taxes on its Forms 1120S and did not later amend those returns. On his amended Forms 1040 for those tax years, the shareholder claimed he was entitled to flow-through FICA tip credits with respect to his interest in the S corporation. FICA Tip Credit IRC Section 45B allows an employer working in the food and beverage industry to claim business tax credits for the portion of the FICA taxes i.e., social security and Medicare taxes that it paid on employee tips in excess of the minimum wage. The employer must have employees who receive tips from customers for providing food or beverages for consumption and must be deemed to have paid FICA taxes on the tips in excess of the minimum wage. The employer must not have already claimed a deduction for the FICA tax payment. An employer claims its FICA tip credits on Form Here, when the S corporation chose to deduct its FICA tax payments, it had made an election not to claim any FICA tip credits. The S corporation never claimed or intended to claim FICA tip credits. Based on this reporting position, the shareholder was not entitled to any flow-through FICA tip credits for either tax year. S Corporation Elections Under IRC Section 1363(c) and its regulations, elections that affect the computation of items derived from an S corporation generally must be made by the S corporation, not separately by its shareholders. There are two exceptions: the shareholder claims any elections (1) for the deduction and recapture of certain mining exploration expenditures, and (2) for foreign tax credits. In this case, the shareholder argued, in effect, that the S corporation s election to deduct FICA tax payments could be changed unilaterally by his request, made in his capacity as a shareholder, that the S corporation amend its returns to claim the FICA tip credit. The shareholder s position was rejected based on the plain text of IRC Section 1363(c) and of IRC Section 45B(d), which states that the credit does not apply to a taxpayer if the taxpayer elects to have the credit provision not apply. Further, the Tax Court stated that it refused to create a new precedent that would give each individual shareholder the power to change an S corporation s tax election unilaterally. Such a change, stated the Court, would not only affect the tax liabilities of the requesting shareholder, but could also affect the tax liabilities of the shareholders who have not consented to the change. For more information about this article, please contact our tax professionals at taxalerts@windes.com or 2

3 Congressional Lawmakers Introduce Bipartisan Historic Rehabilitation Credit Bill A bipartisan group of House and Senate lawmakers have introduced companion Historic Rehabilitation Tax Credit (HTC) bills. The measure aims to strengthen the HTC by encouraging investment and minimizing administrative burdens, according to the lawmakers. Rehabilitation Credit As amended by the Tax Cuts and Jobs Act (TCJA) (P.L ), the rehabilitation credit under Code Sec. 47 is limited to 20% of qualified rehabilitation expenditures (QREs) of the taxpayer for qualified rehabilitated buildings. The credit is claimed ratably over a five-year period beginning in the tax year in which the rehabilitated building is placed in service. A "qualified rehabilitated building" (QRB) is a building and its structural components for which depreciation is allowable, and that has been substantially rehabilitated and placed in service before the beginning of the rehabilitation. The building must be a certified historic structure, but any expenditure attributable to rehabilitation of the structure is not a QRE unless it is a certified rehabilitation. Property is considered substantially rehabilitated only if the expenditures during an elected 24-month measurement period (60-month period for phased rehabilitations) ending with or within the tax year are greater than the adjusted basis of the property or $5,000. Basis-Adjustment Requirement The bipartisan HTC Enhancement Bill would eliminate the existing basis-adjustment requirement. Eliminating this requirement would "bring the HTC in line with other tax credits claimed over multiple years," according to a joint press release by the bill s sponsors. The measure was introduced by Sens. Bill Cassidy, R-La., Ben Cardin, D-Md., and Susan Collins, R-Me., and Reps. Darin LaHood, R-Ill., and Earl Blumenauer, D-Ore. "Protecting this credit was one of my top priorities in tax reform, and I m glad there is bipartisan support for making it even better," Cassidy said in the joint press release. Cardin praised the measure for helping to create economic growth. Improved HTC Likewise, Collins said the bill would make the HTC easier to use as well as create economic development across the country. Additionally, an improved HTC would create jobs, according to Blumenauer. "Strengthening the Historic Tax Credit will further revitalize American cities while creating local jobs and spurring economic development in communities large and small," Blumenauer said. For more information about this article, please contact our tax professionals at taxalerts@windes.com or 3

4 Railroad Stock Options Are Not Money Remuneration Under RRTA The U.S. Supreme Court has determined that nonqualified employee stock options are not taxable compensation under the Railroad Retirement Tax Act (RRTA). The term "money remuneration" in the Act unambiguously excludes "stock." Background Several railroads filed a refund claim for overpaid Railroad Retirement taxes. The railroads claimed they overpaid their taxes because they included the value of employee stock options when calculating the tax. The IRS denied the refund request. The IRS argued that stock options were taxable "money remuneration" under the RRTA because stock can be easily converted into money. The railroads replied that stock options are not money. Moreover, they argued that when Congress passed the RRTA, it sought to mimic existing industry pension practices. Generally, those practices ignored in-kind benefits like food, lodging, and railroad tickets. Stock Options Not Money When Congress adopted the RRTA in 1937, it understood "money" as "currency issued by a recognized authority as a medium of exchange." Stock options do not fall within this definition. Further, while stock can be bought or sold for money, it is not usually considered a medium of exchange. Few people value goods and services using stock or buy groceries or pay rent with stock. Also, adding the word remuneration did not alter the meaning of the word money. Thus, "any form of money remuneration" indicated that Congress wanted to tax money compensation. It did not indicate that Congress wanted to tax things, like stock, that are not money. Statutory Context Moreover, the broader statutory context pointed to the same conclusion. For example, the 1939 Internal Revenue Code treated money and stock differently. However, the Federal Insurance Contribution Act taxes all remuneration, including benefits paid in a medium other than cash. Further, a contemporaneous IRS rule explained that the RRTA taxed all money compensation. The rule lists examples like salaries, wages, commissions and bonuses. It also included things that could be used as money, like scrip. However, the rule did not suggest that stock was taxable compensation. Thus, Congress knew the difference between money and other forms of compensation. The choice of Congress to use the narrower term for railroad pensions had to be respected. For more information about this article, please contact our tax professionals at taxalerts@windes.com or 4

5 Son-of-BOSS Arrangements Participants in the Son-of-BOSS tax shelter have maintained their perfect losing record in the Tax Court. Therefore, another Son-of-BOSS deal has failed to produce its promised loss deductions. Son-of-BOSS Arrangements Son-of-BOSS is a variation of a slightly older tax shelter known as the "bond and options sales strategy, or BOSS. Son-of-BOSS transactions take many forms, but they all have one thing in common: Assets that are encumbered by significant liabilities must always be transferred to a partnership. The goal is to increase basis in that partnership or in the assets themselves. The liabilities are usually obligations to buy securities. However, they are typically not completely fixed when they are transferred to the partnership. This contingency is supposed to let the partnership treat the liabilities as uncertain. This, in turn, is supposed to let the partnership ignore the liabilities in computing basis. The result is supposed to give the partners basis in the partnership or in the assets themselves. This increased basis is supposed to translate into large loss deductions for the partners, all with no actual economic losses. The Tax Court has yet to fall for the scheme. Invalid Partnerships The Court has used several theories to reject Son-of-BOSS losses. In this case, the Court once again relied on the fact that the two partnerships involved in the transactions did not actually exist. The partnerships were invalid because they were created only to carry out tax avoidance schemes. Thus, their members never intended to run any business through them. The partnerships also failed the prongified test for determining whether the parties intended to and did, in fact, join together for the present conduct of an undertaking or enterprise. One managed to scrupulously adhere to the formal requirements for looking like a partnership. However, it did not display any objective indication of a mutual combination for the conduct of an ongoing enterprise. The second partnership barely even went through the motions. It filed partnership returns and issued K-1s to its purported partners. However: there was no evidence the purported partners made any contributions to the partnership; the partnership did not have a formal operating agreement; the partnership did not conduct any business in its own name; there was no real profit for the partners to control or withdraw; and the partnership did not keep any books or records. Since the partnerships were invalid, they were simply disregarded. Thus, the purported partners were treated as directly engaging in the partnerships activities and directly owning the partnerships property. 5

6 Son-of-BOSS Arrangements (continued) This meant that the supposedly separate long and short options that were the heart of the transaction were actually a single-option spread. Thus the options were part of one contract, and they could not be separated to produce artificial losses. For more information about this article, please contact our tax professionals at taxalerts@windes.com or Penalty Relief Available for Untimely 2017 Repatriation Tax Payments This article is reproduced with permission from Spidell Publishing, Inc. Individual taxpayers who unexpectedly found themselves subject to the new Internal Revenue Code (IRC) Section 965 repatriation tax (aka the "transition tax") on previously deferred foreign income can now breathe a sigh of relief. The IRS has announced that it will not be imposing estimated tax and late-payment penalties for certain individual taxpayers who failed to make sufficient estimated tax payments or failed to meet the April 18, 2018 payment deadline for the first repatriation tax installment. The relief is not available to corporate taxpayers. Corporate taxpayers who failed to meet deadlines must seek first-time penalty abatement or reasonable cause penalty abatement. IRC Section 965, enacted in December 2017 as part of the Tax Cuts and Jobs Act (TCJA), imposes a repatriation tax on previously untaxed foreign earnings of specific foreign corporations owned by U.S. shareholders by deeming those earnings to be repatriated. Foreign earnings held in the form of cash and cash equivalents are taxed at 15.5%, and the remaining earnings are taxed at 8%. Paying the Tax The tax generally may be paid in installments over an eight-year period when a taxpayer files a timely election by the extended due date of the 2017 tax return. The repatriation tax is not included in computing a taxpayer's estimated tax liabilities. The first repatriation tax installment was due April 18, 2018, even though the installment election can be made on an extended return. If an installment payment is not timely made, including the first installment due on April 18, 2018, all future installments become immediately due. The IRS had previously announced that all overpayments of tax, including both the taxpayer's regular tax and repatriation tax amounts, will be applied to any outstanding repatriation tax due, even future installments. In other words, the taxpayers will not be receiving any regular tax refunds or credits if they elect to pay the tax in installments. 6

7 Penalty Relief Available for Untimely 2017 Repatriation Tax Payments (continued) Relief provided The following relief is provided to eligible taxpayers: The estimated tax penalty will be waived for taxpayers who improperly attempted to apply calculated overpayment to their 2018 estimated tax, as long as: they make all required estimated tax payments by June 15, 2018; and their first required installment was due by April 18, For individual taxpayers with a total repatriation tax liability of less than $1 million who missed the April 18, 2018 deadline for making the first of the eight annual installment payments, the IRS will waive the late-payment penalty if the taxpayer makes a timely election and pays the installment in full by April 15, 2019 (June 17, 2019, for taxpayers living outside the U.S.), and will not require that all future installments be paid immediately. Individuals who have already filed a 2017 return without electing to pay the repatriation tax in eight annual installments can still make the election by filing a 2017 Form 1040X with the IRS. The amended Form 1040 generally must be filed by October 15, For more information about this article, please contact our tax professionals at taxalerts@windes.com or 7

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