WASHINGTON TAX UPDATE OCTOBER 10, 2012 Welcome to Washington Tax Update, where you will find useful information about taxes, including current events in our nation s capital, as well as informed opinions and predictions about what is expected to happen. Tax Look Inside Tax Planning Tip of the Week IRS Courts What s New from the IRS What s New from the Courts It Bears Repeating Tax Laughs Congress
tax planning tip of the week There s more than meets the eye in C corporation tax planning Businesses that operate as C corporations are not directly affected by the pending expiration of the Bush-era tax cuts or the new 3.8 percent Medicare tax, scheduled to take effect in 2013. Since the tax rates that apply to C corporations are expected to be the same in 2013 as 2012, there is a natural tendency to conclude that accelerating deductions or deferring revenue may be the recommended year-end tax strategy. But as the following examples demonstrate, year-end tax planning for your C corporation deserves a bit more study. Example 1 Corporations are subject to a 39 percent rate bubble that exists for taxable income between $100,000 and $335,000. For instance, assume Corporation A is projecting $80,000 of taxable income for 2012 and $200,000 of taxable income for 2013. Through a combination of accelerating income and deferring deductions, Corporation A accelerates $20,000 of income from 2013 to 2012.
As a result, Corporation A will save $1,000 in tax (5 percent of $20,000), since the income will be taxed in 2012 at the 34 percent rate instead of being taxed in 2013 at the 39 percent rate. That is a 29.4 percent return on the investment of the $3,400 early tax payment. The time value of money is relatively minor compared to this return. Corporations, other than certain large corporations, can avoid being penalized for underpaying estimated taxes if they pay installments based on 100 percent of the tax shown on the return for the preceding year. Otherwise, they must pay estimated taxes based on 100 percent of the current year s tax. To be eligible to use the 100-percent-of-last-year s-tax exception, the corporation must file a return for the preceding year that showed a liability for tax. A return showing a zero tax liability does not satisfy this requirement. In general, a corporation is treated as a large corporation only if it had taxable income of $1 million or more in any one of the three preceding tax years. Example 2 Assume Corporation B (not a large corporation) is projecting a $10,000 net operating loss for 2012 and $200,000 of taxable income for 2013. Through a combination of accelerating income and deferring deductions, Corporation B accelerates $15,000 of income from 2013 to 2012. As a result, Corporation B will be able to make 2013 estimated tax payments totaling $750 (15 percent of $5,000) instead of $26,150 (the amount of estimated tax for 2013 due on $200,000 in taxable income if no tax was paid in 2012). If you are an owner or manager of a C corporation, you should consult your tax adviser for other year-end tax planning strategies. tax planning tip of the week
what s new from the IRS Federal government now decides if exchange is like-kind A like-kind exchange, often called a Section 1031 exchange, allows you to defer gain when you exchange real or personal property used in a business or held for investment for property of a like kind. For personal property, like kind means property of the same asset or product class. With real estate, most any other type of real estate qualifies, so long as it is business or investment property. Now the IRS chief counsel has concluded that federal law, rather than state law, controls the determination of whether exchanged properties are like kind. (CCA 201238027) While state law is relevant, the chief counsel determined that all the facts and circumstances should be considered to determine whether properties are of the same nature and character and, therefore, of like kind.
For example, the chief counsel determined that a right-of-way with a natural gas pipeline was like kind with another pipeline and right-of-way in a different state, because the pipelines were of the same nature and character. Although one state classified the pipeline as personal property and the other state classified it as real property, the chief counsel indicated that pipelines are real property because: They are inherently permanent structures affixed to real property; They will ordinarily remain for an indefinite period of time; and They are transferred as part of the land. In another example, a steam turbine attached as a fixture to a building that helps to generate electricity is exchanged for a similar steam turbine in another state. One state classifies the turbine as personal property; the other state treats it as real property. The chief counsel concluded that the turbines are like kind and should be classified as personal property because they are machinery used to produce electricity, not structural components. what s new from the IRS
what s new from the courts Does a poorly run investment constitute theft? A recent federal district court case demonstrates that a poorly run investment activity does not necessarily result in a theft loss. (Ralph E. Labus v. Commissioner, 2012-2 USTC 50,597, Sept. 27, 2012) Theft losses in an income-producing activity are fully deductible and can create a net operating loss, which can be carried back three years and forward up to 20 years. Ralph Labus became involved with American Business Financial Services (ABFS), a company that offered high interest notes to investors. Between December 2002 and August 2003, Labus loaned $260,000 to ABFS, receiving monthly interest checks. In February 2004, Labus received a principal payment of $92,500. Sometime in 2004, ABFS began defaulting on its obligations to investors. On Jan. 21, 2005, ABFS filed for Chapter 7 bankruptcy.
In 2008, Labus amended his 2005 tax return, claiming a theft loss. The IRS disallowed the loss. The court concluded that to claim a theft loss deduction, Labus had to prove that the loss resulted from a theft, larceny, embezzlement or robbery as defined by the law of the state where the loss took place (Ohio, in this case). To establish a theft by deception, Labus had to prove that ABFS engaged in a deceptive act and that ABFS s misrepresentations actually caused Labus to transfer property to ABFS. In denying the deduction, the court ruled that: 1. There was no showing that ABFS possessed the criminal intent to deprive Labus of his money without any plan of repayment. Instead, ABFS sent monthly interest checks for some time prior to the bankruptcy filing. 2. There was no indication that ABFS made fraudulent misrepresentations on which Labus relied or that ABFS deceived Labus. 3. Because Labus willfully invested with ABFS, there is no support for an assertion that ABFS deprived Labus of his money without his consent or by means of threat or intimidation.
it bears repeating Behind on payroll taxes? You may be able to avoid responsible-person penalty If your small business has found itself in a cash squeeze during the economic downturn and failed to deposit payroll taxes, you may be able to get square with the IRS and avoid the personal penalty on the persons responsible for depositing withheld taxes. You should explore the IRS In-Business Trust Fund Express Installment Agreement (IBTF-Express IA). These arrangements do not require detailed financial information and may help you avoid a responsible-person penalty. To qualify for an IBTF-Express IA, a business owing payroll taxes must satisfy the following requirements: The business must owe $25,000 or less at the time the agreement is established. If your business owes more than $25,000, you can pay down the liability to the required amount before entering into the agreement. You must pay the debt in full within 24 months, unless the statute of limitations for collection expires sooner.
You must enroll in a Direct Debit installment agreement (DDIA) if the amount owed is between $10,000 and $25,000. You must be compliant with all filing and payment requirements. One advantage of an IBTF-Express IA is that you do not have to provide a financial statement or other financial verification as part of the application process. Also, it is IRS policy not to pursue the trust fund recovery penalty against an individual in a business that has set up an IBTF-Express IA.
tax laughs Guess who s not paying their employment taxes? Regular readers of Washington Tax Update are aware of their responsibilities as business owners to timely forward payroll taxes to the government. Chief executives and other responsible persons face severe personal penalties for failure to timely deposit withheld taxes. So a recent report issued by the Treasury Inspector General for Tax Administration (TIGTA) is particularly surprising (TIGTA Report No. 2012-30-094). The inspector general found that 70 federal agencies had unpaid employment taxes totaling $14 million, and 18 federal agencies were delinquent in filing 39 employment tax returns, as of December 31, 2011. The report lists several factors contributing to the delinquency, including:
tax laughs The IRS is not permitted to assess penalties and interest or take other enforcement action against these agencies. The agencies are often prohibited from using funds from one fiscal year to pay liabilities for an earlier year. There is a lack of awareness on the part of the agencies of their tax filing and payment obligations. And this issue is not new. TIGTA issued a similar report in 2007 about the same problem, looking at tax accounts that were delinquent as of Dec. 2008. The new report follows up on the 2008 list, finding that: 43 of the accounts were closed because the agencies paid the amount due. 48 had their collection statutes expire, resulting in a loss of $175,594. 40 are still open, with the IRS having suspended collection of 34 of those. In 14 cases, the collection efforts were suspended because the IRS was unable to contact the agency. The government solution to a problem is usually as bad as the problem. ~ Milton Friedman
Courts Tax IRS Congress The technical information in this newsletter is necessarily brief. No final conclusion on these topics should be drawn without further review and consultation. Please be advised that, based on current IRS rules and standards, the information contained herein is not intended to be used, nor can it be used, for the avoidance of any tax penalty assessed by the IRS. 2012 CPAmerica International