Form 6198 At-Risk Limitations: IRC 465 Calculations, Grouping, Elections and Schedules Identifying Loss Deferrals, Recapture Requirements; Tracking Carry-Forward Amounts TUESDAY, SEPTEMBER 26, 2017, 1:00-2:50 pm Eastern IMPORTANT INFORMATION FOR THE LIVE PROGRAM This program is approved for 2 CPE credit hours. To earn credit you must: Participate in the program on your own computer connection (no sharing) if you need to register additional people, please call customer service at 1-800-926-7926 x10 (or 404-881-1141 x10). Strafford accepts American Express, Visa, MasterCard, Discover. Listen on-line via your computer speakers. Respond to five prompts during the program plus a single verification code. You will have to write down only the final verification code on the attestation form, which will be emailed to registered attendees. To earn full credit, you must remain connected for the entire program. FOR LIVE PROGRAM ONLY WHO TO CONTACT DURING THE LIVE EVENT For Additional Registrations: -Call Strafford Customer Service 1-800-926-7926 x10 (or 404-881-1141 x10) For Assistance During the Live Program: -On the web, use the chat box at the bottom left of the screen If you get disconnected during the program, you can simply log in using your original instructions and PIN.
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Form 6198 At-Risk Limitations Sept. 26, 2017 Robert S. Barnett, Partner Capell Barnett Matalon & Schoenfeld, Jericho, N.Y. rbarnett@cbmslaw.com
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At Risk Rules and S Corporation Basis and Losses By Robert S. Barnett CPA, JD, MS (TAXATION) CAPELL BARNETT MATALON & SCHOENFELD, LLP. ATTORNEYS AT LAW (516) 931-8100 rbarnett@cbmslaw.com 5
LOSS ORDERING Apply other disallowance provisions; 162, 163(d), etc. Determine if there is Basis Apply 465 At-Risk Rules Apply 469 PAL Therefore, Basis, At-Risk Tests & PAL 6
LOSS Excess of Deductions Over income received or accrued During the taxable year From the activity 7
Why At-Risk Rules? Key aspects of Tax Shelters: Little cash upfront (low risk) Funded by non-recourse loans Consolidate income and deductions Result: deductions exceed outlay 8
Why At-Risk Rules? This leveraging aspect of virtually all classical tax shelters was based on the long-established right to deduct interest, business expenses, and other out-ofpocket items when paid or incurred, even if they are defrayed with borrowed funds, and on the fact that depreciation and amortization are computed on the full adjusted basis of property, even if it is purchased with funds borrowed on a nonrecourse basis. In effect, the tax law gives taxpayers advance credit for the debt. Bittker & Lokken: Federal Taxation of Income, Estates, and Gifts (WG&L), 28.1. Introductory. 9
Crane v. Comm r, 331 U.S. 1 (1947) TP include nonrecourse liability in Basis Depreciable Basis includes liability Losses w/o economic risk 10
Goal of At-Risk Rules Deduct loss if at risk Limit non-economic losses Attack two aspects of tax shelters: Aggregation of income/deductions Abuse of non-recourse loans BUT not limited to Tax Shelters 11
Who Is Affected? Individuals S corp Shareholders Partners Personal holding companies Estates Trusts Closely held C corporations 12
Closely Held Corps 5 or fewer SH own > 50% stock Attribution applies 13
Flow Through Entities Not applicable to S corps IS applicable to S corp shareholders Not applicable to partnerships IS applicable to partners Not applicable to LLCs IS applicable to LLC members 14
Reporting Form 6198 Separate form for each activity Partnerships and S corps - separate statements for each activity Two methods Simplified: If Adjusted Basis known Detailed: May allow more At-Risk 15
Activity 1. Motion pictures and video tapes 2. Farming 3. Leasing 1245 property 4. Oil and gas 5. Geothermal deposits Other T/B or production of income 16
465 At-Risk Rules Loss limited To amount at risk in activity Initial Amount = AB in activity Amount at risk = money + AB property + amounts borrowed If personally liable 17
Not At-Risk To extent protected from loss Nonrecourse financing Guarantee 3 rd party Stop Loss Agreement Etc. 18
Rev. Rul. 78-413 2 TPs Each buys half of a TV series Each uses an identical note Each personally liable on respective note Cross indemnification Each entitled to reimbursed from other Not At-Risk 19
Moreno, 113 AFTR 2d 2014-2149 (DC LA 2014) Loan to Aircraft Leasing LLC TP personally guaranteed loan Right to 50% contribution TP At-Risk for 50% 20
Unused Losses Carry Forward Unlimited years 21
Example Joe starts a farm, contributes: $110K from personal savings $360K equipment, AB = $240K $280K from loans Joe s total At-Risk = $110K + $240K + $280K = $630K. OR IS IT? 22
At-Risk Adjustments Adjust each year Increase/decrease At-Risk before determining loss allowed Allowed Losses reduce At-Risk Increase/Decrease adjustments 23
At-Risk Adjustments INCREASE: Additional contributions Activity income > deductions Activity s tax-exempt income 24
At-Risk Adjustments DECREASE: Allowable loss Money and property distributions Repayments of debt by others Non-deductible expenses relating to tax-exempt income 25
Definition of Loss Excess of deductions over income Losses cannot reduce At-Risk below 0 Recapture 26
Loss Disallowed Joe At-Risk at start of year = $1,000 $3000 income during the year $7500 deductions during year $3500 disallowed Disallowed deductions carry forward 27
Loss Recapture Loss cannot reduce At-Risk below 0 At-Risk may be less than 0 RECAPTURE Initial At-Risk = $100 $120 distributed from activity At-Risk = -$20 28
Loss Recapture (Continued) At-Risk falls to -$20 Recognize $20 gross income AND receive $20 deferred deduction At-Risk rises to $0 $20 deduction carries forward Effect: recapture previous loss deductions 29
LOSS RECAPTURE (Continued) Debt/Equity Classification Shift in debt Recourse Non Recourse Distributions Guaranty or Contract Modification Not Losses 30
ZELUCK, TCM 2012-98 At Risk Recapture Drilling Partnerships Loss years closed Debt not paid/demanded Debt becomes NONGENUINE Accuracy Penalties Applied 31
FRAUD OMEGA FOREX GROUP 119 AFTR 2d 2017-519 (DC UT 3/8/17) Currency Speculation T/P college grad./dentist Didn t tell CPA about offshore account He had access to investment Creative Bookkeeping No Loss Potential 32
WATCH OUT! T/P Claimed RELIANCE ON CPA 33
Activity Grouping Allocate loss based on activity 1. Motion pictures and video tapes 2. Farming 3. Leasing 1245 property 4. Oil and gas 5. Geothermal deposits Other T/B or production of income 35
Individuals Separate activities; No Aggregation: Interest in each different film Interest in each different farm Interest in each different 1245 property Interest in each different oil/gas activity 36
Partnerships or S Corp Partner or S corp SH MAY aggregate: Interests in different films Interests in different farms Interests in different oil/gas activities Interests in different geothermal activities Partner or S corp SH MUST aggregate: 1245 leasing activities placed in service in taxable year 37
Reporting Partnerships or S Corp At-Risk Partnership, S Corporation: Give separate statement of income, expenses, and deductions for each at-risk and not-at-risk activity Partner, S Corp SH: Use info on K-1 or similar Report At-Risk on Form 6198 38
NOTICE 89-39 IRS Recognized Admin. Nightmare TP may use old rules Not for Leasing Activities in same category 39
Other T/B Other T/B aggregated if Activities constitute a single T/B AND TP Actively Participates, or S corp, partnership 65% of losses allocated to active members 40
What is an Activity? 1976 Originally enumerated 5 1978 dragnet Other T/B added Treasury authorized to regulate Tax shelter characteristics; inter alia: 1. Accelerated deductions 2. Mismatching income and deductions 3. Substantial nonrecourse financing* BUT Regulations never issued *HR Rep. No. 1445, 95 th Cong. 2d Sess. 70 (1978). 41
469 Activity Compared 469 Appropriate Economic Unit Important Factors: Similarities & differences in T/B Extent of common control Extent of common ownership Geographical location Interdependencies 42
469 Interdependencies Activities: Buy/sell goods Related products/services Same customers Same employees Same books and records 465? 43
What Is Active Participation? FACTORS FAVORING: Day-to-day decisions Performing services Hires/fires employees H.R. Rep. No. 1445, 95 th Cong. 2d Sess. 69-70 (1978). 44
Contrast: PAL Material Participation TP materially participates Regular Continuous Substantial Seven different tests, including: Quantitative - > 500 hours in year Facts and Circumstances 45
469 Active Participation Material Participation Not Required Significant & bona fide participation making management decisions approving new tenants, deciding rental terms, approving capital expenses; or Arranging of others to provide services 46
No Aggregation Partnership 1 Restaurant Partnership 2 Oil & Gas Active participation BUT No aggregation Separate T/B Determine At-Risk separately PLR 9035005 47
NO AGGREGATION Distribution Activity Sublicense Activity John v. Commissioner 86 TC 492 (1986) 48
Cash Contributions Source? From taxpayer? Borrowed? Apply Rules Implicit tracing (no specific rules) 163-8T a guide? How is cash used? Loss limitation? 49
Property Contributions At-risk = AB, unless encumbered If encumbered, personal liability? B contributes property P FMV = $100K AB = $50K $25K nonrecourse debt secured by P B At-Risk = $25K 50
Contributions of Borrowed $ Two Views: 1. Economic Reality Approach Generally followed (circuit split) No realistic possibility of economic loss 2. Payor of last resort Economic loss in worst-case scenario Related party rules apply 51
Economic Reality Lease GCC Sale Elmco Sale TP Sale-Leaseback Not At-Risk No realistic possibility of loss Offsetting payments & bookkeeping entries Circularity Broad indemnity Kimmich v. Comm r, T.C. Memo 1999-349 (1999) 52
CIS Worst Case (6 th Cir.) Lease PLS LEA Sale Sale TP 7.57% Sale Leaseback At-Risk TP payer of last resort; in worst case: CIS bankrupt TP required to pay PLS No collateral agreement/indemnity Emershaw v. Comm r, 949 F2d 841 (1991) 53
Recourse Liabilities At-Risk If: 1. Incurred for use in activity AND 2. TP personally liable 3. Lender Only a Creditor No interest in activity Not related to person with interest Repayment of recourse loan Does not affect TP s At-Risk 54
Nonrecourse Liabilities Generally not At-Risk Subsequent repayment by TP Increases At-Risk 55
Ex. Commissions from activity 56 Nonrecourse Liabilities Pledged Property: Readily Ascertainable FMV 1.465-8 At-Risk to extent of FMV NOT property used in activity IF NO FMV Lender may not receive financial gain
Nonrecourse Liabilities 1. Joe spends $100K to make a film $10K from savings $90K borrowed nonrecourse Film loses $50K At-Risk $10K $40K loss carries over 2. If Joe repays $30K of loan At-Risk for additional $30K 57
At-Risk & Related Party Not At-Risk borrowed from: Person with interest in activity OR Related party (other than the borrower) with interest in activity Related Party (inter alia): Siblings, spouse, ancestors, etc. Corp >10% ownership S corps with common (>10%) owner 58
Interest in Activity Other than as creditor only if : Capital Interest or Net Profits Interest Capital Interest interest in activity assets if liquidated (partners & SH) Net Profits Interest activity net profits determine compensation 59
Related Not At-Risk SH1 Loan SH2 SH1 & SH2 Related SH1 interested in S corp activity SH2 not At-Risk Van Wyk v. Comm r, 113 TC 440 (1999) 60
Not Related Not At-Risk SH1 Loan SH2 SH1 & SH2 Not Related SH1 has Capital Interest SH2 not At-Risk S corp 61
Not Related Not At-Risk SH1 Loan SH2 SH1 & SH2 Not Related SH1 has Profits Interest SH2 not At-Risk Pritchett, TC Memo 1989-21. S corp 62
Not Related At-Risk SH1 Loan SH2 S corp SH1 & SH2 Not Related SH1 - no Capital Interest SH1 - no Profits Interest SH2 At-Risk 63
Anti-Abuse IRS may make adjustments if: Not normal commercial practice No valid business purpose Device to avoid 465 Facts and circumstances 65
Qualified Non-Recourse Debt 5 Requirements: 1. Relates to holding real property 2. Secured by Real property 3. Lender is a Qualified Person 4. No one is personally liable; AND 5. Instrument cannot be convertible 66
Qualified Person (QP) 1. Actively & regularly in $ lending business 2. QP NOT Related to TP*; 3. TP did NOT acquire the property from QP; 4. QP does NOT receive fee from TP s investment *Exception: Commercially reasonable and terms substantially same as unrelated 67
Partner Basis 704(d) loss limited to AB 722 Basis Contribution $ or Property 752 Partner s share of liabilities Considered contribution of $ 68
Partnership At-Risk Applied to partner, not partnership Each partner computed separately Prop. Reg. 1.465-7 applies 1.752-1(e) Basis rules 69
Partnership Example Joe contributes $100K to partnership Joe has a 20% interest in the partnership Partnership invests in $1,000K oil well P ship borrows $500K, nonrecourse Joe s initial Basis is $200K Loan Basis - 752 Joe s initial At-Risk is $100K 70
Limited Partner At-Risk EXCLUDE: Most partnership liabilities INCLUDE: Share of Qualified Nonrecourse Debt Contractually obligated contributions Gefen v. Comm r, 87 TC 1471 (1986) Guarantee, no reimbursement Creditor could proceed against LP Melvin v. Comm r, 88 TC 63 (1987). Arms-length contribution obligations 71
At-Risk & S Corp Prop. Reg. 1.465-10 (6/5/1979): Corp must be At-Risk SH must be At-Risk PL 97-354 (1982): Removed S corp Retained individual 72
S Corp SH Basis Similar to Partner BUT no Basis for corporate debt LOSS LIMITED AB Stock AB Corp. Debt to SH 73
At-Risk & S Corp SH At-Risk AB in activity includes Corp Debt to SH, 1366(d) Joe contributes $50K to S Corp Joe borrows $40K, personally liable Joe contributes borrowed $40K Borrowed $40K used in activity At-Risk for $90K? Or $50K? 74
S CORP. FINAL YEAR Suspended Losses Carried Forward May be used in PTTP Generally 1 year after S termination 1996 Tax Act 75
Broz, 137 TC 46; 727 F.3d 621 (6 th Cir., 2013) RFB Cellular telephone Alpine New licenses; loss Alpine Not in T/B D/N meet FCC Rules 76
Related Corp Stock Used in Business? Pledge RFB stock as security TP Bank Loan 100% RFB Loan 99% Alpine TP Pledge RFB stock RFB stock used in activity? Does RFB have interest in activity? 77
Back-to-Back Loan Bookkeeping entries No Economic Outlay Recharacterized loans Financial statements w/n enforce 1366(d) NO BASIS 78
Not At-Risk Never guaranteed loan No realistic possibility of loss Pledge RFB Stock TC Stock in related S Corp is property used in the business 6th Cir D/N address At-Risk No Basis and not T/B 79
TC Correct? Not determinable FMV But does RFB have economic interest in activity? Treas. Reg. 1.465-8 80
Circular Loan Loan Loan SH Loan Loan Dart HL HS Loan Oren, TC Memo 2002-172 81
Oren, TC Memo 2002-172 465: not At-Risk Circularity Default unlikely No economic change Unlimited control No realistic possibility payment Insurance Worst-case scenario inappropriate 82
BACK TO BACK LOANS Treas. Reg. 1.1366-2 (7/23/14) Bona fide indebtedness All facts & circumstances considered MAGUIRE, TCM 2012-160 Auto dealer and finance company A/R distributed then contributed Substitutions state law formalities 83
Example Based on Maguire Owners Distribute $600 AR Contribute $600 AR FB AB $6,000 profit $400 basis $1000 loss 84
Maguire Example (Cont.) IRS: No economic outlay, no cost Court: Economic outlay Legitimate loans SH resolutions Formalities documentation Consistency and timing Distribution reduced Basis in FB Exposure to AB s creditors 85
Maguire Example (Cont.) Owner at risk? Related party but to borrower Interest only as a creditor? Interested in activity? Capital interest? Interest in net profits? 86
Maguire Example, Modified DIRECT LOAN FB Loan $600 AB $6,000 profit $400 basis $1,000 loss 87
Maguire Example, Modified Owner At-Risk? No Remember Broz Not personally liable & No contribution to AB Also, 1366(d) No Basis 88
QSub & At-Risk Rules PL 97-354 (1982) Removed S corp Retained individual Committee Report H.R. 104-586 (1996) SH ability to deduct losses Limited: To extent At-Risk w/r/t Qsub 89
QSub At-Risk Example Shareholder S corp FB QSub Loan $600 AB QSub $6,000 profit $400 basis $1,000 loss 90
QSub & At-Risk Example SH At-Risk? Perhaps Facts and circumstances Active participation in both operations Aggregation? Perhaps 1366(d) Basis QSub attributes to S 91
QSub At-Risk Example Shareholder Guaran tee Loan S corp FB QSub Loan $600 AB QSub $6,000 profit $400 basis $1,000 loss 92
QSub & At-Risk Example SH At-Risk? Yes, if: Bona fide and enforceable No contribution/reimbursement Not otherwise protected Goatcher state law Also, consider aggregation 93
What if: Shareholder S corp Ford QSub BMW $6,000 profit $400 basis Aggregation? QSub $1,000 loss VW QSub $400 basis $3,000 loss Single T/B 94
Thank You Robert S. Barnett CPA, JD, MS (TAXATION) CAPELL BARNETT MATALON & SCHOENFELD, LLP. ATTORNEYS AT LAW (516) 931-8100 rbarnett@cbmslaw.com 95