S Corporations: Dealing with Accumulated Earnings and Profits

Please send articles for the Tax Section blog to: Herman Spence at HSpence@robinsonbradshaw.com.

By Kerri L.S. Mast

C corporation income is generally subject to two levels of taxation.  It is taxed at the corporate level when earned and at the shareholder level when distributed.  An S corporation, on the other hand, generally is not taxed at the corporate level; its items of income and deduction flow through to its shareholders when earned.  Subsequent distributions by the S corporation to the shareholders often can be made tax-free.  However, the taxation of distributions is more complicated if the S corporation has C corporation accumulated earnings and profits (E&P).

An S corporation does not generate E&P.  However, it can possess E&P as a result of either converting from C corporation to S corporation or acquiring a C corporation.  E&P generated in a C corporation are subject to two levels of taxation – corporate and shareholder – and retain this character even if subsequently owned by an S corporation.  Accumulated E&P was taxed at the C corporation level and will be taxed again as a dividend to recipient S corporation shareholders when distributed.

Read more

Pro Bono Opportunity

By Helen Herbert

Are you looking for a pro bono opportunity where you can use your tax expertise?  The NCBA Tax Section is looking for tax attorneys to train selected military personnel to be tax return preparers through the Military Volunteer Income Tax Assistance (VITA) Program.

The Military VITA Program is designed to assist US military personnel with preparation of federal and state tax returns and thereby save US military families the cost of tax return preparation and, in many instances, receive tax refunds. Many US military families are unfamiliar with federal and state tax requirements and how to file a complete and accurate tax returns and, accordingly, need help in preparing their personal income tax returns.

Read more

Employee Educational Fringe Benefits Under the 2017 Tax Act

By John G. Hodnette

One of the most appealing benefits of working for a university is an educational assistance program.  Free or discounted college education is extremely valuable given tuition continues to increase at an average of 8% per year.  Whether these benefits are taxed as compensation or excluded from income is vitally important to university employees.

Three code sections are especially important when an employer provides an employee or employee’s family with free or discounted college education.  The first is Section 117, which excludes from gross income qualified scholarships granted to an individual who is a candidate for a college degree.  Section 117(d)(1) additionally provides where an educational institution at the university level grants qualified tuition reduction to an employee for an undergraduate degree, that tuition reduction is not included in gross income.

Read more

The Importance of Purchase Price Allocations in Asset Acquisitions

By John G. Hodnette

The maxim “don’t let the tax tail wag the business dog” is often bandied about in the business world.  Tax attorneys know, however, there are times, such as in Section 1060 allocations in asset acquisitions, when tax issues are an important part of the business negotiation.

Section 1060 applies when a business sells assets constituting its trade or business.  Asset acquisitions can be more attractive to a purchaser than stock acquisitions because of its concerns about hidden liabilities associated with the stock.  Additionally, purchasing assets directly increases the tax basis in the assets to a cost basis consistent with the purchase price.  This step-up in basis translates to larger depreciation deductions for the purchaser, resulting in long-term tax savings.  In contrast, a stock acquisition results only in an increased basis in the stock itself, not in the underlying assets of the company.  Since stock cannot be depreciated, this increased stock basis remains unused, for the most part, unless and until the stock is later sold.  If a purchaser and seller agree to an asset acquisition, how the purchase price is allocated among the purchased assets is important.  That is where Section 1060 comes into play.

Read more

Don’t Get Caught Holding the Bag: Embezzlement Repayments and NOL Limitations

By John G. Hodnette

The net operating loss (“NOL”) rules in Section 172 are complex. A revisit every few years is beneficial, particularly given the 2017 Tax Act modified these rules to disallow NOL carrybacks and allow NOL carryforwards indefinitely, with a new limit of 80% of taxable income.

While the rules seem simple at first glance, how they work with various types of losses is surprising. For example, one who embezzles from an employer is rightfully assessed tax on the income from his or her illegal activities pursuant to the landmark ruling of James v. United States, 366 U.S. 213 (1961). That decision, while answering the question of whether illegally obtained income is taxable, created a new question of how the repayment of embezzled funds is treated for income tax purposes. Although both the IRS and the taxpayers agreed a deduction should be allowed where embezzled funds are repaid, they differed on which Code section provides the deduction. The IRS maintained the deduction is allowed under Section 165(c)(2), which addresses “losses incurred in any transaction entered into for profit, though not connected with a trade or business.”  In contrast, the taxpayers in a number of cases argued the embezzlement itself was a trade or business, the embezzled funds were invested in a trade or business, or the embezzlement from their employer was inextricably linked to their trade or business of being an employee with such employer.

Read more

2017 Tax Act’s $11.2 Million Estate, Gift, and GST Tax Exemption Will Expire In 2025

By John G. Hodnette

The Tax Cuts and Jobs Act of 2017 doubled the unified exemption for the estate, gift, and GST taxes from about $5.6 million to about $11.2 million (adjusted yearly for inflation).  This dramatic change means for years after 2017, a married couple can gift during life or pass by their death up to $22.4 million of assets free of transfer taxes.  While many high net worth clients are aware of the doubled exemption, it is less well known that this doubled exemption is set to expire on December 31, 2025.

This is not the first time Congress has used a sunset schedule for the unified transfer tax exemption amount.  At the end of 2012, taxpayers faced a similar dilemma when it was uncertain whether Congress would act to prevent the automatic reversion of the unified transfer tax exemption from about $5.12 million to $1 million.  In that case, Congress did act to keep the exemption at $5.12 million.  It is unclear, however, if the same will occur in 2025, particularly given the rhetoric about “taxing the ultra-wealthy” from presidential candidates and Democratic Senators such as Bernie Sanders and Elizabeth Warren.  This uncertainty calls for tax planning designed to take maximum advantage of the Tax Act’s increased exemption regardless of what may happen at the end of 2025.

Read more

Tricky Rules For Amending Tax Returns

By John G. Hodnette

Amending returns can cause clients and practitioners needless anxiety if they do not fully understand the applicable rules.  This short article describes those rules regardless of whether the amended return provides an addition to tax or requests a refund.

The first concern is the statute of limitations.  Section 6501(a) generally provides a three-year statute for the IRS to assess additional tax.  Therefore, the IRS generally has three years to initiate and conclude an audit.  Although certain circumstances (substantial omissions of income and fraud) can increase this limitations period to six years or indefinitely, for simplicity this article assumes the statute is three years.  The three-year period runs from either the due date (generally April 15th of the year following the tax year in question) or the date actually filed (if filed after the due date).  Returns filed after the due date include returns filed on extension.  One might think filing an amended return automatically starts over the three-year period, but that is not the case.  Instead, the IRS is still generally bound by the original three-year period based on the filing of the original return.

Read more

The Ricky Ricardo Tax: Taxation of Marital Transfers to Non-Citizen Spouses

By John G. Hodnette

“I Love Lucy,” running originally from 1957 to 1960, exists in the collective memory of multiple generations of Americans as one of our most iconic television programs.  In fact, in 2012 (52 years after its end-date) it was voted as the “Best TV Show of All Time” in a survey conducted by ABC News and People magazine.  But Lucy’s zany antics would not have been nearly as entertaining without her foil character, Ricky Ricardo.  Ricky, Lucy’s Cuban singer/bandleader husband, constantly loses his patience at his wife’s ceaseless attempts to get into showbiz and exorbitant spending on clothes or furniture.  Lucy and Ricky as a married couple share everything, but the gift tax does not treat them the same way as most other married couples because Ricky is a U.S. resident, but a Cuban citizen.

Read more

Federal Income Tax Update No. 2

By Keith A. Wood

This is the second of two installments of this article.  Read the first installment here.

I. Charitable Deduction Fails Where Tax Basis Not Shown on Form 8283.

Belair Woods, LLC v. Comm., TC Memo 2018-159, involved a taxpayer who tried to claim a conservation easement deduction under Section 170.  Originally, Belair acquired an interest in certain property with a carryover tax basis of approximately $2,605 per acre. A little more than a year later, Belair granted a conservation easement to Georgia Land Trust. On Belair’s tax return, it claimed a charitable contribution deduction of $33,707 per acre.

Read more