Posts Tagged ‘corporate tax’

Transfer of home to closely held shareholders was constructive dividend—penalties imposed

Monday, August 9th, 2010 by Moore McLaughlin

A new Tax Court decision illustrates the need for closely held corporations to be wary of constructive dividends when dealing with their owners. In RVJ Cezar Corporation et al, TC Memo 2010 –173 a closely held construction company’s transfer of a home to its shareholders resulted in dividend/capital gain income to them, and taxable gain to the corporation. What’s more, both the shareholders and the corporation were held liable for accuracy related penalties.

Background. A dividend is a distribution of property from a corporation to its shareholders out of the corporation’s earnings and profits. (IRC Section 316(a)) The amount of the distribution equals the fair market value of the distributed property on the distribution date. (IRC Sections 301(b)(1) and (3)) For dividends received before 2011, qualified dividend income is taxed at the same rates as long-term capital gain. (IRC Section 1(h)(11)) After 2010, unless Congress changes the rules, dividend income will be taxed as ordinary income. The amount of a distribution that exceeds earnings and profits, and is therefore not a dividend, is taxable capital gain to the recipient. (IRC Section 301(c)(3)) Under long-established case law, dividends may be formally declared or they may be constructive. A constructive dividend arises when a corporation confers a benefit on a shareholder by distributing available earnings and profits without expectation of repayment.

A corporation that distributes appreciated property to a shareholder recognizes gain as if the property were sold to the shareholder at its fair market value. (IRC Section 311(b)(1)) Gain is recognized to the extent that the property’s fair market value exceeds the corporation’s adjusted basis in the property.

Taxpayers are liable for an accuracy-related penalty for any portion of an underpayment of income tax attributable to negligence or disregard of rules and regulations, unless they establish that there was reasonable cause for the underpayment and that they acted in good faith. (IRC Section 6662(a), IRC Section 6662(b)(1), IRC Section 6664(c)(1)) Under IRC Section 6662(b), an accuracy related applies for a substantial understatement of income tax, i.e., the amount of the understatement exceeds the greater of 10% of the tax required to be shown on the return, or $10,000.

Facts. Mr and Mrs. Cezar were the sole shareholders of RVJ Cezar Corporation, which built “spec” houses that it sold to the public. They paid $500 for their stock. Mr. Cezar, a general contractor, was the sole employee of the corporation. In 2001, Cezar Corp paid $150,000 for a lot, financing part of the purchase price with a mortgage, and spent $502,000 building an amenity-rich home approximately twice the size of its usual spec homes. Cezar Corp was listed as the sole owner of the spec home on the blueprints, permit, and notice of completion. Some of the construction materials were paid with a credit card issued in both Mr. Cezar’s name and Cezar Corp, and the Cezars were unable to document most of the labor costs of building the home.

The home was finished in 2004 and was offered for sale, but there were no takers. That year, Cezar Corp transferred the lot and improvements to the Cezars by quitclaim deed; they assumed the outstanding mortgage of $57,227. At the time of the transfer the lot and improvements had a total fair market value of $920,000. The transfer of ownership report filed with the Assessor’s Office did not indicate that the property interest transferred to the Cezars was a partial interest. The Cezars did not report the receipt of the lot or the improvements on their return for 2004, nor did the corporation report the distribution of the lot and the improvements on its return for 2004.

On audit, IRS determined that the distribution of the lot and the improvements was a constructive dividend from the corporation. It determined that the Cezars received a qualified dividend up to the amount of the corporation’s earnings and profits, and treated the balance of the distribution, less their $500 initial capital contribution, as long-term capital gain. IRS also determined that both the Cezars and their corporation were liable for the accuracy related penalty.

Tax Court sides with IRS. The Cezars conceded that they received the lot as a constructive dividend from the corporation. However, they argued that the improvements were not a constructive dividend because they owned the improvements by having paid for the construction materials and having done all the work to construct the improvements. The Tax Court agreed with IRS’s assessment that improvements are built on land that one owns or else there would be an agreement identifying the rights and responsibilities of the parties. The Cezars failed to show that there was an agreement between them and the corporation that would have allowed them to construct a home on the corporation’s property. Their ownership argument also was directly contradicted by Mr. Cezar’s statements during the audit that the lot and the improvements were both corporate assets. Moreover, there was no credible evidence to support the Cezars’ claim that they owned the improvements by paying the construction costs and personally completing the labor. The only records the Cezars produced to establish that they paid the construction costs were insufficient. Furthermore, the corporation was the sole owner of the lot as well as the improvements from the start of construction until the distribution to the Cezars. The corporation received property tax bills for both the lot and the improvements and did not protest that it had been billed for improvements that it did not own. The Tax Court also find it compelling that the corporation, which was in the business of building and selling homes, offered the lot and the improvements for sale without obtaining any transfer of interest from the Cezars. No prospective buyer would buy only the improvements and not the lot or vice versa. The Tax Court also noted that no other spec home that the corporation sold before or since was owned by the Cezars individually. Rather, all the homes and lots were owned and offered for sale by the corporation.

As a result, the Tax Court found that the Cezars did not establish that they owned the improvements, and sustained IRS’s determination that the Cezars must include the distribution of the lot and the improvements in gross income as a constructive dividend from the corporation. The Tax Court also found that treatment of the home as a constructive dividend to the Cezars caused the corporation to recognize taxable income to the extent that the fair market value of the lot and improvement exceeded its adjusted basis.

The Tax Court also hit the Cezars with an accuracy related penalty for the underpayment of income tax attributable to negligence or disregard of rules and regulations. It also hit Cezar Corp with an accuracy related penalty for substantial understatement of its income tax.

With proper planning, this tax and the penalties could have been avoided.  The tax attorneys at McLaughlin & Quinn, LLC regularly provide planning for taxpayers in situations such as the one faced by the Cezars.  For more information, contact F. Moore McLaughlin, IV, Esq., CPA by e-mail at MMcLaughlin@McLaughlinQuinn.com or by phone at 401-421-5115 ext. 212.

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Posted in Asset Protection Planning, IRS and state tax collections, Tax Current Events and News, Tax planning

Massachusetts Enacts 2011 Budget Act

Tuesday, July 6th, 2010 by Moore McLaughlin
Massachusetts

Massachusetts

On June 30, 2010, Governor Deval Patrick signed the 2011 budget act (H4800), which includes credit transparency provisions, extends the historic rehabilitation tax credit, and provides administrative provisions to facilitate collection. The bill takes effect July 1, 2010, unless otherwise stated.

Credit transparency. Effective January 1, 2011, the head of the administrative agency of each tax credit program must submit, on or before May 15 each year, a report to the Commissioner on each tax credit program authorized for the previous calendar year. Tax credits required to be disclosed include the historic preservation tax credit, dairy farm tax credit, USFDA user fees credit, film tax credit, life sciences investment tax credit, low-income housing tax credit, medical device tax credit, refundable research credit, credit under the economic development incentive program, and any transferable or refundable credits under the corporate and personal income tax laws established after January 1, 2011. The report will contain: (1) the identity of each taxpayer receiving an authorized tax credit and from which tax credit program the credit was received; (2) the amount of the authorized tax credit awarded and issued for each taxpayer and each project, if applicable; and (3) the date that the authorized tax credit was awarded and issued for each taxpayer and each project. The report will be a public record. The report will cover only credits awarded or claimed after January 1, 2011. For purposes of the report, the taxpayer is the initial recipient of an authorized tax credit.

Historic rehabilitation tax credit. The historic rehabilitation tax credit is extended for a 12-year period up to December 31, 2017. Under current law the Commissioner, in consultation with the Massachusetts Historical Commission, is authorize to annually grant a historic rehabilitation tax credit in an amount not to exceed $50 million per year to qualified taxpayers for the 6-year period beginning January 1, 2006, and ending December 31, 2011.

Determination of partner’s distributive share. The budget act also includes a provision clarifying how a partner’s distributive share of an item of income, loss, deduction or credit from a partnership is determined. It provides that a partner’s distributive share is determined in accordance with the partner’s interest in the partnership, determined by taking into account all facts and circumstances, such as, if the allocation to a partner under the agreement of income, gain, loss, deduction or credit had no substantial economic effect or the partnership agreement does not provide as to the partnership’s distributive share of income, gain, loss, deduction or credit. It also provides that the determination of a partner’s distributive share must take into account rules and principles developed under the Internal Revenue Code and any regulations promulgated thereunder, and adjusted as required or appropriate to properly reflect income and other tax items for Massachusetts tax purposes.

Pass-through entity provision. The budget act includes provisions involving unified audit procedures for pass-through entities. It requires members or indirect owners of a pass-through entity to report items of income, expense or credit derived from the pass-through entity in a manner consistent with reporting of the pass-through entity, except to the extent that a taxpayer, member or indirect owner makes a declaration of inconsistency with its original return. The Commissioner is mandated to establish by regulation unified audit procedures.

Penalty provisions. The budget act amends the additional tax liability provision in cases when the federal government determines a difference from the amount previously reported in the taxable income of a person or the federal credit to which such person may be entitled or in cases when the tax due any other state, U.S. territory or the Dominion of Canada or any of its provinces, on account of any item of Massachusetts gross income of a Massachusetts resident, is finally determined by that jurisdiction to be less than the tax previously reported, and such tax was the basis for a credit claimed by the Massachusetts resident. It provides that failure to report such difference under both circumstances is subject to a penalty of 10% of the additional tax found due. Prior law provided that the penalty is $100 or 10% of the additional tax found due, whichever sum is smaller. A new provision provides that a person who fails to pay to the Commissioner any cigarette excise required to be paid will be personally and individually liable. “Person” includes, but not limited to, an officer or employee of a corporation or a member or employee of a partnership or limited liability company who, as such officer, employee or member, is under a duty to pay over the cigarette excise tax.

Installment and deferred payment sales. The budget act also provides a new provision requiring interest to be paid on some deferred tax liabilities generated from the use of installment sales applicable for tax years beginning on or after January 1, 2010 with respect to installment obligations as of the close of the tax year.

Sales tax provision. The budget act repeals the sales tax provision making it unlawful for any vendor to advertise or hold out or state to the public or any customer that the vendor will assume or absorb the tax or that it will not be added to the selling price of the property or services sold or, if added, it will be refunded.

For more information on these new provisions, contact tax attorney and CPA Moore McLaughlin at MMcLaughlin@McLaughlinQuinn.com or by phone at 401-421-5115 ext. 212.

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Posted in Asset Protection Planning, Current Events, Financial workout, IRS and state tax collections, Tax Current Events and News, Tax planning

Many business tax law changes go into effect in 2010

Thursday, January 7th, 2010 by Moore McLaughlin

Many important tax changes go into effect in 2010.  These non-indexing changes result from various laws that were enacted and regulations and other guidance issued over the past few years. This post reviews the non-indexing tax law changes for 2010 for businesses.

Deduction for domestic production activities increases. For tax years beginning after 2009, the IRC §199 deduction for domestic production activities increases. Taxpayers will be able to claim a deduction generally equal to 9% (up from 6% for tax years beginning in 2007-2009) of the lesser of: (1) the taxpayer’s “qualified production activities income” (QPAI) for the tax year or (2) taxable income (modified adjusted gross income, for individual taxpayers) without regard to this deduction, for the tax year. (IRC §199(a); Reg. §1.199-1(a)).  The deduction is further limited to 50% of the W-2 wages of the employer for the tax year.

Smaller employers may establish combined plans. For plan years beginning after 2009, employers with 500 or fewer employees may establish a combined defined benefit-401(k) plan (a “DB(k) plan”). In general, the defined benefit rules apply to the defined benefit portion of the plan and the defined contribution rules apply to the defined contribution portion of the plan. The 401(k) component must have automatic enrollment and must meet minimum matching contribution requirements. (IRC §414(x)(2))

Nonspouse beneficiary rollover option mandatory for qualified plans. Under §108(f) of the Worker, Retiree, and Employer Recovery Act of 2008 (WRERA, P.L. 110-458), qualified retirement plans must offer nonspouse beneficiaries the opportunity to roll over an inherited plan account balance to an IRA set up to receive the rollover on the nonspouse beneficiary’s behalf, effective for plan years beginning after December 31, 2009. For earlier plan years, plans could, but were not required to, offer nonspouse beneficiaries this rollover option.

Increased penalty for failure to file partnership or S corporation returns. Civil penalties apply for failure to file a partnership and S corporation returns. The penalty is a statutory dollar amount times the number of partners or shareholders for each month (or fraction of a month) that the failure continues, up to a maximum of 12 months. The base amount on which a penalty is computed for a failure with respect to filing either a partnership or S corporation return for a tax year beginning after December 31, 2009, increases from $89 to $195 per partner or shareholder. (IRC §6698(b)(1) and IRC §6699(b)(1))

Electronic filing changes go into effect. Beginning in 2010, IRS will allow the electronic filing of Schedule R (Form 941), Allocation Schedule for Aggregate Form 941 Filers, using the Employment Tax e-file System. Schedule R is a new form that must be completed by consolidated Form 941 filers, beginning with the first quarter 2010 Form 941. Form 2678, Employer/Payer Appointment of Agent, must be mailed to the applicable address listed on the instructions for the agent to be eligible to file Schedule R. After receiving IRS approval, the agent must file one Form 941 return for each tax period, using the agent’s own employer identification number (EIN), regardless of the number of employers for whom the agent acts. The agent must maintain records that will disclose the full wages paid for each of his or her clients, as reported on the Schedule R. (IRS Publication 3823, Employment Tax e-file System Implementation and User Guide)

Standard mileage rate changes. The optional mileage allowance for owned or leased autos (including vans, pickups or panel trucks) is 50¢ per mile for business travel after 2009 (down from 55¢ per mile for 2009). For 2010, the depreciation component of the mileage rate is 23¢ per mile (up from 21¢ per mile for 2009 and 2008).

Employers that require employees to supply their own autos may reimburse them at a rate that doesn’t exceed 50¢ per mile for employment-connected business mileage during 2010 (down from 55¢ per mile for 2009), whether the autos are owned or leased. The reimbursement is treated as a tax-free accountable-plan reimbursement if the employee substantiates the time, place, business purpose, and mileage of each trip. Additionally, an employee’s personal use of lower-priced company autos during 2010 may be valued at 50¢ per mile if the conditions specified in Reg. §1.61-21(e)(1) are met. (Rev Proc 2009-54, 2009-51 IRB)

Many business tax breaks expired at the end of 2009. Unless Congress acts to retroactively revive them, all of the following business tax breaks won’t be available this year because they expired at the end of 2009. Note that tax breaks that would be extended by the “Tax Extenders Act” as passed by the House of Representatives in December of 2009 are indicated with an asterisk.

… Additional first-year 50% bonus depreciation for qualified property under IRC §168(k)(2) (but note that certain aircraft and long-production-period property continues to be eligible if placed in service in 2010). In addition, the $8,000 increase in the first-year depreciation limit for passenger automobiles that are qualified property also expired at the end of 2009.

 … For tax years beginning in 2010, (a) the maximum amount that may be expensed under IRC §179 is $134,000 (down from $250,000 for tax years beginning in 2008 or 2009); and (b) the maximum annual expensing amount generally is reduced dollar-for-dollar by the amount of IRC §179 property placed in service during the tax year in excess of $530,000 (down from $800,000 for tax years beginning in 2008 or 2009).

 … Incremental research credit under IRC §41.*

 … Election to accelerate AMT and research credits in lieu of additional first-year depreciation under IRC §168(k)(4).

 … Five-year depreciation for farming business machinery and equipment under IRC §168(e)(3)(B)(vii).*

 … Fifteen-year straight-line cost recovery for qualified leasehold improvements, qualified restaurant buildings and improvements, and qualified retail improvements under IRC §168(e)(3)(E)(iv), IRC §168(e)(3)(E)(v), and IRC §168(e)(3)(E)(ix).*

 … Deduction allowable for income attributable to domestic production activities in Puerto Rico under IRC §199.*

 … Expensing of “brownfields” environmental remediation costs under IRC §198(h).*

 … Credit for construction of new energy efficient homes under IRC §45L.

 … Encouragement of contributions of capital gain real property made for conservation purposes under IRC §170(b)(1)(E) and IRC §170(b)(2)(B).*

 … Enhanced charitable deduction for contributions of food inventory under IRC §170(e)(3)(C).*

 … Enhanced charitable deduction for contributions of book inventories to public schools under IRC §170(e)(3)(D).*

 … Enhanced deduction for corporate contributions of computer equipment for educational purposes under IRC §170(e)(6)(G).*

 … The active financing exception from Subpart F of the Code. (IRC §953, IRC §954)*

 … The look-through treatment of payments between related controlled foreign corporations. (IRC §954(c))*

 … Seven-year straight line cost recovery period for property used for land improvement and support facilities at motorsports entertainment complexes. (IRC §168(i)(15))*

 … The railroad track maintenance credit. (IRC §45G )*

 … Film and television producers’ election to expense the first $15 million of production costs incurred in the U.S. ($20 million if the costs are incurred in economically depressed areas in the U.S.). (IRC §181)*

 … The credit for training mine rescue team members. (IRC §45N)*

 … Election to expense 50% of the cost of qualified underground mine safety equipment. (IRC §179E)*

 … The credit for eligible small business employers equal to 20% of the sum of differential wage payments to activated military reservists. (IRC)*

 … The tax treatment of interest-related dividends, short-term capital gain dividends, and other special rules applicable to foreign shareholders that invest in regulated investment companies (RICs). (IRC §871(k))*

 … Suspension on the taxable income limit for purposes of claiming depletion deductions on a marginal oil or gas well. (IRC §613A(c)(6))

 … The new markets tax credit. (IRC §45D(f)(1))*

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Posted in Current Events, Tax Current Events and News, Tax planning

Another Attack on RI Small Business by our Elected Officials (UPDATED, AGAIN)

Tuesday, June 30th, 2009 by Moore McLaughlin

The Rhode Island Legislature has done it again.  They have managed to find a way to not only drive more Rhode Island small businesses out of business or out of state, but at the same time they have managed to reduce tax revenues in the state.  To top it all off, their actions are likely unconstitutional.  This does not seem like the way to get Rhode Island back on its economic feet.

Amazon.comWhat I’m referring to is the recent passage of a law that requires Amazon.com to collect Rhode Island sales tax on sales made through Rhode Island-based associates.  Click here for the entire article from the Providence Business News.  Not surprisingly, Amazon.com immediately severed all relationships with Rhode Island-based associates.

Since book buyers can go directly to Amazon.com to buy their books, with no Rhode Island intermediary, Amazon does not have an obligation to collect the Rhode Island sales tax.  So, now the state will still not receive any sales tax, and no income taxes, property taxes, employment taxes, etc., from the Rhode Island-based associate that may now go out of business, or move to another state.  Absolutely brilliant! (more…)

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Posted in IRS and state tax collections, Tax Current Events and News, Tax planning

IRS seeks more taxes on your cell phone

Tuesday, June 16th, 2009 by Moore McLaughlin

The IRS says it is looking to make it easier for taxpayers to comply with recordkeeping requirements for employer-provided cell phones. Others see this as another attack on small business.  A new notice from the IRS confirms several IRS proposals to simplify the procedures under which employers substantiate an employee’s business use of employer-provided cellphones.  The notice also requests suggestions for alternative approaches.cell-phone-tax

In 2008, two identical bills-H.R. 5450 and S. 2668, both entitled “Modernize Our Bookkeeping In the Law for Employee’s Cell Phone Act of 2008″-were introduced in the House and Senate to remove cell phones and similar telecommunications equipment from the category of listed property. These measures, which had bipartisan support, and were backed by a number of companies and business associations, were never enacted. Perhaps that is why IRS is taking the matter into its own hands.

Under Internal Revenue Code Section 132, an employee may exclude from gross income the business use of an employer-provided cell phone as a working condition fringe benefit. However, because cell phones are listed property in Code Section 280F, strict substantiation requirements must be satisfied for business cell phone usage to qualify for the code Section 132 exclusion. Moreover, any personal usage of an employer-provided cell phone is a taxable fringe benefit. Thus, the current rules require documentation of the business and personal use of the cell phone.

(more…)

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Posted in IRS and state tax collections, Tax Current Events and News, Tax planning

Where Does Your State Rank for Corporate Taxes?

Monday, May 18th, 2009 by Moore McLaughlin

The 2009 CFO Magazine State Tax Survey, conducted with KPMG, has just been released, and the results, while in some cases cfo3very predictable, are still enlightening.  According to the article in the May 2009 issue of CFO Magazine, “more than 40 states are facing budget shortfalls, and as many as ten expect fiscal 2010 revenues to lag expenses by more than 20%.”  Click here for the full article.

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Posted in Tax Current Events and News, Tax planning