Promoting Tax Neutrality: A Proposal For Nonrecognition Treatment of Cross-entity Mergers

As my time at the graduate tax program at the University of Florida draws to an end, I am about to finalize my comprehensive paper. The thesis of this article is that our tax laws should promote tax neutrality by treating the mergers of dissimilar entities (or, cross-entity) as if they are similar. The Code has codified nonrecognition treatment for the merging of two corporations, and the Treasury Regulations provide for, essentially, nonrecognition treatment for the merger of two partnerships. But why do our tax laws not provide nonrecognition when a corporation merges into an LLC, or when an LLC merges into a partnership? (Under certain circumstances, it is possible to merge an LLC into a corporation using section 351, but only if the section 368(c) control requirements are met.).

Does this de facto prohibition make policy sense in light of nonrecognition treatment provided to corporate mergers, or partnership mergers? I argue no, especially in light of state statues and the ULLCA which provide for cross-entity mergers. This is a very important issue because of the growing popularity of LLCs and the historical popularity of the partnership form.

In the upcoming weeks, I will post excerpts from this paper and establish my argument that our tax laws should provide nonrecognition treatment for cross-entity mergers.

Celebrities Who Fail to Pay Taxes

The most famous among the celebrity tax dodgers are: Wesley Snipes, Nicolas Cage, Burt Reynolds, Marc Anthony, Ruben Studdard, Helio Castroneves, Tim Geithner, Dionne Warwick, Joe Francis, and Jose Canseco.

For more details, click here.

Revenue Raisers in the Health Care Bill: Elimination of the “Black Liquor” Biomass Tax Credit

After the historic passage of H.R. 3590  and H.R. 4872, many were left wondering where the taxes and fees would  come from. One of the primary revenue raisers is the elimination of the  $1.01 tax credit per gallon on "black liquor" biomass.

Code section 40(b)(6) is amended and excludes unprocessed fuels from the biofuel producer credit. This exclusion  applies if any fuel is more than 4 percent of such is any combination of  water or sediment; or the ash content is more than 1 percent. Each of  these amounts is determined by weight.

This seeks to eliminate “black liquor” biomass. Some  lawmakers saw this as an abuse by certain industries. In the Technical  Explanation of the bill, the Joint Committee on Taxation described this  process as: “The kraft process for making paper produces a byproduct  called black liquor, which has been  used for decades by paper manufacturers as a fuel in the papermaking  process. Black liquor is composed of water, lignin and the  spent chemicals used to break down the wood. The amount of the biomass  in black liquor varies. The portion of the black liquor that is not  consumed as a fuel source for the paper mills is recycled back into the  papermaking process. Black liquor has ash content (mineral and other  inorganic matter) significantly above that of other fuels.”

HIRE Act's Hiring Tax Incentives

Last week, the President signed H.R. 2847 the Hiring Incentives to Restore Employment (HIRE) Act. As the title of the bill indicates, the purpose is to increase private sector hiring by giving tax incentives for employers.

The highest impact tax provision on the new law is the hiring incentive for employers. Code section 3111 is amended and subsection (d) is added and reads:

“(1) IN GENERAL- Subsection (a) shall not apply to wages paid by a qualified employer with respect to employment during the period beginning on the day after the date of the enactment of this subsection and ending on December 31, 2010, of any qualified individual for services performed--

‘(A) in a trade or business of such qualified employer, or

‘(B) in the case of a qualified employer exempt from tax under section 501(a), in furtherance of the activities related to the purpose or function constituting the basis of the employer’s exemption under section 501.”

The incentives are available for both private and public sector employers. When a qualified employer (defined in section 3111(d)(2)) hires a qualified individual (defined in section 3111(d)(3)) the employer is exempted from paying the employer’s share of social security taxes on the employee for 2010.

To qualify, the employee must be hired after February 3, 2010 and before January 1, 2011. The employee must not have worked more than forty hours in the last sixty days. What is interesting is in section 3111(d)(3)(C), a qualifying employee cannot replace another employee unless the employee leaves “voluntarily.” This requirement is very intriguing in its vagueness and will certainly lead to mischief and litigation. For example, what does it mean to replace? Will employers simply change the title of the position of the new employee? Even among very similar individuals, skills and qualifications are not identical and thus there may be a case to be made that John Doe 1 is not replacing John Doe 2 because John Doe 1 has a distinct skill, etc. Further, there will certainly be disagreement about what “voluntary” means. A common practice among law firms is to not explicitly fire an employee, but suggest/inform the employee that he will not be made partner and he is best served to find employment elsewhere. Technically, this appears to be voluntary but substantively, it appears to not be voluntary. It will be interesting to see how this language is interpreted.

There is also an increase in the general business tax credit for the retention of such employees for at least one year at specified wage levels. Code section 51(c) is amended and allows an increase in the credit for such employees if they are retained at specified wage levels.

If these new employees are retained for fifty-two weeks, Code section 38(b) is amended and provides for a tax credit of either $1,000 or 6.2 percent of the wages paid to the qualified retained worker during a fifty-two week period.

This will impact both part-time workers and new full time workers. The new law does not require a minimum number of hours. It is likely that most employers will max out this credit at $1,000 because the 6.2 percent threshold will be reached when wages are $16,129.

There are issues that will likely keep labor and employment attorneys busy for a while. Classifications of employees versus contractors, specifically changing these classifications to qualify for this credit will need to be addressed. If an individual perform services for a business but is property classified as in independent contractor (see Revenue Ruling 87-41), the individual is not employed by the business. Therefore, expect to see employers taking proactive steps to reclassify independent contractors as employees to receive this credit.

A couple additional observations based on the new law. The payroll tax exemption does not cover the employer portion of Medicare payroll taxes, just the 6.2 percent Social Security payroll taxes. Further, this exemption will provide immediate tax relief while but will also decrease the employer’s business expense deductions (because payroll taxes are ordinary and necessary) during the tax year.

A final curious point is the tax credit for retaining an employee for fifty-two weeks. By classifying this credit as a general business credit under section 38(b), the credit can be carried forward or carried back. This carryover is key because it will give employers the incentive to retain employees even if fiscal year 2010 will end in the red.

Here is the full text of H.R. 2847.

HIRE Act Extends Section 179

Section 179 expensing of tangible property and computer software was set to be limited to $125,000 and phased out starting at $500,000 of section 179 property placed in service during the year. The HIRE Act, passed last week, has extended 2008 and 2009 increases in limitations for 2010. For 2010, taxpayers are allowed to expense up to $250,000 of section 179 property and the limit on section 179 property remains at $800,000.

The extension of the 2008 and 2009 amounts is also important because 2010 is the last year that computer software qualifies as section 179 property (section 179(d)(1)(A)(ii); computer software defined under section 179(e)(3)(B) described in section 197(e)(3)(A)(i).

Here is the full text of the HIRE Act.

Does the NCAA Tournament Justify Exam Rescheduling?

A law student at the University of Washington sought to reschedule an exam because of the NCAA Tournament this weekend. The Registrar did not sympathize with his plight, and denied the request. Below are some excerpts from the request. It is quite good and creative.

The first weekend of the NCAA Division 1 basketball tournament occurs on March 18-21 this year. This is, by far, my favorite weekend of the year, specifically Thursday and Friday, in which the first round takes place. I am not a member of any church and have no children, so I consider this my "holiday," the most important day of the year. For the past several years, a couple of friends of mine, who are in similar position in life, and I have spent the weekend enjoying this "holiday" in Reno, NV. It is a central location for the gathering and meeting there for this weekend has become a tradition that has become very important and dear to me.
I understand that this is not a typical request, but I'd like to move my Compensation and Benefits final to the following Monday (3/22) or earlier in finals week. This is so important to me that I wouldn't even mind it if it were rescheduled during a day that I already have a final.
Please give my request ample consideration. I appreciate your time.
Reschedule class:
Fri. March 19 - 6:00 PM T521B Comp & Benefits (Thorson)
Requested date: Wednesday, March 17
Requested time: 1:00 PM

Here is the link to the email and the registrars response. 

Reporting Requirements for Ownership in a Foreign Partnership

The US economy is increasingly global, which has resulted in Americans seeking to diversify their investments through foreign businesses. An often used entity is a foreign partnership. Under US tax laws, partnerships are conduit entities and it is partners that are liable for income taxes based on their distributive share of partnership items under section 704 of the Code.

US citizens and residents, for purposes of the Code, are subject to US taxation on their worldwide income. As a result, the income "earned" through foreign partnerships is taxable to their US partners, regardless of where the partnership is located. If the foreign partnership has a trade or business connected with the US, it will also file a Form 1065.

Aside from the general partnership reporting requirements, US persons who own interests in foreign partnerships may be required to file additional information with the IRS. Treasury Regulations pursuant to section 6046A and 6038 detail the information required. US persons who fall under the requirements of section 6046A and 6038 must file a Form 8865. This form is an informational return and should accompany the individuals Form 1040 for the appropriate year.

Section 6046A requires that a US person with an interest in a foreign partnership report to the IRS when they have a reportable event. These reportable events include acquisitions, dispositions, and changes in the proportional interests of a foreign partnership that exceeds 10%.

Form 8865 can be found here. 

The 2010 Dirty Dozen - IRS' Top Tax Scams

Every year, the IRS releases a list of the top tax scams, known as the "Dirty Dozen." Here is a look at this years list:

1. Return Preparer Fraud
2. Hiding Income Offshore
3. Phishing
4. Filing False or Misleading Forms
5. Nontaxable Social Security Benefits with Exaggerated Withholding Credit
6. Abuse of Charitable Organizations and Deductions
7. Frivolous Arguments
8. Abusive Retirement Plans
9. Disguised Corporate Ownership
10. Zero Wages
11. Misuse of Trusts
12. Fuel Tax Credit Scams

If you find yourself preparing your tax return and have a transaction, or multiple transactions, that look like one of these listed transactions you should proceed with great caution and seek a tax professional.

The majority of these listed transactions serve no legitimate purpose and will all but certainly result in penalties if a taxpayer engages in an abusive transaction.

If you suspect that tax fraud, you can file a Form 3949-A with the IRS. 

For further details of these transactions, see the IRS website here. 

The Consequences of New Taxes - Jobs

As states struggle with increasing budget deficits, legislatures are turning to new sources to generate revenue. A popular new favorite tax is known as the "Amazon Tax" aimed at online merchants, coined after online retailing giant. While billions of dollars pass through these online retailers annually, most avoid taxation, the implementation of new sources of taxation have tangential consequences.

Colorado is a state that recently enacted such a tax, primarily aimed at a $1.3 billion budget shortfall. It is estimated that Amazon's tax bill would be $6.4 million annually in online sales taxes from this new tax. The Colorado tax is different than other states that have enacted similar taxes because the law requires out-of-state retailers to help enforce collection of the 2.9 percent state tax that online consumers in Colorado.

As a result of this new tax:
[R]etailers would have to tell their customers what taxable items they bought and that they need to pay the tax to Colorado. Retailers also would have to turn over those documents to the state to help enforce the law.



State revenue officials have acknowledged that retailers may want to avoid all of that, and just collect the tax themselves.


Unfortunately for Colorado, Amazon has announced that it will cut ties with Colorado-based affiliate marketers. These affiliates exceed 4,000 in the state of Colorado alone, which means jobs will be lost as a result of this effort to Colorado seeks to increase revenue. 

IRS Releases 2009 Tax Data Book

Last week, the IRS released the 2009 Tax Data Book. This publication is one of the more interesting reads published by the IRS every year and contains the Service's compiled statistics for the prior tax year (Oct. 1, 2008, to Sept. 30, 2009).

Some of the highlights from fiscal year 2009 include:
    1) The IRS collected more than $1.9 trillion in taxes (net of refunds);
    2) The IRS processed more than 236 million returns;
    3) Individual income tax refunds totaled $321.3 billion, and economic stimulus payments totaled over $11.5 billion;
    4) The IRS spent an average of 50 cents to collect each $100 of tax revenue;
    5) IRS examined more than 1.4 million individual income tax returns and about 28,000 returns filed by corporations, excluding S corporations; and 
    6) IRS personnel answered nearly 68 million toll-free calls from taxpayers during the fiscal year, and the IRS Web site received more than 296 million visits.

The complete report is available here. 

Capital Gains Cut to 0%?

The GOP has been an advocate in recent years for cutting the capital gains and dividend tax rate even further than its current preferential treatment. The argument goes that cutting the tax rate on these passive income sources encourages economic development and the free flow of capital. Recently, a new tax reform plan has circulated among the GOP to eliminate taxation on capital gains entirely. While this proposal will certainly generate headlines, it is unlikely that the proposal has any chance of passing given the current party alignment in Congress. But, it is worth debating and discussing the merits of not taxing capital gains. 

My biggest worry about eliminating taxation on capital gains is unintended consequences of such a policy shift. Principally, eliminating the taxation on capital gains would certainly lead to an increased effort to reclassify income classified as salary to capital gains and dividends (based on the current rate structure, it is likely that a rate cut in capital gains will also result in a rate cut in dividends). These cuts would likely cost the Treasury billions of dollars annually.

For further reading, see Derek Thompson's Atlantic article.

Some States Delaying Tax Refunds

The recent budgetary troubles of the states has been well documented. Most states are struggling to meet their fiscal obligations. Many states, including Oregon, have raised taxes to combat this problem Aside from raising taxes, the infamous Stimulus Bill provided direct aid to the states.

But the recent saga in state budgetary woes appears to be more problematic. Some states are now delaying the payment of tax refunds owed to taxpayers. While many taxpayer are up in arms about this, my initial reaction is that this could have been avoided with proper tax planning.

The perfect scenario for a taxpayer is to owe $0 and receive $0 upon the filing of his/her taxes. When a taxpayer is entitled to a refund, he/she has over payed in either estimated tax payments or withholdings during the year. Upon the filing of the annual state income tax return that results in a tax refund for the taxpayer, he/she is receiving back what was overpaid. Effectively, this is a zero interest loan to the state for the year. If this was the result of estimated tax payments for the first quarter, the taxpayer has given the state a zero interest loan starting on April 15th of the prior year to when a refund is claimed the following year. Further, according to the time value of money, $1 paid today is worth more than $1 owed one year from now.

While taxpayers have reason to be upset over state's delaying tax refunds, it is a problem that could have been prevented with proper tax planing. To avoid this problem in 2010, please consult a tax professional to ensure proper tax planning in 2010.

For more information about states delaying tax refunds, click here.

Top Tax Deductions for Small Businesses

Pursuant to the Internal Revenue Code, C Corporation and S Corporation tax returns are due on the 15th day of the third month following the end of the corporation’s tax year. For the majority of corporations, this day will be March 15th (unless the 15th is a Saturday or Sunday). Because March 15th is in just two days, here are some often-overlooked corporate tax deductions.
1-    Automobile deductions.
2-    Start-up expenses (up to $5,000, remainder must be amortized over 15 years).
3-    Legal and professional fees (if they are for legitimate business purposes).
4-    Meals and entertainment are 50% deductible.
5-    Purchase of new equipment (up to $250,00, subject to phase out when purchases exceed $800,000 in 2009. Additional requirements must also be met).

For a complete list, see Top deductions for your small business.