(under Regs 301.9100)
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Tricks and traps to watch out for
including NOL filing tips
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Elections & Extensions (under Regs 301.9100) |
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Tricks and traps to watch out for |
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| One spouse is a Prisoner of War (POW) or Missing in Action (MIA) | One spouse can sign if a statement attesting to those facts is attached. |
| One spouse is deceased | 1. Surviving spouse may sign and indicate the date of death. 2. The court appointed representative signing the return must attach a court certificate showing they represent the deceased and have the right to sign. 3. A POA may sign for a deceased taxpayer if they have a court certificate from the municipal government or Register of Wills attesting that the POA may continue to represent taxpayer after death. |
| Taxpayer is divorced or separated and filing a claim or amended return requesting a tax decrease for their portion of a refund on a previously filed joint return | Only the spouse who owns or has interest in the refund must sign. Refer to IRM 21.6.1.4.8, Allocating Jointly Filed Cases Procedures. |
| A claim or amended return is filed to request a refund or credit of tax other than income tax | Only the spouse who owns or has an interest in the refund must sign, unless credit is used as a credit against income tax.
Note:This includes claims for overpayments of Excise Tax, Employment Tax, etc. |
| A dependent child cannot sign | The parent or guardian may sign as "parent or guardian of minor child." |
| A corporate claim is filed | Any of these officers may sign the claim: – President – Vice President – Treasurer – Assistant Treasurer – Chief Accounting Officer – Other corporate officer with authority to sign. Note:The signature on the claim is evidence that the individual is authorized to sign. |
| Taxpayer files a partnership claim | Any one partner may sign |
| Taxpayer files a sole-proprietor claim | The owner may sign |
| An exempt organization files a claim | Any of these officers may sign: – Executive Director – Director - President – Vice President – Treasurer – Assistant Treasurer – Chief Accounting Officer – Any other officer with authority to sign. Note:The signature on the claim is evidence that the individual is authorized to sign |
§6013(a) Election to file an initial tax return for a given year
jointly with your spouse:
A husband and wife may make a single return jointly of income taxes
even though one of the spouses has neither gross income nor
deductions, except as provided below:
§6013(f)(1) Joint Return Where Individual Is In Missing Status as a result of service in a combat zone the spouse of such individual is otherwise entitled to file a joint return for any taxable year which begins on or before the day which is 2 years after the date designated under section 112 as the date of termination of combatant activities in such zone, then such spouse may elect under subsection (a) to file a joint return for such taxable year.
§6013(f)(2)(A) such election shall be valid even if such individual died before the beginning of such year, and
§1(d) Choosing to file an initial tax return
for a given year separately from spouse:
1(d) Married Individuals Filing
Separate Returns. --
There is hereby imposed on the taxable income of every married individual (as defined in section 7703) who does not make a single return jointly with his spouse under section 6013, a tax as determined.
§7703(a) General Rule
7703(a)(1) the determination of whether an individual is married shall
be made as of the close of his taxable year; except that if his spouse
dies during his taxable year such determination shall be made as of
the time of such death; and
7703(a)(2) an individual legally separated from his spouse under a decree of divorce or of separate maintenance shall not be considered as married.
7703(b) Certain Married Individuals Living Apart
For purposes of those provisions of this title which refer to this subsection, if--
7703(b)(1) an individual who is married (within the meaning of subsection (a)) and who files a separate return maintains as his home a household which constitutes for more than one-half of the taxable year the principal place of abode of a child (within the meaning of section 152(f)(1)) with respect to whom such individual is entitled to a deduction for the taxable year under section 151 (or would be so entitled but for section 152(e)),
7703(b)(2) such individual furnishes over one-half of the cost of maintaining such household during the taxable year, and
7703(b)(3) during the last 6 months of the taxable year, such
individual's spouse is not a member of such household, such individual
shall not be considered as married.
Filing Status: Married Filing Separately and Allocation of Deductions
and Expenses
Most married taxpayers can choose whether to file joint returns or separate returns. Most couples will pay less tax if they file joint returns, but in some situations they will benefit from filing separate returns.
A married individual filing a separate return must report on that return his or her own items of gross income, exemptions, deductions and credits.54 A married resident of a community property state must report half of the combined community income and deductions along with his or her separate income and deductions, unless the husband and wife live apart at all times during the tax year.55 If a husband and wife jointly own income-producing property, each must report a share of the income in proportion to the fractional ownership interest in the property.
IRS Publication 504, Divorced or Separated Individuals (2002), includes a chart showing how itemized deductions are allocated when separate returns are filed in community and noncommunity property states.
Allowable deductions may be taken by the individual who actually makes the expenditure.56 However, if the husband and wife maintain a joint bank account in a common-law jurisdiction, a rebuttable presumption treats payments of deductible items from the account by one spouse as though each spouse paid one half of the payment.57 Similarly, in community property jurisdictions, obligations discharged with community funds are treated as though one half is paid by each spouse.58 In addition, if either spouse itemizes deductions, the standard deduction for the other spouse is zero.59
54 IRS Publication 17, Your Federal Income Tax, 22 (2001).
55 Code Sec. 66(a); IRS Publication 555, Community Property, 4 (1999).
56 A.L. Zeeman v US, CA-2, 68-1 USTC ¶9406, 395 F2d 861; A.E. Calvin v US, DC Colo., 65-1 USTC ¶9112, 235 FSupp 594, aff'd, CA-10, 66-1 USTC ¶9108, 354 F2d 202.
57 Rev. Rul. 59-66, 1959-1 CB 60.
58 Rev. Rul. 55-479, 1955-2 CB 57; Commr v D. Newcombe, 10 TCM 152, Dec. 18,140(M) (1951), aff'd, CA-9, 53-1 USTC ¶9241, 203 F2d 128; M.V. Godchaux v US, DC La., 52-1 USTC ¶9183, 102 FSupp 266, appeal dism'd, CA-5, 53-1 USTC ¶9375.
59 Code Sec. 63(c)(6)(A).
Filing Status: When Married Taxpayers Should File Separate Returns
Married couples usually have a lower tax liability if they file a
joint return than if they file separately because of the tax rates and
other provisions which are generally more generous to married
individuals filing joint returns. However, circumstances may be such
that one spouse does not want to incur the potential liability for tax
on a joint return and would therefore rather file a separate return
even though the resulting tax liability may be higher.
Comment
Professor Dennis Calfee and Professor
David Hudson, Holland Law Center, University of Florida, Gainesville,
FL note that: There are a few, somewhat unusual situations when a
married couple might have a lower combined tax liability by filing
separate returns rather than by filing a joint return. When these fact
patterns appear, computations of tax liability should be made under
both the married filing separate returns rules and the married filing
jointly provisions so that a comparison can be made.
84 Code Sec. 67(a).
85 Code Sec. 63(c)(6)(A).
86 Code Sec. 165(h)(2)(A).
87 Code Sec. 165(h)(2)(B).
88 Code Sec. 1(h).
89 Code Sec. 213(a).
90 Code Sec. 1231(a)(1), (2).
91 Code Sec. 1211(b).
Tax Consequences for Married Taxpayers Filing Separate Returns
Most married taxpayers can choose whether to file joint returns or separate returns. Most couples will pay less tax if they file joint returns, but in some situations they will benefit from filing separate returns.
Individuals who are married filing separate returns have smaller amounts of taxable income taxed at the lower tax rates than do individuals with any other filing status.60 A number of other provisions treat taxpayers with this filing status in a manner that is generally more onerous than treatment of other taxpayers. These include:
60 Rev. Proc. 91-65, 1991-2 CB 867.
61 Code Sec. 63(c)(2)(D).
62 Code Sec. 63(c)(6)(A).
63 Code Sec. 21(e)(2).
64 Code Sec. 22(c)(2)(A)(iii), (d)(3), (e)(1).
65 Code Sec. 23(f)(1).
66 Code Sec. 25A(g)(6).
67 Code Sec. 32(d).
68 Code Sec. 38(c)(2)(A).
69 Code Sec. 68(b)(1); Code Sec. 68(f), (g), as added by the Economic Growth and Tax Relief Reconciliation Act of 2001, P.L. 107-16, Act §103(a) (June 7, 2001).
70 Code Sec. 86.
71 Code Sec. 121.
72 Code Sec. 129(a)(2)(A).
73 Code Sec. 135(d)(2).
74 Code Sec. 151(d)(3)(A) through (D); Code Sec. 151(d)(3)(E), (F), as added by the Economic Growth and Tax Relief Reconciliation Act of 2001, P.L. 107-16, Act §102(a) (June 7, 2001).
75 Code Sec. 163(h)(3)(B)(ii), (C)(ii).
76 Code Sec. 165(l)(5)(B)(ii).
77 Code Sec. 179(b)(4).
78 Code Sec. 194(b)(1), as amended by the American Jobs Creation Act of 2004, P.L. 108-357, Act §322(a) (October 22, 2004).
79 Code Sec. 221(b)(2).
80 Code Sec. 469(i)(5).
81 Code Sec. 1211(b)(1).
82 Code Sec. 6654(d)(1)(C)(ii).
83 Code Sec. 1(f)(6)(B).
§7703 Determination of Marital Status:
7703(a)General Rule.
§1.6013-2 Election to file a joint return for a given year after
filing separate return:
Where an individual has filed a separate return for a taxable year for
which a joint return could have been made by him and his spouse under
section 6013(a), and the time prescribed by law for filing the return
for such taxable year has expired, such individual and his spouse may,
under conditions hereinafter set forth, make a joint return for such
taxable year.
§1.6013-2(b) Limitations with respect to making of election.
A joint return shall not be made under section 6013(b)(1) with
respect to a taxable year:
§1.6013-1 Election to file a separate return for a given year after
filing joint return:
Where a couple files a joint return for
a taxable year, they cannot later file separate returns after the last
date prescribed for filing the return.
On the other hand, where a couple files separate returns, they may
later change their minds and file a joint return, provided it is not
filed after any of the following events:
1.6013-1(a)(1) For any taxable year with respect to which a joint return has been filed, separate returns shall not be made by the spouses after the time for filing the return of either has expired. See, however, paragraph (d)(5) of this section for the right of an executor to file a late separate return for a deceased spouse and thereby disaffirm a timely joint return made by the surviving spouse.
1.6013-1(a)(2) A joint return of a husband and wife (if not made by an agent of one or both spouses) shall be signed by both spouses. The provisions of paragraph (a)(5) of § 1.6012-1, relating to returns made by agents, shall apply where one spouse signs a return as agent for the other, or where a third party signs a return as agent for one or both spouses.
1.6013-1(d)(5) If the surviving spouse makes the joint return provided for in subparagraph (3) of this paragraph and thereafter an executor or administrator of the decedent is appointed, the executor or administrator may disaffirm such joint return. This disaffirmance, in order to be effective, must be made within one year after the last day prescribed by law for filing the return of the surviving spouse (including any extension of time for filing such return) and must be made in the form of a separate return for the taxable year of the decedent with respect to which the joint return was made. In the event of such proper disaffirmance the return made by the survivor shall constitute his separate return, that is, the joint return made by him shall be treated as his return and the tax thereon shall be computed by excluding all items properly includible in the return of the deceased spouse. The separate return made by the executor or administrator shall constitute the return of the deceased spouse for the taxable year.
Rev. Proc. 96-61, 1996-2 C.B. 401 Taxpayer's use of an alternate mailing address:
SECTION 8. INFORMATION AN ELECTRONIC FILER MUST PROVIDE TO THE TAXPAYER
.01 The ERO must furnish the taxpayer with a complete paper copy of the taxpayer's return. A complete copy of a taxpayer's return includes: (1) Form 8453 and other paper documents that cannot be electronically transmitted, and (2) a printout of the electronic portion of the return. See section 2.02 of this revenue procedure. The electronic portion of the return can be contained on a replica of an official form or on an unofficial form. However, on an unofficial form, data entries must be referenced to the line numbers on an official form.
.02 The ERO must advise the taxpayer to retain a complete copy of the return and any supporting material.
.03 The ERO must advise the taxpayer than an amended return, if needed, must be filed as a paper return and mailed to the service center that would handle the taxpayer's paper return.
.04 The ERO must, upon request, provide the taxpayer with the Declaration Control Number and the date the electronic portion of the taxpayer's return was acknowledged as accepted for processing by the Service.
.05 The ERO must advise taxpayers that they can call the local IRS TeleTax number to inquire about the status of their tax refund. The ERO should also advise taxpayers to wait at least three weeks from the acceptance date of the electronic return before calling the TeleTax number.
.06 If a taxpayer chooses to use an address other than his or her home address on the return, the Electronic Filer must inform the taxpayer that the address on the electronic portion of the return once processed by the Service, will be used to update the taxpayer's address of record. The Internal Revenue Service uses the taxpayer's address of record for various notices that are required to be sent to a taxpayer's "last known address" under the Internal Revenue Code, and for refunds of overpayments of tax (unless otherwise specifically directed by the taxpayer, such as by Direct Deposit).
Rev. Rul. §1.151-1(c)(2) and Rev. Proc. 2003-72 Special rules for birthday on January 1st:
Determination of a child's specific age:
A child attains an age on his or her birthday for purposes of Code
sections 21 (child and dependent care credit), 23 (adoption credit),
24 (child tax credit), 32 (earned income credit), 129 (excludable
dependent care benefits), 131 (excludable foster care benefits), 137
(excludable adoption assistance benefits), and 151 (dependency
exemptions).
For purposes of each of the provisions identified in this revenue
ruling, a child attains a given age on the anniversary of the date
that the child was born. For example, a child born on January 1, 1993,
attains the age of 17 on January 1, 2010.
http://www.irs.gov/irb/2003-33_IRB/ar06.html
There is an exception with regard to when a person turns age 65 for purpose
of the standard deduction amount (the so-called old-age
exemption).
"For the purposes of the old-age exemption, an individual attains the
age of 65 on the first moment of the day preceding his sixty-fifth
birthday. Accordingly, an individual whose sixty-fifth birthday falls
on January 1 in a given year attains the age of 65 on the last day of
the calendar year immediately preceding.
Personal and Dependency
Exemptions
§1.441-1T
Fiscal-year Individuals
An individual adopts a tax year when he is first required to file a
return and he may adopt any tax year, provided it matches his annual
accounting period and meets the requirement that books of account be
maintained for that accounting period. Once adopted, the fiscal year
applies to any business operated as a sole-proprietorship.
§1.441-1T Period for computation of
taxable income (temporary).
(b) Taxable year--(1) Definition of taxable year--(i) In general. Except as otherwise provided in this paragraph (b)(1), the term "taxable year" means--
(A) The taxpayer's annual accounting period if it is a calendar year or a fiscal year; or
(B) The calendar year if section 441(g) (relating to taxpayers who keep no books or have no accounting period) applies. Except as provided in administrative provisions of the Internal Revenue laws, a taxable year may not cover a period of more than 12 calendar months. If a return is made under section 443 for a period of less than 12 months (a "short period"), the taxable year is the short period for which the return is made.
§1.645-1(c)
Election to treat certain revocable (living) trusts as part of the Decedent's Estate
Recognizing that a revocable inter vivos trust can be used to settle
a decedent's affairs and distribute assets to the beneficiaries,
Congress provided an irrevocable election to treat a "qualified
revocable trust" as part of the decedents estate (and not as a
separate trust) for federal income tax purposes. Both
the trustee of the qualified revocable trust and the executor of the
decedent's estate must make the election. Technically the
election is only effective for two of more years.
The election is due by and is made with the first timely
filed income tax return if the estate, thereby
eliminating
any need to file an initial short-year return for the trust.
See
IRS Form 8855.
See §7508A for limited extensions to the deadline.
Some additional benefits:
Pursuant to §644 estates, unlike trusts, are not required to use a
calendar year-end and thus, they may use a fiscal year-end to defer
the recognition of income to the estate and its beneficiaries.
Also, pursuant to §6654(1)(2) estates, unlike trusts, are not
required to pay estimated taxes for the first two years of their
existence. And pursuant to §642(b) estates are entitled to a
$600 exemption, compared to a $100 exemption for a complex trust.
Further, a trust that is treated as an estate may be able to pass
certain losses and deductions through to its beneficiaries at its
termination as an estate, even though the trust itself may continue
in the form of a trust thereafter. And pursuant to §213(c)
medical expenses incurred by the decedent that are paid by the
estate during the one-year period after death may be deductible on
the decedent's final return, whereas this medical deduction is not
available if the medical expenses are paid by a trust.
§461
What year to deduct an expense?:
see:
The 2˝ month rule: Regs §1.404(b)-1T A-2(b)(1) regarding accrual of deferred
compensation
The 3˝ month rule: Regs §1.461-4(d)(6)(ii)
regarding prepaid services
The 8˝ month rule: Regs §1.461-5(b)(1)(i)
regarding accrual of reoccurring items
The 3˝ month rule:
Regs §1.461-4(d)(6)(ii) A taxpayer is permitted to treat services or
property as provided to the taxpayer as the taxpayer makes payment to
the person providing the services or property (as defined in paragraph
(g)(1)(ii) of this section), if the taxpayer can reasonably expect the
person to provide the services or property within 3-1/2 months
after the date of payment.
The 8˝ month "recurring
item" rule:
Under the recurring item exception, a liability is treated as incurred
for a taxable year if --
1.461-5(b)(1)(i) As of the end of that taxable year, all events have occurred that establish the fact of the liability and the amount of the liability can be determined with reasonable accuracy;
(ii) Economic performance with respect to the liability occurs on or before the earlier of
(ii)(A) The date the taxpayer files a timely (including extensions) return for that taxable year; or
(ii)(B) The 15th day of the 9th calendar month after the close of that taxable year;
(iii) The liability is recurring in nature; and
(iv) Either
(iv)(A) The amount of the liability is not material; or
(iv)(B) The accrual of the liability for that taxable year results in a better matching of the liability with the income to which it relates than would result from accruing the liability for the taxable year in which economic performance occurs.
From IRS Publication 538
Under an accrual method of
accounting, you generally deduct or capitalize a business expense when
both the following apply.
You generally cannot deduct or capitalize a business expense until economic performance occurs. If your expense is for property or services provided to you, or for your use of property, economic performance occurs as the property or services are provided or the property is used. If your expense is for property or services you provide to others, economic performance occurs as you provide the property or services.
Example. You are a calendar year taxpayer. You buy office supplies in December 2003. You receive the supplies and the bill in December, but you pay the bill in January 2004. You can deduct the expense in 2003 because all events have occurred to fix the fact of liability, the liability can be determined, and economic performance occurred in 2003.
Your office supplies may qualify as a recurring item, discussed later. If so, you can deduct them in 2003, even if the supplies are not delivered until 2004 (when economic performance occurs).
Workers' compensation and tort liability. If you are required to make payments under workers' compensation laws or in satisfaction of any tort liability, economic performance occurs as you make the payments. If you are required to make payments to a special designated settlement fund established by court order for a tort liability, economic performance occurs as you make the payments.
Taxes. Economic performance generally occurs as estimated income tax, property taxes, employment taxes, etc. are paid. However, you can elect to treat taxes as a recurring item, discussed later. You can also elect to ratably accrue real estate taxes. See chapter 6 of Publication 535 for information about real estate taxes.
Other liabilities. Other liabilities for which economic performance occurs as you make payments include liabilities for breach of contract (to the extent of incidental, consequential, and liquidated damages), violation of law, rebates and refunds, awards, prizes, jackpots, insurance, and warranty and service contracts.
Interest. Economic performance occurs with the passage of time (as the borrower uses, and the lender forgoes use of, the lender's money) rather than as payments are made.
Compensation for services. Generally, economic performance occurs as an employee renders service to the employer. However, deductions for compensation or other benefits paid to an employee in a year subsequent to economic performance are subject to the rules governing deferred compensation, deferred benefits, and funded welfare benefit plans. For information on employee benefit programs, see Publication 15-B, Employer's Tax Guide to Fringe Benefits.
Vacation pay. You can take a current deduction for vacation pay earned by your employees if you pay it during the year or, if the amount is vested, within 2 months after the end of the year. If you pay it later than this, you must deduct it in the year actually paid. An amount is vested if your right to it cannot be nullified or cancelled.
Exception for recurring items. An exception to the economic performance rule allows certain recurring items to be treated as incurred during the tax year even though economic performance has not occurred. The exception applies if all the following requirements are met.
This exception does not apply to workers' compensation or tort liabilities.
Amended return. You may be able to file an amended return and treat a liability as incurred under the recurring item exception. You can do so if economic performance for the liability occurs after you file your tax return for the year, but within 8 1/2 months after the close of the tax year.
Recurrence and consistency. To determine whether an item is recurring and consistently reported, consider the frequency with which the item and similar items are incurred (or expected to be incurred) and how you report these items for tax purposes. A new expense or an expense not incurred every year can be treated as recurring if it is reasonable to expect that it will be incurred regularly in the future.
Materiality. Factors to consider in determining the materiality of a recurring item include the size of the item (both in absolute terms and in relation to your income and other expenses) and the treatment of the item on your financial statements.
An item considered material for financial statement purposes is also considered material for tax purposes. However, in certain situations an immaterial item for financial accounting purposes is treated as material for purposes of economic performance.
Matching expenses with income. Costs directly associated with the revenue of a period are properly allocable to that period. To determine whether the accrual of an expense in a particular year results in a better match with the income to which it relates, generally accepted accounting principles are an important factor. For example, if you report sales income in the year of sale, but you do not ship the goods until the following year, the shipping costs are more properly matched to income in the year of sale than the year the goods are shipped. Expenses that cannot be practically associated with income of a particular period, such as advertising costs, should be assigned to the period the costs are incurred. However, the matching requirement is considered met for certain types of expenses. These expenses include taxes, payments under insurance, warranty, and service contracts, rebates and refunds, and awards, prizes, and jackpots.
An expense you pay in advance is deductible only in the year to which it applies, unless the expense qualifies for the "12-month rule." Under the 12-month rule, a taxpayer is not required to capitalize amounts paid to create certain rights or benefits for the taxpayer that do not extend beyond the earlier of the following.
If you have not been applying the general rule (an expense paid in advance is deductible only in the year to which it applies) and/or the 12-month rule to the expenses you paid in advance, you must get IRS approval before using the general rule and/or the 12-month rule. See Change in Accounting Method, later, for information on how to get IRS approval. See Expense paid in advance under Cash Method, earlier, for examples illustrating the application of the general and 12-month rules.
Business expenses and interest owed to a related person who uses the cash method of accounting are not deductible until you make the payment and the corresponding amount is includible in the related person's gross income. Determine the relationship for this rule as of the end of the tax year for which the expense or interest would otherwise be deductible. If a deduction is denied, the rule will continue to apply even if your relationship with the person ends before the expense or interest is includible in the gross income of that person.
Related persons. For purposes of this rule, the following persons are related.
Ownership of stock. To determine whether an individual directly or indirectly owns any of the outstanding stock of a corporation, the following rules apply.
Reallocation of income and deductions. Where it is necessary to clearly show income or prevent tax evasion, the IRS can reallocate gross income, deductions, credits, or allowances between two or more organizations, trades, or businesses owned or controlled directly or indirectly by the same interests.
If you use an accrual method of accounting and contest an asserted liability, you can deduct the liability either in the year you pay it (or transfer money or other property in satisfaction of it) or in the year you finally settle the contest. However, to take the deduction in the year of payment or transfer, you must meet certain conditions.
Conditions to be met. You must satisfy each of the following conditions to take the deduction in the year of payment or transfer.
Liability must be contested. You do not have to start a suit in a court of law to contest an asserted liability. However, you must deny its validity or accuracy by a positive act. A written protest included with payment of an asserted liability is enough to start a contest. Lodging a protest in accordance with local law is also enough to contest an asserted liability for taxes. You do not have to deny the validity or accuracy of an asserted liability in writing if you can show by all the facts and circumstances that you have asserted and contested the liability.
Contest must exist. The contest for the asserted liability must exist after the time of the transfer. If you make payment after the contest is settled, you must accrue the liability in the year in which the contest is settled.
Example. You are a calendar year taxpayer using an accrual method of accounting. You had a $500 liability asserted against you in 2000 for repair work completed that year. You contested the asserted liability and settled in 2002 for the full $500. You pay the $500 in January 2003. Since you did not make the payment until after the contest was settled, the liability accrues in 2002 and you can deduct it only in 2002.
Transfer to creditor. You must transfer to the creditor or other person money or other property to provide for the payment of the asserted liability. The money or other property transferred must be beyond your control. If you transfer it to an escrow agent, you have met this requirement if you give up all authority over the money or other property. However, buying a bond to guarantee payment of the asserted liability, making an entry on your books of account, transferring funds to an account within your control, transferring your indebtedness or your promise to provide services or property in the future, or transferring (except to the creditor) your stock or the stock or indebtedness of a related person will not meet this requirement.
Liability deductible. The liability must have been deductible in the year of payment, or in an earlier year when it would have accrued, if there had been no contest.
Economic performance rule satisfied. You generally cannot deduct contested liabilities until economic performance occurs. For workers' compensation or a tort liability, or a liability for breach of contract (to the extent of incidental, consequential, and liquidated damages), violation of law, rebates and refunds, awards, prizes, jackpots, insurance, warranty and service contracts, and taxes, economic performance occurs as payments are made to the person. The payment or transfer of money or other property into escrow to contest an asserted liability is generally not a payment to the claimant that discharges the liability. This payment does not satisfy the economic performance test, discussed earlier, except as provided in section 26 USC 468B or the regulations thereunder.
Recovered amounts. An adjustment is usually necessary when you recover any part of a contested liability. This occurs when you deduct the liability in the year of payment and recover any part of it in a later tax year when the contest is settled. Include in gross income in the year of final settlement the part of the recovered amount that, when deducted, decreased your tax for any tax year.
Also see:
http://www.traderstatus.com/prepaidexpenses.htm
Deduction for water & sewer fees &
assessments:
Internal Revenue Code (IRC) section 164
permits a deduction for state and local real property taxes. Under
Federal law, a tax is an enforced contribution, collected for the
purpose of raising revenue to be used for governmental purposes, and
not as a payment for a service rendered. In addition, Section
1.164-3(b) of the Treasury Regulations defines "real property taxes"
as taxes imposed on interests in real property and levied for the
general public welfare, but does not include taxes assessed against
local benefits.
Charges for services - Itemized charges for trash collection, water, sewer, etc. are not deductible as real estate taxes.
Special assessments-principal portion - Charges for improvements that tend to increase the value of the property are added to the basis of the property and are not deductible. Example: an assessment to build a new sidewalk or to connect up to a city sewer system.
Charges to repair or maintain existing public facilities already in service - are deductible as real estate taxes. Example: repairs to an existing sidewalk.
Special assessments-interest portion - IR Regs. §1.164-4(b)(1) say that any interest charged to the property owner on his sewer assessment is deductible, not as interest, but as property taxes regardless if the assessment was for improvements or a repair.
Fees for water/sewer services are not imposed on an interest in real property nor levied for the general public welfare. The charges by a water/sewer authority to its customers for water and sewer services are simply fees for a service and do not qualify as a tax. Consequently, no portion of the fees would qualify as a deduction on the customer's income tax return.
The confusion may come from a misunderstanding of Treasury
Regulation 1.164-4(b)(1). This regulation states that:
"Insofar as assessments against local benefits are made for the
purposes of maintenance or repair or for the purpose of meeting
interest charges with respect to such benefits, they are deductible.
In such cases, the burden is on the taxpayer to show the allocation of
the amounts assessed to the different purposes. If the allocation
cannot be made, none of the amount so paid is deductible."
In some circumstances, the local governments are attempting to calculate the portion of the water/sewer fees that go to maintenance and interest expenses of their systems. That figure is then provided as being tax deductible. The problem is the service fees do not qualify as a tax to begin with so the provisions of 1.164-4(b)(1) do not apply.
Below are some common situations, with the relevant law that clarifies the issue:
In summary, most of the time water and sewer fees are simply fees for
services and are not deductible.
http://apps.irs.gov/pub/irs-tege/p_4090_fed_1204_text.pdf
IRS-TE/GE is the Tax Exempt & Government Entities Division. The TE/GE Division was established in late 1999 as part of the IRS's modernization effort. This Division replaces the former Assistant Commissioner (Employee Plans and Exempt Organizations) function, which was established as a result of the Employee Retirement Income Security Act (ERISA) of 1974.
Deduction for ad valorem taxes (motor vehicle property taxes):
Automobile License Fees
You may not deduct an auto license fee based on weight, model, year, or horsepower. But you may deduct a fee based on the value of the car as a state personal property tax if these three tests are met:
AL - based on the
fair and reasonable value of the vehicle, therefore this is
deductible for IRS itemized deduction purpose.
AR - based on 20% of the value of the vehicle,
therefore this is deductible for IRS itemized deduction purpose. The
mill rate is assessed by the Counties, Cities and the School
Districts.
CA - the "License Fee" or "Vehicle License Fee"
(VLF)
portion of the Vehicle Registration Renewal Notice is based on the value
of the vehicle, therefore the VLF is deductible for IRS itemized deduction purpose.
CT - based on 70% of the value of the vehicle, therefore this is
deductible for IRS itemized deduction purpose. For CT
residents, it is also a limited, non-refundable state income tax
credit.
FL - has no ad valorem tax assessed upon motor vehicles.
GA - based on a combination of the FMV and the
wholesale value of the vehicle, therefore this is deductible for IRS
itemized deduction purpose.
IL - has no ad valorem tax assessed upon motor vehicles.
KS - based on the value of the vehicle, therefore
this is deductible for IRS itemized deduction purpose.
KY - based on the value of the vehicle, therefore
this is deductible for IRS itemized deduction purpose.
LA - based on the value of the vehicle, therefore
this is deductible for IRS itemized deduction purpose.
MN - The "Car Tabs" are based on the value of the
vehicle, therefore this is deductible for IRS itemized deduction
purpose.
MS - based on the value of the vehicle, therefore
this is deductible for IRS itemized deduction purpose.
NY - has no ad valorem tax assessed upon motor vehicles.
OR - "Vehicle License Fee" is based on the value of
the vehicle, therefore is deductible for IRS itemized deduction
purpose.
SC - based on the value of the vehicle, therefore
this is deductible for IRS itemized deduction purpose.
TX - DPS registration fee and county road bridge
add-on fee are not based on the value of the vehicle, therefore not
deductible for IRS itemized deduction purposes.
VA - based on the value of the vehicle, therefore this is
deductible for IRS itemized deduction purpose.
VT - has no ad valorem tax assessed upon motor vehicles.
WY - .
§1031 Tax-Deferred
Exchanges:
http://www.1031.org/
§709(b)(1) election to
deduct LLC, partnership and Sch C start-up expenditures:
(also see §195(b) and see §248(a) for corporations)
After October 22, 2004 a new law
allows this election to be made for expenditures of $5,000 or less for
start-up, §248 organizational, syndication and formation costs to be
deducted when it begins business. Otherwise, generally, these
costs are amortized over a 15 year period starting with the month it
begins business.
Prior to October 23, 2004 these costs were usually amortized
straight-line over 60 months.
After September 8, 2008 the qualifying costs are expensed,
by default.
How to make the election. You elect to deduct the start-up or
organizational costs paid or incurred before 9/9/08 by claiming the deduction on the income tax
return (filed by the due date including extensions) for the tax year
in which the active trade or business begins. However, if you timely
filed your return for the year without making the election, you can
still make the election by filing an amended return within 6 months of
the due date of the return (excluding extensions). Clearly indicate
the election on your amended return and write "Filed pursuant to section
301.9100-2." File the amended return at the same address you
filed the original return. The election applies when computing taxable
income for the current tax year and all subsequent years.
After September 8, 2008 - the election to capitalize start-up or
organizational costs is made similar to the above.
Start-up costs are costs for creating an active trade or business or
investigating the creation or acquisition of an active trade or
business. Start-up costs include any amounts paid or incurred in
connection with any activity engaged in for profit and for the
production of income in anticipation of the activity becoming an
active trade or business.
Qualifying costs. A start-up cost is amortizable if it meets both the
following tests.
Start-up costs include costs for the following items.
Disposition of business.
If you completely dispose of your business before the end of the
amortization period, you can deduct any remaining deferred start-up
costs. However, you can deduct these deferred start-up costs only to
the extent they qualify as a loss from a business.
A special note about educational seminars attended before you begin
trading:
Education is deductible when it is not part of a program
that will qualify you for a new trade or business. Therefore for
tax deduction purposes it is perhaps best to consider avoiding such
controversy and defer your trader training seminars until after you
have actually begun active trading. The trading needs to be done with
appropriately significant dollars at stake - "paper trading" without
dollars at stake does not necessarily qualify as a legitimate trade or
business.
IRS Publication 17
Maintaining skills vs. qualifying for new job.
Education to maintain or improve skills needed in your present work is
not qualifying education if it will also qualify you for a new
trade or business.
IRS Publication 970
Temporary absence. If you stop working for a year or less in
order to get education to maintain or improve skills needed in your
present work and then return to the same general type of work, your
absence is considered temporary. Education that you get during a
temporary absence is qualifying work-related education if it maintains
or improves skills needed in your present work.
Indefinite absence. If you stop work for more than a year, your
absence from your job is considered indefinite. Education during an
indefinite absence, even if it maintains or improves skills needed in
the work from which you are absent, is considered to qualify you for a
new trade or business. Therefore, it is not qualifying work-related
education.
/Footnote/ 264 §172(b)(1)(A), (H). The two-year carryback and 20-year carryover periods were implemented by the Taxpayer Relief Act of 1997, P.L. 105-34, §1082(a), effective for tax years beginning after Aug. 5, 1997. The five-year carryback period for net operating losses for taxable years ending during 2001 or 2002 was implemented by the Job Creation and Worker Assistance Act of 2002, P.L. 107-147, §102(a).
/Footnote/ 265 The waiver of the two-year carryback period is discussed at ¶2410.04.C., below. The waiver of the five-year carryback period is discussed at ¶2410.04.A.2.b., below.
Delinquent filers:
Unless the timely-filed 2005 return has an election to relinquish the
carryback, the NOL must first be carried back and then carried
forward. The number of years of the carryback depends on the type of
loss. it can be as much as 10 years under IRC 172(b)(1)(C).
Assuming the 1040X carryback is not timely filed, the amount of loss (if any) that can be carried forward is determined as if the 1040X carryback had been filed. The only difference is that the refunds from the carryback years are lost.
The interplay of the two and three year rules that are normally looked
at basically relate to the situation where the refund is being claimed
for the "current" year, not a carryback year.
First, Reg. 301.6511(a)-1(a)(1) says that a refund claim must be filed within 3 years of the time the original return is filed or, if later, 2 years from the time the tax was paid. Note that the original return may, in itself, be a refund claim. Note also that, if no return is filed, Reg. 301.6511(a)-1(a)(2) also allows a refund claim of taxes paid within two years, which presumably would refer to an adjustment by the IRS, since I can't think of any other way a refund could be claimed without filing a return.
IRC 6511(b)(1) says there will be no refund or credit based on that refund claim unless it is timely. Note that neither Reg. 301.6511(a)-1 nor 6511(B)(1) refer to the due date of the return. Both refer to the timeliness of the refund claim.
Second, assuming that the claim is timely under Reg. 301.6511(a)-1, IRC 6511(b)(2) limits the amount that can be refunded. If the claim was filed within 3 years of filing the original return, the limit under IRC 6511(b)(2)(A) is the tax paid within 3 years plus, if an extension of time was granted for the original return, the period of the extension, prior to filing the refund claim.
If the refund claim is not filed within 3 years of filing the original return, the limit is the tax paid within 2 years of filing the refund claim, per IRC 6511(b)(2) (B).
Note that none of the periods involved refer to the due date of the return except to the extent that IRC 6513 deems a tax paid before the due date to be paid on the due date of the return.
If a form 1040 has not yet been filed but it shows an overpayment of tax, filing it before the three year statute would constitute a valid refund claim for the overpayment of tax. Filing after the three year statute would constitute a valid refund claim only for the tax paid 3 years plus the period of any extension granted prior to the date of filing. (Since this is the original return and, simultaneously a refund claim, the refund claim is filed within 3 years of the original return.)
Net Operating Loss (NOL)
Helpful Hints:
http://www.irs.gov/businesses/small/article/0,,id=128495,00.html
Net Operating Loss (NOL) Helpful Hints
Headliner Volume 98 - August 16, 2004
Tax practitioners can speed up the processing of net operating losses (NOLs) by avoiding some common errors. Individuals, estates and trusts may have an NOL if deductions exceed income for the year. Taxpayers can use an NOL by deducting it from income in another year or years.
If you carry back your NOL, you can use Form 1045, Application for Tentative Refund, or Form 1040X Amended U. S. Individual Income Tax Return. Form 1045, is an application for a quick refund, resulting from a tentative adjustment of tax in a carryback year. Generally, Form 1045 must be filed after the NOL year tax return was filed, but not later than one year after the NOL year. Any claims filed more than one year after the end of the NOL year must be filed on Form 1040X, or an amended Form 1041, U.S. Income Tax Return for Estates and Trusts.
Here are some common errors that resulted in an NOL rejection during processing:
Error: Failure to provide documentation to support the NOL calculation.
Solution: Review the checklist of "What to Attach" in the Form 1045 instructions. Be sure to include all forms or schedules for items refigured in the carryback year. Also, provide a copy of any examination reports if the IRS has previously audited the return.
Error: Failure to separate all items shown on the return and tax account when an allocation is required because of a change in filing status or marital status.
Solution: Attach a complete breakdown of each spouse's income; a detailed capital gain calculation; deductions, including a list of total Schedule A Itemized Deductions; exemptions; taxable income; credits; other taxes, including separate Forms 6251, Alternative Minimum Tax; federal tax withheld; payments; offsets; and refunds. For information about figuring the NOL carrybacks and carryovers for married people whose filing status changes for any tax year involved in figuring an NOL carryback or carryover, see Publication 536, Net Operating Losses (NOLs) for Individuals, Estates, and Trusts.
Error: Incorrect "before carryback" figures on Form 1045 or Form 1040X.
Solution: "Before carryback" figures are the amounts from the original filed return. If there have been any adjustments made to the original tax return amounts, either by the taxpayer or the IRS, use personal records or order an IRS transcript of the tax account. To order a transcript, call (800) 829-1040 for Form 1040, U.S. Individual Income Tax Return, or (800) 829-4933 for business returns, or file Form 4506-T Request for Transcript of Tax Return.
Error: Incorrect use of Table 1. Worksheet for NOL Carryover From 2003 to 2004 (For an NOL Year Before 2003) in Publication 536 instead of Form 1045, Schedule B, NOL Carryover, to compute absorbed carryback.
Solution: Calculate the total NOL absorbed in each carryback year using Form 1045, Schedule B. Taxpayer should not use the carryforward worksheet shown in Publication 536 to calculate the absorbed NOL for carryback claims. The worksheet is used to figure the amount of an NOL from a prior year still remaining after applying it to the current year.
Error: Missing NOL and alternative tax net operating loss (ATNOL) calculations.
Solution: For NOL calculations attach Form 1045, Schedule A NOL. For ATNOL calculations attach the calculation and a Form 6251, Alternative Minimum Tax. If taxpayer did not file a Form 6251, with the loss year and/or carryover years' returns, IRS must have a copy of completed Forms 6251 to determine the total adjustments and preferences for the ATNOL deductions.
Error: Incorrect NOL and ATNOL calculations.
Solution: The NOL calculation on Form 1045, Schedule A and ATNOL calculations must include all non-business and business capital gains and losses equal to the net capital gains or losses from Form 1040, Schedule D Capitol Gains and Losses.
Error: Recalculating charitable contributions based on an NOL carryback.
Solution: The charitable contributions on Form 1040 Schedule A, Itemized Deductions, are not changed by an NOL carryback. Only carryforward losses (where the loss year occurred before the carryover year) will affect the adjusted gross income for computing the percentages for allowable contributions.
Error: Election to waive carryback period filed late.
Solution: To make the election to carry an NOL and ATNOL forward without first carrying it back, the election must have been made with the original loss year return, or filed with a Form 1040X within six months of the original due date (excluding extensions) of the loss year return. If the election was not timely made, the NOL must be carried back before being carried forward. Remember to attach a copy of the timely election to the return where the NOL is carried forward.
Error: Failure to provide a breakdown of how each NOL changed the tax figures when combining multiple years' NOL carrybacks on the same Form1040X.
Solution: If you are carrying over more than one NOL, apply each one separately, starting with the earliest one to determine your NOL deduction. Attach a copy of each separate computation to your 1040X.
Error: Combining changes to other income/deductions on a prior year return that are not related to an NOL carryback adjustment.
Solution: NOLs have different processing dates and statutory requirements than regular tax changes. Therefore, non-NOL adjustments must be made on a separate amended return.
For additional information on net operating losses, see Publication 536, Form 1045 and instructions. Forms and publications are available by download from the IRS Web site, or by calling toll free 1-800-TAX-FORM (1-800-829-3676).
NOL carrybacks must be filed within three years of the original due date of the tax return for the tax year of the loss being carried back. Otherwise the portion that must be carried back is in effect lost since any resulting refund is forfeited as a late filing penalty. Any remaining carryback losses, that are then being carried forward are reduced by the portions used up in computing the forfeited refunds.
Net Operating Loss (NOL) form 1045 and 1040X
preparation (corporations use 1138, 1139 & 1120X):
Instructions for form 1045:
http://www.irs.gov/pub/irs-pdf/i1045.pdf
What to Attach
Attach copies of the following, if applicable, to Form 1045 for
the year of the loss or credit:
Instructions for form 1040X:
http://www.irs.gov/pub/irs-pdf/i1040x.pdf
Net operating loss (NOL). Attach a computation of your NOL using Schedule A (Form 1045) and any carryover using Schedule B (Form 1045). A refund based on an NOL should not include a refund of self-employment tax reported on Form 1040X, line 9. See Pub. 536, Net Operating Losses (NOLs) for Individuals, Estates, and Trusts, for details.
Carryback claims. You must attach copies of the following if Form 1040X is used as a carryback claim.
Using
form 1040X to deal with a CP2000 notification:
CP2000 notices are
sometimes so complicated that the preparation of an amended tax
return, Form 1040X, is the best way to address any errors made on the
original Form 1040. A problem in doing this is that the IRS mail room
upon seeing a 1040X is not letting the CP2000 dept people see it,
rather they reship it away to another dept that is very overworked.
The IRS CP2000 notices dept, fed up with the slow processing of 1040X's, now requests that you send them a full photocopy of the 1040X and it's supporting statements with the CP2000 notice firmly stapled on top of it (the trick is to hide the 1040X under the CP2000 paperwork). ALSO in red ink across the top of the page #1 of the 1040X write "CP2000 RESPONSE" Send the package of materials to the address shown on the CP2000 notice.
Statute of Limitations limited
to three years, not six years for traders that report each individual
sale:
A taxpayer overstated
the tax basis (cost) of sales that were made during the year. In
Bakersfield Energy Partners, 128 TC No. 17 6/14/07 the Tax Court decided that
the IRS was not entitled to assess the underpaid tax by using the
special six year look-back statute of limitations that is applicable
when a taxpayer omits more than 25% of gross income pursuant to IR
Code §6501(e). The logic as stated by the court in denying the
IRS the six year statute of limitations was that there was no
"omission" since the sale was actually reported on the tax return (see
IR Code §6501(e)(1)(A)(ii)).
Statute of Limitations limited
to three years, not six years for partners who overstated basis:
Partners overstated
their deductible basis on a §754 election by their partnership (husband and wife
partnership). In
Grapeview Imports Ltd v. U.S., No 05-296T Fed. Cl. 7/17/07 the Court decided that
the IRS was not entitled to assess the underpaid tax by using the
special six year look-back statute of limitations that is applicable
when a taxpayer omits more than 25% of gross income pursuant to IR
Code §6501(e)(1)(A). The logic as stated by the court in denying the
IRS the six year statute of limitations was based on US Supreme Court
Colony Inc v. Comr, 357 U.S. 28 1958 and Bakersfield Energy Partners
LP (above) - that there was no
"omission" since the sale was actually reported on the tax return (see IR Code §6501(e)(1)(A)(ii))
update: 9/24/2009 IRS issues proposed and temporary regulations to clarify that an overstatement of basis can create a substantial omission of gross income under IR Code §§6229(c)(2) and 6501(e) for purposes of the six-year extended period for assessments and collections of tax attributable to partnership items. (see Treas. Reg. §301.6229(c)(2)-1T)
Statute of Limitations
not limited
to three years when NOL is carried forward:
A taxpayer overstated
the tax basis (cost) of partnership items. In Curr-Spec Partners
LP the Court decided that
the IRS was entitled to assess the underpaid tax by ignoring the
general three year statute of limitations. Partners had elected to
carry forward a Net Operating Loss (NOL) and by the time the IRS audit
was underway the three year statute of limitations had expired for the
year that originally created the NOL. The logic, as stated by the court in denying the
taxpayer the right to the protection of three year statute of
limitations, was that IR
Code §5118(a) says
that the statute of limitations period "shall not expire before" three
years from the date the partnership return was filed or, if later,
when is was due. The Fifth Circuit Court said that the
phrase shall not expire before" is unambiguous; that is, it can extend
but never shorten the
§6501(a)
period for assessing individual tax liabilities attributable to
partnership items.
Rev. Rul. 73-361 and Rev. Rul. 82-83 stockholder-officer of s-corporation is an employee, form W-2 is to be issued:
Rev. Rul. 73-361
Advice has been requested whether a stockholder-officer of an electing small business corporation should be treated as a partner or as an employee for purposes of the Federal Insurance Contributions Act (chapter 21, subtitle C, Internal Revenue Code of 1954).
The corporation is a small business corporation, as defined in section 1371 of the Code, that has elected, pursuant to section 1372(a), not to be subject to the corporate income tax, but to have all its income taxed directly to its shareholders.
During 1972, the majority stockholder was an officer of the corporation, and performed substantial services for the corporation in that capacity for which he was paid a salary.
Section 3121(d)(1) of the Federal Insurance Contributions Act provides that, for purposes of the taxes imposed by this Act, the term "employee" means any officer of a corporation. Section 31.3121(d)-1(b) of the Employment Tax Regulations provides that an officer who, as such, does not perform any services or performs only minor services and who neither receives nor is entitled to receive, directly or indirectly, any remuneration is considered not to be an employee of the corporation.
Neither the election by the corporation as to the manner in which it will be taxed for Federal income tax purposes nor the consent thereto by the stockholder-officers has any effect in determining whether they are employees or whether payments made to them are "wages" for Federal employment tax purposes. A corporation does not lose its identity by reason of such an election but remains a legal corporate entity and is required, under section 6037 of the Code, to file a return containing information needed to comply with the provisions of Subchapter S of the Code.
Since the stockholder-officer in the instant case performed substantial services for the electing small business corporation, for which he received remuneration, he is an employee of the corporation.
Accordingly, the "wages" he received in 1972 for his services as an officer are subject to the taxes imposed by the Federal Insurance Contributions Act. This conclusion is also applicable for purposes of the Federal Unemployment Tax Act and the Collection of Income Tax at Source on Wages (chapters 23 and 24, respectively, subtitle C of the Code).
Rev. Rul. 82-83 EMPLOYER-EMPLOYEE; CORPORATE OFFICERS
ISSUE
Is a corporation that treats officers as independent contractors rather than as employees when they are performing duties normally within the scope of duties of a corporate officer entitled to relief under section 530 of the Revenue Act of 1978 (the Act), 1978-3 (Vol. 1) C.B. 1, 119, extended by section 9(d) of Pub. L. 96-167, 1980-1 C.B. 483, 486, and by section 1 of Pub. L. 96- 541, 1980-2 C.B. 596?
FACTS
A corporation, which is owned by its two officers (president and vice- president/treasurer, respectively) operates a summer theater. The officers perform substantial services for the corporation, including deciding on productions to be performed, setting admission prices, and hiring performers. The officers control and direct all of the operations of the theater and determine the amount of their own compensation, the hours of their employment, and the duties they will perform.
The corporation treats the officers as independent contractors rather than employees and pays them compensation characterized as 'draws' rather than 'salaries.' In treating the officers as independent contractors, the corporation does not rely on any basis that would fall within the 'safe haven' provisions of section 530(a)(2)(A), (B), or (C) of the Act.
LAW AND ANALYSIS
Section 530 of the Act provides relief from employment tax liability to eligible taxpayers who have failed to pay or withhold employment taxes on remuneration paid to workers because the taxpayers did not regard them as employees. Section 530(a)(1), as extended, provides, in general, that if a taxpayer did not treat an individual as an employee for any period ending before July 1, 1982, the individual will be deemed not to be an employee for purposes of applying employment taxes for the period unless the taxpayer had no reasonable basis for treating the individual as other than an employee.
Section 530(a)(2) provides several alternative standards that constitute 'safe havens' in determining whether a taxpayer has a 'reasonable basis' for not treating an individual as an employee. Reasonable reliance on any one of the following 'safe havens' is sufficient:
(A) Judicial precedent or published rulings (whether or not relating to the particular industry or business in which the taxpayer is engaged), technical advice, a letter ruling, or a determination letter pertaining to the taxpayer.
(B) A past Internal Revenue Service audit (not necessarily for employment tax purposes) of the taxpayer, if the audit entailed no assessment attributable to the taxpayer's employment tax treatment of individuals holding positions substantially similar to that held by the individual whose status is at issue. However, a taxpayer does not meet this test if, in the conduct of a prior audit, an assessment attributable to the taxpayer's treatment of the individual was offset by other claims asserted by the taxpayer.
(C) Long-standing recognized practice of a significant segment of the industry in which the individual was engaged. It is not necessary that the practice be uniform throughout an entire industry.
Taxpayers who fail to meet any of these three 'safe havens' may nevertheless be entitled to relief if they can demonstrate, in some other manner, a reasonable basis for not treating the individual as an employee. The term 'reasonable basis' should be construed liberally in favor of the taxpayer.
Sections 3121(d) and 3401(c) of the Internal Revenue Code, applicable to the Federal Insurance Contributions Act and income tax withholding, respectively, provide that the term 'employee' includes any officer of a corporation. Section 3306(i), applicable to the Federal Unemployment Tax Act, includes within the meaning of the term 'employee' the meaning assigned by section 3121(d).
Section 31.3121(d)-1(b) of the Employment Tax Regulations states that, generally, an officer of a corporation is an employee of the corporation. However, an officer of a corporation who as such does not perform any services or performs only minor services and who neither receives nor is entitled to receive, directly or indirectly, any pay is considered not to be an employee of the corporation. For instance, directors of corporations in their capacity as such are not employees of the corporations.
Rev. Rul. 71-86, 1971-1 C.B. 285, holds that when an individual who is the president and sole shareholder, except for qualifying shares, of a closely held corporation performs services as an officer of the corporation, the president is an employee for purposes of employment taxes and income tax withholding, even though all services performed and the amount of compensation for them are under the individual's complete control.
Rev. Rul. 73-361, 1973-2 C.B. 331, holds that a stockholder-officer of an electing small business corporation who performs substantial services as an officer of the corporation is its employee for purposes of the FICA, the FUTA, and income tax withholding.
In Royal Theatre Corp. v. United States, 66 F. Supp. 301 (D. Kan. 1946), the sole shareholder and president of two corporations contracted with each for him to manage each corporation's operations and to determine matters of policy for each corporation. The court observed that compensation an officer receives for services as an officer is subject to social security taxes, and held that the contracts by which the president of each corporation purportedly managed the affairs of each corporation as an independent contractor could be disregarded in determining the reality of the situation.
It is a question of fact in all cases whether officers of a corporation are performing services within the scope of their duties as officers or whether they are performing services as independent contractors. Here, the duties being performed customarily fall within the scope of duties of corporate officers. Involved are fundamental decisions regarding the operation of the corporation. Such decisions are rarely delegated to independent contractors, and are customarily made by corporate officers or other employees. Thus, since the officers are performing substantial services typical of officers and are paid for those services, they are employees of the corporation for purposes of federal tax law. Therefore, even though the corporation calls the officers' pay 'draws' rather than 'salaries,' there is no reasonable basis for treating the officers as other than employees, even under a liberal application of the reasonable basis rule of section 530 of the Act.
HOLDING
The corporation is not entitled to relief under section 530 of the Act.
Supporting Law
Revenue Ruling 84-52, 1984-1 C.B. 157 - The conversion of a general partner interest into a limited partner interest, and vice versa, within the same partnership, generally will result in no gain or loss recognition by the partner under section 741 or 1001 of the Code.
Revenue Ruling 84-53, 1984-1 C.B. 159 - Rev. Rul. 84-53 illustrates basis allocations and adjustments that may occur when a partner owns multiple interests in a partnership and disposes of only a portion of such interests.
Revenue Ruling 95-37, 1995-1 C.B. 130 - This ruling treats the conversion of a partnership interest into an LLC interest in much the same manner as conversions described in Rev. Rul. 84-52.
Crenshaw v. United States , 450 F.2d 472 (5th Cir. 1971) - The court found, in a case of substance versus form, that a series of transactions in which the taxpayer claimed tax-free liquidation treatment under IRC section 736(b) followed by a tax-free exchange of like-kind property under IRC section 1031 amounted to a sale of a partnership interest.
Pollack v. Commissioner, 69 T.C. 142 (1977) - The Tax Court ruled that the loss resulting from the disposition of a partner’s interest in a partnership should be characterized as a capital loss pursuant to IRC section 741 rather than an ordinary business loss, as the taxpayer had claimed. Characterization of a partnership interest as a capital asset neither depends on the taxpayer’s motive when acquiring the interest nor the fact that treatment would be different if the taxpayer had established the enterprise as a business other than a partnership.
1) ABC Associates is located at 100 Co-Ownership Road, Rockville, Maryland 20852. A copy of the operating agreement is available at that location.
2) ABC Associates qualifies for this election as an investing partnership that satisfies the requirements of Regulation §1.761-2(a)(1) & (2).
3) The members of ABC Associates are:
(a) Mr. W. Smith ###-##-####
100 Co-Ownership Road
Rockville, Maryland 20852
(b) Ms. J. Jones ###-##-####
102 Co-Ownership Road
Rockville, Maryland 20852
Search this link of an IRS Auditor Guide excerpt for the word * Guarantees * for the IRS position on this: http://www.irs.gov/businesses/partnerships/article/0,,id=134694,00.html
If you deposit additional cash into an LLC before the end of the year
that should help cure this issue.
But be aware that there's also new 2008 rules regarding the
old-school s-corp trick of
removing the cash back out early in the following year.
These new rules became effective for any money loaned to the entity
after October 20, 2008. While the rules deal specifically with s-corps
the implications can be that LLC members trying to circumvent
§1.465-6(d) should be cautious as well.
http://www.irs.gov/irb/2008-47_IRB/ar09.html
The Levin bill provides an opportunity to consider Congress’ latest thinking on this matter. While it is not clear that this version of the bill will be enacted, it appears increasingly likely that some sort of carried interest legislation will become law. In its recently released Green Book, the Obama administration indicated that it will push for carried interest legislation to be effective in 2011.
Under current law, when the partnership sells a long-term investment at a capital gain, the portion of the gain allocated to the fund manager’s carried interest is taxed at the favorable capital gains rate, currently 15%. By contrast, compensation income for services is taxed at ordinary income rates, currently, a maximum rate of 35%, and is subject to social security and other payroll taxes. In the Green Book, the Obama administration proposes to allow the maximum rates for capital gains to increase to 20% and for ordinary income to rise to 39.6%.
President Obama’s proposal would be effective for taxable years beginning after December 31, 2010 and would apply to all partnerships. Under the proposal, a partner’s share of income on a services partnership interest (SPI) would be taxed as ordinary income rather than capital gain, regardless of the character of the income at the partnership level. The proposal also requires the partner to pay self employment taxes on the share of income, and any gain recognized on the sale of an SPI would be taxed as ordinary income rather than capital gain.
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ISSUES
Under section 26 USC 743(b) of
the Internal Revenue Code, does a sale of an interest in an upper-tier
partnership (UTP) result in an adjustment to the basis of the property
of a lower-tier partnership (LTP) in which UTP has an interest if:
FACTS
UTP is a partnership in which A,
B, C, and D are equal partners. A, B, C, and D each contributed 30x
dollar interest in partnership capital and surplus. A's share of the
adjusted basis of partnership property is 30x dollars, the sum of A's
interest as a partner in partnership capital and surplus, plus A's
share of partnership liabilities (neither UTP nor LTP have any
liabilities). UTP is an equal partner in LTP, along with X and Y. LTP
was formed by X, Y, and Z, who each contributed 110x dollars of cash
to LTP upon its formation. UTP purchased its interest in LTP from Z
for 80x dollars in a taxable year for which LTP did not have an
election under section 26 USC 754 in effect. UTP, X, and Y each have a
110x dollar interest in partnership capital and surplus.
UTP has an adjusted basis of 120x dollars in its property as follows: an adjusted basis of 80 dollars in its partnership interest in LTP and an adjusted basis of 40x dollars in inventory. UTP's partnership interest in LTP has a fair market value of 120x dollars, and UTP's inventory has a fair market value of 80x dollars. LTP has only one asset, a capital asset that is not a section 26 USC 751 asset. LTP's asset has an adjusted basis of 330x dollars and a fair market value of 360x dollars.
In 1985, A sold A's entire interest in UTP to E for 50x dollars.
SITUATION 1
Both UTP and LTP have valid
section 26 USC 754 elections in effect.
SITUATION 2
UTP has a section 26 USC 754
election in effect, but LTP does not.
SITUATION 3
UTP does not have a section 26
USC 754 election in effect, but LTP does.
LAW AND ANALYSIS
Section 26 USC 742 of the Code
provides that the basis of an interest in a partnership acquired other
than by contribution shall be determined under part II of subchapter O
of chapter 1 (sections 26 USC 1011 through 26 USC 1015).
Section 26 USC 1012 of the Code provides, with certain exceptions, that the basis of property shall be the cost of such property.
Section 26 USC 754 of the Code provides that if a partnership files an election, in accordance with regulations prescribed by the Secretary, the basis of partnership property shall be adjusted, in the case of a transfer of a partnership interest, in the manner provided in section 26 USC 743(b). Such election shall apply with respect to all transfers of interests in the partnership during the taxable year with respect to which such election was filed and all subsequent years.
Section 26 USC 743(a) of the Code provides the general rule that the basis of partnership property shall not be adjusted as the result of a transfer of an interest in a partnership by sale or exchange or on the death of a partner unless the election provided by section 26 USC 754 is in effect with respect to such partnership.
Section 26 USC 743(b) of the Code provides that, in the case of a transfer of an interest in a partnership by sale or exchange or upon the death of a partner, a partnership with respect to which the election provided in section 26 USC 754 is in effect shall (1) increase the adjusted basis of partnership property by the excess of the basis to the transferee partner of such partner's interest in the partnership over the partner's proportionate share of the adjusted basis of partnership property; or (2) decrease the adjusted basis of partnership property by the excess of the transferee partner's proportionate share of the adjusted basis of partnership property over the basis of such partner's interest in the partnership. Section 26 USC 743(b) further provides that the increase or decrease shall be an adjustment to the basis of partnership property with respect to the transferee partner only.
Section 26 CFR 1.743-1(b)(1) of the Income Tax Regulations provides that, in general, a partner's share of the adjusted basis of partnership property is equal to the sum of that partner's interest as a partner in partnership capital and surplus, plus that partner's share of partnership liabilities.
Section 26 USC 755(a) of the Code requires that, in general, the amount of the basis adjustment be allocated among partnership assets in a manner which has the effect of reducing the difference between the fair market value and the adjusted basis of those assets, or in any other manner permitted by the regulations prescribed by the Secretary.
Section 26 USC 755(b) of the Code provides that in applying the allocation rules provided in section 26 USC 755(a), increases or decreases in the adjusted basis of partnership property arising from the transfer of an interest attributable to (1) capital assets and property described in section 26 USC 1231(b)("capital assets"), or (2) any other property of the partnership, shall in general be allocated to partnership property of like character.
Section 26 CFR 1.755-1(b)(2) of the Income Tax Regulations provides that to the extent an amount paid by a purchaser of a partnership interest is attributable to the value of capital assets, any difference between the amount so attributable and the transferee partner's share of the partnership basis of such property shall constitute a special basis adjustment with respect to partnership capital assets. Similarly, any such difference attributable to any other property of the partnership shall constitute a special basis adjustment with respect to such property.
Section 26 USC 741 of the Code provides that, except as provided in section 26 USC 751, the gain or loss on the exchange of an interest in a partnership shall be considered as a gain or loss from the sale of a capital asset.
Rev. Rul. 78-2, 1978-1 C.B. 202, concerns the transfer of an interest in an investment partnership, X, which is a partner of an operating partnership, Y. The ruling concludes that if elections under section 26 USC 754 of the Code are in effect for X and Y, the adjustment to the basis of partnership property under section 26 USC 743(b) includes (a) an adjustment to X's partnership interest in Y and (b) a corresponding basis adjustment to Y's property with respect to X and the transferee partner of X only.
In essence, if an election under section 26 USC 754 is not in effect, the partnership is treated as an independent entity, separate from its partners. Thus, absent a section 26 USC 754 election, even though the transferee receives a cost basis for the acquired partnership interest, the partnership does not adjust the transferee's share of the adjusted basis of partnership property. If, however, an election under section 26 USC 754 is in effect, the partnership is treated more like an aggregate of its partners, and the transferee's overall basis in the assets of the partnership is generally the same as it would have been had the transferee acquired a direct interest in its share of those assets. Nevertheless, the transferee's adjusted basis for specific partnership assets will not necessarily equal the basis the assets would have had if the transferee had acquired a direct interest in the assets. The difference is due to the fact that the transferee's basis in specific partnership assets is controlled by section 26 USC 755, which does not adopt a pure aggregate approach. See section 26 CFR 1.755-1(c) of the regulations.
SITUATION 1
E purchased A's interest for 50x
dollars. Thus, under section 26 USC 742, E's basis in E's partnership
interest is 50x dollars. Because UTP made a valid section 26 USC 754
election, under section 26 USC 743(b) UTP must increase the adjusted
basis of its property by 20x dollars, the excess of the transferee
partner's basis in the partnership interest (50x dollars) over the
partner's share of the adjusted basis of such property. Under section
26 CFR 1.743-1(b)(1), E's share of the adjusted basis of partnership
property is 30x dollars, because E succeeds to A's interest in
partnership capital and surplus. See, e.g., section 26 CFR
1.743-1(b)(1) Example (2). The 20x dollar special basis adjustment
raises UTP's adjusted basis in its partnership property to 140x
dollars, but the additional 20x dollars must be segregated and
allocated solely to E. Under section 26 USC 755, the 20x dollars must
be allocated between capital assets (UTP's interest in LTP) and other
assets (UTP's inventory).
Under section 26 CFR 1.755-1(b)(2) of the regulations, to the extent that an amount paid by a purchaser of a partnership interest (here, 50x dollars) is attributable to the value of capital assets (here, 120x dollars, the value of UTP's interest in LTP), any difference between the amount so attributable and the transferee partner's share of the partnership basis of such property constitutes a special basis adjustment with respect to such capital assets. In the instant case, 30x dollars (60 percent of 50x dollars) of E's purchase price is attributable to the value of UTP's interest in LTP, because 120x dollars, the value of UTP's interest in LTP, is 60 percent of 200x dollars, the total value of UTP's property. Thus, 10x dollars, the difference between the 30x dollars attributable to the value of UTP's interest in LTP and 20x dollars, E's proportionate share of UTP's basis in LTP, is a special basis adjustment to UTP's interest in LTP. This adjustment gives E an adjusted basis of 30x dollars in UTP's in LTP. The remaining 10x dollars of the 20x dollar special basis adjustment is allocated to the adjusted basis of UTP's inventory. This gives E a 20x dollar adjusted basis in UTP's inventory.
Because UTP made a section 26 USC 754 election manifesting an intent to be treated as an aggregate for purposes of sections 26 USC 754 and 26 USC 743, it is appropriate, for purposes of section 26 USC 743 and 26 USC 754, to treat the sale of A's partnership interest in UTP as a deemed sale of an interest in LTP. The selling price of E's share of UTP's interest in LTP is deemed to equal E's share of UTP's adjusted basis in LTP, 30x dollars (1/4 of 80x dollars plus 10x dollars, E's special basis adjustment). Further, this deemed sale of an interest in LTP triggers the application of section 26 USC 743(b) to LTP. Because LTP made a valid section 26 USC 754 election, under section 26 USC 743(b) LTP must increase the adjusted basis of its partnership property by 2.5x dollars, the excess of E's share of UTP's adjusted basis in LTP (30x dollars) over E's share of the adjusted basis of LTP's property (1/4 of 110x dollars, or 27.5 dollars). Section 26 USC 755 applies to LTP to allocate this basis adjustment, but because LTP has only one asset, no allocation is necessary. The 2.5x dollar adjustment must be segregated and allocated solely to UTP and E, the transferee partner of UTP.
SITUATION 2
UTP has made a valid section 26
USC 754 election. Thus, as in SITUATION 1, E gets an adjusted basis of
30x dollars in UTP's interest in LTP and an adjusted basis of 20x
dollars in UTP's inventory. Also, as in SITUATION 1, because UTP made
a section 26 USC 754 election, it is appropriate, for purposes of
sections 26 USC 754 and 26 USC 743, to treat the sale of A's interest
in UTP as the sale of an interest in LTP. However, in this situation,
LTP does not have a section 26 USC 754 election in effect. That is,
under section 26 USC 743(a), LTP chose not to have the basis of its
property adjusted as the result of the transfer of an interest in it.
Thus, E's purchase of a partnership interest in UTP has no effect on
LTP's adjusted basis in its property.
SITUATION 3
LTP has made a valid election
under section 26 USC 754, but UTP does not make a section 26 USC 754
election. On the sale by A of an interest in UTP, E succeeds to A's
20x dollar adjusted basis in UTP's interest in LTP and to A's 10x
dollar adjusted basis in UTP's inventory. E succeeds to these bases
because, by not making a section 26 USC 754 election, UTP chose not to
have the basis of its property adjusted as the result of the transfer
of an interest in UTP.
In addition, by not making a section 26 USC 754 election, UTP manifested an intent to be treated as an entity for purposes of sections 26 USC 754 and 26 USC 743. Thus, it is inappropriate, for purposes of sections 26 USC 754 and 26 USC 743, to treat A's sale of an interest in UTP as the sale of an interest in LTP. Consequently, UTP cannot increase E's share of the basis of LTP's property. Nevertheless, LTP's section 26 USC 754 election is not meaningless. If UTP were to sell its partnership interest in LTP, the purchaser's share of the adjusted basis of LTP's assets would be adjusted.
HOLDINGS
SITUATION 1
Upon the sale of A's partnership
interest in UTP, the transferee's (E's) shares of UTP's adjusted basis
in its assets is adjusted by the amount by which the basis in E's
partnership interest differs from E's share of UTP's adjusted basis in
its assets. In addition, E's share of LTP's adjusted basis in its
assets is adjusted by the amount by which E's share of UTP's adjusted
basis in LTP differs from E's share of the adjusted basis of LTP's
property.
SITUATION 2
Upon the sale of A's partnership
interest in UTP, E's share of UTP's adjusted basis in its assets is
adjusted by the amount by which the basis in E's partnership interest
differs from E's share of UTP's adjusted basis in its assets. However,
because LTP did not make a section 26 USC 754 election, the transfer
does not affect LTP's adjusted basis in its property.
SITUATION 3
The sale of A's partnership interest in UTP does not affect either
UTP's adjusted basis in its property or LTP's adjusted basis in its
property.
EFFECT ON OTHER REVENUE RULINGS.
Rev. Rul. 78-2 is clarified and
amplified.
Rev. Rul 91-26 "Section 26 USC 707(c) of the Code provides that payments to a partner for services,
to the extent the payments are determined without regard to the income
of the partnership, are considered as made to one who is not a member
of the partnership, but only for purposes of section 26 USC 61(a)
(relating to gross income)and, subject to section 26 USC 263
(prohibiting deductions for capital expenditures), for purposes of
section 26 USC 162(a) (relating to trade or business expenses). These
payments are termed 'guaranteed
payments.'"
Regs. §1.707-1(c) "a partner
who receives guaranteed payments is not regarded as an employee of the
partnership for the purposes of
withholding of tax at source, deferred compensation plans, etc."
Rev. Rul. 81-300 "the statutory test for a guaranteed payment,
that it be 'determined without
regard to the income of the partnership'"
Rev. Rul. 81-300 "Section 26 USC 707(c) of the Code provides
that to the extent determined without regard to the income of the
partnership, payments to a
partner for services, termed "guaranteed payments",
shall be considered as made to one who is not a member of the
partnership, but only for purposes of section 26 USC 61(a) and,
subject to section 26 USC 263, for purposes of section 26 USC 162(a)."
Rev. Rul. 81-301 "Section 26 USC 707(c) of the Code provides
that to the extent determined without regard to the income of the
partnership, payments to a
partner for services shall be
considered as made to one who is not a member of the partnership, but
only for purposes of section 26 USC 61(a) and, subject to section 26
USC 263, for purposes of section 26 USC 162(a). "
Rev. Rul. 69-184
"26 CFR 31.3121(d)-1: Who are employees. Bona fide members of a partnership are
not employees of the partnership
within the meaning of the Federal Insurance Contributions Act, the
Federal Unemployment Tax Act, and the Collection of Income Tax at
Source on Wages (chapters 21, 23, and 24, respectively, subtitle C,
Internal Revenue Code of 1954). Such a partner who devotes his
time and energies in the conduct of the trade or business of the
partnership, or in providing services to the partnership as an
independent contractor, is, in either event, a self-employed
individual rather than an individual who, under the usual common law
rules applicable in determining the employer-employee relationship,
has the status of an employee. Sections 26 USC 1402(a) and 26 USC
3121(d)(2) of the Code."
Rev. Rul. 69-184 "Remuneration
received by a partner from the partnership is not "wages" with respect
to "employment" and therefore is
not subject to the taxes imposed by the Federal Insurance
Contributions Act and the Federal Unemployment Tax Act. Such
remuneration also is not subject to Federal income tax withholding."
Rev. Rul. 69-183 "An
individual is an employee for
Federal employment tax purposes
if he has the status of employee under the usual common law rules
applicable in determining the employer-employee relationship.
Guides for determining that status are found in three substantially
similar sections of the Employment Tax Regulations: namely, sections
26 CFR 31.3121(d)-1(c), 26 CFR 31.3306(i)-1, and 26 CFR 31.3401(c)-1."
Rev. Rul. 72-467 "The
right to discharge is also an important factor indicating that the
person possessing that right is an employer.
If the relationship of employer and employee exists, the designation
or description of the relationship by the parties as anything other
than employer and employee is immaterial. Thus, if such relationship
exists, it is of no consequence that the employee is designated as a
partner, co-adventurer, agent, independent contractor, or the like."
704(e)(1) Recognition of
interest created by purchase or gift.-
A person shall be recognized as a
partner for purposes of this subtitle if he owns a
capital interest in a partnership in which capital
is a material income-producing factor, whether or
not such interest was derived by purchase or gift
from any other person.
In the case of any partnership interest created by gift, the distributive share of the donee under the partnership agreement shall be includible in his gross income, except to the extent that such share is determined without allowance of reasonable compensation for services rendered to the partnership by the donor, and except to the extent that the portion of such share attributable to donated capital is proportionately greater than the share of the donor attributable to the donor's capital. The distributive share of a partner in the earnings of the partnership shall not be diminished because of absence due to military service.
For purposes of this section, an interest purchased by one member of a family from another shall be considered to be created by gift from the seller, and the fair market value of the purchased interest shall be considered to be donated capital. The "family" of any individual shall include only his spouse, ancestors, and lineal descendants, and any trusts for the primary benefit of such persons.
SECTION 2. BACKGROUND
.01 S Corporation Elections.
(1) In General. Section 1361(a)(1) of the Internal Revenue Code (Code)
provides that the term "S corporation" means, with respect to any
taxable year, a small business corporation for which an election under
§ 1362(a) is in effect for that year. Section 1362(b)(1) provides that
a small business corporation may make an election to be an S
corporation for any taxable year (A) at any time during the preceding
taxable year, or (B) at any time during the taxable year and on or
before the 15th day of the 3rd month of the taxable year. Section
1.1362-6(a)(2) of the Income Tax Regulations provides that a small
business corporation makes an election to be an S corporation by
filing a completed Form 2553, Election by a Small Business
Corporation. Under ' 1362(b)(3), if an S corporation election is made
after the 15th day of the 3rd month of the taxable year and on or
before the 15th day of the 3rd month of the following taxable year,
then the S corporation election is treated as made for the following
taxable year.
(2) Late S Corporation Elections. Section 1362(b)(5) provides that if (A) an election under ' 1362(a) is made for any taxable year (determined without regard to ' 1362(b)(3)) after the date prescribed by ' 1362(b) for making the election for the taxable year or no election is made for any taxable year, and (B) the Secretary determines that there was reasonable cause for the failure to timely make the election, the Secretary may treat the election as timely made for the taxable year (and ' 1362(b)(3) shall not apply). Rev. Proc. 97-48, 1997-2 C.B. 521 provides special procedures to obtain automatic relief for certain late S corporation elections. Generally, relief is available in situations in which a corporation intends to be an S corporation, the corporation and its shareholders reported their income consistent with S corporation status for the taxable year the S corporation election should have been made and for every subsequent year, and the corporation did not receive notification from the Internal Revenue Service regarding any problem with the S corporation status within 6 months of the date on which the Form 1120S, U.S. Income Tax Return for an S Corporation, for the first year was timely filed.
Rev. Proc. 2003-43 provides, in part, a simplified method for a taxpayer to request relief for a late S corporation election where the entity fails to qualify as an S corporation solely because of the failure to file the election timely with the applicable campus. Under the revenue procedure, certain entities may be granted relief for failing to file the elections in a timely manner if the request for relief is filed within 24 months of the due date of the election.
.02 Entity Classification Elections.
(1) In General. Section 301.7701-2(a) of the Procedure and
Administration Regulations defines a “business entity” as any entity
recognized for federal tax purposes that is not properly classified as
a trust under § 301.7701-4 or otherwise subject to special treatment
under the Code. Section 301.7701-3(a) provides that a business entity
that is not classified as a corporation under § 301.7701-2(b)(1), (3),
(4), (5), (6), (7), or (8) (an “eligible entity”) can elect its
classification for federal tax purposes. Section 301.7701-3(b)(1)
provides that, except as otherwise provided in paragraph (b)(3) of the
section, unless the entity elects otherwise, a domestic eligible
entity is (i) a partnership if it has two or more members; or (ii)
disregarded as an entity separate from its owner if it has a single
owner. Section 301.7701-3(c)(1) provides that, except as provided in §
301.7701- 3(c)(1)(iv) and (v), an eligible entity may elect to be
classified other than as provided in § 301.7701-3(b) by filing Form
8832, Entity Classification Election, with the campus designated on
Form 8832. Section 301.7701-3(c)(iii) provides that the entity
classification election will be effective on the date specified by the
entity on the Form 8832 or on the date filed if no date is specified
on the election form. The effective date specified on Form 8832 can
not be more than 75 days prior to the date on which the election is
filed and can not be more than 12 months after the date on which the
election is filed. If an election specifies an effective date more
than 75 days prior to the date on which the election is filed, the
election will be effective 75 days prior to the date it was filed. If
an election specifies an effective date more than 12 months from the
date on which the election is filed, the election will be effective 12
months after the date the election was filed. (2) Late Entity
Classification Elections. Under § 301.9100-1(c), the Commissioner may
grant a reasonable extension of time under the rules set forth in §§
301.9100-2 and 301.9100-3 to make a regulatory election, or a
statutory election (but no more than 6 months except in the case of a
taxpayer who is abroad), under all subtitles of the Code, except
subtitles E, G, H, and I. Section 301.9100-1(b) defines the term
“regulatory election” as an election whose due date is prescribed by a
regulation published in the Federal Register, or a revenue ruling,
revenue procedure, notice, or announcement published in the Internal
Revenue Bulletin.
Requests for relief under § 301.9100-3 will be granted when the taxpayer provides the evidence to establish to the satisfaction of the Commissioner that the taxpayer acted reasonably and in good faith, and the grant of relief will not prejudice the interests of the Government. Rev. Proc. 2002-59, 2002-2 C.B. 615, provides guidance for an entity newly formed under local law that requests relief for a late initial classification election filed by the due date of the entity's first federal income tax return (excluding extensions). Under § 301.7701-3(c)(1)(v)(C), an eligible entity that timely elects to be an S corporation under § 1362(a)(1) is treated as having made an election to be classified as an association, provided that (as of the effective date of the election under § 1362(a)(1)) the entity meets all other requirements to qualify as a small business corporation under § 1361(b). Section 301.7701-3(c)(1)(v)(C) further provides that, subject to § 301.7701-3(c)(1)(iv), the deemed election to be classified as an association generally will apply as of the effective date of the S corporation election and will remain in effect until the entity makes a valid election under § 301.7701-3(c)(1)(i), to be classified as other than an association. Rev. Proc. 2004-48 provides a simplified method for taxpayers to request relief for a late S corporation election and a late corporate classification election which was intended to be effective on the same date the S corporation election was intended to be effective. Under Rev. Proc. 2004-48, generally, certain eligible entities may be granted relief if the requirements of section 4 of the revenue procedure are satisfied. To obtain relief under Rev. Proc. 2004-48, the entity must file a properly completed Form 2553 with the applicable campus within 6 months after the due date for the tax return, excluding extensions, for the first taxable year the entity intended to be an S corporation. Attached to the Form 2553 must be a statement explaining the reason for the failure to file timely the S corporation election and a statement explaining the reason for the failure to file timely the entity classification election.
SECTION 3. SCOPE
.01 In General. This revenue procedure supplements Rev. Proc. 2003-43 and provides an additional simplified method for obtaining relief for a late S corporation election, provided that the requirements of section 4 of this revenue procedure are satisfied. This revenue procedure also supplements Rev. Proc. 2004-48 and provides an additional simplified method for obtaining relief for a late S corporation election and a late corporate classification election, provided that the requirements of section 5 of this revenue procedure are satisfied. Section 4.01 of this revenue procedure provides the eligibility requirements for relief for a late S corporation election, and section 4.02 of this revenue procedure provides the procedural requirements for relief. Section 5.01 of this revenue procedure provides the eligibility requirements for relief for a late S corporation election and a late corporate classification election, and section 5.02 of this revenue procedure provides the procedural requirements for relief. This revenue procedure provides procedures in lieu of the letter ruling process ordinarily used to obtain relief for a late S corporation election and a late corporate classification election filed pursuant to ' 1362(b)(5), ' 301.9100-1 and ' 301.9100-3. Accordingly, user fees do not apply to corrective actions under this revenue procedure. .02 Entities T (1) Rev. Procs. 97-48, 2003-43, and 2004-48. An entity that does not meet the requirements for relief under this revenue procedure may request relief for a late S corporation election following the procedures of Rev. Proc. 97-48, or Rev. Proc. 2003- 43, or, for relief for a late S corporation election and a late corporate classification election following the procedures of Rev. Proc. 2004-48.
(2) Letter Rulings. If an entity does not qualify for relief for a late S corporation election, or relief for a late S corporation election and a late corporate classification election, under Rev. Proc. 97-48, Rev. Proc. 2003-43, or Rev. Proc. 2004-48, as appropriate, the entity may request relief by requesting a letter ruling. The Service will not ordinarily issue a letter ruling if the period of limitations on assessment under § 6501(a) has lapsed for any taxable year for which an election should have been made or any taxable year that would have been affected by the election had it been timely made. The procedural requirements for requesting a letter ruling are described in Rev. Proc. 2007-1, 2007-1 I.R.B. 1 (or its successor). SECTION 4. RELIEF FOR LATE S CORPORATION ELECTION UNDER THIS REVENUE PROCEDURE
.01 Eligibility for Relief. An entity may request relief under this revenue procedure if the following requirements are met: (1) The entity fails to qualify for its intended status as an S corporation on the first day that status was desired solely because of the failure to file a timely Form 2553 with the applicable campus; (2) The entity has reasonable cause for its failure to file a timely Form 2553; (3) The entity seeking to make the S corporation election has not filed a tax return for the first taxable year in which the election was intended; (4) The application for relief is filed under this revenue procedure no later than 6 months after the due date of the tax return (excluding extensions) of the entity seeking to make the election for the first taxable year in which the election was intended; and (5) No taxpayer whose tax liability or tax return would be affected by the S corporation election (including all shareholders of the S corporation) has reported inconsistently with the S corporation election, on any affected return for the year the S corporation election was intended.
.02 Procedural Requirements for Relief. An entity may request relief for a late S corporation election by filing with the applicable campus a properly completed Form 2553 (see Form 2553 and Instructions) with a Form 1120S for the first taxable year the entity intended to be an S corporation. A properly completed Form 2553 includes a statement establishing reasonable cause for the failure to file the S corporation election timely. The Form 2553 will be modified to allow for the inclusion of such statement. The forms must be filed together no later than 6 months after the due date of the tax return (excluding extensions) of the entity for the first taxable year in which the S corporation election was intended. These items constitute the application requesting relief.
.03 Relief for Late S Corporation Election. Upon receipt of a completed application requesting relief under section 4.02 of this revenue procedure, the Service will determine whether the requirements for granting relief for the late S corporation election have been satisfied.
SECTION 5. RELIEF FOR LATE S CORPORATION ELECTION AND LATE
CORPORATE CLASSIFICATION ELECTION UNDER THIS REVENUE PROCEDURE
.01 Eligibility for Relief. An entity may request relief under this revenue procedure if the following requirements are met:
(1) The entity is an eligible entity as defined in § 301.7701-3(a); (2) The entity intended to be classified as a corporation as of the intended effective date of the S corporation status; (3) The entity fails to qualify as a corporation solely because Form 8832 was not timely filed under § 301.7701-3(c)(1)(i), or Form 8832 was not deemed to have been filed under § 301.7701-3(c)(1)(v)(C);
(4) In addition to section 5.01(3) of this section, the entity fails to qualify as an S corporation on the intended effective date of the S corporation status solely because the S corporation election was not timely filed pursuant to § 1362(b); (5) The entity has reasonable cause for its failure to file a timely Form 2553 and a timely Form 8832; (6) The entity seeking to make the S corporation election has not filed a tax return for the first taxable year in which the election was intended; (7) The application for relief is filed under this revenue procedure no later than 6 months after the due date of the S corporation return (excluding extensions) of the entity seeking to make the election for the first taxable year in which the election was intended, and
(8) No taxpayer whose tax liability or tax return would be affected by the S corporation election (including all shareholders of the S corporation) has reported inconsistently with the S corporation election, on any affected return for the year the S corporation election was intended.
.02 Procedural Requirements for Relief. An entity may request relief for a late S corporation election and a late corporate classification election by filing a properly completed Form 2553 (see Form 2553 and Instructions) with a Form 1120S for the first taxable year the entity intended to be an S corporation. A properly completed Form 2553 includes a statement explaining the reason for the failure to file the S corporation election timely and a statement explaining the reason for the failure to file the entity classification election timely. The Form 2553 will be modified to allow for the inclusion of such statements. The forms must be filed together no later than 6 months after the due date of the tax return (excluding extensions) of the entity for the first taxable year in which the S corporation election was intended. These items constitute the application requesting relief. .03 Relief for Late S Corporation Election and Late Corporate Classification Election. Upon receipt of a completed application requesting relief under section 5.02 of this revenue procedure, the Service will determine whether the requirements for granting relief for the late S corporation election and late corporate classification election have been satisfied. An entity receiving relief under this revenue procedure is treated as having made an election to be classified as an association taxable as a corporation under § 301.7701-3(c) as of the effective date of the S corporation election.
SECTION 6. EFFECT ON OTHER DOCUMENTS
This revenue procedure supplements Rev. Procs. 2003-43 and 2004-48.
SECTION 7. EFFECTIVE DATE
This revenue procedure is effective for S corporation elections and corporate classification elections intended to be effective for taxable years that end on or after December 31, 2007.
SECTION 8. DRAFTING INFORMATION
The principal author of this revenue procedure is Jian H. Grant of the Office of the Associate Chief Counsel (Passthroughs and Special Industries). For further information regarding this revenue procedure, contact Ms. Grant at (202) 622-3050 (not a toll free call).
3.02 Relief if this Revenue Procedure is not Applicable. An
entity that does not meet the requirements for relief or is denied
relief under this revenue procedure may seek relief by requesting a
letter ruling. The procedural requirements for requesting a letter
ruling are described in Rev. Proc. 2004-1, 2004-1 I.R.B. 1., or its
successors.
4.01 Eligibility for Relief. An entity may request relief under
this revenue procedure if the following requirements are met:
(1) The entity is an eligible entity as defined in section 301.7701-3(a);
(2) The entity intended to be classified as a corporation as of the intended effective date of the S corporation status;
(3) The entity fails to qualify as a corporation solely because Form 8832 was not timely filed under section 301.7100-3(c)(1)(i), or Form 8832 was not deemed to have been filed under section 301.7701-3T(c)(1)(v)(C);
(4) In addition to section 4.01(3) of this section, the entity fails to qualify as an S corporation on the intended effective date of the S corporation status solely because the S corporation election was not filed timely pursuant to section 1362(b); and
(5) The entity has reasonable cause for its failure to file timely the S corporation election and the entity classification election.
4.02 Procedural Requirements for Relief. Within 6 months after the due date for the tax return, excluding extensions, for the first year the entity intended to be an S corporation), the corporation must file a properly completed Form 2553 with the applicable service center. The Form 2553 must state at the top of the document "FILED PURSUANT TO REV. PROC. 2004-48." Attached to the Form 2553 must be a statement explaining the reason for the failure to file timely the S corporation election and a statement explaining the reason for the failure to file timely the entity classification election.
4.03 Relief for Late S Corporation Election and Relief for a Late Corporate Classification Election. Upon receipt of a completed application requesting relief under section 4 of this revenue procedure, the Service will determine whether the requirements for granting additional time to file the elections have been satisfied and will notify the entity of the result of this determination. An entity receiving relief under this revenue procedure is treated as having made an election to be classified as an association taxable as a corporation under section 301.7701-3(c) as of the effective date of the S corporation election.
(1) The entity fails to qualify for its intended status as an S corporation, ESBT, QSST, or QSub on the first day that status was desired solely because of the failure to file the appropriate Election Under Subchapter S timely with the applicable service center;
(2) Less than 24 months have passed since the original Due Date of the Election Under Subchapter S;
(3) Either,
(a) the entity is seeking relief for a late S corporation or QSub election and the entity has reasonable cause for its failure to make the timely Election Under Subchapter S, or
(b) the S corporation and the entity are seeking relief for an inadvertent invalid S corporation election or an inadvertent termination of an S corporation election due to the failure to make the timely ESBT or QSST election and the failure to file the timely Election Under Subchapter S was inadvertent; and
(4) Either,
(a) all of the following requirements are met: (i) the entity seeking to make the election has not filed a tax return (in the case of QSubs, the parent has not filed a tax return) for the first year in which the election was intended, (ii) the application for relief is filed under this revenue procedure no later than 6 months after the due date of the tax return (excluding extensions) of the entity seeking to make the election (in the case of QSubs, the due date of the tax return of the parent) for the first year in which the election was intended, and, (iii) no taxpayer whose tax liability or tax return would be affected by the Election Under Subchapter S (including all shareholders of the S corporation) has reported inconsistently with the S corporation election (as well as any ESBT, QSST or QSub elections), on any affected return for the year the Election Under Subchapter S was intended; or
(b) all of the following requirements are met: (i) the entity seeking to make the election has filed a tax return (in the case of QSubs, the parent has filed a tax return) for the first year in which the election was intended within 6 months of the due date of the tax return (excluding extensions), and (ii) all taxpayers whose tax liability or tax returns would be affected by the Election Under Subchapter S (including all shareholders of the S corporation) have reported consistently with the S corporation election (as well as any ESBT, QSST or QSub elections), on all affected returns for the year the Election Under Subchapter S was intended, as well as for any subsequent years.
4.03 Procedural Requirements for Relief.
(1) Procedural Requirements When a Tax Return Has Not Been Filed for the First Year of the Intended Election Under Subchapter S. If the entity seeking the election has not filed a tax return for the first taxable year of the intended Election Under Subchapter S, the entity may request relief for the late Election Under Subchapter S by filing with the applicable service center the properly completed election form(s). The election form(s) must be filed within 18 months of the original Due Date of the intended Election Under Subchapter S (but in no event later than 6 months after the due date of the tax return (excluding extensions) of the entity (in the case of QSubs, the due date of the tax return of the parent) for the first year in which the election was intended) and must state at the top of the document "FILED PURSUANT TO REV. PROC. 2003-43." Attached to the election form must be a statement establishing either reasonable cause for the failure to file the Election Under Subchapter S timely (in the case of S corporation or QSub elections), or a statement establishing that the failure to file the Election Under Subchapter S timely was inadvertent (in the case of ESBT or QSST elections.)
(2) Procedural Requirements When a Tax Return Has Been Filed for the First Year of the Intended Election Under Subchapter S. If the entity seeking the election has filed a tax return for the first taxable year of the intended Election Under Subchapter S within 6 months of the due date of that tax return (excluding extensions), then the entity may request relief for the late Election Under Subchapter S by filing with the applicable service center the properly completed election form(s) and the supporting documents described below. The election form(s) must be filed within 24 months of the original Due Date for the Election Under Subchapter S and must state at the top of the document "FILED PURSUANT TO REV. PROC. 2003-43." Attached to the election form must be a statement establishing either reasonable cause for the failure to file the Election Under Subchapter S timely (in the case of S corporation or QSub elections), or a statement establishing that the failure to file the Election Under Subchapter S timely was inadvertent (in the case of ESBT or QSST elections.) The following additional documents must be attached to the election form (if applicable):
(a) S Corporations. An entity seeking relief for a late S corporation election must file a completed Form 2553, signed by an officer of the corporation authorized to sign and all persons who were shareholders at any time during the period that began on the first day of the taxable year for which the election is to be effective and ends on the day the election is made. The completed election form must include the following material:
(i) Statements from all shareholders during the period between the date the S corporation election was to have become effective and the date the completed election was filed that they have reported their income (on all affected returns) consistent with the S corporation election for the year the election should have been made and for all subsequent years; and
(ii) A dated declaration signed by an officer of the corporation authorized to sign which states: "Under penalties of perjury, I declare that, to the best of my knowledge and belief, the facts presented in support of this election are true, correct, and complete."
(b) ESBTs and QSSTs. The trustee of an ESBT or the current income beneficiary of a QSST must sign and file the appropriate election with the applicable service center. The completed election form must include the following material:
(i) A statement from the trustee of the ESBT or the current income beneficiary of the QSST that includes the information required by section 1.1361-1(m)(2)(ii) (in the case of ESBT elections) or section 1.1361-1(j)(6)(ii) (in the case of QSST elections);
(ii) In the case of a QSST, a statement from the trustee that the trust satisfies the QSST requirements of section 1361(d)(3) and that the income distribution requirements have been and will continue to be met;
(iii) In the case of an ESBT, a statement from the trustee that all potential current beneficiaries meet the shareholder requirements of section 1361(b)(1) and that the trust satisfies the requirements of an ESBT under section 1361(e)(1) other than the requirement to make an ESBT election;
(iv) A statement from the trustee of the ESBT or the current income beneficiary of the QSST that the beneficiary or trustee acted diligently to correct the mistake upon its discovery;
(v) Statements from all shareholders during the period between the date the S corporation election terminated or was to have become effective and the date the completed election was filed that they have reported their income (on all affected returns) consistent with the S corporation election for the year the election should have been made and for all subsequent years; and
(vi) A dated declaration, signed by the trustee of the ESBT or the current income beneficiary of the QSST which states: "Under penalties of perjury, I declare that, to the best of my knowledge and belief, the facts presented in support of this election are true, correct, and complete."
(c) QSubs. An S corporation seeking relief for a late QSub election for a subsidiary must file a completed Form 8869. The completed election form must include the following material:
(i) A statement that the corporation satisfies the QSub requirements of section 1361(b)(3)(B), and that all assets, liabilities, and items of income, deduction, and credit of the QSub have been treated as assets, liabilities, and items of income, deduction, and credit of the S corporation (on all affected returns) consistent with the QSub election for the year the election was intended and for all subsequent years;
(ii) A dated declaration signed by an officer of the S corporation authorized to sign which states: "Under penalties of perjury, I declare that, to the best of my knowledge and belief, the facts presented in support of this election are true, correct, and complete."
4.04 Relief for Late Election Under Subchapter S. Upon receipt of a completed application requesting relief under section 4.03 of this revenue procedure, the Service will determine whether the requirements for granting additional time to file the Election Under Subchapter S have been satisfied and will notify the entity of the result of this determination.
How should the payments/reimbursements be reported on the employee's W-2 and form 1040 and the S-corp's form 1120S?
Are payments/reimbursements totally tax-free fringe benefits?
Are payments/reimbursements included in gross wages?
Are the wages subject to FICA/Medicare?
Common
oversight - there are different rules for S corporation shareholders
holding more than 2% (as opposed to exactly 2% or less
than 2%) of the issued and outstanding stock.
Subject to the satisfaction of certain non-discrimination and other
requirements, (see, e.g., §§79(d), 105(h) and 125(b)) an
employer can provide certain types of fringe benefits to its employees
on a tax-free basis while deducting the cost of the fringe benefit.
Shareholder-employees of S corporations qualify for the exclusion of
these fringe benefit items from income, although a special restriction
applies to greater-than-2% shareholders. Self-employed persons
(i.e., sole proprietors or partners) generally are not entitled to
exclude fringe benefits from income, because the exclusion is limited
to employees, and a sole proprietor or partner is not considered an
"employee" for this purpose.
For fringe benefit purposes, an S corporation is treated as a
partnership, and each more-than-2% shareholder is treated as a
partner under §1372(a). Thus, certain fringe benefits that can
be provided on a tax-free basis to shareholder-employees of C
corporations cannot be provided on a tax-free basis to a
more-than-2% shareholder in an S corporation. Other employees of
an S corporation, however, are not affected by this rule and can
exclude the fringe benefits from income.
Example of "Indirect Ownership" - Husband owns all of the stock of an
S corporation. His wife is employed by the S-corp. The wife is
treated as a more-than-2% shareholder for purposes of the S
corporation fringe benefit rules, pursuant to §1372(b) & §318.
IR Code §1372. Partnership Rules To Apply For Fringe Benefit
Purposes
§1372(a) General Rule - For purposes of applying the
provisions of this subtitle which relate to employee fringe benefits--
§1372(a)(1) the S corporation shall be treated as a partnership, and
§1372(a)(2) any 2-percent shareholder of the S corporation shall be
treated as a partner of such partnership.
§1372(b) 2-Percent Shareholder
Defined
For purposes of this section,
the term "2-percent shareholder" means any person who owns
(or is considered as owning within the meaning of section 318) on any day
during the taxable year of the S corporation more than 2 percent
of the outstanding stock of such corporation or stock possessing more
than 2 percent of the total combined voting power of all stock of such
corporation. (Added Pub. L. 97-354, 2, Oct. 19, 1982, 96 Stat.
1682.)
Whether medical expenses and insurance premiums are subject to
FICA/Medicare depends on whether the payments are made pursuant to a
plan qualifying under IRC §3121(a)(2).
Medical expenses (see §105) and insurance premiums (see §106) paid for the benefit of 2%(exactly) S corporation shareholders and for persons holding less than 2% on the company's stock are separately deducted on Form 1120S (on page 1, line 18 "employee benefit programs") when the appropriate plan qualifying under IRC §3121(a)(2) has been established.
Medical expenses and insurance premiums paid for a more than 2% shareholder are not separately deducted Form 1120S page 1, line 18. Rather, these items are included as a salary deduction on page 1, line 7 of Form 1120S, and are also included on the shareholder's Form W-2 as income . These items are only shown as supplemental information on form 1120S, Schedules K and K-1 so that the shareholder may be reminded to deduct the health insurance on Form 1040, page 1, line 29 (for 2007) and deduct the medical expenses on Schedule A, line 1. For the W-2 wages to be excluded from Social Security and Medicare taxes the payments must be made pursuant to a plan qualifying under IRC §3121(a)(2) which is non-discriminatory pursuant to IRC §105(h).
Q.
As is quite common, the corporation forgets to include
medical expenses and insurance premiums for more than 2% shareholder
on any payroll tax returns (forms 940, 941 W-2 and related State forms
and disability insurance forms), or taken as a salary deduction on the
books. In this situation, may the corporation simply report
these items as "Other Deductions" on Schedules K and K-1?
A.
When the maximum amount of Social Security tax has already been
paid or withheld by the shareholder, and otherwise reporting in this
manner does not place the corporation or shareholder in jeopardy for
underpaid payroll taxes, then this might be a solution. Of
course, an obvious problem remains: Medicaid tax would still be
underpaid, and State withholding tax may be underwithheld.
But see below for another opinion:
Some "double talk" to be aware of:
Generally, fringe benefits which are treated as compensation to a
2%-or-more shareholder are subject to payroll (i.e., FICA and FUTA)
withholding. But see §3121(a)(2)(C). Section 3121(a)(2) provides
that these amounts are not subject to Social Security and Medicare
taxes if the payments are made under a plan or system for employees or
a class of employees. See Announcement 92-16, 1992-5 I.R.B. 53.
Announcement 92-16, 1992-5 I.R.B. 53
FICA Taxation of Health Insurance Premiums for 2%-Shareholder-Employees of S Corporations
Announcement 92-16
In response to taxpayer questions, this Internal Revenue Service announcement is intended to clarify the social security and Medicare tax treatment of accident and health insurance premiums paid by an S corporation on behalf of 2%-shareholder-employees.
On April 15, 1991, the Service published Revenue Ruling 91-26, 1991-1 C.B. 184, regarding employer-provided accident and health insurance for S corporations and 2%-shareholder-employees. Revenue Ruling 91-26 indicates that amounts paid by an S corporation for accident and health insurance covering a 2%-shareholder-employee must be reported as wages on his or her Form W-2, Wage and Tax Statement.
Revenue Ruling 91-26 does not directly address the treatment of the amounts for such purposes. The Service has been asked whether these amounts are wages for purposes of social security and Medicare taxes. The facts presented in the ruling are insufficient to ascertain whether tax would be imposed in these circumstances. A basic analysis is provided below to assist taxpayers.
Like other employees of an S corporation, 2%-shareholder employees are subject to social security and Medicare taxes on "wages" paid to them by the corporation. The term "wages" generally includes fringe benefits provided in cash or in kind to an employee. However, under section 3121(a) of the Code certain payments are expressly excluded from "wages" for purpose of social security and Medicare taxes.
Section 3121(a)(2)(B) excludes from wages certain amounts paid by an employer to or on behalf of an employee (including amounts paid by an employer for insurance, annuities, or into a fund) for medical and hospitalization expense in connection with sickness or accident disability. For this exclusion to apply, the payments must be made under a plan or system for employees and their dependents generally or for a class (or classes) of employees and their dependents. Thus, whether amounts of this type are actually subject to social security or Medicare tax depends on whether in the particular case the taxpayer satisfies the requirements for the exclusion.
If the requirements for the exclusion under section 3121(a)(2)(B) are satisfied, amounts paid by an S corporation for accident and health insurance covering a 2%-shareholder-employee are not wages for social security and Medicare tax purposes, even though the amounts must be included in wages for income tax withholding purposes on the 2%-shareholder-employee's Form W-2.
On the other hand, if the requirements for an exclusion are not satisfied, amounts paid by an S corporation for accident and health insurance covering a 2%-shareholder-employee must be included in wages for social security and Medical tax purposes, as well as for income tax withholding purposes, and reported in the appropriate boxes on the 2%-shareholder-employee's Form W-2.
IRS Notice 2008-1, 2008-2 I.R.B. 251 (1/14/2008)
Part III - Administrative, Procedural, and Miscellaneous
Special Rules for Health Insurance Costs of 2-Percent
Shareholder-Employees
PURPOSE
This notice provides rules under
which a 2-percent (sic)
shareholder-employee in an S corporation is entitled to the deduction
under §26 USC 162(l) of the Internal Revenue Code for accident and health insurance premiums
that are paid or reimbursed by the S corporation and included in the
2-percent shareholder-employee's gross income.
LAW AND ANALYSIS
Section 26 USC 1372(a) provides
that, for purposes of applying the income tax provisions of the Code
relating to employee fringe benefits, an S corporation shall be
treated as a partnership, and any 2-percent shareholder of the S
corporation shall be treated as a partner of such partnership. For
purposes of §26 USC 1372, the term "2-percent shareholder" is any
person who owns (or is considered as owning within the meaning of §26
USC 318)on any day during the taxable year of the S corporation more than 2 percent
of the outstanding stock of such corporation or stock possessing more
than 2 percent of the total combined voting power of all stock of such
corporation. Section 26 USC 1372(b).
Accident and health insurance premiums paid or furnished by an S
corporation on behalf of its 2-percent shareholders in
consideration for services rendered are treated for income tax
purposes like partnership guaranteed payments under §26 USC
707(c) of the Code. Rev. Rul. 91-26, 1991-1 C.B. 184. An S corporation
is entitled to deduct the cost of such employee fringe benefits under
§26 USC 162(a) if the requirements of that section are satisfied
(taking into account the rules of §26 USC 263). The premium payments are included in
wages for income tax withholding purposes on the
shareholder-employee's Form W-2, Wage and Tax Statement, but are not
wages subject to Social Security and Medicare taxes if the
requirements for exclusion under section 26 USC 3121(a)(2)(B) are satisfied.
See §26 USC 3121(a)(2)(B); Ann. 92-16, 1992-5 I.R.B. 53. The 2-percent
shareholder is required to include the amount of the accident and
health insurance premiums in gross income under §26 USC 61(a).
Section 26 USC 106 provides an exclusion from the gross income of an
employee for employer-provided coverage under an accident and health
plan. A 2-percent shareholder is not an employee for purposes of §26
USC 106. Treas. Reg. §26 CFR 1.106-1; section 26 USC 1372(a).
Accordingly, the premiums are
not excludible from the 2-percent shareholder-employee's gross income
under §26 USC 106.
Section 26 USC 162(l)(1)(A) allows an individual who is an employee
within the meaning of §26 USC 401(c)(1) to take a deduction in computing adjusted gross
income for amounts paid during the taxable year for insurance that
constitutes medical care for the taxpayer,
his or her spouse, and dependents. The deduction is not allowed to the
extent that the amount of the deduction exceeds the earned income
(within the meaning of section 26 USC 401(c)(2)) derived by the
taxpayer from the trade
or business with respect to
which the plan providing the medical care coverage is established.
Section 26 USC 162(l)(2)(A). Also, the deduction is not allowed for amounts during a month in which the
taxpayer is eligible to participate in any subsidized health plan
maintained by an employer of the taxpayer or of the spouse of the
taxpayer. Section 26 USC
162(l)(2)(B).
A 2-percent shareholder-employee in an
S corporation, who otherwise meets the requirements of section 26 USC
162(l), is eligible for the
deduction under section 26 USC
162(l) if the plan providing
medical care coverage for the 2-percent shareholder-employee is
established by the S corporation.
Rev. Rul. 91-26, 1991-1 C.B. 184. A plan providing medical care
coverage for the 2-percent shareholder-employee in an S corporation is
established by the S corporation if:
If the accident and health insurance premiums are not paid or
reimbursed by the S corporation and included in the 2-percent
shareholder-employee's gross income, a plan providing medical care
coverage for the 2-percent shareholder-employee is not
established by the S corporation and the 2-percent
shareholder-employee in an S corporation is not allowed the deduction
under §26 USC 162(l).
In order for the 2-pecent shareholder-employee to deduct the amount of
the accident and health insurance premiums, the S corporation must report the
accident and health insurance premiums paid or reimbursed as wages
on the 2-percent shareholder-employee's Form W-2 in that same year. In
addition, the shareholder must report the premium payments or
reimbursements from the S corporation as gross income on his or her
Form 1040, U.S. Individual Income Tax Return.
EXAMPLES
The following examples
illustrate these rules. The following examples assume that each
shareholder is a 2-percent shareholder-employee in an S corporation,
whose earned income from the S corporation exceeds the amount of the
premiums for the accident and health insurance policies covering the
shareholder, his or her spouse and dependents.
None of the
shareholders in the following examples are eligible to participate in
any subsidized health plan maintained by an employer of the
shareholder or the shareholder's spouse.
Example 1. (i) For 2008, shareholder
A obtains an accident and health insurance policy in the name of
shareholder A and makes the
premium payments on the policy.
The S corporation makes no
payments or reimbursements with
respect to the premiums.
(ii) A plan providing medical care for shareholder A is not
established by the S corporation and shareholder
A is not entitled to the deduction
under §26 USC 162(l).
Example 2. (i) For
2008, the S corporation obtains an accident and health insurance plan in the name of the S
corporation. The health plan
provides coverage for shareholder B, B's spouse and dependents.
The S corporation makes all
the premium payments to the
insurance company. The S
corporation reports the amount of the premiums as wages
on shareholder B's Form W-2 for 2008 and
shareholder B reports that
amount as gross income on Form 1040 for 2008.
(ii) A plan providing medical care for shareholder B has been
established by the S corporation and
shareholder B is allowed the deduction under §26 USC 162(l) for 2008.
Example 3. (i) For 2008, shareholder
C obtains an accident and health insurance policy in the name of
shareholder C. The S corporation
makes all the premium payments
to the insurance company. The S
corporation reports the amount of the premiums as wages
on shareholder C's Form W-2 for 2008 and
shareholder C reports that
amount as gross income on Form 1040 for 2008.
(ii) A plan providing medical care for shareholder C has been
established by the S corporation and
shareholder C is allowed the deduction
under §26 USC 162(l) for 2008.
Example 4. (i) For 2008, shareholder
D obtains an accident and health insurance policy in the name of
shareholder D. Shareholder D
makes the premium payments to
the insurance company and furnishes proof of premium payment to the S
corporation. The S corporation
then reimburses shareholder D
for the premium payments. The S
corporation reports the amount of the premium reimbursements as wages
on shareholder D's Form W-2 for 2008 and
shareholder D reports that
amount as gross income on Form 1040 for 2008.
(ii) A plan providing medical care for shareholder D has been
established by the S corporation and shareholder
D is allowed the deduction
under §26 USC 162(l) for 2008.
Rev. Rul. 91-26, 1991-1 C.B. 184 Clarified by Ann. 92-16.
ISSUES
1. If a partner performs services in the capacity of a partner and the partnership pays accident and health insurance premiums for current year coverage on behalf of such partner without regard to partnership income, what is the Federal income tax treatment of the premium payments?
2. If an S corporation pays accident and health insurance premiums for current year coverage on behalf of a 2-percent shareholder-employee, what is the Federal income tax treatment of the premium payments?
FACTS
SITUATION 1. AB is a partnership in which individuals A and B are equal partners. During 1989, AB paid accident and health insurance premiums for 1989 coverage on behalf of each partner under AB's accident and health plan.
The premiums paid by AB on behalf of A and B were for services rendered by A and B in their capacities as partners and were payable without regard to partnership income. The premiums paid by AB would qualify as ordinary and necessary business expenses under section 26 USC 162(a) of the Code if paid by AB on behalf of individuals who were not partners of AB. The value of the premiums to A and B is equal to the cost of the premiums paid on behalf of A and B, respectively.
SITUATION 2. X corporation made a valid election to be an S corporation under section 26 USC 1362 of the Code effective for its taxable year beginning January 1, 1989. Three individuals own X's stock in the following proportions: C, 51 percent; D, 48 percent; and E, 1 percent. C, D, and E are also employees of X.
During 1989, X paid accident and health insurance premiums for 1989 coverage on behalf of each of its employees under X's accident and health plan. The premiums paid by X would qualify as ordinary and necessary business expenses under section 26 USC 162(a) of the Code if paid by X on behalf of individuals who were not "2-percent shareholders."The value of the premiums to C, D, and E is equal to the cost of the premiums paid on behalf of C, D, and E, respectively.
LAW AND ANALYSIS
Section 26 USC 106 of the Code excludes from the gross income of an employee coverage provided by an employer under an accident or health plan.
Section 26 USC 162(l) of the Code allows as a deduction, in the case of an individual who is an employee within the meaning of section 26 USC 401(c)(1), an amount equal to 25 percent of the amount paid during the taxable year for insurance that constitutes medical care for the individual and the individual's spouse and dependents. This provision applies to taxable years beginning after December 31, 1986, and before January 1, 1992.
Section 26 USC 401(c)(1) of the Code treats certain self-employed individuals as employees. Section 26 USC 401(c)(1)(B) defines a "self- employed individual,"with respect to any taxable year, as an individual who has earned income (as defined in section 26 USC 401(c)(2)) for the taxable year. Section 26 USC 401(c)(2) defines "earned income" as, in general, the net earnings from self-employment as defined in section 26 USC 1402(a). Under section 26 USC 1402(a), the term net earnings from self-employment is defined to include, with certain specified exceptions, a partner's distributive share of income or loss described in section 26 USC 702(a)(8) from any trade or business carried on by a partnership in which the individual is a partner. Guaranteed payments to a partner for services also are included in net earnings from self-employment. In addition, section 26 USC 162(l)(5)(A) provides that, for purposes of section 26 USC 162(l), if a shareholder owns more than 2 percent of the outstanding stock of an S corporation, the shareholder's wages (as defined in section 26 USC 3121) from the S corporation are treated as "earned income" within the meaning of section 26 USC 401(c)(1).
SITUATION 1. (Partnerships and most LLC's)
Section 26 USC 707(c) of the Code provides that payments to a partner for services, to the extent the payments are determined without regard to the income of the partnership, are considered as made to one who is not a member of the partnership, but only for purposes of section 26 USC 61(a) (relating to gross income) and, subject to section 26 USC 263 (prohibiting deductions for capital expenditures), for purposes of section 26 USC 162(a) (relating to trade or business expenses). These payments are termed "guaranteed payments."
Section 26 CFR 1.707-1(c) of the Income Tax Regulations provides that for a guaranteed payment under section 26 USC 707(c) of the Code to be deductible by the partnership, it must meet the same tests under section 26 USC 162(a) as it would if the payment had been made to a person who was not a member of the partnership. Generally, for purposes of Code provisions other than sections 26 USC 61(a) and 26 USC 162(a), guaranteed payments are treated as a partner's distributive share of ordinary income. The regulation states, by way of an illustration, that a partner who receives guaranteed payments is not entitled to exclude them from gross income as disability payments under section 26 USC 105(d) (as in effect prior to its repeal by section 122(b) of the Social Security Amendments of 1983, Pub. L. No. 98-21, 1983-2 C.B. 309, 315). The regulation also provides that a partner who receives guaranteed payments is not, by virtue of the payments, regarded as an employee of the partnership for purposes of withholding of tax at source, deferred compensation plans, and other purposes.
Amounts paid in cash or in kind by a partnership, without regard to its income, to or for the benefit of its partners, for services rendered in their capacities as partners, are guaranteed payments under section 26 USC 707(c) of the Code. A partnership is entitled to deduct such cash amounts, or the cost to the partnership of such in-kind benefits, under section 26 USC 162(a), if the requirements of that section are satisfied (taking into account the rules of section 26 USC 263). Under section 26 USC 61(a), the cash amount or the value of the benefit is included in the income of the recipient-partner. The cash amount or value of the benefit is not excludible from the partner's gross income under the general fringe benefit rules (except to the extent the Code provision allowing exclusion of a fringe benefit specifically provides that it applies to partners) because the benefit is treated as a distributive share of partnership income under section 26 CFR 1.707-1(c) of the regulations for purposes of all Code sections other than sections 26 USC 61(a) and 26 USC 162(a), and a partner is treated as self-employed to the extent of his or her distributive share of income. Section 26 USC 1402(a). See also Rev. Rul. 69-184, 1969-1 C.B. 256 (employment taxes); cf. section 26 USC 401(c), which recognizes that partners are self-employed individuals but treats them as employees for certain limited purposes.
Therefore, AB may deduct under section 26 USC 162(a) of the Code (subject to section 26 USC 263) the cost of the accident and health insurance premiums paid on behalf of A and B. A and B may not exclude the cost of the premiums from their gross income under section 26 USC 106, but must include the cost of the premiums in gross income under section 26 USC 61(a). Provided all the requirements of section 26 USC 162(l) are met, however, A and B may deduct the cost of the premiums to the extent provided by section 26 USC 162(l).
A partnership may account for accident and health insurance premiums paid on behalf of a partner as a reduction in distributions to the partner. Under these circumstances, the premiums are not deductible by the partnership, so distributive shares of partnership income and deduction (and other payment items) are not affected by payment of the premiums. A partner may deduct the cost of the premiums paid on that partner's behalf to the extent allowed under section 26 USC 162(l).
SITUATION 2. (S-Corporations)
Section 26 USC 1372 of the Code provides that, for purposes of applying the income tax provisions of the Code relating to employee fringe benefits, an S corporation shall be treated as a partnership, and any person who is a "2-percent shareholder" of the S corporation shall be treated like a partner of a partnership. Section 26 USC 1372(b) defines a "2-percent shareholder" as any person who owns (or is considered as owning within the meaning of section 26 USC 318) on any day during the taxable year of the S corporation more than 2 percent of the outstanding stock of the corporation or stock possessing more than 2 percent of the total combined voting power of all stock in the corporation.
Under section 26 USC 1372 of the Code, for purposes of applying the provisions of the Code relating to employee fringe benefits, a 2- percent shareholder who is also an employee of an S corporation is treated like a partner of a partnership. Employee fringe benefits paid or furnished by an S corporation to or for the benefit of its 2- percent shareholder-employees in consideration for services rendered, therefore, are treated for income tax purposes like partnership guaranteed payments under section 26 USC 707(c). An S corporation is entitled to deduct the cost of such employee fringe benefits under section 26 USC 162(a) if the requirements of that section are satisfied (taking into account the rules of section 26 USC 263). Like a partner, a 2- percent shareholder is required to include the value of such benefits in gross income under section 26 USC 61(a) and is not entitled to exclude such benefits from gross income under provisions of the Code permitting the exclusion of employee fringe benefits (except to the extent the Code provision allowing exclusion of a fringe benefit specifically provides that it applies to partners).
Therefore, X may deduct under section 26 USC 162(a) of the Code the cost of the accident and health insurance premiums paid on behalf of C, D, and E. C and D may not exclude the cost of the premiums from their gross income under section 26 USC 106, but must include the cost of the premiums in gross income under section 26 USC 61(a). Provided all the requirements of section 26 USC 162(l) are met, however, C and D may deduct the cost of the premiums to the extent provided by section 26 USC 162(l). E (who does not own more than 2 percent of X's stock) may exclude from gross income under section 26 USC 106 the cost of the premiums paid by X on E's behalf.
Unlike a partnership, an S corporation may not account for accident and health insurance premiums paid on behalf of a shareholder-employee as a reduction in distributions to the shareholder-employee because the shareholder-employee's pro rata share of S corporation income would not be subject to employment taxes.
HOLDINGS
1. Accident and health insurance premiums paid by a partnership on behalf of a partner are guaranteed payments under section 26 USC 707(c) of the Code if the premiums are paid for services rendered in the capacity of partner and to the extent the premiums are determined without regard to partnership income. As guaranteed payments, the premiums are deductible by the partnership under section 26 USC 162 (subject to the capitalization rules of section 26 USC 263) and includible in the recipient-partner's gross income under section 26 USC 61. The premiums are not excludible from the recipient-partner's gross income under section 26 USC 106;however, provided all the requirements of section 26 USC 162(l) are met, the partner may deduct the cost of the premiums to the extent provided by section 26 USC 162(l).
A partnership must report the cost of accident and health insurance premiums that are guaranteed payments on its U.S. Partnership Return of Income (Form 1065) and the Schedule K-1s. A partnership is not required to file a Form 1099 or a Wage and Tax Statement (Form W-2) for accident and health insurance premiums that are guaranteed payments.
2. Under section 26 USC 1372 of the Code, accident and health insurance premiums paid by an S corporation on behalf of a 2-percent shareholder-employee as consideration for services rendered are treated like guaranteed payments under section 26 USC 707(c) of the Code. Therefore, the premiums are deductible by the corporation under section 26 USC 162 (subject to the capitalization rules of section 26 USC 263), and includible in the recipient shareholder-employee's gross income under section 26 USC 61. The premiums are not excludible from the recipient shareholder-employee's gross income under section 26 USC 106;however, provided all the requirements of section 26 USC 162(l) are met, the shareholder-employee may deduct the cost of the premiums to the extent provided by section 26 USC 162(l).
An S corporation may deduct as salary and wages accident and health insurance premiums paid on behalf of its 2-percent shareholder-employees on its U.S. Income Tax Return for an S Corporation. The S corporation is required to file a Wage and Tax Statement (Form W-2) for each 2-percent shareholder-employee. The Form W-2 must include for a 2-percent shareholder-employee the cost of accident and health insurance premiums paid on behalf of the shareholder-employee in the shareholder-employee's wages.
EFFECT ON OTHER REVENUE RULINGS
Rev. Rul. 72-596, 1972-2 C.B. 395, concerns the deductibility under section 162 of the Code of premiums paid by a partnership on behalf of its partners for workmen's compensation insurance. Rev. Rul. 72-596 relies on the general rule that a partner is not an employee and suggests that workmen's compensation premiums are deductible by the partnership only if paid on behalf of an employee.
The partners in Rev. Rul. 72-596 were acting in their capacities as partners and the workmen's compensation premiums were payable without regard to partnership income. Thus, the premiums are guaranteed payments under section 26 USC 707(c) of the Code, and as such are deductible by the partnership under section 26 USC 162 (if the requirements of that section are satisfied) and includible in the incomes of the partners under section 26 USC 61. Rev. Rul. 72-596 is incorrect to the extent it concludes otherwise. Rev. Rul. 72-596 is revoked.
ADMINISTRATIVE RELIEF
For S corporation tax years beginning before January 1, 1991, the Service will not challenge the treatment of accident and health insurance premiums paid by S corporations for 2-percent shareholder- employees in accordance with the instructions to the Form 1120S and Schedule K-1 to the Form 1120S. These instructions provide that such fringe benefits are nondeductible by the S corporation and cannot be treated as deductible or excludable employee fringe benefits (except for benefits allowed partners, such as section 26 USC 162(l)).
The Service does not consider payments of accident and health insurance premiums by an S corporation on behalf of 2-percent shareholder-employees to be distributions for purposes of the single class of stock requirement of section 26 USC 1361(b)(1)(D).
However, for open account debt,
additional advances restore zero-basis or low-basis loans repaid
during the year. Under Regs. Sec. 1.1367-2(b)(1), basis for open
account debt is determined at the close of the year. Thus, advances
and repayments are netted throughout the year; the final
determination of debt basis for open account debt is determined at
the dose of the year. This provision allows S shareholders time to
make a corrective loan before the end of the year to restore debt
basis.
In a court decision, Brooks, TC Memo 2005-204, S shareholders
advanced money to their S-corporation in one year, using those
advances to enable them to deduct the corporate losses. Then at the
beginning of the subsequent year the corporation repaid the loans.
Then before the end of the year, the shareholders made additional
loans to restore debt basis. This situation continued over several
years, allowing the shareholders to defer income recognition
indefinitely.
Under Prop. Regs. Sec. 1.1367-2(a) (2)(ii), the shareholder must
maintain a daily running log to account for the open account debt.
If, at any point during the S corporation's tax year, the aggregate
balance of the open account debt exceeds $10,000, it is treated in
the same way as debt evidenced by a note. The resulting debt
repayments are treated in this manner for the loan's remaining life;
see Prop. Regs. Sec. 1.1367-2(d)(2)(ii).
Effect on open account debt: By limiting the definition of open
account debt, the proposed regulations minimize S shareholders'
ability to defer income recognition. Shareholders now must bear the
administrative burden of maintaining a daily log to record advances
and repayments on open account debt.
Below is a list of options that taxpayers can use in light of the
proposed regulations:
Effective October 20, 2008 (T.D.
9428):
Regulations apply to any and all shareholder advances to the S
corporation made on or after October 20, 2008, and repayments on
those advances by the S corporation.
Treasury Department and the IRS have concluded that the aggregate
principal threshold dollar amount for open account debt should be
increased and that other changes are necessary. Therefore, the final
regulations adopt a $25,000 aggregate principal threshold amount per
shareholder for open account debt. For example, an S corporation
with ten shareholders could receive up to $250,000 of open account
debt as long as no single shareholder advanced more than $25,000.
The Treasury Department and the IRS believe that the $25,000
threshold, together with certain other changes noted below, balances
concerns over deferral potential with normal business practices.
Under the final regulations, for any particular shareholder advances
and repayments on those advances for which, as of the specified
determination date, the aggregate principal balance exceeds the
$25,000 aggregate principal threshold amount will no longer
constitute open account debt, but instead will be treated as debt
evidenced by a separate written instrument subject to the basis
adjustment and repayment accounting rules applicable to S
corporation shareholder debt generally.
http://goliath.ecnext.com/coms2/gi_0199-3165763/S-corporation-elections-guide.html
http://www.docstoc.com/docs/1036730/S-Corporation-Elections-Guide---1
http://www.allbusiness.com/legal/laws-government-regulations/370149-1.html
http://tax.aicpa.org/Resources/S+Corporations/
1.1367-1(f) Ordering Rules For Taxable Years Beginning On Or After
August 18, 1998.
For any taxable year of a corporation beginning on or after August
18, 1998, except as provided in paragraph (g) of this section, the
adjustments required by section 1367(a) are made in the following
order--
1.1367-1(f)(1)
Any increase in basis attributable to the income items described
in section 1367(a)(1)(A) and (B), and the excess of the deductions
for depletion described in section 1367(a)(1)(C);
1.1367-1(f)(2)
Any decrease in basis attributable to a distribution by the
corporation described in section 1367(a)(2)(A);
1.1367-1(f)(3)
Any decrease in basis attributable to noncapital, nondeductible
expenses described in section
1367(a)(2)(D),
and the oil and gas depletion deduction described in section
1367(a)(2)(E); and
1.1367-1(f)(4)
Any decrease in basis attributable to items of loss or deduction
described in section
1367(a)(2)(B) and (C).
1.1367-1(g) Elective
Ordering Rule.
A shareholder may elect to decrease basis under paragraph (e)(3)
or (f)(4) of this section, whichever applies, prior to decreasing
basis under paragraph (e)(2) or (f)(3) of this section, whichever
applies. If a shareholder makes this election, any amount
described in paragraph (e)(2) or (f)(3) of this section, whichever
applies, that is in excess of the shareholder's basis in stock and
indebtedness is treated, solely for purposes of this section, as
an amount described in paragraph (e)(2) or (f)(3) of this section,
whichever applies, in the succeeding taxable year.
A shareholder makes the election
under this paragraph by attaching a statement to the shareholder's
timely filed original or amended return that states that the
shareholder agrees to the carryover rule of the preceding
sentence. Once a shareholder
makes an election under this paragraph with respect to an S
corporation, the shareholder must continue to use the rules of
this paragraph for that S corporation in future taxable years
unless the shareholder receives the permission of the
Commissioner.
1367(a) General Rule
1367(a)(1) Increases In Basis
The basis of each shareholder's stock in an S corporation
shall be increased for any period by the sum of the following
items determined with respect to that shareholder for such period:
1367(a)(1)(A) the items of income described in subparagraph (A) of
section 1366(a)(1),
1367(a)(1)(B) any nonseparately computed income determined under
subparagraph (B) of section 1366(a)(1), and
1367(a)(1)(C) the excess of the deductions for depletion over the
basis of the property subject to depletion.
1367(a)(2) Decreases In Basis
The basis of each shareholder's stock in an S corporation
shall be decreased for any period (but not below zero) by the sum
of the following items determined with respect to the shareholder
for such period:
1367(a)(2)(A) distributions by the corporation which were not
includible in the income of the shareholder by reason of section
1368,
1367(a)(2)(B) the items of
loss and deduction described in subparagraph (A) of section
1366(a)(1),
1367(a)(2)(C)
any nonseparately computed loss determined under subparagraph (B)
of section 1366(a)(1),
1367(a)(2)(D) any expense of
the corporation not deductible in computing its taxable income and
not properly chargeable to capital account,
and
1367(a)(2)(E) the amount of the shareholder's deduction for
depletion for any oil and gas property held by the S corporation
to the extent such deduction does not exceed the proportionate
share of the adjusted basis of such property allocated to such
shareholder under section 613A(c)(11)(B).
The decrease under subparagraph (B) by reason of a charitable
contribution (as defined in section 170(c)) of property shall be
the amount equal to the shareholder's pro rata share of the
adjusted basis of such property. The preceding sentence shall not
apply to contributions made in taxable years beginning after
December 31, 2009.
Nine nonexclusive factors listed in Publication 535 Business Expenses show what the IRS looks to to determine if an activity is a "trade or business:"
also see: http://www.traderstatus.com/entities.htm#parttime
§1.469-2T(c)(3) Items of
portfolio income specifically excluded
§1.469-2T(c)(3)(i) In general. --Passive activity gross income does
not include portfolio income. For purposes of the preceding sentence,
portfolio income includes all gross income, other than income derived
in the ordinary course of a trade or business (within the meaning of
paragraph (c)(3)(ii) of this section), that is attributable to --
§1.469-2T(c)(3)(ii) Gross income derived in the ordinary course of a
trade or business. --Solely for purposes of paragraph (c)(3)(i) of
this section, gross income derived in the ordinary course of a trade
or business includes only --
§1.469-2T(c)(3)(ii)(D)
Income or gain derived in the ordinary course of an activity of
trading or dealing in any property if such activity constitutes a
trade or business (but see paragraph (c)(3)(iii)(A) of this section);
§1.469-2T(c)(3)(iii) Special rules
§1.469-2T(c)(3)(iii)(A) Income from property held for investment by
dealer. --For purposes of paragraph (c)(3)(i) of this section, a
dealer's income or gain from an item of property is not derived by the
dealer in the ordinary course of a trade or business of dealing in
such property if the dealer held the property for investment at any
time before such income or gain is recognized.
Paul
D Garnett & Alicia Garnett v. Comr of the Internal Revenue, 132 TC No
19 June 30, 2009
The individual participates in the activity for more than "500
hours" during such year;
The individual's participation in the activity for the taxable year
constitutes "substantially all" of the participation in such
activity of all individuals (including individuals who are not
owners of interests in the activity) for such year;
The individual participates in the activity for more than "100
hours" during the taxable year, and such individual's participation
in the activity for the taxable year is not less than the
participation in the activity of any other individual (including
individuals who are not owners of interests in the activity) for
such year;
The activity is a "significant participation activity" for the
taxable year, and the individual's aggregate participation in all
significant participation activities during such year exceeds 500
hours;
The individual materially participated in the activity for any five
taxable years (whether or not consecutive) during the ten taxable
years that immediately precede the taxable year;
The activity is a personal service activity, and the individual
materially participated in the activity for any three taxable years
(whether or not consecutive) preceding the taxable year; (A personal
service activity is an activity that involves (1) the performance of
personal services in the fields of health, law, engineering,
architecture, accounting, actuarial science, performing arts or
consulting, or (2) any other trade or business in which capital is
not a material income-producing factor) or
Based on all of the facts and circumstances if the individual
participates in the activity on a regular, continuous, and
substantial basis during such year. The regulations establish 100+
hours as the minimum number for participation in an activity under
this test, if an individual participates in the activity for 100
hours or less during the taxable year, he cannot be treated as
materially participating in the activity for the taxable year under
the facts and circumstances test.
For married taxpayers, any
participation by your spouse in the activity during the year is
treated as participation by you under all the above tests for material
participation. This rule applies even if the spouse does not own an
interest in the activity and even if the spouses do not file a joint
return for the taxable year. There is no other attribution of hours
for work done by other family members.
It is important to determine what
work constitutes "participation" by an individual, to apply the first
six material participation tests. In general, any work done by an
individual in any capacity in connection with an activity in which the
individual owns an interest at the time the work is done is treated as
participation of the individual in the activity. Such ownership
interest may be indirect, as long as it is not through a C
corporation.
There are a couple important
exceptions to the above rules that any work done in any capacity is
treated as participation.
Work done in connection with an activity is not treated as
participation if the work is not of a type customarily done by an
owner of such an activity and one of the principal purposes for the
performance of the work is to avoid the disallowance of losses or
credits under the passive loss rules.
Work done by an individual in the individual's capacity as an
investor in an activity is not treated as participation in the
activity unless the individual is directly involved in the
day-to-day management of the activity. Work done as an investor in
an activity includes, for example, time spent studying and reviewing
financial statements or reports on an activity, preparing studies or
analyses of the activity's finances or operations for the investor's
own use, or monitoring the activity's finances or operations in a
nonmanagerial capacity.
A trader may establish his
participation in an activity by any reasonable means. Reasonable
would mean the identification of your activities performed over a
period of time and the number of hours spent based on daybooks,
spreadsheets or contemporaneously maintained summaries. An individual
is not required to maintain contemporaneous daily time reports, logs
or similar documents, provided he can otherwise substantiate the level
of his participation in an activity. While the substantiation rule
appears pretty liberal, taxpayers should keep careful records whenever
at all possible. Taxpayers carry the burden of proving the amount of
participation when challenged and so accurate detailed records will
help meet this burden. (Rule 142(a), Tax Court Rules of Practice and
Procedure.)
In light of the above the safest
bet might be to make sure you meet the first test and well document
that you actively trade for at least 500 hours each year. Ideally
these hours would be spread evenly throughout the year, say at least
10 hours per week. Treatment of Mark-to-Market Gains of Electing Traders
The Bill clarifies that, for securities or commodities traders, gain
or loss that is treated as ordinary solely by reason of election of
mark-to-market treatment is not treated as other than gain or loss
from a capital asset for purposes of determining net-earnings from
self-employment for Self-Employment Contributions Act tax purposes or
for purposes of determining whether the passive type income exception
to the publicly-traded partnership rules is met.
The provision applies to taxable years of electing securities and
commodities traders ending after August 5, 1997, the date of enactment
of the 1997 Act.
[Bill §6010(a)(3); Code §475(f)(1)(D)] Limited partner for self-employment tax purposes:
Definition of.
REG-209824-96 INTERNAL REVENUE
SERVICE NOTICE OF PROPOSED RULEMAKING AND PUBLIC HEARING
(REG-209824-96) ON DEFINITION OF LIMITED PARTNER FOR SELF-EMPLOYMENT
TAX PURPOSES, ISSUED JAN. 10, 1997 ACTION: Notice of proposed
rulemaking and notice of public
hearing. SUMMARY: This document contains proposed amendments to the regulations
relating to the self-employment income tax imposed under section 1402
of the Internal Revenue Code of 1986. These regulations permit individuals to
determine whether they are limited partners for purposes of section
1402(a)(13), eliminating the uncertainty in calculating an
individual's net earnings from self-employment under existing law.
This document also contains a notice of public hearing on the proposed
regulations.
Background
This document contains proposed amendments to the Income Tax
Regulations (26 CFR part 1) under section 1402 of the Internal Revenue
Code and replaces the notice of proposed rulemaking published in the
Federal Register on December 29, 1994, at 59 FR 67253, that treated
certain members of a limited liability company (LLC) as limited
partners for self-employment tax purposes. Written comments responding
to the proposed regulations were received, and a public hearing was
held on June 23, 1995.
Under the 1994 proposed regulations, an individual owning an interest
in an LLC was treated as a limited partner if (1) the individual
lacked the authority to make management decisions necessary to conduct
the LLC's business (the management test), and (2) the LLC could have
been formed as a limited partnership rather than an LLC in the same
jurisdiction, and the member could have qualified as a limited partner
in the limited partnership under applicable law (the limited partner
equivalence test). The intent of the 1994 proposed regulations was to
treat owners of an LLC interest in the same manner as similarly
situated partners in a state law partnership.
Public comments on the 1994 proposed regulations were mixed. While
some commentators were pleased with the proposed regulations for
attempting to conform the treatment of LLCs with state law
partnerships, others criticized the 1994 proposed regulations based on
a variety of arguments.
A number of commentators discussed administrative and compliance
problems with the 1994 proposed regulations. For example, it was noted
that both the management test and the limited partner equivalence test
depend upon legal or factual determinations that may be difficult for
taxpayers or the IRS to make with certainty.
Another commentator pointed out that basing the self-employment tax
treatment of LLC members on state law limited partnership rules would
lead to disparate treatment between members of different LLCs with
identical rights based solely on differences in the limited
partnership statutes of the states in which the members form their
LLC. For example, State A's limited partnership act may allow a
limited partner to participate in a partnership's business while State
B's limited partnership act may not. Thus, an LLC member, who is not a
manager, that participates in the LLC's business would be a limited
partner under the proposed regulations if the LLC is formed in State
A, but not if the LLC is formed in State B. Commentators asserted that
this disparate treatment is inherently unfair for federal tax
purposes.
Some commentators argued for a ``material participation'' test to
determine whether an LLC member's distributive share is included in
the individual's net earnings from self-employment. The proposed
regulations did not contain a participation test. Commentators
advocating a participation test stressed that such a test would
eliminate uncertainty concerning many LLC members' limited partner
status and would better implement the self-employment tax goal of
taxing compensation for services.
Other commentators argued for a more uniform approach, stating that a
single test should govern all business entities (i.e., partnerships,
LLCs, LLPs, sole proprietorships, et al.) whose members may be subject
to self-employment tax. These commentators generally recognized,
however, that a change in the treatment of a sole proprietorship or an
entity that is not characterized as a partnership for federal tax
purposes would be beyond the scope of regulations to be issued under
section 1402(a)(13).
Finally, some commentators focused on whether the Service would
respect the ownership of more than one class of partnership interest
for self-employment tax purposes (bifurcation of interests). The
proposed regulations treated an LLC member as a limited partner with
respect to his or her entire interest (if the member was not a manager
and satisfied the limited partner equivalence test), or not at all (if
either the management test or limited partner equivalence test was not
satisfied). Commentators, however, pointed to the legislative history
of section 1402(a)(13) to support their argument that Congress only
intended to tax a partner's distributive share attributable to a
general partner interest. Under this argument, a partner that holds
both a general partner interest and a limited partner interest is only
subject to self-employment tax on the distributive share attributable
to the partner's general partner interest. This intent also may be
inferred from the statutory language of section 1402(a) (13) that the
self-employment tax does not apply to ". . . the distributive share
of any item of income or loss of a limited partner, as such . . . .''
Based on this evidence, these commentators requested that the proposed
regulations be revised to allow the bifurcation of interests for
self-employment tax purposes.
After considering the comments received, the IRS and Treasury have
decided to withdraw the 1994 notice of proposed rulemaking and to
re-propose amendments to the Income Tax Regulations (26 CFR part 1)
under section 1402 of the Code.
Explanation
of Provisions
The proposed regulations contained in this document define which
partners of a federal tax partnership are considered limited partners
for section 1402(a)(13) purposes. These proposed regulations apply to
all entities classified as a partnership for federal tax purposes,
regardless of the state law characterization of the entity. Thus,
the
same standards apply when determining the status of an individual
owning an interest in a state law limited partnership or the status of
an individual owning an interest in an LLC. In order to achieve this
conformity, the proposed regulations adopt an approach which depends
on the relationship between the partner, the partnership, and the
partnership's business. State law characterizations of an individual
as a ``limited partner'' or otherwise are not determinative.
Generally, an individual will be treated as a limited partner under
the proposed regulations unless the individual (1)
has personal
liability (as defined in Section 301.7701-3(b)(2)(ii) of the Procedure
and Administration Regulations) for the debts of or claims against the
partnership by reason of being a partner; (2) has authority to
contract on behalf of the partnership under the statute or law
pursuant to which the partnership is organized; or, (3) participates
in the partnership's trade or business for more than 500 hours during
the taxable year. If, however, substantially all of the activities of
a partnership involve the performance of services in the fields of
health, law, engineering, architecture, accounting, actuarial science,
or consulting, any individual who provides services as part of that
trade or business will not be considered a limited partner.
By adopting these functional tests, the proposed regulations ensure
that similarly situated individuals owning interests in entities
formed under different statutes or in different jurisdictions will be
treated similarly. The need for a functional approach results not only
from the proliferation of new business entities such as LLCs, but also
from the evolution of state limited partnership statutes. When
Congress enacted the limited partner exclusion found in section
1402(a)(13), state laws generally did not allow limited partners to
participate in the partnership's trade or business to the extent that
state laws allow limited partners to participate today. Thus, even in
the case of a state law limited partnership, a functional approach is
necessary to ensure that the self-employment tax consequences to
similarly situated taxpayers do not differ depending upon where the
partnership organized. The proposed
regulations allow an individual who is not a limited
partner for section 1402(a)(13) purposes
to nonetheless exclude from
net earnings from self-employment a portion of that individual's
distributive share if the individual holds more than one class of
interest in the partnership.
Similarly, the proposed
regulations permit an individual that participates in the trade or
business of the partnership to bifurcate his or her distributive share
by disregarding guaranteed payments for services. In each case, however, such
bifurcation
of interests is permitted only to the extent the individual's
distributive share is identical to the distributive share of partners
who qualify as limited partners under the proposed regulation (without
regard to the bifurcation rules) and who own a substantial interest in
the partnership. Together, these
rules exclude from an individual's net earnings from self-employment
amounts that are demonstrably returns on capital invested in the
partnership.
ed:
In other words pursuant to Prop. Reg. §1.1402(a)-2(h)(6)(iv) at least one member of the LLC must own 20% or more
as a limited partner and he must not own any other (bifurcated) interest
in the LLC.
Bifurcation of a
Member’s Interest
If an LLC member
fails the limited partner test because that member participates in a
nonprofessional LLC for more than 500 hours during the tax year,
Proposed Treasury Regulations section 1.1402(a)-2(h)(4) allows that
member to be taxed as a limited partner for SE tax purposes if she
owns only one class of interest and if, immediately after acquiring
the interest, the member has rights and obligations identical to
those of the other members who are already classified as limited
partners and who own a substantial (i.e., at least 20%) continuing
interest in that class of interest.
In addition,
Proposed Treasury Regulations section 1.1402(a)-2(h)(3) allows an
LLC member of a nonprofessional LLC who fails one or more of the
limited partner tests, but who holds more than one class of
interest, to be treated as a limited partner with respect to a
particular class of interest if, immediately after acquiring the
interest, the member has rights and obligations identical to those
of the other members who are already classified as limited partners
and who own a substantial (i.e., at least 20%) continuing interest
in that class of interest.
Because
application of the SE tax to LLC members under the proposed
regulations depends not only upon their formal status as members or
managing-members but also on their level of participation in the
entity, strategies for minimizing an LLC member’s SE tax exposure
generally involve the governing provisions of the LLC. This is
because issues such as the designation of a manager and the extent
of authority given to nonmanaging members, while fundamentally
business considerations, have significant tax implications.
The proposed
regulations specifically allow bifurcation of an LLC member’s
distributive share of income in situations where the member holds
dual classes of interest, one of which is the same as nonmanaging
members. Furthermore, the proposed regulations seem to sanction a
nominal amount of income attributable to a general-partner interest
as long as a reasonable guaranteed payment is made for services
rendered to, or on behalf of, the LLC. One strategy for SE tax
reduction is to issue two classes of interest, a managing interest
and an investment interest, to the same individual. Special Analyses It has been determined that
this notice of
proposed rulemaking is not a significant regulatory action as
defined in EO 12866. Therefore, a regulatory assessment is not
required. It also has been determined that section 553(b) of the
Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to
these regulations, and, because the regulations do not impose a
collection of information on small entities, the Regulatory
Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to
section 7805(f) of the Internal Revenue Code, this notice of
proposed rulemaking will be submitted to the Chief Counsel for
Advocacy of the Small Business Administration for comment on its
impact on small business. Drafting Information The principal author of
these regulations
is Robert Honigman of the Office of Assistant Chief Counsel (Passthroughs
& Special Industries). However, other personnel from the IRS and
Treasury Department participated in
their development. * * * * *
Proposed
Amendments to the Regulations Accordingly, 26 CFR part 1
is proposed to
be amended as follows: PART 1--INCOME TAXES Paragraph 1. The authority citation for part 1
continues to read in part as follows: Authority: 26 U.S.C. 7805 * * * Par. 2. Section
1.1402(a)-2
is amended by: 1. Revising the first sentence of paragraph (d). 2. Removing the reference “section 702(a)(9)” in
the first sentence of paragraph (e) and adding “section 702(a)(8)”
in its place. 3. Revising the last sentence of paragraph (f). 4. Revising paragraphs (g) and (h). 5. Adding new paragraphs (i) and (j). The revisions and additions read as follows: §1.1402(a)-2
Computation of net earnings from
self-employment.
* * * * *
1.1402(a)-2(d) * * * Except as otherwise provided in section 1402(a)
and paragraph (g) of this section, an individual's net earnings from
self-employment include the individual's distributive share (whether
or not distributed) of income or loss described in section 702(a)(8)
from any trade or business carried on by each partnership of which the
individual is a partner.
* * * * * * * *
1.1402(a)-2(f) * * * For rules governing the classification of an
organization as a partnership or otherwise, see Sections 301.7701-1,
301.7701-2, and 301.7701-3 of this chapter.
1.1402(a)-2(g) Distributive share of limited partner.
An individual's net earnings from self-employment do not include the
individual's distributive share of income or loss as a limited partner described in paragraph (h) of
this section. However, guaranteed payments described in section 707(c)
made to the individual for services actually rendered to or on behalf
of the partnership engaged in a trade or business are included in the
individual's net earnings from self-employment.
1.1402(a)-2(h) Definition of limited partner--
1.1402(a)-2(h)(1) In general.
Solely for purposes of section 1402(a)(13) and paragraph (g) of this
section, an individual is considered to be a limited partner to the
extent provided in paragraphs (h)(2), (h)(3), (h)(4), and (h)(5) of
this section.
1.1402(a)-2(h)(2) Limited partner.
An individual is treated as a limited partner under this paragraph
(h)(2) unless the individual--
1.1402(a)-2(h)(2)(i) Has personal liability (as defined in Section
301.7701-3(b)(2)(ii) of this chapter for the debts of or claims
against the partnership by reason of being a partner;
1.1402(a)-2(h)(2)(ii) Has authority (under the law of the jurisdiction
in which the partnership is formed) to contract on behalf of the
partnership; or
1.1402(a)-2(h)(2)(iii) Participates in the partnership's trade or
business for more than 500 hours during the partnership's taxable
year.
1.1402(a)-2(h)(3) Exception for holders of more than one class of
interest.
An individual holding more than one class of interest in the
partnership who is not treated as a limited partner under paragraph
(h)(2) of this section is treated as a limited partner under this
paragraph (h)(3) with respect to a specific class of partnership
interest held by such individual if, immediately after the individual
acquires that class of interest--
1.1402(a)-2(h)(3)(i) Limited partners within the meaning of paragraph
(h) (2) of this section own a substantial, continuing interest in that
specific class of partnership interest; and,
1.1402(a)-2(h)(3)(ii) The individual's rights and obligations with
respect to that specific class of interest are identical to the rights
and obligations of that specific class of partnership interest held by
the limited partners described in paragraph (h)(3)(i) of this section.
1.1402(a)-2(h)(4) Exception for holders of only one class of interest.
An individual who is not treated as a limited partner under paragraph
(h)(2) of this section solely because that individual participates in
the partnership's trade or business for more than 500 hours
during the
partnership's taxable year is treated as a limited partner
under this
paragraph (h)(4) with respect to the individual's partnership interest
if, immediately after the individual acquires that interest--
1.1402(a)-2(h)(4)(i) Limited partners within the meaning of paragraph
(h)(2) of this section own a substantial, continuing interest in that
specific class of partnership interest; and
1.1402(a)-2(h)(4)(ii) The individual's rights and obligations with
respect to the specific class of interest are identical to the rights
and obligations of the specific class of partnership interest held by
the limited partners described in paragraph (h)(4)(i) of this section.
1.1402(a)-2(h)(5) Exception for service partners in service
partnerships.
An individual who is a service partner in a service partnership may
not be a limited partner under paragraphs (h)(2), (h)(3), or (h)(4) of
this section.
1.1402(a)-2(h)(6) Additional definitions.
Solely for purposes of this paragraph (h)--
1.1402(a)-2(h)(6)(i) A class of interest is an interest that grants
the holder specific rights and obligations. If a holder's rights and
obligations from an interest are different from another holder's
rights and obligations, each holder's interest belongs to a separate
class of interest. An individual may hold more than one class of
interest in the same partnership provided that each class grants the
individual different rights or obligations. The existence of a
guaranteed payment described in section 707(c) made to an individual
for services rendered to or on behalf of a partnership, however, is
not a factor in determining the rights and obligations of a class of
interest.
1.1402(a)-2(h)(6)(ii) A service partner is a partner who provides
services to or on behalf of the service partnership's trade or
business. A partner is not considered to be a service partner if that
partner only provides a de minimis amount of services to or on behalf
of the partnership.
1.1402(a)-2(h)(6)(iii) A service partnership is a partnership
substantially all the activities of which involve the performance of
services in the fields of health, law, engineering, architecture,
accounting, actuarial science, or consulting.
1.1402(a)-2(h)(6)(iv) A substantial interest in a class of interest is
determined based on all of the relevant facts and circumstances. In
all cases, however, ownership of 20 percent or more of a specific
class of interest is considered substantial.
1.1402(a)-2(h)(6)(i) Example.
The following example illustrates the principles of paragraphs (g) and
(h) of this section:
Example.
(i) A, B, and C form LLC, a limited liability company, under the laws
of State to engage in a business that is not a service partnership
described in paragraph (h)(6)(iii) of this section. LLC, classified as
a partnership for federal tax purposes, allocates all items of income,
deduction, and credit of LLC to A, B, and C in proportion to their
ownership of LLC. A and C each contribute $1x for one LLC unit. B
contributes $2x for two LLC units. Each LLC unit entitles its holder
to receive 25 percent of LLC's tax items, including profits. A does
not perform services for LLC; however, each year B receives a
guaranteed payment of $6x for 600 hours of services rendered to LLC
and C receives a guaranteed payment of $10x for 1000 hours of services
rendered to LLC. C also is elected LLC's manager. Under State's law, C
has the authority to contract on behalf of LLC. (ii) Application of general rule of paragraph (h)(2) of this section. A is treated as a limited
partner in LLC under paragraph (h)(2) of this section because A is not
liable personally for debts of or claims against LLC, A does not have
authority to contract for LLC under State's law, and A does not
participate in LLC's trade or business for more than 500 hours during
the taxable year. Therefore, A's
distributive share attributable to A's LLC unit is excluded from A's
net earnings from self-employment under section 1402(a)(13).
(iii) Distributive share not included in net earnings from
self-employment under paragraph (h)(4) of this section. B's guaranteed
payment of $6x is included in B's net earnings from self-employment
under section 1402(a) (13). B is not treated as a limited partner
under paragraph (h)(2) of this section because, although B is not
liable for debts of or claims against LLC and B does not have
authority to contract for LLC under State's law, B does participates
in LLC's trade or business for more than 500 hours during the taxable
year. Further, B is not treated as a limited partner under paragraph
(h) (3) of this section because B does not hold more than one class of
interest in LLC. However, B is treated as a limited partner under
paragraph (h)(4) of this section because B is not treated as a limited
partner under paragraph (h)(2) of this section solely because B
participated in LLC's business for more than 500 hours and because A
is a limited partner under paragraph (h)(2) of this section who owns a
substantial interest with rights and obligations that are identical to
B's rights and obligations. In this example, B's distributive share is
deemed to be a return on B's investment in LLC and not remuneration
for B's service to LLC. Thus, B's distributive share attributable to
B's two LLC units is not net earnings from self-employment under
section 1402(a)(13).
(iv) Distributive share included in net earnings from self-employment.
C's guaranteed payment of $10x is included in C's net earnings from
self-employment under section 1402(a). In addition, C's distributive
share attributable to C's LLC unit also is net earnings from
self-employment under section 1402(a) because C is not a limited
partner under paragraphs (h)(2), (h)(3), or (h) (4) of this section. C
is not treated as a limited partner under paragraph (h) (2) of this
section because C has the authority under State's law to enter into a
binding contract on behalf of LLC and because C participates in LLC's
trade or business for more than 500 hours during the taxable year.
Further, C is not treated as a limited partner under paragraph (h)(3)
of this section because C does not hold more than one class of
interest in LLC. Finally, C is not treated as a limited partner under
paragraph (h)(4) of this section because C has the power to bind LLC.
Thus, C's guaranteed payment and distributive share both are included
in C's net earnings from self-employment under section 1402(a).
Self Employment Taxes Amounts paid to
members of corporate LLC may be deductible as salary
(Treasury Regulations Section 1.162-8) Amounts paid to
members of partnership LLC may be treated as net
earnings from self-employment, salary or wages, or
distributable share of partnership income (IRC,
Subchapter K) A member's
distributive share of LLC income is self-employment
income, unless member is limited partner
(Regulations Section 1.1402(a)-2(d); IRC Section
1402(a)(13)) Exceptions: a) If activities of LLC involved
services in the fields of health, law, engineering, architecture,
accounting, actuarial science or consulting, individual who provided
services would not be treated as limited partner (Proposed
Regulations Sections 1.1402(a)-2(h)(5); 1.1402(a-2(h)(6)(iii)) b) A member that holds more than one
class of interests of the LLC could be treated as a limited partner
(Pro. Regulations 1.1402(a)-2(h)(3); 1.1402(a)-2(h)(6)(iv)) c) A member owning only one class of
partnership interest who is disqualified as a limited partner (Prop.
Regulations Section 1.1402(a)-2(h)(4))
http://www.nysscpa.org/cpajournal/2006/606/essentials/p32.htm
http://edocket.access.gpo.gov/cfr_2008/aprqtr/pdf/26cfr1.1402(a)-2.pdf
http://www.goralkalawfirm.com/CM/Custom/LLCright.asp On
May 5, 2003, the Treasury Department and the IRS published an Advance
Notice of Proposed Rulemaking (ANPRM), REG-100420-03, and Announcement
2003-35, 2003-21 C.B. 956, setting forth a possible safe harbor using
values reported on an applicable financial statements for valuing
securities for purposes of §475 and requesting comments on various
aspects of such a safe harbor. After receiving comments from the public,
the Treasury Department proposed these regulations, setting forth a safe
harbor for valuing securities and commodities under §475.
Safe Harbor. Under the proposed safe harbor, eligible taxpayers
generally would be permitted to elect to have the values that are
reported for eligible positions on certain financial statements treated
as the fair market values reported for those eligible positions for
purposes of §475, if certain conditions were met. To ensure minimal
divergence from fair market value under tax principles, certain
restrictions would be imposed on the financial accounting methods and
financial statements that are eligible for the safe harbor and also
require certain adjustments to the values of the eligible positions on
those financial statements that may be used under the safe harbor.
Further, the safe harbor would require that financial statement values
be adjusted to comply with the requirements of §482 or §482 principles
when applicable.
Eligible Taxpayers and Eligible Positions. The safe harbor would be
available to any taxpayer subject to the mark-to-mark regime under §475
and, further, that a revenue procedure will be issued enumerating the
types of securities and commodities subject to the safe harbor.
The preamble cautions that the valuation methodology under the safe
harbor would apply only for positions that are properly marked under
§475. For example, it notes that: (1) if a security is not marked under
§475 because it has been identified as held for investment, then under
the safe harbor it may not be marked for federal income tax purposes
even though it is properly marked on the financial statement in
accordance with U.S. Generally Accepted Accounting Principles (U.S. GAAP);
and (2) if a security is not marked on the applicable financial
statement because it is a hedge but §475(a) applies because the security
was not identified as a hedge, then the security must still be marked
under §475.
Eligible Method. To qualify for the safe harbor, a financial accounting
method would be required to satisfy four basic requirements—it would be
required: (1) to mark eligible positions to market through valuations
made as of the last business day of each taxable year; (2) to recognize
into income on the income statement any gain or loss from marking
eligible positions to market; (3) to recognize into income on the income
statement any gain or loss on disposition of an eligible position as if
a year-end mark occurred immediately before the disposition; and (4) to
arrive at fair value in accordance with U.S. GAAP. In
addition to the basic requirements, the safe harbor would also impose
certain limitations that ensure minimal divergence from fair market
value. First, in the case of securities and commodities dealers, except
for eligible positions that are traded on a qualified board or exchange
(as defined in §1256(g)(7)), the financial accounting method must not
result in values at or near the bid or ask values, even if the use of
bid or ask values is permissible in accordance with U.S. GAAP. Second,
if the method of valuation consists of determining the present value of
projected cash flows from an eligible position or positions, then the
method must not take into account any cash flows of income or expense
that are attributable to a period or time before the valuation date.
Third, no cost or risk may be accounted for more than once, either
directly or indirectly.
Election and Revocation. The election to use the safe harbor would be
made by filing a statement with the taxpayer's timely filed federal
income tax return for the taxable year for which the election is first
effective. Such statement: (1) would be required to declare that the
taxpayer makes the safe harbor election for all of its eligible
positions; and (2) in addition to any other information that the
Commissioner may require, the statement would be required to describe
the taxpayer's applicable financial statement for the first taxable year
for which the election is effective and to state that the taxpayer
agrees to timely provide upon the request of the Commissioner all
information, records, and schedules required by the safe harbor. The
election would continue to be in effect for all subsequent taxable years
unless it is revoked. A
taxpayer would not be allowed to revoke the election without the consent
of the Commissioner. However, the Commissioner would be permitted to
revoke the election if: (1) the taxpayer fails to comply with any of the
recordkeeping and production requirements and cannot show reasonable
cause for the failure; (2) the taxpayer ceases to use an eligible
method; (3) the taxpayer ceases to have an applicable financial
statement, as described below; or (4) the taxpayer holds a de minimis
quantity of eligible positions that are subject to the safe harbor. A
revocation would not be required if the taxpayer ceased to qualify as an
eligible taxpayer, or §475 did not otherwise apply, because the safe
harbor would only be permitted to be used to determine values and could
not be used unless §475 applied. Once revoked by either the Commissioner
or the taxpayer, neither the taxpayer nor any of its successors would be
permitted to make the election for any taxable year that begins before
the date that is six years after the first day of the earliest taxable
year affected by the revocation without the consent of the Commissioner.
Applicable Financial Statements. Three categories of financial
statements would qualify under the safe harbor and are set forth in
order of priority, from highest to lowest. In the first and highest
category are those financial statements that must be filed with the
Securities and Exchange Commission (SEC) (e.g., 10-Ks and the Annual
Statements to Shareholders). In the second category are those financial
statements that must be provided to the federal government or any of its
agencies other than the IRS (e.g., statements filed by
foreign-controlled financial institutions engaged in trade or business
within the United States who report their mark-to-market results to the
Federal Reserve or the Office of the Comptroller of the Currency). In
the third category are certified audited financial statements that are
provided to creditors to make lending decisions, that are provided to
equity holders to evaluate their investment, or that are provided for
other substantial non-tax purposes and are reasonably anticipated to be
directly relied on for the purposes for which the statements were
created. For a financial statement described in any of the three
categories above to qualify as an applicable financial statement, it
would be required to be prepared in accordance with U.S. GAAP. Further,
if a taxpayer has two statements in the same category, each of which
would qualify under the safe harbor, then the statement that results in
the highest aggregate valuation of eligible positions would be the only
financial statement that may qualify for the safe harbor.
The preamble to the proposed regulations notes that statements filed
with the SEC provide a high degree of confidence that the values used on
those statements reflect reasonable approximations of fair value, and,
consequently, there would be no additional business use requirements for
those statements. However, the for the second category (statements filed
with other agencies of the federal government) and the third category of
statements (the other certified audited financial statements), this
degree of confidence is ensured by requiring some substantial non-tax
use in the taxpayer's business. Accordingly, the safe harbor would
require that the values for eligible positions contained in these
financial statements be used by the taxpayer in most of the significant
management functions of all or substantially all of its business. This
use includes activities such as: (1) senior management review of
business-unit profitability; (2) market risk measurement or management;
(3) credit risk measurement or management; (4) internal allocation of
capital; and (5) compensation of personnel but would not include either
tax accounting or reporting the results of operations to other persons.
The preamble notes that the IRS and the Treasury Department understand
that some dealers maintain internal books of account, not prepared in
accordance with U.S. GAAP, for separate segments of their business and
that these internal books of account may include a charge to each
operating segment of an internal "cost of carry" calculated in the
manner of interest (and the derivatives dealer book may be treated as a
separate business segment for that purpose). The preamble states that
the maintenance of these segmented accounts, which may apply an
accounting approach that does not qualify as an eligible accounting
method, does not prevent some other financial statement prepared in
accordance with U.S. GAAP from qualifying as the taxpayer's applicable
financial statement.
Record Retention and Production; Use of Different Values. The proposed
regulations provide specific requirements for the types of records that
would be required to be maintained and provided to enable ready
verification. In general, electing taxpayers would be required to
clearly show: (1) that the same value used for financial reporting was
used on the federal income tax return; (2) that no eligible position
subject to §475 is excluded from the application of the safe harbor; and
(3) that only eligible positions subject to §475 are carried over to the
federal income tax return under the safe harbor. The proposed
regulations outline what records would be required to be retained and
produced, including certain forms and schedules filed with the Federal
income tax return, such as the Schedule M-1, Net Income (Loss)
Reconciliation for Corporations With Total Assets of $10 Million or
More; Schedule M-3, Net Income (Loss) Reconciliation for Corporations
With Total Assets of $10 Million or More; and Form 1120F, U.S. Income
Tax Return of a Foreign Corporation. The proposed regulations also
provide that the Commissioner would be permitted to enter into an
advance agreement with a taxpayer on how records are to be maintained
and how long the records are to be retained. All of the necessary
records would be required to be retained as long as their contents may
become material in the administration of any internal revenue law.
To
encourage rapid examinations of the federal income tax returns of
electing taxpayers, all necessary records would be required to be
produced within 30 days after the Commissioner requests them. If the
required records are not provided as required, the proposed regulations
would permit the Commissioner to use his discretion to: (1) extend the
30-day period; (2) excuse minor or inadvertent failures to provide the
requested records; (3) require use of values that clearly reflect income
but which are different from those used on the applicable financial
statement; or (4) revoke the election if a taxpayer does not demonstrate
reasonable cause for the failure to maintain and produce the required
records. Mark-to-Market Method §475
Material participation is defined generally as regular, continuous,
and substantial involvement in the business operations. Sec.
469(h)(1). The regulations provide
seven exclusive tests
for material participation in an activity.10 Sec. 1.469-5T(a),
A taxpayer materially participates
in an activity if he meets any
one of these seven tests:
IRS Code §446 General Rule For
Methods Of Accounting:
§446(c) Permissible Methods
Subject to the provisions of subsections (a) and (b), a taxpayer may
compute taxable income under any of the following methods of
accounting--
§446(c)(1) the cash receipts and disbursements method;
§446(c)(2) an accrual method;
§446(c)(3) any other method permitted by this chapter; or
§446(c)(4) any combination of the foregoing methods permitted under
regulations prescribed by the Secretary.
§446(d) Taxpayer Engaged In More Than One Business
A taxpayer engaged in more than one trade or business may, in
computing taxable income, use a different method of accounting for
each trade or business.
§446(e) Requirement Respecting Change Of Accounting Method
Except as otherwise expressly provided in this chapter, a taxpayer
who changes the method of accounting on the basis of which he
regularly computes his income in keeping his books shall, before
computing his taxable income under the new method, secure the
consent of the Secretary.
Rev. Proc. 2002-28:
2.02 Section 446(c) generally allows a taxpayer to select the method
of accounting it will use to compute its taxable income. A
taxpayer is entitled to adopt any one of the permissible methods for
each separate trade or business...
IRS Code §446(a) General Rule:
Taxable income shall be computed
under the method of accounting on the basis of which the taxpayer
regularly computes his income in keeping his books.
IRS Regs. §1.446-1 General rule for methods of accounting.
§1.446-1(1)(a)(1) Section 446(a)
provides that taxable income shall be computed under the method of
accounting on the basis of which a taxpayer regularly computes his
income in keeping his books.
§1.446-1(b)(2) A taxpayer whose sole source of income is wages need
not keep formal books in order to have an accounting method. Tax
returns, copies thereof, or other records may be sufficient to
establish the use of the method of accounting used in the preparation
of the taxpayer's income tax returns.
§1.446-1(c)(1)(iv)(b) A taxpayer using one method of accounting in
computing items of income and deductions of his trade or business may
compute other items of income and deductions not connected with his
trade or business under a different method of accounting.
§1.446-1(c)(2)(ii) No method of accounting will be regarded as
clearly reflecting income unless all items of gross profit and
deductions are treated with consistency from year to year. The
Commissioner may authorize a taxpayer to adopt or change to a method
of accounting permitted by this chapter although the method is not
specifically described in the regulations in this part if, in the
opinion of the Commissioner, income is clearly reflected by the use of
such method. Further, the Commissioner may authorize a taxpayer
to continue the use of a method of accounting consistently used by the
taxpayer, even though not specifically authorized by the regulations
in this part, if, in the opinion of the Commissioner, income is
clearly reflected by the use of such method.
See section 446(a) and paragraph (a) of this section, which require
that taxable income shall be computed under the method of accounting
on the basis of which the taxpayer regularly computes his income in
keeping his books, and section 446(e) and paragraph (e) of this
section, which require the prior approval of the Commissioner in the
case of changes in accounting method.
§1.446-1(d) Taxpayer engaged in more than one business.
§1.446-1(d)(1) Where a taxpayer has two or more separate and distinct
trades or businesses, a different method of accounting may be used for
each trade or business, provided the method used for each trade or
business clearly reflects the income of that particular trade or
business. For example, a taxpayer may account for the operations of a
personal service business on the cash receipts and disbursements
method and of a manufacturing business on an accrual method, provided
such businesses are separate and distinct and the methods used for
each clearly reflect income. The method first used in accounting for
business income and deductions in connection with each trade or
business, as evidenced in the taxpayer's income tax return in which
such income or deductions are first reported, must be consistently
followed thereafter.
§1.446-1(d)(2) No trade or business will be considered separate
and distinct for purposes of this paragraph unless a complete and separable set of books and
records is kept for such trade or business.
§1.446-1(e) Requirement respecting the adoption or change of
accounting method.
§1.446-1(e)(1) A taxpayer filing his first return may adopt any
permissible method of accounting in computing taxable income for the
taxable year covered by such return. See section 446(c) and paragraph
(c) of this section for permissible methods. Moreover, a
taxpayer may adopt any permissible method
of accounting in connection with each separate and distinct trade or
business, the income from which is reported for the first time.
See section 446(d) and paragraph (d) of this section. See also section
446(a) and paragraph (a) of this section.
Mark-to-Market
Accounting Method §475:
IRS Issues Procedures for Electing Mark-to-Market Method for Dealers,
Traders
The IRS issued exclusive procedures for dealers in commodities and
traders in securities or commodities to make an election to use the
mark-to-market method of accounting under §475(e) or (f).
A. Elections effective for tax years for which the original federal
tax return was filed before March 18, 1999. For a taxpayer to make a
§475(e) or (f) election that is effective for a taxable year for which
the original federal income tax return was filed before March 18,
1999, the taxpayer must either: (1) have properly reflected the
application of §475 (including any required §481(a) adjustment) in the
calculation of the taxpayer's tax liability on its original federal
income tax return for the election year; or (2) have failed to
properly reflect the application of §475 (including any required
§481(a) adjustment) in the calculation of the taxpayer's tax liability
on its original federal income tax return for the election year, but
clearly demonstrated on that return its intent to make the election
for that year (for example, by a statement on, or attachment to, the
return), and file an amended return for the election year on or before
June 16, 1999, that properly reflects the application of §475
(including any required §481(a) adjustment).
B. Elections effective for other taxable years beginning before
January 1, 1999. For a taxpayer to make a §475(e) or (f) election that
is effective for a taxable year which begins before January 1, 1999,
and for which the original federal income tax return is filed on or
after March 18, 1999, the taxpayer must make the election by attaching
a statement to an original federal income tax return for the election
year that is timely filed (including extensions). The required
statement must describe the election being made, the first taxable
year for which the election is effective, and, in the case on an
election under §475(f), the trade or business for which the election
is made.
C. Elections effective for a taxable year beginning on or after
January 1, 1999.
(1) General procedure. Except for new
taxpayers (discussed below), for a taxpayer to make a §475(e) or (f)
election that is effective for a taxable year beginning on or after
January 1, 1999, the taxpayer must file a required statement
(described above). The statement must be filed not later than the due
date (without regard to extensions) of the original federal income tax
return for the taxable year immediately preceding the election year
and must be attached either to that return or, if applicable, to a
request for an extension of time to file that return.
(2) New taxpayers. A new taxpayer is a
taxpayer for which no federal income tax return was required to be
filed for the taxable year immediately preceding the election year. A
new taxpayer makes the election by placing in its books and records no
later than 2 months and 15 days after the first day of the election
year a required statement (described above). The new taxpayer must
attach a copy of the statement to its original federal income tax
return for the election year.
This revenue procedure is effective February 8, 1999.
Rev. Proc. 99-17 is scheduled to appear in I.R.B. 1999-7, dated
February. 16, 1999.
¨ Rev. Proc. 99-17, 1999-7 I.R.B. ___.
Treatment of Mark-to-Market
Gains of Electing Traders (SECA tax):
TITLE VI. TECHNICAL CORRECTIONS (SECA portion as submitted to IRS Code
draft writers by Colin M. Cody, CPA)
Technical Corrections to
Taxpayer Relief Act of 1997
Effective Dates: The technical corrections of Title VI are effective
as if included in the provisions of the Taxpayer Relief Act of 1997
to which they relate, unless otherwise indicated.
Treatment of Limited Liability Company members (SECA
tax):
[Proposed Regulations, NPRM REG-209824-96],
I.R.B. 1997-11,Internal
Revenue Service,
(Jan. 13, 1997)
[Code Sec. 1402]
Definition of Limited Partner for Self-Employment Tax Purposes
There are no related party rules here, therefore a spouse could be
that 20% limited partner.
IRS Code §475(f) Mark-to-Market election
for taxpayers who have filed at least one federal income tax return
(normally the year immediately preceding the election year):
Normal
Defective
TBA
IRS Code §475(f) Mark-to-Market elections
for newly formed entities that have not filed a tax return yet:
No extension is available. No extension is required.
For those taxpayers who are filing their first ever tax return, no filing deadlines for a timely
mark-to-market election have been established, other than that the
properly drafted election statement be placed in its books and records
immediately in the first year and that a copy also be attached to the
first original federal income tax return filed. Typically this
pertains to taxpaying entities other than individuals, such as a newly
formed corporation or LLC.
Normal
Defective
TBA
Treasury Proposes Regulations on Safe Harbor for Valuation Under
Mark-to-Market Accounting Method:
The Treasury Department proposes regulations setting forth an elective
safe harbor for dealers in securities and commodities, and traders in
securities and commodities, permitting an election pursuant to which
values of positions reported on certain financial statements are fair
market values of those positions for purposes of §475.
M2M losses are excluded from
Reportable Transactions:
IRS Issues Revenue Procedure Excluding Certain Losses from Reportable
Transactions
The IRS released a revenue
procedure that provides that certain losses are not taken into account
in determining whether a transaction is a reportable loss transaction
for purposes of the tax shelter disclosure rules under Regs.
§1.6011-4(b)(5).
The IRS stated that the revenue procedure applies to taxpayers required
to disclose reportable transactions under Regs. §1.6011-4, material
advisors required to disclose reportable transactions under §6111 (as
amended by the 2004 American Jobs Creation Act, P.L. 108-357, §815), and
material advisors required to maintain lists under former and new §6112.
Under the revenue procedure, stated the IRS, a loss under §165 from the
sale or exchange of an asset is not taken into account if: (1) the basis
of the asset (for purposes of determining the loss) is a "qualifying
basis;" (2) the asset is not an interest in a passthrough entity under
§1260(c)(2), other than regular interests in a REMIC as defined in
§860G(a)(1); (3) the loss from the sale or exchange of the asset is not
treated as ordinary under §988; (4) the asset has not been separated
from any portion of the income it generates; and (5) the asset is not,
and has never been, part of a straddle under §1092(c), excluding mixed
straddles under Regs. §1.1092(b)-4T. The IRS provided further guidance
on in what situations a taxpayer's basis in an asset is a "qualifying
basis."
The IRS stated that the revenue procedure also provides that the
following losses under §165 are also not taken into account under Regs.
§1.6011-4(b)(5): (1) a loss under §165(c)(3) from fire, storm,
shipwreck, or other casualty, or from theft; (2) a loss from a
compulsory or involuntary conversion under §1231(a)(3)(A)(ii) or (4)(B);
(3) a loss to which §475(a) or §1256(a) applies; (4)
a loss arising from any mark-to-market
treatment of an item under §475(f),
§1296(a), Regs. §1.446-4(e), Regs. §1.988-5(a)(6), or Regs.
§1.1275-6(d)(2), and any loss from a sale or disposition of an item to
which one of the foregoing provisions applied, provided that the
taxpayer computes its loss by using a qualifying basis or a basis
resulting from previously marking the item to market, or computes its
loss by making appropriate adjustments for previously determined
mark-to-market gain or loss; (5) a loss arising from a §1221(b) hedging
transaction, if the taxpayer properly identifies the transaction as a
hedging transaction, or from a mixed straddle account under Regs.
§1.1092(b)-4T; (6) a loss attributable to basis increases under
§860C(d)(1) during the period of the taxpayer's ownership; (7) a loss
attributable to the abandonment of depreciable tangible property that
was used by the taxpayer in a trade or business and that has a
qualifying basis; (8) a loss arising from the bulk sale of inventory if
the basis of the inventory is determined under §263A; (9) a loss that is
equal to, and is determined solely by reference to, a payment of cash by
the taxpayer; (10) a loss from the sale to a person other than a related
party under §267(b) or §707(b) of property described in §1221(a)(4) in a
factoring transaction in the ordinary course of business; or (11) a loss
arising from the disposition of an asset to the extent that the
taxpayer's basis in the asset is determined under §338(b).
The revenue procedure modifies and supersedes Rev. Proc. 2003-24,
2003-11 I.R.B. 599.
Rev. Proc. 2004-66 is effective November 16, 2004, and applies to
transactions that are entered into on or after January 1, 2003.
Rev. Proc. 2004-66 is scheduled to appear in I.R.B. 2004-50, dated
December 13, 2004.
IRS Code §481 elections:
See lower portion
of the form 3115 web page
IRS Code §1256 Mark-to-Market
election for dealers:
TBA
IRS Code §1256 hedging election:
TBA
Deadline to be Extended for Elections Under Mark-to-Mark Accounting:
Deadline to Be Extended for
Elections Under Mark-to-Mark Accounting
The IRS plans to issue
additional guidance on how
securities dealers may elect out
of exemptions provided for in the final regulations under §475 tro The
regulations contain elections out of certain exemptions, including the
intragroup-customer election (Regs. §1.475(c)-1(a)(3)(iii)(B)), the
customer paper election (Regs. §1.475(c)-1(b)(4)(i)), and the
negligible sales election (Regs. §1.475(c)-1(c)(1)(ii)). Regs.
§1.475(c)-1(b)(4)(i)(B) provides a June 23, 1997, deadline to make the
customer paper election on an amended return.
The IRS intends to issue guidance that will address the interplay of
the elections under Regs. §1.475(c)-1, the extent to which these
elections are available on a retroactive basis, and the application of
the §475(b)(2) identification requirements to taxpayers making these
elections. The additional guidance will extend the filing deadline
from June 23, 1997, to at least 45 days after that guidance is
released.
Notice 97-37 is scheduled to appear in I.R.B. 1997-27, dated July 7,
1997.
Notice 97-37, 1997-27 I.R.B. ___.
SECTION 2. BACKGROUND
.01 Section 301.7701-3(a) of the Procedure and Administration
Regulations provides in part that a business entity that is not
classified as a corporation under § 301.7701-2(b)(1), (3), (4), (5),
(6), (7), or (8) (an eligible entity) can elect its classification for
federal tax purposes as provided in § 301.7701-3. An eligible entity
with at least two members can elect to be classified as either an
association (and thus as a corporation under § 301.7701-2(b)(2)) or a
partnership, and an eligible entity with a single owner can elect to be
classified as an association or to be disregarded as an entity separate
from its owner. Section 301.7701-3(b) provides a default classification
for an eligible entity that does not file an entity classification election. Thus, an entity classification election is necessary only when an eligible entity chooses to be classified initially as other than its default classification or when an eligible entity chooses to change its classification.
.02 Section 301.7701-3(c)(1)(i) provides the general rules for the time and place for filing an entity classification election. Section 301.7701-3(c)(1)(i) provides that, except as provided in paragraphs (c)(1)(iv) (limitation) or (c)(1)(v) (deemed elections) of § 301.7701-3, an eligible entity may elect to be classified other than as provided under § 301.7701-3(b), or to change its classification, by filing Form 8832, “Entity Classification Election,” with the IRS service center designated on Form 8832. An election will not be accepted unless all of the information required by the form and instructions, including the taxpayer identifying number of the entity, is provided on Form 8832. See § 301.6109-1 for rules on applying for and displaying Employer Identification Numbers.
.03 Section 301.7701-3(c)(1)(ii) provides that an eligible entity required to file a federal tax or information return for the taxable year for which an election is made must attach a copy of its Form 8832 to its federal tax or information return for that year. If the entity is not required to file a return for that year, a copy of its Form 8832 must be attached to the federal income tax or information return of any direct or indirect owner of the entity for the taxable year of the owner that includes the date on which the election was effective.
.04 Section 301.7701-3(c)(1)(iii) provides that an election made under § 301.7701-3(c)(1)(i) will be effective on the date specified by the entity on Form 8832 or on the date filed if no such date is specified on the election form. The effective date specified on Form 8832 cannot be more than 75 days prior to the date on which the election is filed and cannot be more than 12 months after the date on which the election is filed. If an election specifies an effective date more than 75 days prior to the date on which the election is filed, it will be effective 75 days prior to the date it was filed. If an election specifies an effective date more than 12 months from the date on which the election is filed, it will be effective 12 months after the date it was filed.
.05 Section 301.7701-3(d)(1) provides in general that a foreign eligible entity’s classification is relevant when its classification affects the liability of any person for federal tax or information purposes.
.06 Under § 301.9100-1(c) the Commissioner may grant a reasonable extension of time to make a regulatory election or certain statutory elections under all subtitles of the Code, except subtitles E, G, H, and I.
.07 Section 301.9100-1(b) defines the term “regulatory election” as an election whose due date is prescribed by a regulation published in the Federal Register, or a revenue ruling, revenue procedure, notice, or announcement published in the Internal Revenue Bulletin. An entity classification election made pursuant to § 301.7701-3(c) is a regulatory election.
.08 The Commissioner has authority under § 301.9100-1 and § 301.9100-3 to grant an extension of time if a taxpayer fails to file a timely election under § 301.7701-3(c). Section 301.9100-3 provides that the Commissioner will grant an extension of time when the taxpayer provides the evidence to establish to the satisfaction of the Commissioner that the taxpayer has acted reasonably and in good faith and the grant of relief will not prejudice the interests of the government.
.09 Rev. Proc. 2002-59, 2002-2 C.B. 615, provides guidance under § 301.7701-3 for entities newly formed under local law to request relief for a late initial classification election filed by the due date for the first federal tax return (excluding extensions) of the entity’s desired classification for the year of the entity’s formation.
SECTION 3. SCOPE
.01 This revenue procedure supersedes Rev. Proc. 2002-59 by
extending late entity classification relief to both initial
classification elections and changes in classification elections along
with extending the time for filing late entity classification elections
to within 3 years and 75 days of the requested effective date of the
eligible entity’s classification. Thus, the extended filing period no
longer is limited, as it was under Rev. Proc. 2002-59, to entities newly
formed under local law requesting relief to file an initial
classification election and to the due date for the first federal tax
return (excluding extensions) of the entity’s desired classification for
the year of the entity’s formation. For those entities that satisfy the
requirements set forth in Section 4.01, this revenue procedure is the
exclusive means for obtaining relief for a late entity classification
election and is in lieu of the letter ruling procedure that is used to
obtain relief for a late entity classification election under §
301.9100-1 and § 301.9100-3. Accordingly, user fees do not apply to
action under this revenue procedure.
.02 An eligible entity may qualify for alternative relief under § 301.7701-3(c)(1)(v)(C), which treats an entity as having made a classification election to be treated as an association when it timely elects to be an S corporation under § 1362(a)(1). Also, see Rev. Proc. 2004-48, 2004-2 C.B. 172, and Rev. Proc. 2007-62, 2007-41 I.R.B. 786, or their successors for special rules applicable to late S corporation elections and late entity classification elections.
.03 An entity that does not satisfy the requirements for relief under this revenue procedure may request relief by applying for a letter ruling. Additionally, eligible entities that do not qualify for relief under this revenue procedure, because they do not satisfy all of the requirements set forth in Section 4.01, and that request a letter ruling for late entity classification relief either must include as part of their letter ruling request the affirmative representation in Section 4.04 or an explanation why the entity cannot make the affirmative representation in Section 4.04. The procedural requirements for requesting a letter ruling are described in Rev. Proc. 2009-1, 2009-1 I.R.B. 1 (or its successor).
SECTION 4. RELIEF FOR
LATE CLASSIFICATION ELECTIONS
.01 Eligibility for relief. An entity
is eligible for relief under Section 4.03 of this revenue procedure for
a late classification election if the following requirements are met:
(1)(a) the entity failed to obtain its requested classification as of
the date of its formation or upon the entity’s classification becoming
relevant within the meaning of § 301.7701-3(d) solely because Form 8832
was not filed timely under § 301.7701-3(c)(1)(iii); or (b) the entity
failed to obtain its requested change in classification (subject to the
limitations of § 301.7701-3(c)(1)(iv)) solely because Form 8832 was not
filed timely under § 301.7701-3(c)(1)(iii); and
(2)(a) the eligible entity seeking an extension of time to make an entity classification election has not filed a federal tax or information return for the first year in which the election was intended because the due date has not passed for that year’s federal tax or information return; or
(b) the eligible entity seeking an extension of time to make an entity classification election timely filed all required federal tax returns and information returns consistent with its requested classification for all of the years the entity intended the requested election to be effective and no inconsistent tax or information returns have been filed by or with respect to the entity during any of the taxable years. For changes in an eligible entity’s classification election, consistent filing of returns includes filing returns consistent with the deemed treatment of elective changes under § 301.7701-3(g).
Under this revenue procedure, if the eligible entity is not required to file a federal tax return or information return, each affected person, who is required to file a federal tax return or information return, must have timely filed all such returns consistent with the entity’s requested classification for all of the years the entity intended the requested election to be effective and no inconsistent tax or information returns have been filed during any of the taxable years. Solely for purposes of this section 4.01(2)(b), an entity and an affected person will be treated as having timely filed a required tax or information return if the return is filed within 6 months after its due date, excluding extensions. An indirect owner of an eligible entity (such as a partner in a partnership that holds an interest in the eligible entity) is not an affected person if an entity in which the indirect owner holds a direct or indirect interest would be required to attach a copy of the eligible entity’s Form 8832 to its federal tax or information return in the circumstances described in section 4.01(2)(b)(i) or (ii) . An affected person is either:
(i) with respect to the effective date of the eligible entity’s classification election, a person who would have been required under § 301.7701-3(c)(1)(ii) to attach a copy of the Form 8832 for the eligible entity to its federal tax or information return for the taxable year of the person which includes that date; or
(ii) with respect to any subsequent date after the entity’s requested effective date of the classification election, a person who would have been required under § 301.7701-3(c)(1)(ii) to attach a copy of the Form 8832 for the eligible entity to its federal tax or information return for the person’s taxable year that includes that subsequent date had the election first become effective on that subsequent date; and
(3) the eligible entity has reasonable cause for its failure to timely make the entity classification election; and
(4) 3 years and 75 days from the requested effective date of the eligible entity’s classification election have not passed.
.02 Procedural requirements for requesting relief. Within 3 years and 75 days from the requested effective date of the eligible entity’s classification election, the eligible entity must file with the applicable IRS service center (determined in accordance with the instructions to Form 8832) a completed Form 8832, signed in accordance with § 301.7701-3(c)(2). The Form 8832 must indicate that it is being filed pursuant to this revenue procedure in accordance with the Form 8832 and accompanying instructions. The Form 8832 must include both a declaration that the elements required for relief in Section 4.01 of this revenue procedure have been satisfied and a statement explaining the reason for the failure to file a timely entity classification election (referred to as "the reasonable cause statement"). (Until Form 8832 is modified to include the declaration contained in this revenue procedure and space for a reasonable cause statement, the eligible entity should write "Filed Pursuant to Rev. Proc. 2009-39(sic)" { ed. (preferably in red ) and it should actually say: "Filed Pursuant to Rev. Proc. 2009-41" } at the top of Form 8832 and attach both the declaration and the reasonable cause statement to its Form 8832 that is filed with the applicable IRS service center. The declaration and reasonable cause statement must be accompanied by a dated declaration, signed by an authorized representative of the eligible entity and the affected person(s), if any, which states: "Under penalties of perjury, I (we) declare that I (we) have examined this election, including accompanying documents, and, to the best of my (our) knowledge and belief, the election contains all the relevant facts relating to the election, and such facts are true, correct, and complete." The individual or individuals who sign must have personal knowledge of the facts and circumstances related to the election. The copy of the Form 8832 that is required under §301.7701-3(c)(1)(ii) to be attached to either the eligible entity’s or the affected person’s return does not need the writing at the top of the Form 8832 or the attachments described in this section 4.02.)
.03 Relief for late entity classification elections. Upon receipt of a completed Form 8832 requesting relief under Section 4.01 of this revenue procedure, the IRS service center will determine whether the requirements for granting the late entity classification election have been satisfied and will notify the entity of the result of its determination. An entity receiving relief under this revenue procedure is treated as having made a timely entity classification election as of the requested effective date of the election.
.04 Eligible entities that do not meet all of the eligibility requirements under Section 4.01 of this revenue procedure. Eligible entities requesting a letter ruling because they do not meet all of the eligibility requirements of Section 4.01 of this revenue procedure must include either the following representation as part of the entity’s request for a letter ruling or an explanation regarding why they do not qualify to do so: “All required U.S. tax and information returns of the entity (or, if the entity was not required to file any such returns under the desired classification, then all required U.S. tax and information returns of each affected person as defined in Section 4.02 of Rev. Proc. 2009-39) were filed timely or within 6 months of the due date of the respective return (excluding extensions) as if the entity classification election had been in effect on the requested date. No U.S. tax or information returns were filed inconsistently with those described in the prior sentence.”
SECTION 5. EFFECTIVE DATE
.01 In general. Except as provided in section 5.02, this revenue
procedure is effective September 28, 2009, the date of publication of
this revenue procedure in the Internal Revenue Bulletin. This revenue
procedure applies to requests pending with the IRS service center
pursuant to Rev. Proc. 2002-59 on September 28, 2009, and to requests
received thereafter. It also applies to all ruling requests pending in
the national office on September 28, 2009, and to requests for relief
received thereafter.
.02 Transition rule for pending letter ruling requests. If an entity has filed a request for a letter ruling seeking relief for a late entity classification election and that letter ruling request is pending in the national office on September 28, 2009, the entity may rely on this revenue procedure, withdraw that letter ruling request and receive a refund of its user fee. However, the national office will process letter ruling requests pending on September 28, 2009, unless, prior to the earlier of November 12, 2009, or the issuance of the letter ruling, the entity notifies the national office that it will rely on this revenue procedure and withdraw its letter ruling request.
SECTION 6. EFFECT ON OTHER
DOCUMENTS
Rev. Proc. 2002-59 is superseded.
SECTION 7. PAPERWORK REDUCTION
ACT
The collections of information contained in this revenue procedure
have been reviewed and approved by the Office of Management and Budget
(OMB) in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C.
3507(d)) under control number 1545-1771.
The collection of information in these regulations is in Sections 4.02 and 4.04 of this revenue procedure. The information will help the IRS to determine if an eligible entity meets the requirements of Section 4.01 of this revenue procedure. The collection of information is required to obtain permission to file a late entity classification election. The information will be reported on Form 8832 or submitted as part of a letter ruling request. The time needed to complete and file a letter ruling request or a Form 8832 will vary depending on individual circumstances. The estimated burden for eligible entities filing a letter ruling request or Form 8832 are included in the estimates shown in the Paperwork Reduction Act of the annually published letter ruling revenue procedure and the instructions for Form 8832 respectively. An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless the collection of information displays a valid control number.
Books or records relating to a collection of information must be retained as long as their contents may become material in the administration of any internal revenue law. Generally, tax returns and tax return information are confidential, as required by 26 U.S.C. 6103.
Extensions of Time to Make Elections:
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 301 and 602
[TD 8680]
RIN 1545-AU41
Extensions of Time to Make
Elections
AGENCY: Internal Revenue
Service (IRS), Treasury.
ACTION: Temporary regulations.
SUMMARY: This document contains temporary regulations concerning
extensions of time for making certain elections under the Internal
Revenue Code (Code). The regulations provide the standards that
the Commissioner will use to grant taxpayers extensions of time for
making these elections. The text of these temporary regulations
also serves as the text of the proposed regulations set forth in the
notice of proposed rulemaking on this subject in the Proposed Rules
section of this issue of the Federal Register.
DATES: These regulations are effective June 27, 1996.
For dates of applicability, see
§301.9100-1T(h) of these regulations.
FOR FURTHER INFORMATION CONTACT: Robert A. Testoff at (202)
622-4960 (not a toll-free number).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
These regulations are being issued without prior notice
and public procedure pursuant to the Administrative Procedure Act
(5 U.S.C. 553). For this reason, the collection of information
contained in these regulations has been reviewed and, pending receipt
and evaluation of public comments, approved by the Office of Management
and Budget under control number 1545-1488.
Responses to this collection of information are required to obtain an
extension of time for making an election.
An agency may not conduct or sponsor, and a person is
not required to respond to, a collection of information unless the
collection of information displays a valid control number.
For further information concerning this collection of
information, where to submit comments on the collection of information
and the accuracy of the estimated burden, and suggestions for reducing
this burden, please refer to the preamble to the cross-referencing
notice of proposed rulemaking published in the Proposed Rules section of
this issue of the Federal Register.
Books or records relating to a collection of
information must be retained as long as their contents may become
material in the administration of any internal revenue law.
Generally, tax returns and tax return information are confidential, as
required by 26 U.S.C. 6103. Background
This document contains temporary regulations amending
the Regulations on Procedure and Administration (26 CFR part 301)
concerning extensions of time for making certain elections. The
regulations provide the standards that the Commissioner will use to
grant taxpayers extensions of time for making these elections.
These standards provide relief to taxpayers who reasonably and in good
faith fail to make a timely election when granting relief will not
prejudice the interests of the government. The regulations provide
a means by which taxpayers can be in the same position they would have
been in had they made their elections in a timely fashion.
Explanation of Provisions
These temporary regulations provide the standards the
Commissioner will use to determine whether to grant an extension of time
to make an election when the deadline for making the election is
prescribed by regulation, revenue ruling, revenue procedure, notice, or
announcement published in the Federal Register or the Internal Revenue
Bulletin (regulatory election). Under section 6081(a), these regulations
also provide an automatic extension of time to make an election when the
deadline for making the election is prescribed by statute (statutory
election) and the deadline for making the election is the due date of
the return or the due date of the return including extensions.
These regulations adopt and revise the standards for relief provided in
Rev. Proc. 92-85, 1992-2 C.B. 490.
Automatic Extensions
Rev. Proc. 92-85 provides an automatic 12-month
extension for certain regulatory elections listed in Appendix A of that
revenue procedure. The temporary regulations continue the
automatic 12-month extension and update the list of eligible regulatory
elections.
Rev. Proc. 92-85 also provides an automatic 6-month
extension for statutory elections when the deadline for making the
election is prescribed as the due date of the return or the due date of
the return including extensions. The temporary regulations expand
the automatic 6-month extension to include regulatory elections.
Other Extensions
Rev. Proc. 92-85 provides relief for certain regulatory
elections that do not qualify for relief under the automatic extensions.
Rev. Proc. 92-85 requires a taxpayer to demonstrate that (1) it acted
reasonably and in good faith and (2) granting relief will not prejudice
the interests of the government. The temporary regulations
continue to provide extensions for such regulatory elections upon a
showing of reasonable action and good faith and no prejudice to the
interests of the government.
The temporary regulations adopt the standards for
reasonable action and good faith in Rev. Proc. 92-85. The
regulations provide that a taxpayer is deemed to have acted reasonably
and in good faith if: (1) the taxpayer applies for relief before the
failure to make the regulatory election is discovered by the IRS; (2)
the taxpayer inadvertently failed to make the election because of
intervening events beyond its control; (3) the taxpayer failed to make
the election because after exercising reasonable diligence the taxpayer
was unaware of the necessity for the election; (4) the taxpayer
reasonably relied on written advice of the IRS; or (5) the taxpayer
relied on a qualified tax professional, including a professional
employed by the taxpayer, and the professional failed to make or advise
the taxpayer to make the election. However, a taxpayer is deemed
to have not acted reasonably and in good faith if: (1) the taxpayer is
requesting relief for an election to alter a return position for which
an accuracy-related penalty could have been imposed under section 6662;
(2) the taxpayer was fully informed of the required election and related
tax consequences and chose not to file the election; or (3) the taxpayer
uses hindsight in requesting relief.
The temporary regulations adopt the standards for
prejudice to the interests of the government in Rev. Proc. 92-85.
The regulations provide that the interests of the government are deemed
to be prejudiced if granting relief would result in a taxpayer having a
lower tax liability than the taxpayer would have had if the regulatory
election had been timely made. In addition, the interests of the
government are ordinarily deemed to be prejudiced if the tax year in
which the election should have been made or any affected tax years are
closed by the statute of limitations.
Accounting Method and Period Elections
Rev. Proc. 92-85 provides limited relief (ordinarily
not to exceed 90 days from the deadline for filing Form 3115,
Application for Change in Accounting Method) for requests to change an
accounting method subject to the procedure described in
§1.446-1(e)(3)(i) (requiring the advance written consent of the
Commissioner). The temporary regulations continue this limited
relief. Rev. Proc. 92-85 provides an automatic 12-month extension
for the election to use the last-in, first-out (LIFO) inventory method
under section 472 and also provides relief for the section 472 election
beyond the automatic 12-month extension.
Rev. Proc. 92-85 is otherwise inapplicable to accounting method
regulatory elections, except for three specific elections listed in
Appendix B of that revenue procedure.
The temporary regulations provide relief for all
accounting method regulatory elections. For example, relief will
now be available for elections under sections 197 (amortization of
goodwill and certain other intangibles) and 468A (special rules for
nuclear decommissioning costs).
The temporary regulations provide
additional rules regarding what constitutes prejudice to the interests
of the government for accounting method regulatory elections. The
temporary regulations provide that the interests of the government are
deemed to be prejudiced except in unusual and compelling circumstances
if: (1) the election requires an adjustment under section 481(a); (2)
the taxpayer is under examination, requests relief to change from an
impermissible method of accounting, and granting relief will provide the
taxpayer a more favorable method of accounting or more favorable terms
and conditions than the taxpayer would receive if the change is made as
part of the examination; or (3) the election provides a more favorable
method of accounting or more favorable terms and conditions if the
election is made by a certain date or taxable year.
Rev. Proc. 92-85 provides an automatic 12-month extension for elections
to use other than the required taxable year under section 444.
Rev. Proc. 92-85 also provides limited relief (ordinarily not to exceed
90 days from the deadline for filing Form 1128, Application to Adopt,
Change, or Retain a Tax Year) for accounting period regulatory elections
subject to Rev. Proc. 87-32, 1987-2 C.B. 396. Rev. Proc. 92-85 is
otherwise inapplicable to accounting period regulatory elections.
The temporary regulations extend the limited relief for elections
subject to Rev. Proc. 87-32 to all other accounting period regulatory
elections except for the section 444 election, and provide relief for
the section 444 election beyond the automatic 12-month extension.
Effect on other documents
Rev. Proc. 92-85, 1992-2 C.B. 490, as modified and
clarified by Rev. Proc. 93-28, 1993-2 C.B. 344, is obsolete as of June
27, 1996.
Rev. Proc. 92-20, 1992-1 C.B. 685, is modified as of
June 27, 1996, to the extent that the provisions of this regulation
apply to applications for relief with respect to requests to change an
accounting method subject to the procedures of Rev. Proc. 92-20.
Rev. Proc. 87-32, 1987-2 C.B. 396, is modified as of
June 27, 1996, to the extent that the provisions of this regulation
apply to applications for relief with respect to requests to change an
accounting period subject to the procedures of Rev. Proc. 87-32.
Special Analyses
It has been determined that this Treasury decision is
not a significant regulatory action as defined in EO 12866.
Therefore, a regulatory assessment is not required. It has also
been determined that section 553(b) of the Administrative Procedure Act
(5 U.S.C. chapter 5) and the Regulatory Flexibility Act (5 U.S.C.
chapter 6) do not apply to these regulations, and, therefore, a
Regulatory Flexibility Analysis is not required.
Pursuant to section 7805(f) of the Internal Revenue Code, these
temporary regulations will be submitted to the Chief Counsel for
Advocacy of the Small Business Administration for comment on their
impact on small businesses.
Drafting Information
The principal author of these regulations is Robert A.
Testoff of the Office of Assistant Chief Counsel (Income Tax and
Accounting). However, other personnel from the IRS and Treasury
Department participated in their development.
List of Subjects
26 CFR Part 301
Employment taxes, Estate taxes, Excise taxes, Gift
taxes, Income taxes, Penalties, Reporting and recordkeeping
requirements.
26 CFR Part 602
Reporting and recordkeeping requirements.
Adoption of Amendments to the Regulations
Accordingly, 26 CFR parts 301 and 602 are amended as
follows:
PART 301--PROCEDURE AND ADMINISTRATION
Paragraph 1. The authority citation for part 301
is amended by adding entries in numerical order to read as follows:
Authority: 26 U.S.C. 7805 * * *
Section 301.9100-1T also issued under 26 U.S.C. 6081;
Section 301.9100-2T also issued under 26 U.S.C. 6081;
Section 301.9100-3T also issued under 26 U.S.C. 6081; * * *
Par. 2. Sections 301.9100-1T through 301.9100-3T
are added to read as follows:
§ 301.9100-1T
Extensions of time to make elections (temporary). [Removed]
(a) - (c)
[Reserved].
(d) Introduction. The regulations under this
section and §§301.9100-2T through
301.9100-3T provide the standards the Commissioner will use to determine
whether to grant an extension of time to make a regulatory election.
The regulations under this section and §§301.9100-2T
through 301.9100-3T also provide an automatic extension of time to make
certain statutory elections. An extension of time is available for
elections that a taxpayer is otherwise eligible to make and the granting
of an extension of time is not a determination that the taxpayer is
otherwise eligible to make the election. Section 301.9100-2T
provides automatic extensions of time for making regulatory and
statutory elections when the deadline for making the election is the due
date of the return or the due date of the return including extensions.
Section 301.9100-3T provides extensions of time for making regulatory
elections that do not meet the requirements of §301.9100-2T.
(e) Terms. The following terms have the meanings
provided below:
Election includes an application for relief in
respect of tax; a request to adopt, change, or retain an accounting
method or accounting period; but does not include an application for an
extension of time for filing a return under section 6081.
Regulatory election means an election whose deadline is prescribed by a
regulation published in the Federal Register, or a revenue ruling,
revenue procedure, notice, or announcement published in the Internal
Revenue Bulletin.
Statutory
election means an election whose deadline is prescribed by statute.
Taxpayer
means any person within the meaning of section 7701(a)(1).
(f) General standards for relief. The
Commissioner in the Commissioner's discretion may grant a reasonable
extension of time to make a regulatory election, or a statutory election
(but no more than 6 months except in the case of a taxpayer who is
abroad), under all subtitles of the Internal Revenue Code except
subtitles E, G, H, and I, provided the taxpayer demonstrates to the
satisfaction of the Commissioner that--
(1) The taxpayer acted reasonably and in good faith;
and
(2) Granting relief will not prejudice the interests of
the government.
(g) Exceptions. Notwithstanding the provisions of
paragraph (f) of this section, an extension of time will not be
granted--
(1) For elections under section 4980A(f)(5);
(2) For elections required to be made prior to November
20, 1970, in the case of an election--
(i) Required to be made in or with the taxpayer's
original
income tax return;
(ii) Required to be exercised by filing a claim for
credit or refund, unless the election is required to be exercised on or
before a date that precedes the date of expiration of the period of
limitations provided in section 6511;
(iii) Required to be filed in a petition to the Tax
Court;
(iv) To change a previous election;
(v) To change an accounting method as described in
§§1.77-1 of this chapter and
1.446-1 of this chapter;
(vi) To change an accounting period as described in
§1.442-1 of this chapter; or
(vii) To change the method of treating bad debts as
described in §1.166-1 of this
chapter; or
(3) For elections that are expressly excepted from
relief or where alternative relief is provided by a statute, a
regulation published in the Federal Register, or a revenue ruling,
revenue procedure, notice, or announcement published in the Internal
Revenue Bulletin.
(h) Effective dates. In general, this section and
§§301.9100-2T through 301.9100-3T are
effective for all requests for relief being considered by the IRS on
June 27, 1996, and for all requests for relief submitted on or after
June 27, 1996.
However, the automatic 12-month extension and the automatic 6-month
extension provided in
§301.9100-2T are effective for elections
whose due dates are on or after June 27, 1996.
§ 301.9100-2T
Automatic extensions (temporary). [Removed]
(a)
Automatic 12-month extension--(1) In general. An automatic
extension of 12 months from the original deadline for making a
regulatory election is granted to make elections described in paragraph
(a)(2) of this section provided the taxpayer takes corrective action as
defined in paragraph (c) of this section within that 12-month extension
period.
(2) Elections eligible for automatic 12-month
extension. The following regulatory elections are eligible for the
automatic 12-month extension described in paragraph (a)(1) of this
section--
(i) The election to use other than the required taxable
year under section 444;
(ii) The election to use the last-in, first-out (LIFO)
inventory method under section 472;
(iii) The 15-month rule for filing an exemption
application for a section 501(c)(9), 501(c)(17), or 501(c)(20)
organization under section 505;
(iv) The 15-month rule for filing an exemption
application for a section 501(c)(3) organization under section 508;
(v) The election to be treated as a homeowners
association under section 528;
(vi) The election to adjust basis on partnership
transfers and distributions under section 754;
(vii) The estate tax election to specially value
qualified real property (where the IRS has not yet begun an examination
of the filed return) under section 2032A(d)(1);
(viii) The chapter 14 gift tax election to treat a
qualified payment right as other than a qualified payment under section
2701(c)(3)(C)(i); and
(ix) The chapter 14 gift tax election to treat any
distribution right as a qualified payment under section
2701(c)(3)(C)(ii).
(b) Automatic 6-month extension. An automatic
extension of 6 months from the due date of a return excluding extensions
is granted to make regulatory or statutory elections whose deadlines are
prescribed as the due date of the return or the due date of the return
including extensions in the case of a taxpayer that timely filed its
return for the year the election should have been made, provided the
taxpayer takes corrective action as defined in paragraph (c) of this
section within that 6-month extension period. This extension does
not apply, however, to regulatory or statutory elections that must be
made by the due
date of the return excluding extensions.
(c) Corrective action. For purposes of this
section, corrective action means filing an original or an amended return
for the year the regulatory or statutory election should have been made
and attaching the appropriate form or statement for making the election.
For those elections not required to be filed with a return, corrective
action means taking the steps required to file the election in
accordance with the statute, the regulation published in the Federal
Register, or the revenue ruling, revenue procedure, notice, or
announcement published in the Internal Revenue Bulletin. Taxpayers
who make an election under an automatic extension (and all taxpayers
whose tax liability would be affected by the election) must report their
income in a manner that is consistent with the election and comply with
all other requirements for making the election for the year the election
should have been made and for all affected years; otherwise, the Service
may invalidate the election.
(d) Procedural requirements. Any return,
statement of election, or other form of filing that must be made to
obtain an automatic extension must provide the following statement at
the top of the document: "FILED PURSUANT TO §
301.9100-2T". Any filing made to obtain an automatic extension
must be sent to the same address that the filing to make the election
would have been sent had the filing been timely made. No request
for a letter ruling is required to obtain an automatic extension.
Accordingly, user fees do not apply to taxpayers taking corrective
action to obtain an automatic extension.
(e) The following example illustrates the rules of this
section:
Example. Taxpayer A fails to make a certain
election when filing A's 1996 income tax return on March 17, 1997, the
due date of the return. This election does not affect the tax
liability of any other taxpayer. The applicable regulation
requires that the election be made by attaching the appropriate form to
a timely filed return including extensions. In accordance with
paragraphs (b) and (c) of this section, A may make the regulatory
election by filing an amended return with the appropriate form by
September 15, 1997 (6 months from the March 17, 1997, due date).
§ 301.9100-3T Other
extensions (temporary). [Removed]
(a) In
general. Requests for extensions of time for regulatory elections
that do not meet the requirements of §301.9100-2T
must be made under the rules of this section.
Requests for relief subject to this section will be granted when the
taxpayer provides the evidence (including affidavits described in
paragraph (e) of this section) to establish that the taxpayer acted
reasonably and in good faith, and granting relief will not prejudice the
interests of the government.
(b) Reasonable action and good faith--(1) In general.
Except as provided in paragraphs (b)(3)(i) through (iii) of this
section, a taxpayer is deemed to have acted reasonably and in good faith
if the taxpayer--
(i) Requests relief under this section before the
failure to make the regulatory election is discovered by the IRS;
(ii) Inadvertently failed to make the election because
of intervening events beyond the taxpayer's control;
(iii) Failed to make the election because, after
exercising reasonable diligence (taking into account the taxpayer's
experience and the complexity of the return or issue), the taxpayer was
unaware of the necessity for the election;
(iv) Reasonably relied on the written advice of
the IRS; or
(v) Reasonably relied on a qualified tax
professional, including a tax professional employed by the taxpayer, and
the tax professional failed to make, or advise the taxpayer to make,
the election.
(2) Reasonable reliance on a qualified tax
professional. For purposes of this paragraph (b), a taxpayer will not be
considered to have reasonably relied on a qualified tax professional if
the taxpayer knew or should have known that the professional was not--
(i) Competent to render advice on the regulatory
election; or
(ii) Aware of all relevant facts.
(3) Taxpayer deemed to have not acted reasonably or in good
faith. For purposes of this paragraph (b), a taxpayer is deemed to
have not acted reasonably and in good faith if the taxpayer--
(i) Seeks to alter a return position for which an
accuracy-related penalty has been or could be imposed under section 6662
at the time the taxpayer requests relief (taking into account any
qualified amended return filed within the meaning of §1.6664-2(c)(3)) of
this chapter and the new position requires or permits a regulatory
election for which relief is requested;
(ii) Was fully informed of the required election and related
tax consequences, but chose not to file the election; or
(iii) Uses hindsight in requesting relief. If specific
facts have changed since the original deadline for making the election
that make the election advantageous to a taxpayer, the IRS will not
ordinarily grant relief. In such a case, the IRS will grant relief
only when the taxpayer provides strong proof that the taxpayer's
decision to seek relief did not involve hindsight.
(c) Prejudice to the interests of the government--(1) In
general--(i) Lower tax liability. The interests of the
government are prejudiced if granting relief would result in a taxpayer
having a lower tax liability in the aggregate for all years to which the
regulatory election applies than the taxpayer would have had if the
election had been timely made (taking into account the time value of
money). Similarly, if the tax consequences of more than one
taxpayer are affected by the election, the government's interests are
prejudiced if extending the time for making the election may result in
the affected taxpayers, in the aggregate, having a lower tax liability
than if the election had been timely made.
(ii) Closed years. The interests of the government are
ordinarily prejudiced if the tax year in which the regulatory election
should have been made or any tax years that would have been affected by
the election had it been timely made are closed by the period of
limitations on assessment under section 6501(a) before the taxpayer's
receipt of a ruling granting relief under this section. The IRS
may condition a grant of relief on the taxpayer providing the IRS with a
statement from an independent auditor (other than an auditor providing
an affidavit pursuant to paragraph (e)(3) of this section) certifying
that the requirements of paragraph (c)(1)(i) of this section are
satisfied.
(2) Special rules for accounting method regulatory elections.
The interests of the government are deemed to be prejudiced except in
unusual and compelling circumstances if the accounting method regulatory
election is--
(i) Subject to the procedure described in §1.446-1(e)(3)(i)
of this chapter (requiring the advance written consent of the
Commissioner), and the request for relief under this section is filed
more than 90 days after the deadline for filing the Form 3115,
Application for Change in Accounting Method;
(ii) Not an election described in paragraph (c)(2)(i) of this
section and requires an adjustment under section 481(a) (or would
require an adjustment under section 481(a) if the taxpayer changed to
the method of accounting for which relief is requested in a taxable year
subsequent to the taxable year the election should have been made);
(iii) Not an election described in paragraph (c)(2)(i) of
this section, the taxpayer is under examination and requests relief
under this section to change from an impermissible method of accounting,
and granting relief will provide the taxpayer a more favorable method of
accounting or more favorable terms and conditions than the taxpayer
would receive if the change from the impermissible method is made as
part of the examination; or
(iv) Not an election described in paragraph (c)(2)(i) of this
section and the election provides a more favorable method of accounting
or more favorable terms and conditions if the election is made by a
certain date or taxable year.
(3) Special rules for accounting period regulatory elections.
The interests of the government are deemed to be prejudiced except in
unusual and compelling circumstances if an election is an
accounting period regulatory election (other than the election to use
other than the required taxable year under section 444) and the request
for relief is filed more than 90 days after the deadline for filing the
Form 1128, Application to Adopt, Change, or Retain a Tax Year (or other
required statement).
(d) Effect of amended returns--(1) Second examination under
section 7605(b). Taxpayers requesting and receiving an extension
of time under this section waive any objections to a second examination
under section 7605(b) for the issue(s) that is the subject of the relief
request and any correlative adjustments.
(2) Suspension of the period of limitations under
section 6501(a). A request for relief under this section does not
suspend the period of limitations on assessment under section 6501(a).
Thus, for relief to be granted, the IRS may require the taxpayer to
consent under section 6501(c)(4) to an extension of the period of
limitations on assessment for the tax year in which the regulatory
election should have been made and any tax years that would have been
affected by the election had it been timely made.
(e) Procedural requirements--(1) In general. Requests
for relief under this section must provide evidence that satisfies the
requirements in paragraphs (b) and (c) of this section, and must provide
additional information as required by this paragraph (e).
(2) Affidavit and declaration from taxpayer. The
taxpayer, or the individual who acts on behalf of the taxpayer with
respect to tax matters, must submit a detailed affidavit describing the
events that led to the failure to make a valid regulatory election and
to the discovery of the failure. When the taxpayer relied on a
qualified tax professional for advice, the taxpayer's affidavit must
describe the engagement and responsibilities of the professional as well
as the extent to which the taxpayer relied on the professional.
The affidavit must be accompanied by a dated declaration, signed by the
taxpayer, which states: "Under
penalties of perjury, I declare that, to the best of my knowledge and
belief, the facts presented herein are true, correct, and complete."
The individual who signs for an entity must have personal knowledge of
the facts and circumstances at issue.
(3) Affidavits and declarations from other parties. The
taxpayer must submit detailed affidavits from the individuals having
knowledge or information about the events that led to the failure to
make a valid regulatory election and to the discovery of the failure.
These individuals must include the taxpayer's income tax return
preparer, any individual (including an employee of the taxpayer) who
made a substantial contribution to the preparation of the return, and
any accountant or attorney, knowledgeable in tax matters, who advised
the taxpayer with regard to the election. An affidavit must
describe the engagement and responsibilities of the individual as well
as the advice that the individual provided to the taxpayer. Each
affidavit must include the name, current address, and taxpayer
identification number of the individual, and be accompanied by a dated
declaration, signed by the individual, which states: "Under penalties of
perjury, I declare that, to the best of my knowledge and belief, the
facts presented herein are true, correct, and complete."
(4) Other Information. The request for relief filed
under this section must also contain the following information--
(i) The taxpayer must state whether the taxpayer's return(s)
for the tax year in which the regulatory election should have been made
or any tax years that would have been affected by the election had it
been timely made is being examined by a district director, or is being
considered by an appeals office or a federal court. The taxpayer
must notify the IRS office considering the request for relief if the IRS
starts an examination of any such return while the taxpayer's request
for relief is pending;
(ii) The taxpayer must state when the applicable return,
form, or statement used to make the election was required to be filed
and when it was actually filed;
(iii) The taxpayer must submit a copy of any documents that
refer to the election;
(iv) When requested, the taxpayer must submit a copy of the
taxpayer's income tax return for any taxable year for which the taxpayer
requests an extension and any return affected by the
election; and
(v) When applicable, the taxpayer must submit a copy of the
income tax returns of other taxpayers affected by the election.
(5) Filing instructions. A request for relief under
this section is a request for a letter ruling. Requests for relief
should be submitted in accordance with the applicable procedures for
requests for a letter ruling and must be accompanied by the applicable
user fee.
(f) Examples. The following examples illustrate the
provisions of this section:
Example 1. Taxpayer discovers own error. Taxpayer
A prepares A's 1996 income tax return. A is unaware that a
particular regulatory election is available to report a transaction in a
particular manner. A files the 1996 return without making the
election and reporting the transaction in a different manner. In
1998, A hires a qualified tax professional to prepare A's 1998 return.
The professional discovers that A
did not make the election. A promptly files for relief in
accordance with this section. Assuming paragraphs (b)(3)(i)
through (iii) of this section do not apply, A is deemed to have acted
reasonably and in good faith.
Example 2. Reliance on qualified tax professional.
Taxpayer B hires a qualified tax professional to advise B on preparing
B's 1996 income tax return and provides the professional with all the
information requested. The professional fails to advise B that a
regulatory election is necessary in order for B to report income on B's
1996 return in a particular manner. Nevertheless, B reports this
income in a manner that is consistent with having made the election.
In 1999, during the examination of the 1996 return by the IRS, the
examining agent discovers that the election has not been filed. B
promptly files for relief in accordance with this section, including
attaching an affidavit from B's professional stating that the
professional failed to advise B that the election was necessary.
Assuming paragraphs (b)(3)(i) through (iii) of this section do not
apply, B is deemed to have acted reasonably and in good faith.
Example 3. Accuracy-related penalty. Taxpayer C
reports income on its 1996 income tax return in a manner that
contravenes a statutory provision. C was aware of the statutory
provision that prohibited the manner in which C reported this income,
but did not provide adequate disclosure of the return position within
the meaning of §1.6662-3(c) of this chapter. In 1999, during the
examination of the 1996 return, the IRS raises an issue regarding the
reporting of this income on C's return. C requests relief under
this section to elect an alternative method of reporting the income.
Under paragraph (b)(3)(i) of this section, C is deemed to have not acted
reasonably and in good faith because C seeks to alter a return position
for which an accuracy-related penalty could be imposed under section
6662.
Example 4. Election not requiring adjustment under
section 481(a). Taxpayer D prepares D's 1996 income tax return.
D is unaware that a particular accounting method regulatory election is
available. D files the 1996 return using another method of
accounting. In 1998, D hires a qualified tax professional to
prepare D's 1998 return. The professional discovers that D did not
make the election. D promptly files for relief in accordance with
this section. Assume the applicable regulation provides that the
election does not require an adjustment under section 481(a) and the
election is not subject to the procedure described
in §1.446-1(e)(3)(i) of this chapter. Further assume that if D
were granted an extension of time to make the election, D would pay no
less tax than if the election had been timely made. Under
paragraph (c) of this section, the interests of the government are not
deemed to be prejudiced.
Example 5. Election
requiring adjustment under section 481(a). The facts are the same
as in Example 4 of this paragraph (f) except that the applicable
regulation provides that the election requires an adjustment under
section 481(a). Under paragraph (c)(2)(ii) of this section, the
interests of the government are deemed to be prejudiced except in
unusual or compelling circumstances.
Example 6. Under examination. A regulation
permits an automatic change from an impermissible method of accounting
on a cut-off basis. Any change to this method made as part of an
examination is made with a section 481(a) adjustment. Taxpayer E
reports income on E's 1996 income tax return using the impermissible
method of accounting. In 1999, during the examination of the 1996
return by the IRS, the examining agent questions the propriety of E's
method of accounting. E requests relief under this section to make
the change pursuant to the regulation for 1996. E will receive
less favorable terms and conditions if the change in method of
accounting is made with a section 481(a) adjustment by the examining
agent than if the change is made on a cut-off basis pursuant to the
regulation. Under paragraph (c)(2)(iii) of this section, the
interests of the government are deemed to be prejudiced except in
unusual and compelling circumstances. PART 602--OMB CONTROL NUMBERS
UNDER THE PAPERWORK REDUCTION ACT
Par. 3. The authority citation for part 602 continues
to read as follows:
Authority: 26 U.S.C. 7805
Par. 4. Section 602.101(c) is amended by adding the
following entries in numerical order to the table:
602.101 OMB Control numbers
* * * * *
(c) * * *
CFR part or section where
Current OMB
identified and described
control number
* * * * *
301.9100-2T.................................1545-1488
301.9100-3T.................................1545-1488
§ 301.9100-1 Extensions of
time to make elections:
87428342837884818742
301.9100-1(a) Introduction.
The regulations under this section and Sections 301.9100-2 and
301.9100-3 provide the standards the Commissioner will use to determine
whether to grant an extension of time to make a regulatory election. The
regulations under this section and Section 301.9100-2 also provides an
automatic extension of time to make certain statutory elections. An
extension of time is available for elections that a taxpayer is
otherwise eligible to make. However, the granting to an extension of
time is not a determination that the taxpayer is otherwise eligible to
make the election. Section 301.9100-2 provides automatic extensions of
time for making regulatory and statutory elections when the deadline for
making the election is the due date of the return or the due date of the
return including extensions. Section 301.9100-3 provides extensions of
time for making regulatory elections that do not meet the requirements
of Section 301.9100-2.
301.9100-1(b) Terms.
The following terms have the meanings provided below -
Election includes an application for relief in respect of tax; a request
to adopt, change, or retain an accounting method or accounting period;
but does not include an application for an extension of time for filing
a return under section 6081.
Regulatory election means an election whose due date is prescribed by a
regulation published in the Federal Register, or a revenue ruling,
revenue procedure, notice, or announcement published in the Internal
Revenue Bulletin (see Section 601.601(d)(2) of this chapter).
Statutory election means an election whose due date is prescribed by
statute.
Taxpayer means any person within the meaning of section 7701(a)(1).
301.9100-1(c) General standards for relief.
The Commissioner in exercising the Commissioner's discretion may grant a
reasonable extension of time under the rules set forth in Sections
301.9100-2 and 301.9100-3 to make a regulatory election, or a statutory
election (but no more than 6 months except in the case of a taxpayer who
is abroad), under all subtitles of the Internal Revenue Code except
subtitles E, G, H, and I.
301.9100-1(d) Exceptions.
Notwithstanding the provisions of paragraph (c) of this section, an
extension of time will not be granted -
301.9100-1(d)(1) For elections under section 4980A(f)(5); or
301.9100-1(d)(2) For elections that are expressly excepted from relief
or where alternative relief is provided by a statute, a regulation
published in the Federal Register, or a revenue ruling, revenue
procedure, notice, or announcement published in the Internal Revenue
Bulletin (see Section 601.601(d)(2) of this chapter).
301.9100-1(e) Effective dates.
In general, this section and Sections 301.9100-2 and 301.9100-3 apply to
all requests for an extension of time submitted to the Internal Revenue
Service (IRS) on or after Dec. 31, 1997. However, the automatic 12-month
and 6-month extensions provided in Section 301.9100-2 apply to elections
for which corrective action is taken on or after Dec. 31, 1997. For
other requests for an extension of time, see Sections 301.9100-1T
through 301.9100-3T in effect prior to Dec. 31, 1997, (Sections
301.9100-1T through 301.9100-3T as contained in the 26 CFR part 1
edition revised as of April 1, 1997).
[T.D. 8342, 56 FR 14024, Apr. 5, 1991, as amended by T.D. 8378, 56 FR
64982, Dec. 13, 1991; T.D. 8481, 58 FR 34886-34887, June 30, 1993; as
revised by T.D. 8742, 62 FR 68167-68173, Dec. 31, 1997.]
§ 301.9100-2 Automatic
extensions:
874283428378848187428680871987428742
301.9100-2(a) Automatic 12-month extension -
301.9100-2(a)(1) In general.
An automatic extension of 12 months from the due date for making a
regulatory election is granted to make elections described in paragraph
(a)(2) of this section provided the taxpayer takes corrective action as
defined in paragraph (c) of this section within that 12-month extension
period. For purposes of this paragraph (a), the due date for making a
regulatory election is the extended due date of the return if the due
date of the election is the due date of the return or the due date of
the return including extensions and the taxpayer has obtained an
extension of time to file the return. This extension is available
regardless of whether the taxpayer timely filed its return for the year
the election should have been made.
301.9100-2(a)(2) Elections eligible for automatic 12-month extension.
The following regulatory elections are eligible for the automatic
12-month extension described in paragraph (a)(1) of this section -
301.9100-2(a)(2)(i) The election to use other than the required taxable
year under section 444;
301.9100-2(a)(2)(ii) The election to use the last-in, first-out (LIFO)
inventory method under section 472;
301.9100-2(a)(2)(iii) The 15-month rule for filing an exemption
application for a section 501(c)(9), 501(c)(17), or 501(c)(20)
organization under section 505;
301.9100-2(a)(2)(iv) The 15-month rule for filing an exemption
application for a section 501(c)(3) organization under section 508;
301.9100-2(a)(2)(v) The election to be treated as a homeowners
association under section 528;
301.9100-2(a)(2)(vi) The election to adjust basis on partnership
transfers and distributions under section 754;
301.9100-2(a)(2)(vii) The estate tax election to specially value
qualified real property (where the Internal Revenue Service (IRS) has
not yet begun an examination of the filed return) under section
2032A(d)(1);
301.9100-2(a)(2)(Viii) The chapter 14 gift tax election to treat a
qualified payment right as other than a qualified payment under section
2701(c)(3)(C)(i); and
301.9100-2(a)(2)(ix) The chapter 14 gift tax election to treat any
distribution right as a qualified payment under section
2701(c)(3)(C)(ii).
301.9100-2(b) Automatic 6-month extension.
An automatic extension of 6 months from the due date of a return
excluding extensions is granted to make regulatory or statutory
elections whose due dates are the due date of the return or the due date
of the return including extensions provided the taxpayer timely filed
its return for the year the election should have been made and the
taxpayer takes corrective action as defined in paragraph (c) of this
section within that 6-month extension period.
This paragraph (b) does not apply to regulatory or statutory elections
that must be made by the due date of the return excluding extensions.
301.9100-2(c) Corrective action.
For purposes of this section, corrective action means taking the steps
required to file the election in accordance with the statute or the
regulation published in the Federal Register, or the revenue ruling,
revenue procedure, notice, or announcement published in the Internal
Revenue Bulletin (see Section 601.601(d)(2) of this chapter). For those
elections required to be filed with a return, corrective action includes
filing an original or an amended return for the year the regulatory or
statutory election should have been made and attaching the appropriate
form or statement for making the election. Taxpayers who make an
election under an automatic extension (and all taxpayers whose tax
liability would be affected by the election) must file their return in a
manner that is consistent with the election and comply with all other
requirements for making the election for the year the election should
have been made and for all affected years; otherwise, the IRS may
invalidate the election.
301.9100-2(d) Procedural requirements.
Any return, statement of election, or other form of filing that must be
made to obtain an automatic extension must provide the following
statement at the top of the document: "FILED PURSUANT TO Section
301.9100-2". Any filing made to obtain an automatic extension must be
sent to the same address that the filing to make the election would have
been sent had the filing been timely made. No request for a letter
ruling is required to obtain an automatic extension. Accordingly, user
fees do