Tax practitioners are familiar with Subchapter C (C corporations), Subchapter K (partnerships), and Subchapter S (S corporations) but are generally less familiar with Subchapter T (§§ 1381-1388), which governs the taxation of cooperatives.
A cooperative is an association otherwise taxable as a C corporation that markets, purchases, or performs business functions for its patrons on a cooperative basis. The means of production and distribution are owned in common. The earnings revert to the members in proportion to their patronage (i.e., in proportion to the amount of business each member transactions with it). The predominant features of a cooperative are: (i) subordination of capital, (ii) democratic control, and (iii) proportionate allocation of profits. Cooperatives developed as a legal concept in 19th century England. In the United States, cooperatives were exempted from taxation as far back as 1916. The policy behind such exemption is cooperatives, unlike traditional corporations, are merely agents or conduits of their patrons so income should flow directly to patrons rather than being taxed to the cooperative.
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I trust everyone is having a good summer and finding enjoyable ways (aside from work) to avoid the heat and the daily downpours. We were fortunate this year to have wonderful weather during our annual CLE at Kiawah Island. Our CLE co-chairs, Kristin King and Jordan Fieldstein, did an outstanding job finding a slate of spectacular speakers, and we had a fine turnout of attendees in person and online. Jordan will be staying on as a CLE Committee co-chair, joined by Helen Herbert. Please plan to join us over Memorial Day weekend in 2025 for another wonderful weekend of sun and tax topics.
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I. Thanksgiving Holiday Extends the Due Date for Filing Tax Court Petition; Sall vs. Commissioner, 161 T.C. No. 13 (2023).
Mr. Sall received a notice of deficiency dated August 25, 2022, which was sent to Mr. Sall by certified mail on August 26. The 90th day after August 26 was Thursday, November 24, Thanksgiving Day. The face of the notice of deficiency stated that “the last day to file a petition with the US Tax Court” was Friday, November 25, 2022. Although the Tax Court’s electronic filing system through Dawson was operational and accessible throughout the entire Thanksgiving week, the Tax Court was closed from Thanksgiving Day until the following Monday. Mr. Sall mailed his petition to the court on Monday, November 28, 2022. The court received Mr. Sall’s petition on Thursday, December 1, 2022.
The IRS filed a motion to dismiss on the basis that the petition was filed late, since according to the IRS, the filing deadline was November 25, 2022. The court, however, concluded the petitioner’s due date was no earlier than Monday, December 12, 2022, which was long after the court received Mr. Sall’s petition. The court navigated the rules of Section 7451 to conclude the filing deadline was extended from Friday, November 25 through Monday December 12, 2022. Even though the electronic Dawson filing system was operational throughout Thanksgiving week, the court was officially closed on Thursday, November 24 and Friday, November 25. Under Section 7451(b), the statute of limitations for filing a Tax Court petition is tolled by “the number of days within the period of inaccessibility, plus an additional fourteen days.” Section 7451(b)(1).
Section 1032 provides no gain or loss is recognized by a corporation on the issuance of its stock to a new owner, whether in exchange for cash or otherwise. Similarly, a shareholder’s acquisition of stock for cash is not a taxable event but is instead an investment creating a cost basis under Section 1012 on which gain or loss can be calculated when the stock is sold or becomes worthless. However, often (particularly at the initial formation of a business), property other than cash is contributed to a corporation in exchange for stock of that company. In such cases, absent the application of Section 351, the default treatment would be a taxable sale or exchange. The new shareholder would recognize gain or loss equal to the difference between the adjusted basis of the property contributed and the value of the stock received.
Section 351 is the key exception to that taxable treatment. Section 351(a) provides the transferor shareholder recognizes no gain or loss on transfer of property solely in exchange for stock if the transferor (or transferors joining in such contribution in exchange for stock) are in control of the corporation immediately after the exchange. Section 368(c) defines control in the Section 351 context to mean “the ownership of stock possessing at least 80 percent of the total combined voting power of all classes of stock entitled to vote and at least 80 percent of the total number of shares of all other classes of stock of the corporation.” Importantly, Section 351(a) contemplates transfers by one or more persons allowing for a control group to be formed where multiple owners (typically at the formation of the new corporation) join together. For example, if owner A and owner B form a new corporation, and A contributes $50 of cash for 50 shares while B contributes equipment with a fair market value of $50 and a tax basis of $10 for 50 shares, the entire transaction can be a tax-free contribution under Section 351(a). A and B together received 100% of the new corporation’s shares even though separately they each received only 50%. That A contributed cash while B contributed other property does not prevent them from being a control group.
I. 2023 Audit Statistics; Chances of Being Audited.
The 2023 Internal Revenue Service Data Book released in April 2024 contains audit statistics for years 2013 through 2021, as of the fiscal year ended September 30, 2023 (FY 2023). For years before 2020, the statute of limitations had generally expired as of September 30, 2023. However, for 2020 and later returns, the statute of limitations has yet to expire, so additional returns for those years may be audited.
For 2013 through 2021, audit rates dropped significantly. For example, individual tax returns had an audit rate of 0.6% for 2013 returns versus 0.2% for 2021. For individuals with income between $1 million and $5 million, the audit rate dropped from 3% for 2013 returns to 0.5% for 2021 returns.
The overall audit rate for C corporations dropped from 1.2% for 2013 returns to 0.3% for 2021 returns. For partnerships and S corporations, the audit rate for 2013 returns was 0.3% compared to 0.1% for 2021 returns.
A partnership may elect to adjust its inside basis under Sections 734(b) and 743(b) by making a Section 754 election with the partnership’s annual tax return. The basis adjustment occurs, however, only when there is (1) a distribution of partnership property or (2) a transfer of partnership interest. 754 elections can be extremely valuable because they provide the possibility of an increase in the inside basis of partnership assets.
If a 754 election is made, when a partnership distributes property to a partner, the partnership’s inside basis is increased pursuant to Section 734(b), by (A) gain recognized by the distributee partner and (B) in the case of non-liquidating distributions of property other than money, by the excess of the adjusted basis of the distributed property to the partnership over the basis of the distributed property to the distributee. Similarly, a partnership’s inside basis is decreased by (A) loss recognized to the distributee partner and (B) in the case of liquidating distributions of property other than money, by the excess of the basis of the distributed property to the distributee over the adjusted basis of the distributed property to the partnership.
Prior to the Tax Cuts and Jobs Act of 2017, transfers between spouses or former spouses incident to divorce were treated as either (a) nontaxable transfers under Section 1041 or (b) alimony or separate maintenance payments under Section 71. Under that prior regime, alimony payments under Section 71 were included in the taxable income of the recipient and resulted in an income tax deduction for the payor. The 2017 Act repealed Section 71 and its corollaries, Sections 62(a)(10) and 215, which provided the deduction for the payor of alimony. Although most states follow the current Internal Revenue Code, some do not. Accordingly, in some states, alimony is still taxable to the recipient and deductible by the payor for state income tax purposes.
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Jack Cummings received Tax Notes’ inaugural Award for Excellence in Tax Commentary on May 3 at the ABA Tax Section’s annual meeting. Jack is counsel in Alston & Bird’s Raleigh and Washington offices.
The quality and quantity of Jack’s tax articles and other scholarly work are extraordinary. Many of us are like Salieri in “Amadeus.” Our lesser talents allow us to appreciate, but not replicate, Jack’s insightful work.
Congratulations, Jack! Below is a conversation with him:
Over the years, what percentage of your time was spent on client work, and what percentage on scholarly pursuits?
That’s a good question. Only in the last few years has it become pretty heavily weighted towards articles, scholarly or not!
How have you found time to write so many excellent and thorough articles?
Often an article grows out of a practice issue, so research can do double duty.
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Under the claim of right doctrine, a taxpayer who receives income under a claim of right that is free of restrictions must include the amount in income in the year of receipt. That is the case even if the taxpayer may, in a future year, be required to return to the payor the amount included in income. If the amount is returned within the same tax year, the rescission doctrine can apply to prevent taxation. Where the amount included in income is repaid after the year of inclusion, a deduction may be available to reduce current year income for the amount repaid. In some cases a deduction in the year of repayment does not produce as much reduction in tax liability as the amount of tax paid in the year of inclusion (due to changes in tax rates or limits on the use of the deduction). Section 1341 addresses that potential whipsaw by allowing taxpayers to elect to reduce the tax liability in the current year by the amount of tax generated in the previous year by the inclusion of such amount in income.
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I. No Reasonable Cause Penalty Defense where CPA did not Give Specific Advice about Erroneous Items; Johnson v. Commissioner, TC Memo 2023-116
Mr. and Mrs. Johnson hired a CPA to prepare their tax returns for 2015-2018. From 2006 to 2013, Mr. and Mrs. Johnson improperly claimed depreciation deductions on certain commercial buildings by using a seven-year depreciation life, rather than the 39-year life applicable to commercial property. As a result, the Johnsons overstated their depreciation deductions between 2006 and 2013 by $1.5 million.
The Johnsons sold their property in 2016 for $5 million. Because of the improper depreciation deductions claimed between 2006 and 2013, the IRS made a Section 481 accounting method adjustment of almost $2 million for 2015. In addition, for 2015, the Johnsons claimed a charitable contribution deduction. However, they filed an incomplete Form 8283 (Non-cash Charitable Contributions) that was fatally defective in numerous respects.
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