Tax Court Again Rules Emotional Distress is Not Physical Illness.
In Tressler v. Commissioner, T.C. Summ. Op. 2021-33, the Tax Court held emotional distress damages are not excluded from income unless those emotional damages are attributable to a direct physical injury. Ms. Tressler brought a lawsuit against her former employer for failing to prevent a physical assault by another employee. Ms. Tressler alleged the assault caused her emotional distress, which caused even more physical injuries. The court held the emotional distress damages were not excludable from income under Section 104(a)(2) because the settlement agreement failed to state the payments Ms. Tressler received were related to physical injuries rather than her claims for emotional distress.
Section 731(c) generally treats marketable securities as money in determining gain or loss on a distribution to a partner. Section 731(a)(1) provides no gain is recognized on a distribution to a partner except to the extent any money distributed exceeds the adjusted basis of the partner in the partnership interest.
The term “marketable security” means financial instruments and foreign currencies that are, as of the date of the distribution, actively traded within the meaning of Section 1092(d)(1). For example, if a partnership distributes publicly traded stock with a value of $100 to a partner with an adjusted basis in her partnership interest of $50, the partner generally recognizes a gain of $50. However, there are a number of exceptions.
The first exception, in Section 731(c)(3)(A)(i), provides a marketable security is not treated as money if the partner receiving the security contributed the security to the partnership.
The second exception, in Section 731(c)(3)(A)(ii), provides a marketable security is not treated as money to the extent provided in regulations if the property was not a marketable security when acquired by the partnership. Reg. § 1.731-2(d)(iii) clarifies that is satisfied if (a) the entity that issued the security had no outstanding marketable securities when the security was acquired by the partnership; (b) the security was held by the partnership for at least six months before the security became marketable; and (c) the partnership distributed the security within five years of the security becoming marketable.
The third exception, in Section 731(c)(3)(A)(iii), provides a marketable security is not treated as money if the partnership is an investment partnership, and the partner is an eligible partner. A future blog post will describe what qualifies as an investment partnership and an eligible partner.
Finally, Section 731(c)(3)(B) provides for a reduction in the amount treated as money on a distribution of marketable securities equal to the difference between the partner’s distributive share of partnership net gain before the distribution and the partner’s distributive share of partnership net gain after the distribution. That is best demonstrated by Example 2 in Reg. § 1.731-2(j).
When gain is recognized as a result of Section 731(c), the basis of the marketable securities to which gain is recognized equals their basis as determined under Section 732 increased by the amount of such gain. IRC § 731(c)(4)(A).
John G. Hodnette, JD, LLM is an attorney with Culp, Elliott, & Carpenter in Charlotte.
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On November 1, 2021, the Chief Judge of the Office of Administrative Hearings, Donald van der Vaart, issued a memorandum announcing all OAH records of every tax case will be available to the public following an administrative law judge’s final decision. https://www.oah.nc.gov/
The promotion of transparency in North Carolina tax appeals began two decades ago. At that time a taxpayer had the choice of paying an assessed tax and appealing to the Superior Court for de novo review or going through a prepayment administrative appeals process. The latter started with a hearing before an assistant Secretary of Revenue, appointed and employed by the Secretary of Revenue. The hearing at DOR was not governed by the rules of civil procedure, nor the rules of evidence, and taxpayers were rarely granted discovery. Yet, this proceeding set the record for all appeals that followed.
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The most common penalties assessed by the IRS are the failure to file and failure to pay penalties under Section 6651. However, another common penalty is the failure to pre-pay penalty assessed pursuant to Section 6654 where a taxpayer who is required to make quarterly payments fails to make the payments. Section 6651 penalties can be abated by a showing of reasonable cause and not willful neglect. In contrast, Section 6654 has very specific rules about when a waiver can be granted.
Section 6654(e) provides narrow exceptions for the failure to pre-pay penalty. First, subsection (e)(1) provides an exception where the tax shown on the return is less than $1,000. Second, subsection (e)(2) provides an exception for U.S. citizens and residents who did not have any tax liability in the prior year. Third, subsection (e)(3)(A) provides a waiver may be granted where there is a casualty, disaster, or some other unusual circumstances that would cause the imposition of the penalty to be against equity and good conscience. That standard is unclear.
The fourth exception, which is in subsection (e)(3)(B), is for reasonable cause and not willful neglect, but only if the taxpayer either (a) retired after having attained the age of 62 within the year for which the estimated payments were required to be made or the year prior to such year or (b) became disabled within the year for which the payments were required to be made or the year prior to such year. Qualifying for either (a) or (b) does not automatically waive the penalty, but it allows the taxpayer to argue reasonable cause exists for a waiver of the penalty.
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In 2017, North Carolina sales and use tax related to construction changed, creating a binary system. Although the Department of Revenue released Directive SD-18-1 to explain the new rules, they remain confusing to many service providers.
Construction projects can be taxed under North Carolina sales and use tax in one of two ways: (a) as a real property contract (“RPC”) or (b) as a repair, maintenance, and installation service (“RMI”). An RPC is defined by G.S. § 105-164.3(207) as “a contract between a real property contractor and another person to perform a capital improvement to real property.” Capital improvement means, in part, “a new construction, reconstruction, or remodeling.” G.S. § 105-164.3(31).
In contrast, an RMI service is a service to customers that does not qualify as an RPC. It is generally a smaller construction job such as updating countertops, repairing fixtures, or other general maintenance contracting work.
The tax treatments of an RPC and RMI are different. Under an RPC, services are provided to the general contractor or homeowner. The service provider pays sales tax to its supplier for materials purchased for the job. However, because sales tax on materials need be paid only once, RPCs are exempt from the sales tax on services. The service provider does not invoice the general contractor or homeowner for any tax. To ensure a job qualifies as an RPC, the service provider should request a Form E-589CI (affidavit of capital improvement) from the general contractor or homeowner. Receipt of this form absolves the service provider from responsibility for collecting taxes and, in the event of a sales tax audit, shows reasonable reliance that sales tax was not due.
As to an RMI, the end client is responsible for paying tax on both the services provided and the cost of the goods incident to such service. Because sales tax need be paid only once, RMIs use Form E-595E resale exemptions to defer tax on the purchase of goods to be used in the RMI until the services are provided to the final customer. In such case, sales tax should be charged on the total cost of the service and goods provided to the customer unless the customer provides a Form E-595E indicating an exemption.
John G. Hodnette, JD, LLM is an attorney with Culp, Elliott, & Carpenter in Charlotte.
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Holding real estate through an S corporation may seem like a good idea at first glance. Almost all professionals, however, recommend a partnership over an S corporation as the preferred vehicle to own real estate. S corporations and partnerships are both pass-through entities, meaning the income or loss generated by these entities flows through to the owners, who are responsible for paying the tax due. However, there are a number of disadvantages of owning real estate via an S corporation compared to a partnership.
First, although S corporations are often excellent for reducing self-employment taxes, income from passive real estate investments do not benefit from that because such income is not subject to self-employment taxes.
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For administrative convenience, federal and North Carolina law both provide that after a specific period of time, uncollected taxes are written off and released. This provides some relief for taxpayers who owe taxes for years long past as well as preventing tax agencies from fruitlessly pursuing old and cold liabilities.
Section 6502 provides the federal collection time limit, stating the collection statute expiration date (“CSED”) is 10 years after the assessment of the tax. There are certain events that extend the date as provided in Section 6503, including the taxpayer’s bankruptcy, spending time outside the United States, and filing a collection due process appeals hearing request. Before the expiration of the CSED, the IRS can seek to extend the 10-year period. However, it rarely does that.
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Limited liability companies can elect to be taxed under federal and state law in a number of different ways. One popular choice for small business owners is for an LLC to elect to be an S corporation.
The primary tax advantage of operating as an S corporation is minimizing self-employment taxes. When operating as a sole proprietorship (whether through a disregarded LLC or not), an individual’s profits are subject to a 15.3% self-employment tax in addition to the individual income tax. The same is true for wages paid to employees of the S corporation (although in that case 7.65% is paid by the employee while the other 7.65% is paid by the S corporation itself). The IRS requires owners of an S corporation to pay themselves a reasonable salary, and not doing so (or paying too small of a salary) is the subject of many employment division audits of S corporations. However, S corporations are not required to pay out all of their profits as salaries to their employees. Rather, the IRS (in publications such as FS-2008-25) requires only that the salary be reasonable.
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This is the second installment of this article. The first installment was previously posted on the Tax Section’s blog.
I. No Easement Charitable Contribution Deduction Allowed Where Form 8283 Did Not Include Cost Basis Information.
In yet another case of a failed charitable contribution donation deduction, in Oakhill Woods, LLC v. Commission, TC Memo 2020-24, the Tax Court disallowed an easement charitable contribution donation deduction because the taxpayer failed to include tax basis information on the Form 8283. That resulted in a disallowed deduction of almost $8 million.
On its tax return for the year of the donation, the taxpayer did not report its income tax basis in the donated easement but instead added an attachment to the Form 8283 stating that “the basis of the property is not taken into consideration when computing the amount of the deduction.” The Tax Court ruled, since the tax basis information was not included on the Form 8283 as originally filed for the year of the donation, the charitable deduction failed the substantiation requirements of Section 170.
The Tax Court noted the taxpayer may not qualify for the reasonable cause defense under Section 170(f)(11)(A)(ii)(II). The LLC argued it prepared and filed its Form 8283 in this manner based on advice of its CPA, who prepared the return, as well as the advice of a consulting firm named Forever Forests. Because Forever Forests was involved with the conservation donation, another court would have to determine, at a later date, whether it was a “competent and independent advisor unburdened with a conflict of interest” and whether the CPA was a competent tax professional who provided tax advice independent of that supplied by Forever Forests.
The decrease in the corporate tax rate by the 2017 Tax Act has made it more favorable for businesses to operate as C corporations. With more businesses opting to be C corporations, the gain exclusion of Section 1202 is more important. Section 1202 provides an exemption to eligible taxpayers of between 50% and 100% of the gain of the sale of Section 1202 stock.
Section 1202 applies only to qualified small business stock held for more than five years. Qualified small business stock is stock of a C corporation that was issued on or after August 10, 1993, if (a) as of the date of issuance, the corporation was a qualified small business, and (b) the stock was acquired by the taxpayer at its original issue (subject to narrow exceptions). A qualified small business is a U.S. corporation that is a C corporation and the aggregate gross assets of which at all times after August 10, 1993, and before and immediately after issuance did not exceed $50 million. Additionally, the corporation must meet an active business requirement. At least 80% by value of the assets of the corporation must be used in the active conduct of one or more qualified trades or businesses. A qualified trade or business is any trade or business other than the performance of services in the field of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, or financial services, any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees, banking, insurance, financing, leasing, investing, or similar business, any farming business (including raising or harvesting trees), any business involving the production or extraction of products to which a deduction is allowable under Section 613 or 613A, or operating a hotel, motel, restaurant, or similar business.
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