Tax Relief Blog

Heroes Earnings Assistance and Relief Tax Act of 2008

June 4, 2008 | Mike Habib, EA

Overview of tax changes in the Heroes Earnings Assistance and Relief Tax Act of 2008

The recently enacted “Heroes Earnings Assistance and Relief Tax Act of 2008” (the 2008 Heroes Act) provides targeted tax relief for military members and their families, fully offset with tightened expatriation rules, a new rule requiring U.S. companies working under federal government contract to treat overseas employees as subject to employment taxes, and a higher failure to file penalty. Here’s a summary of the tax provisions in the Act:

New relief provisions. The 2008 Heroes Act makes the following liberalizations for members of the military and their families:

Clarifies that those in the active military who file a joint tax return are eligible for the stimulus rebate payment under the Economic Stimulus Act of 2008 even if one spouse does not have a Social Security number.
Makes permanent the ability to include combat pay as earned income for purposes of the earned income tax credit (EITC) (under pre-2008 Heroes Act law, this benefit was only available for tax years ending before 2008).
Makes permanent an exception that permits qualified mortgage bonds to be issued to finance mortgages for qualified veterans who served in the active military without regard to the first-time homebuyer requirement (under pre-2008 Heroes Act law, this exception only applied for bonds issued before 2008).
Modifies the law which provides certain retirement plan protections for reservists who are called to active duty and who are able to return to their civilian employers after serving our country. The new law requires tax-qualified retirement plans to provide that if a participant dies while performing qualified military service, his or her survivors would be entitled to any additional benefits (other than benefit accruals relating to the period of qualified military service) that would have been provided had the participant resumed employment and then terminated employment on account of death. Similar rules apply to 403(b) annuities and 457(b) plans. Additionally, the new law provides that retirement plans can permit individuals who leave for qualified military service and cannot be reemployed on account of death or disability to be treated as if they had been rehired as of the day before death or disability and then had terminated employment on the date of death or disability. These changes apply to deaths or disabilities occurring after 2006.
Includes differential wages paid by an employer to an employee who becomes active duty military in the calculation of wages for retirement plan and IRA purposes, effective for years beginning after 2008. Differential pay is also made subject to federal income tax withholding, effective for amounts paid after 2008.
Extends the limitations period for filing tax refund credit claims arising from Department of Veterans Affairs disability determinations.
Makes permanent the expiring Internal Revenue Code provision that permits active duty reservists to make penalty-free withdrawals from retirement plans.
Permits a military death gratuity or amount received under the Servicemembers’ Group Life Insurance (SGLI) program to be rolled over to a Roth IRA or Coverdell education savings account, notwithstanding the contribution limits that otherwise apply.
Entitles Peace Corps volunteers and certain employees to a similar tolling of the homesale exclusion ownership and use period that already applies to members of the uniformed services, Foreign Service, and intelligence community. The Act also makes permanent the special homesale exclusion rules for certain employees of the intelligence community and repeals the requirement that those employees move overseas in order to qualify for special treatment.
Provides small employers with a 20% tax credit for differential wage payments made to employees who are on active military duty.
Provides an exclusion for state or local payments of bonuses to active or former military personnel or their dependents on account of such military personnel’s service in a combat zone.
Allows members of the reserves who are called to active duty to withdraw unused amounts held in a health flexible spending account (health FSA).
Retroactively clarifies that certain property tax rebates and other benefits made with respect to volunteer firefighters, and excluded from gross income under the Mortgage Forgiveness Debt Relief Act of 2007, are not subject to Social Security tax or unemployment tax.

Revenue raising provisions. To offset the cost of the new tax breaks (and the cost of various SSI liberalizations for the military), the Act:

Triangular Reorganizations Tax Resolution

June 4, 2008 | Mike Habib, EA

Temporary regs curb abuses in triangular reorganizations involving foreign corporations

T.D. 9400, 05/23/2008, Reg. § 1.367(a)-3T, Reg. § 1.367(b)-14T, Preamble to Prop Reg 05/23/2008

IRS has issued temporary (along with final and proposed regs) under Code Sec. 367(b) to curb abusive triangular reorganizations involving foreign corporationssometimes referred to as “Killer B” transactions. The temporary regs implement the rules in Notice 2006-85 and Notice 2007-48, and their text serves as the text of the proposed regs.

Statutory background. A U.S. person’s transfer of appreciated property (including stock) to a foreign corporation in connection with Code Sec. 332, Code Sec. 351, Code Sec. 354, Code Sec. 356, or Code Sec. 361 exchanges, generally is treated under Code Sec. 367(a)(1) as a taxable transaction, unless an exception applies. Code Sec. 367(b) provides that a foreign corporation is considered to be a corporation for purposes of these exchange provisions, except to the extent provided in regs issued to prevent tax avoidance.

No gain or loss is recognized to a corporation on the receipt of money or other property in exchange for stock of that corporation. (Code Sec. 1032) In the case of a forward triangular merger, a triangular C reorganization, or a triangular B reorganization, a parent’s stock provided by it to its subsidiaryunder a reorganization plan is treated as a disposition by the parent of shares of its own stock. (Reg. § 1.1032-2(b)) However, if the subsidiary did not receive the parent’s stock from the parent under a reorganization plan, it must recognize gain or loss on the exchange of its parent stock for the target’s stock or assets. (Reg. § 1.1032-2(c)) The subsidiary does not recognize gain or loss on the parent’s stock that it exchanges for the target’s stock in a reverse triangular merger. (Code Sec. 361)

A corporation’s distribution of property to its shareholder with respect to its stock is included in the shareholder’s gross income to the extent the distribution is a dividend under Code Sec. 316 (which defines a dividend as a distribution out of a corporation’s current and accumulated earnings and profits). (Code Sec. 301(c)(1)) To the extent the distribution is not a dividend, the shareholder reduces basis in the distributing corporation’s stock, and any amount of the distribution in excess of the shareholder’s basis is treated as gain from the sale or exchange of the corporation’s stock. (Code Sec. 301(c)(2), Code Sec. 301(c))

APA Tax Relief & Tax Resolution

June 4, 2008 | Mike Habib, EA

IRS expands advance pricing agreement procedures to include other issues relevant to transfer pricing

Rev Proc 2008-31, 2008-23 IRB

In a Revenue Procedure, IRS has expanded the procedures under which taxpayers secure an advance pricing agreement (APA) to include additional types of issues that may be resolved in the APA process.

Background. An APA generally combines a voluntary agreement between a taxpayer and IRS on an appropriate transfer pricing methodology (TPM) for covered transactions with an agreement between the U.S. and one or more foreign tax authorities that the TPM is correct. This kind of bilateral APA assures the taxpayer that the income from the transactions will not be subject to double taxation by the U.S. and the foreign tax authority. IRS and taxpayers also may execute unilateral APAs, which are agreements establishing an approved transfer pricing methodology for U.S. tax purposes. A unilateral APA binds the taxpayer and IRS, but does not prevent foreign tax bodies from taking different positions. If a transaction covered by a unilateral APA is subject to double taxation as the result of an adjustment by a foreign tax administration, the taxpayer may seek relief by requesting that the U.S. Competent Authority consider initiating a mutual agreement proceeding, provided there is an applicable income tax treaty in force with the other country. The APA process is voluntary. Taxpayers submit an application for an APA, together with a user fee.

IRS has now updated Rev Proc 2006-9, 2006-2 IRB 278, which contains the procedures for applying for an APA.

Updated procedures. In Rev Proc 2008-31, IRS modifies the procedures in Rev Proc 2006-9 to state that the APA program also provides a process by which IRS and taxpayers may resolve other issues than transfer pricing arising under certain income tax treaties, the Code, or the regs for which transfer pricing principles may be relevant. For example, these issues would include: attribution of profits to a permanent establishment under an income tax treaty, determining the amount of income effectively connected with the conduct by the taxpayer of a trade or business within the U.S., and determining the amounts of income derived from sources partly within and partly without the U.S., as well as related subsidiary issues.

HEART Act Tax Relief

June 2, 2008 | Mike Habib, EA

House-passed Heroes Act would provide tax relief to military members & their families

On May 20, by a vote of 403-0 the House of Representatives unanimously approved H.R. 6081, the “Heroes Earnings Assistance and Relief Tax Act of 2008.” The bill, dubbed the HEART Act by its sponsors, is very similar to the version of H.R. 3997 (the “Heroes Earnings Assistance and Tax Relief Act of 2007”) that was passed by the House of Representatives in the waning days of 2007 but failed to pass the Senate. The bill would provide targeted tax relief for members of the military and their families, fully offset with tightened expatriation rules, a new rule requiring U.S. companies working under federal government contract to treat overseas employees as subject to employment taxes, and a higher failure to file penalty.

Caution: Several of the HEART Act relief provisions would create significant compliance and plan amendment challenges for tax qualified retirement plans and their sponsors.

The press staff for Speaker of the House Nancy Pelosi (D-CA) has said that H.R. 6081 is the “final agreement with the Senate that is expected to be sent to the President by Memorial Day.”

Here’s a roundup of the tax provisions in the HEART Act:

IRS Employment / Payroll Tax Focus

June 2, 2008 | Mike Habib, EA

IRS focusing efforts on four employment tax initiatives

American Payroll Association 26th Annual Congress May 13-17 (Austin, TX)

John Tuzynski, IRS Chief, Employment Tax Operations, told attendees at APA’s 26th Annual Congress that the IRS is focusing its efforts on the following four key employment tax initiatives: (1) worker classification, (2) tip reporting compensation, (3) officer compensation, and (4) fringe benefits.

Lien foreclosure suits by the IRS

June 2, 2008 | Mike Habib, EA

Levy couldn’t force early distribution of taxpayer’s state retirement account Chief Counsel Advice 200819001

In Chief Counsel Advice (CCA), IRS has concluded that it can’t, after serving a notice of levy on a state retirement fund, exercise the taxpayer’s right to suspend her membership in the fund in order to obtain an immediate distribution of her assets in the fund when she hasn’t yet reached retirement age.

Facts. Married taxpayers, who we’ll call Betty and Bob, have an unpaid joint income tax liability. Betty is 50 years old and not currently receiving benefits from a state retirement fund with which she has an account. Although she no longer works for the state, she has obtained other employment and is not retired. Under the terms of the retirement fund, she may elect to suspend membership in the retirement fund and receive a distribution of all assets in her account. If she doesn’t elect, when she reaches retirement age, she’ll be eligible to receive her retirement benefits from the account.

Aggressive Enforcement Program says the Commissioner

May 13, 2008 | Mike Habib, EA

New IRS Commissioner Shulman airs his philosophy to ABA audience:

The question of whether IRS will focus on services or enforcement poses a false choice, IRS Commissioner Douglas Shulman, who became the 47th Commissioner of Internal Revenue on March 24, 2008, told an American Bar Association audience on May 9.

The agency must do both of these and do them very well, he said. “Stated another way, IRS should do everything possible to make it as seamless and easy as possible for those taxpayers who are trying to pay the right amount of taxes to navigate our organization, get their questions answered, pay their taxes and get their way,” Shulman said. “But for those who understand their federal tax obligation, but fail to comply, we must have an aggressive enforcement program,” he added.

Tax Medicaid Rebates Adjustments

May 13, 2008 | Mike Habib, EA

IRS clarifies ruling allowing drug manufacturers to subtract Medicaid rebates from gross receipts

Rev Rul 2008-26, 2008-21 IRB

In a revenue ruling that clarifies an earlier one issued in 2005 on the same subject, IRS concludes that Medicaid Rebates that a pharmaceutical manufacturer pays to State Medicaid Agencies are adjustments to the sales price in calculating gross receipts rather than ordinary and necessary business expenses that are deductible from gross income under Code Sec. 162.

Observation: In lieu of the foregoing conclusion, the earlier ruling (Rev Rul 2005-28, 2005-19 IRB 997) stated that Medicaid Rebates incurred by a pharmaceutical manufacturer are purchase price adjustments that are subtracted from gross receipts in determining gross income. Also, unlike Rev Rul 2005-28, the current ruling specifically states that its holding is limited to Medicaid Rebates that a pharmaceutical manufacturer pays pursuant to the Medicaid Rebate Program established by the Omnibus Budget Reconciliation Act of 1990.

Benefits of Passthrough Entities

May 7, 2008 | Mike Habib, EA

Which tax-free and tax-favored fringe benefits are passthrough owners entitled to?

Partnerships, LLCs treated as partnerships, and S corporations have distinct tax and nontax advantages. However, entrepreneurs considering these forms of business should be aware that fewer tax-free and tax-favored fringe benefits are available to owner-entrepreneurs of passthroughs than to shareholder-employees of C corporations. This Practice Alert reviews which fringe benefits can be made available on a tax-preferred basis to partners, members of LLCs taxed as partnerships, and more-than-2% S shareholder-employees. It helps practitioners advise clients who are thinking of operating a business as a passthrough, or are operating as a passthrough and are looking for ways to maximize their tax-free compensation.

Note that the statutory rules allowing or denying fringe benefits to passthrough owners are stated explicitly only in the context of partners and partnerships. However, under the default classification rules of Reg. § 301.7701-3(b)(1)(i), a domestic eligible entity with two or more members automatically is treated as a partnership unless it elects to be taxed as an association (i.e., as a corporation). And under Code Sec. 1372 , for fringe-benefit purposes, more-than-2% S corporation shareholder-employees are subject to the rules that apply to partners, and S corporations are treated as partnerships. As a result, unless otherwise noted, the tax consequences of fringes for members of LLCs taxed as partnerships and for more-than-2% S shareholder-employees are the same as they are for partners.

Working condition fringe benefits. Property or services supplied by an employer to an employee are tax-free working condition fringe benefits (WCFBs) if the employee would be entitled to a business expense deduction under Code Sec. 162 or Code Sec. 167 for the item had he paid for it himself. (Reg. § 1.132-5(a)(1)(i)) For WCFB purposes, the term “employee” includes partners who perform services for the partnership. (Reg. § 1.132-1(b)(2)(ii)) Thus, partners may receive the following WCFBs tax-free:

Business-related use of a company auto, if properly substantiated. (Reg. § 1.132-5(a)(1)) The personal-use value of the auto must, however, be treated as compensation income. (Reg. § 1.61-21(a)(1))
The business-use portion of company paid country club dues, even though the dues are completely nondeductible. (Reg. § 1.132-5(s))
Job-related education expenses paid by the firm. (Reg. § 1.132-1(f))
Job placement assistance. (Rev Rul 92-69, 1992-2 CB 51)

De minimis fringe benefits. For purposes of the tax-free de minimis fringe benefit rules, “employees” include any recipient of a fringe benefit. (Reg. § 1.132-1(b)(4)) So partners are entitled to get tax-free supper or supper money or local transportation fare if provided on an occasional basis in connection with overtime work. (Reg. § 1.132-6(d)(2)(i)) Other de minimis fringes include:

Trust & Estate Tax Resolution

May 7, 2008 | Mike Habib, EA

Transfers to LLC were not includable in decedent’s estate
Estate of Mirowski, TCMemo 2008-74

The Tax Court has held that assets the decedent transferred to a family limited liability company (LLC) shortly before she died were not includable in her gross estate under Section 2036(a).

Facts. The decedent’s husband was a cardiologist who developed an implantable cardioverter defibrillator (ICD) device to prevent people who suffered from ventricular fibrillation from dying because they were not in a hospital near an external defibrillator. The husband died in 1990, and, pursuant to his will, his interest under the ICD patents license passed to the decedent. Sales of ICDs increased significantly after the husband’s death, and royalties received under the ICD patents license increased dramatically from thousands of dollars a year to millions of dollars a year.