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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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| Statutory elections: defined by
statute.
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Regulatory
elections: defined by regulation.
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| If | Then |
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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 |
Forward claims or amended returns showing a tax increase or credit decrease to the Statute function if it is within 90 days of the Assessment Statute Expiration Date (ASED). For additional information, see IRM 25.6.1.5, Basic Guide for Processing Cases With Statute of Limitations Issues.
If more than 90 days remain on the ASED, input tax increases or credit decreases upon receipt of an amended return or written inquiry requesting a tax increase or credit decrease even without all required elements (forms, schedules, signature, etc.). Input net zero changes (TC 290 for .00) even without all required elements.
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).
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).
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).
You have obtained a final decree of divorce or separate maintenance by the last day of your tax year. You must follow your state law to determine if you are divorced or legally separated.
Exception. If you and your spouse obtain a divorce in one year for the sole purpose of filing tax returns as unmarried individuals, and at the time of divorce you intend to remarry each other and do so in the next tax year, you and your spouse must file as married individuals.
You have obtained a decree of annulment, which holds that no valid marriage ever existed. You must file amended returns (Form 1040X, Amended U.S. Individual Income Tax Return) for all tax years affected by the annulment that are not closed by the statute of limitations. The statute of limitations generally does not end until 3 years after the due date of your original return. On the amended return you will change your filing status to single, or if you meet certain requirements, head of household.
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.
Because a business jointly owned and operated by a married couple is generally treated as a partnership for Federal tax purposes, the spouses must comply with filing and record keeping requirements imposed on partnerships and their partners. Married co-owners failing to file properly as a partnership may have been reporting on a Schedule C in the name of one spouse, so that only one spouse received credit for social security and Medicare coverage purposes. The election permits certain married co-owners to avoid filing partnership returns, provided that each spouse separately reports a share of all of the businesses’ items of income, gain, loss, deduction, and credit. Under the election, both spouses will receive credit for social security and Medicare coverage purposes. (ed. in other words, it is possible to pay double the Social Security portion of the S/E tax - once for the husband and then again for the spouse - which is the proper way to pay, unless for example, if only one spouse owned the business)
A qualified joint venture is a joint
venture that conducts a trade or business where (1) the only members
of the joint venture are a husband and wife
who file a joint return, (2) both spouses
materially participate in the trade or business, and (3) both
spouses elect not to be treated as a partnership. A qualified joint
venture, for purposes of this provision, includes only businesses
that are owned and operated by spouses as co-owners, and not in the
name of a state law entity (including a limited partnership or
limited liability company) (See below). Note also that mere joint
ownership of property that is not a trade or business does not
qualify for the election. The spouses must share the items of
income, gain, loss, deduction, and credit in accordance with each
spouse's interest in the business. The meaning of "material
participation" is the same as under the passive activity loss rules
in section 469(h) and the corresponding regulations (see
Publication 925, Passive Activity and At-Risk Rules).
Note that, except as provided in section 469(c)(7), rental real
estate income or loss generally is passive under section 469, even
if the material participation rules are satisfied, and filing as a
qualified joint venture will not alter the character of passive
income or loss.
How to make the election to be treated as a qualified joint venture
Spouses make the election on a jointly filed
Form 1040 (PDF) by dividing all items of income, gain, loss,
deduction, and credit between them in accordance with each spouse’s
respective interest in the joint venture, and each spouse filing
with the Form 1040 a separate
Schedule C (Form 1040), Profit or Loss From
Business (Sole Proprietorship) (PDF) or
Schedule F (Form 1040), Profit of Loss From
Farming (PDF), Form
4835, Farm Rental Income and Expenses(PDF) and, if otherwise
required, a separate
Schedule SE (Form 1040), Self-Employment Tax
(PDF). For example, to make the election for 2009, jointly file your
2009 Form 1040, with the required schedules (see below). The
partnership terminates at the end of the taxable year immediately
preceding the year the election takes effect. For information on how
to report the business for the taxable year before the election is
made, see
Publication 541 on Partnerships and terminations. A business owned and operated by the spouses through a
limited liability company does not qualify for the election
(ed. for people not residing in a "community property" state) Only businesses that are owned and operated by
spouses as co-owners (and not in the name of a state law entity)
qualify for the election. See Rev. Proc. 2002-69, 2002-2 C.B. 831,
for special rules applicable to husband and wife state law entities
in community property states.
Ed. Spouses electing qualified joint venture status
are treated as sole proprietors for Federal tax purposes. The
spouses must share the businesses’ items of income, gain, loss,
deduction, and credit. Therefore, the spouses must take into account
the items in accordance with each spouse's interest in the business.
The same allocation
will apply for calculating self-employment tax if
In a
non-community
property
state,
it is a
little
more
confusing.
For tax
years
beginning
after
December
31,
2006,
the
Small
Business
and Work
Opportunity
Tax Act
of 2007
(Public
Law
110-28)
provides
that a
"qualified
joint
venture,"
whose
only
members
are a
husband
and a
wife
filing a
joint
return,
can
elect
not to
be
treated
as a
partnership
for
Federal
tax
purposes.
Reading
the
statute,
it would
seem
that an
LLC that
does not
elect to
be
treated
as a
corporation
should
be a
"qualified
joint
venture"
that can
essentially
be
disregarded.
However,
the IRS
states
that
with
respect
to the
election
provided
by the
statute,
that
"Only
businesses
that are
owned
and
operated
by
spouses
as
co-owners
(and not
in the
name of
a state
law
entity)
qualify
for the
election.
See
Rev.
Proc.
2002-69,
2002-2
C.B. 831,
for
special
rules
applicable
to
husband
and wife
state
law
entities
in
community
property
states."
So the
IRS says
that in
non-community
property
states,
a
husband-and-wife
LLC
cannot
be
disregarded.
Even
though a
reading
of the
statute
does not
appear
to
support
the IRS
position,
in may
be wise,
in a
non-community
property
state,
to file
a
partnership
tax
return
for the
LLC.
http://en.allexperts.com/q/Starting-Small-Business-1637/2008/5/LLC-single-member-disregard.htm
However, if there are other net earnings from self-employment of $400 or more, the spouse(s) with the other net earnings from self-employment should file Schedule SE without including the amount of the net profit from the rental real estate business from Schedule C on line 2. If the election is made for a farm rental business that is not included in self-employment, file two Forms 4835 instead of Schedule F.
In general, spouses do NOT need an Employer Identification Number (EIN) for the qualified joint venture
Spouses electing qualified joint venture status are treated as sole proprietors for Federal tax purposes. Using the rules for sole proprietors, an EIN is not required for a sole proprietorship unless the sole proprietorship is required to file excise, employment, alcohol, tobacco, or firearms returns. If an EIN is required, the filing spouse should complete a Form SS-4 and request an EIN as a sole proprietor.
What to do if the spouses already have an EIN for the partnership
One spouse cannot continue to use that EIN for the qualified joint venture. The EIN must remain with the partnership (and be used by the partnership for any year in which the requirements of a qualified joint venture are not met). If you need EINs for the sole proprietorships, see above on EINs for sole proprietors.
How to handle requests from the IRS for a partnership return from the spouses for tax years for which the election is in effect
Once the election is made, if the spouses receive a notice from the IRS asking for a Form 1065 (PDF) for a year in which the spouses meet the requirements of a qualified joint venture, the spouses should contact the toll-free number that is shown on the notice and advise the telephone assistor that they reported the income on their jointly-filed individual income tax return as a qualified joint venture. Alternatively, the spouses can write to the address shown on the notice and provide the same information.
If the spouses elect to be treated as a qualified joint venture, how do they report and pay Federal employment taxes?
If the business has employees, either of the sole proprietor spouses may report and pay the employment taxes due on wages paid to the employees, using the EIN of that spouse’s sole proprietorship. If the business already filed Forms 941 or deposited or paid taxes for part of the year under the partnership's EIN, the spouse may be considered the "successor employer" of the employee for purposes of determining whether the wages have reached the social security and Federal unemployment wage base limits. See Publication 15 for more information on the successor employer rules. See above regarding the allocation of the deductions for income tax purposes.
Duration that the election remains in effect
Once the election is made, it can be revoked only with the permission of the IRS. However, the election technically remains in effect only for as long as the spouses filing as a qualified joint venture continue to meet the requirements for filing the election.
(ed. for example, by bringing in a third partner, such as a child buying a 1% interest in the partnership, the election is automatically broken) If the spouses fail to meet the qualified joint venture requirements for a year, a new election will be necessary for any future year in which the spouses meet the requirements to be treated as a qualified joint venture. (ed. for example, if the child sells his 1% interest to one of his parents, the election can again be made)Page Last Reviewed or Updated: December 07, 2011
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
Any form of co-ownership of business property is a "partnership"
under both
IRC 761(a) and
IRC 7701(a)(2). There is at least one case (investment tax
credit?) that held that an election not to be treated as a
partnership under
Reg. 1.761-2 applied only to Subchapter K (and the related
reporting requirements of IRC 7031), but did not apply to other
references to "partners" or "partnerships" under IRC 7701(a)(2).
That said, Reg. 1.761-2 provides for special circumstances under
which an unincorporated organization can elect not to be treated as
a "partnership" subject to Subchapter K. This is the "traditional"
route taken by co-owners of rental property who report their share
of "partnership" income individually. The advantage of doing this,
aside from not preparing Form 1065, is that elections normally made
by the "partnership" are, instead, made individually by the
co-owners.
In 2007, the
Small Business and Work Opportunity Tax Act of 2007 (P.L.
110-28) inserted
IRC 761(f) as another method whereby co-ownership by husband and
wife could elect not to be treated as a "partnership" for all
purposes of the IRC, including those whose definition is under IRC
7701(a)(2), if the co-owners elect under
IRC 761(f)(2)(C) to be a Qualified Joint Venture (QJV). The
wording of IRC 761(f) could lead one to conclude that Congress did
not intend this subsection to apply to rental real estate
operations, and the IRS has indicated that it does not apply when a
state entity (such as an LLC) is the actual owner.
http://www.irs.gov/businesses/small/article/0,,id=177376,00.html
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.
http://www.nixonpeabody.com/services_pubdetail.asp?ID=2838&SID=442
http://www.lw.com/upload/pubContent/_pdf/pub2678_1.pdf
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.'"
Rev. Rul. 72-596
Estate of Tilton 8 BTA at 917
THE FOLLOWING IS TEMPORARY
(to be edited in the future)
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.
A TMP may appoint a power of attorney (POA) to represent the partnership before the Service and to perform all acts for the partnership except for the execution of "legally significant documents" . The term "legally significant documents" includes, but is not limited to:
A settlement agreement entered into pursuant to IRC 6224(c)(3) when the TMP is binding certain other partners (e.g., non-notice partners), including a formal closing agreement pursuant to IRC 7121; and
An extension of the limitation period for assessment with respect to partnership items. The appointment of a POA may not meet the requirements of Treas. Reg. 301.6229(b)-1 for purposes of the POA being a person authorized in writing to sign a statute extension.
Other situations in which it is necessary to deal directly with the duly designated TMP rather than the POA include, but are not limited to, mailing of required notices, such as NBAPs or FPAAs. However, a copy of the notice will also be mailed to the POA, but it should not be sent using certified mail.
Form 2848, Power of Attorney and Declaration of Representative, should be completed as follows:
The TMP should execute the POA in his or her capacity as TMP;
The name and address of the entity should be clearly set forth;
Under the heading "Type of Tax" , insert "TEFRA partnership proceedings" ; and
Under the heading "Federal Tax Form Number" , enter "Form 1065 and consequential adjustments" .
The POA for a TEFRA partnership becomes null and void upon the death of the duly designated TMP. A new TMP must be designated and a new POA executed.
(a) In general. Any partnership may authorize any person to extend the period described in section 6229(a) with respect to all partners by filing a statement to that effect with the service center where the partnership return is filed (but, if the notice described in section 6223(a)(1) (beginning of an administrative proceeding) has already been mailed to the tax matters partner, the statement should be filed with the Internal Revenue Service office that mailed such notice). The statement shall-
(1) Provide that it is an authorization for a person other than the tax matters partner to extend the assessment period with respect to all partners;
(2) Identify the partnership and the person being authorized by name, address, and taxpayer identification number;
(3) Specify the partnership taxable year or years for which the authorization is effective; and
(4) Be signed by all persons who were general partners (or, in the case of an LLC, member-managers, as those terms are defined in §301.6231(a)(7)-2(b)) at any time during the year or years for which the authorization is effective.
(b) Effective date. This section is applicable to partnership taxable years beginning on or after October 4, 2001. For years beginning prior to October 4, 2001, see §301.6229(b)-1T contained in 26 CFR part 1, revised April 1, 2001.
(a) In general. Solely for purposes of applying section 6231(a)(7) and §301.6231(a)(7)-1 to an LLC, only a member-manager of an LLC is treated as a general partner, and a member of an LLC who is not a member-manager is treated as a partner other than a general partner.
(b) Definitions - (1) LLC. Solely for purposes of this section, LLC means an organization-
(i) Formed under a law that allows the limitation of the liability of all members for the organization's debts and other obligations within the meaning of §301.7701-3(b)(2)(ii); and
(ii) Classified as a partnership for Federal tax purposes.
(2) Member. Solely for purposes of this section, member means any person who owns an interest in an LLC.
(3) Member-manager. Solely for purposes of this section, member-manager means a member of an LLC who, alone or together with others, is vested with the continuing exclusive authority to make the management decisions necessary to conduct the business for which the organization was formed. Generally, an LLC statute may permit the LLC to choose management by one or more managers (whether or not members) or by all of the members. If there are no elected or designated member-managers (as so defined in this paragraph (b)(3)) of the LLC, each member will be treated as a member-manager for purposes of this section.
§301.7701-2(a) Business entities. For purposes of this section and section 301.7701-3, a business entity is any entity recognized for federal tax purposes (including an entity with a single owner that may be disregarded as an entity separate from its owner under section 301.7701-3) that is not properly classified as a trust under section 301.7701-4 or otherwise subject to special treatment under the Internal Revenue Code. A business entity with two or more members is classified for federal tax purposes as either a corporation or a partnership. A business entity with only one owner is classified as a corporation or is disregarded; if the entity is disregarded, its activities are treated in the same manner as a sole proprietorship, branch, or division of the owner.
§301.7701-1(a)(1) Organizations for federal tax purposes. (1) In general. The Internal Revenue Code prescribes the classification of various organizations for federal tax purposes. Whether an organization is an entity separate from its owners for federal tax purposes is a matter of federal tax law and does not depend on whether the organization is recognized as an entity under local law.
§301.7701-3(f) Changes in number of
members of an entity --
(1) Associations. The classification of an
eligible entity as an association is not affected by any change in
the number of members of the entity.
(2) Partnerships and
single member entities. An eligible entity classified as a
partnership becomes disregarded as an entity separate from its owner
when the entity's membership is reduced to one member. A single
member entity disregarded as an entity separate from its owner is
classified as a partnership when the entity has more than one
member. If an elective classification change under paragraph (c) of
this section is effective at the same time as a membership change
described in this paragraph (f)(2), the deemed transactions in
paragraph (g) of this section resulting from the elective change
preempt the transactions that would result from the change in
membership.
Open question: Can a sole proprietorship (a Schedule C) elect to file form 1120S pursuant to the definition at §301.7701-3(a)? A sole proprietorship files its own Sch. C, E or F (as appropriate), it can adopt its own method of accounting, etc. Therefore it is a business entity for federal tax purposes.
Or as a fall-back position, a husband and wife join as partners, the partnership elects to file form 1120S and then pursuant to §301.7701-3(f) one spouse exits leaving just one owner.
Open question:
Can the sole proprietorship (a Schedule C) elect
to file form 1120S retroactively, pursuant to Rev.
Proc. 2009-41, Sec 4.01 due to the fact that the eligible
entity has reasonable cause for its failure to timely make the
entity classification election? And also elect
Sec 475(f) M2M pursuant to
Rev. Proc. 99-17 Sec 5.03(2)?
Conclusion: after discussion with
Office of
the Chief Counsel is that a sole proprietorship (a Schedule C) electing
to file 1120S would likely be challenged by the IRS, perhaps a
couple years after-the-fact, and therefore it
is probably best avoided. Of course a sole proprietorship (a Schedule C)
could form a SMLLC and then the SMLLC may file form 2553 to elect to file 1120S.
There are no solid answers.
Taxpayer beware and take careful consideration and planning before
proceeding.
Rev. Rul. 2004-77
SECTION 2. BACKGROUND
(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.
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 B. 1., or its
successors.
(1) The entity is an eligible entity as defined in section
301.7701-3(a); (2) (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 n> (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.
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. 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?
http://www.danaconsulting.com/downloads/Health_Premiums_Paid_S_Corps.pdf
http://www.aicpa.org/publications/taxadviser/2011/december/pages/case-study_dec11.aspx
IR Code §162(l)(5) Treatment of certain S
corporation shareholders .- This subsection shall apply in the case
of any individual treated as a partner under section 1372(a), except
that-
§162(l)(5)(A) for purposes of this
subsection, such individual's wages (as defined in section 3121)
from the S corporation shall be treated as such individual's earned
income (within the meaning of section 401(c)(1)), and
§162(l)(5)(B) there shall be such
adjustments in the application of this subsection as the Secretary
may by regulations prescribe.
§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.
§318(a) General Rule .- For purposes of
those provisions of this subchapter to which the rules contained in
this section are expressly made applicable-
§318(a)(1) Members of family.-
§318(a)(1)(A) In general .- An individual
shall be considered as owning the stock owned,
directly or indirectly, by or for-
§318(a)(1)(A)(i) his spouse (other than a
spouse who is legally separated from the individual under a decree
of divorce or separate maintenance), and
§318(a)(1)(A)(ii) his children,
grandchildren, and parents.
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). Heath and accident insurance premiums paid on behalf of the
greater than two percent S corporation shareholder-employee are
deductible and reportable by the S corporation as wages for income
tax withholding purposes on the shareholder-employee’s Form W-2. These benefits are not subject to Social Security or Medicare
(FICA) or Unemployment (FUTA) taxes. The additional compensation is
included in Box 1 (Wages) of the Form W-2, Wage and Tax Statement,
issued to the shareholder-employee, but would not be included in
Boxes 3 and 5 of Form W-2. A 2-percent shareholder-employee is eligible for an Adjusted
Gross Income (AGI) deduction for amounts paid during the year for
medical care premiums if the medical care coverage is established by
the S corporation and the shareholder meets the other self-employed
medical insurance deduction requirements. If, however, the
shareholder or the shareholder’s spouse is eligible to
participate in any subsidized health care plan then the shareholder
is not entitled to the AGI deduction. A medical plan can be considered established by the S corporation
if the S corporation paid or reimbursed the shareholder-employee for
premiums and reported: The insurance laws in some states do not allow a corporation to
purchase group health insurance when the corporation only has one
employee. Therefore, if the shareholder was the sole corporate
employee, the shareholder had to purchase his health insurance in
his own name. The IRS issued Notice 2008-1 which ruled that under certain
situations the shareholder would be allowed an above-the-line
deduction even if the health insurance policy was purchased in the
name of the shareholder. Notice 2008-1 provided four examples, three
of the examples had the shareholder purchasing the health insurance
and the other example had the S corporation purchasing the health
insurance. The Notice held that if the shareholder purchased the health
insurance in his own name and paid for it with his own funds the
shareholder would not be allowed an above-the-line deduction. On the
other hand, if the shareholder purchased the health insurance in his
own name but the S corporation either directly paid for the health
insurance or reimbursed the shareholder for the health insurance and
also included the premium payment in the shareholder’s W-2, the
shareholder would be allowed an above-the-line deduction. The bottom line is that in order for a shareholder to claim an
above-the-line deduction, the health insurance premiums had to be
paid by the S corporation and had to be included in the
shareholder’s W-2.
http://www.irs.gov/businesses/small/article/0,,id=203100,00.html#skiptocontent
(Ed. This Q&A is incorrect)
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.
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,
(PDF) 2008-2 I.R.B. 251 (1/14/2008) 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).
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.
Effective October 20, 2008 (T.D.
9428):
http://goliath.ecnext.com/coms2/gi_0199-3165763/S-corporation-elections-guide.html
Reasonable Compensation must be paid to shareholders
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
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. A taxpayer filing its
first return may adopt
any permissible method
of accounting. See
Treas. Reg.
1.446-1(e)(1). Once the
taxpayer adopts a proper
method of accounting by
filing its return using
such method, it may not
adopt a different method
of accounting by the
filing of an amended
return. However, a taxpayer
filing its first return
using an improper method
of accounting may change
to a proper method by
the filing of an amended
return. The amended
return MUST be filed
prior to the filing of
the next year's return.
See Rev. Rul. 72-491,
1972-2 C.B. 104. Two returns filed for
consecutive years using
an improper method,
establishes a method of
accounting from which
consent to change is
required. Amended
returns may not be used
to change such method.
See Rev. Proc. 90-38.
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.
1.1402(a)-2(h)(2) Limited partner.
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.
§301.7701-3(g)(1)(iv)
Disregarded entity to an association.
If an eligible entity that is
disregarded as an entity separate from its owner
elects under paragraph
(c)(1)(i) of this section to
be classified as an association, the following is
deemed to occur: The owner of the eligible entity
contributes all of the assets and liabilities of the
entity to the association
in exchange for stock of
the association.
Disregarded entities.
This ruling concludes that, if an eligible entity has two owners
under local law, but one of the owners is, for federal tax purposes,
disregarded as an entity separate from the other owner of the
eligible entity, then the eligible entity cannot be classified as a
partnership and is either disregarded as an entity separate from its
owner or an association taxable as a corporation.
If an eligible entity has two members under local law, but one of
the members of the eligible entity is, for federal tax purposes,
disregarded as an entity separate from the other member of the
eligible entity, then the eligible entity cannot be classified as a
partnership and is either disregarded as an entity separate from its
owner or an association taxable as a corporation.
Also see Rev. Proc. 2009-41, 2009-39 .R.B. (9/28/2009) below
Also see Rev. Proc. 2007-62, 2007-166 I.R.B. (10/9/2007) below
Also see Rev. Proc. 2004-48, 2004-32 I.R.B. 172 (8/9/2004) below
Also see Rev. Proc. 2003-43, 2003-23 I.R.B. 998 (6/9/2003) below
S-Corp election: Rev. Proc. 2007-62, 2007-166 I.R.B. (10/9/2007)
late election of S-Corp status:
Rev. Proc. 2007-62,
SECTION 1. PURPOSE
This revenue procedure provides an additional simplified method for
taxpayers to request relief for late S corporation elections and
supplements Rev. Proc. 2003-43, 2003-1 C.B. 998. In addition, this
revenue procedure provides a simplified method for taxpayers to
request relief for a late S corporation election and a late corporate
classification election intended to be effective on the same date that
the S corporation election was intended to be effective and
supplements Rev. Proc. 2004-48, 2004-2, C.B. 172. Generally, this
revenue procedure provides that certain eligible entities may be
granted relief if the entity satisfies the requirements of sections 4
or 5 (as applicable) of this revenue procedure.
.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.
(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.
S-Corp election:
Rev. Proc. 2004-48, 2004-32 I.R.B. 172 (8/9/2004) for LLC's seeking
S-Corp status:
Rev. Proc. 2004-48, 2004-32 I.R.B. 172 (8/9/2004) for LLC's seeking S-Corp status
This revenue procedure 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 that the S
corporation election was intended to be effective. Generally, this
revenue procedure provides that certain eligible entities may be
granted relief if the entity satisfies the requirements of section 4
of this revenue procedure.
3.01 In General. An eligible entity that seeks to be classified
as a subchapter S corporation must elect to be classified as an
association under section 301.7701-3(c)(1)(i)
by filing Form 8832 and must
elect to be an S corporation under section 1362(a) by filing
Form 2553, Election by a Small Business
Corporation. In many situations, an entity may timely file Form 2553
but fail to file the Form 8832. Section
301.7701-3T(c)(1)(v)(C)
applies to these situations and deems an eligible entity that timely
files a Form 2553 to also have filed a Form 8832. In other
situations, an eligible entity fails to file a timely Form 2553. In
these situations, section
301.7701-3T(c)(1)(v)(C)
does not
apply and the entity would be required to obtain relief in a letter
ruling. This revenue procedure provides a simplified method for
requesting relief for those situations not covered by section 301.77013T , provided that the requirements of sections 4.01 and 4.02
of this revenue procedure are satisfied. The method provided in this
revenue procedure is in lieu of to the letter ruling process
ordinarily used to obtain relief for late elections under sections
1362(b)(5), 301.9100-1, and 301.9100-3. Accordingly, user fees do not
apply to corrective action under this revenue procedure.
4.01 Eligibility for Relief. An entity may request relief under
this revenue procedure if the following requirements are met:
Rev. Proc. 2003-43, 2003-23 I.R.B. 998 (6/9/2003) for corporations or LLC's seeking S-Corp status:
This revenue procedure provides a simplified method for taxpayers to
request relief for late S
corporation elections, Electing
Small Business Trust (ESBT) elections, Qualified Subchapter S Trust (QSST)
elections and Qualified Subchapter S Subsidiary (QSub) elections.
Generally, this revenue procedure provides that certain eligible
entities may be granted relief for failing to file these elections in
a timely manner if the request
for relief is filed within 24 months of the due date of the election.
Accompanying this document is a flowchart designed to aid taxpayers in
applying this revenue procedure.
This revenue procedure provides procedures in lieu of the letter
ruling process ordinarily used to obtain relief for a late Election
Under Subchapter S filed pursuant to section 1362(b)(5), section
1362(f), or section 301.9100-1
and section 301.9100-3.
4.02 Eligibility for Relief. Relief is available under section
4.04 of this revenue procedure if the following requirements are met:
Rev. Rul. 73-361
and Rev. Rul. 82-83 stockholder-officer of s-corporation is an
employee, form W-2 is to be issued:
S-Corp shareholders' medical deductions IRC §105
& §106 (belong on form W-2):
Do not confuse §106 Health
insurance vs. §105 Medical
expenses
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.
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).
Treating Medical Insurance Premiums as Wages
Health Insurance Purchased in Name of Shareholder
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?
(But see below for another opinion)
For a 100% shareholder, there would be no difference provided that
the shareholder deduction under IRC 162(l) would be allowable,
keeping in mind that there are other requirements under IRC 162(l),
such as FICA wages equal or greater than the amount of the health
insurance deduction, that there is no other coverage available to
the taxpayer or spouse, etc., that need to be addressed for the
deduction to be allowable.
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.
IRS Notice 2005-8, 2005-4 (1/24/2005) Health Savings Accounts
- S Corporation’s Contributions to a 2-Percent Shareholder-Employee’s HSA
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:
In order for the 2-percent 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.
S-Corp shareholders' tax deductions
based on loans made - and the taxable income based on repayments of
those loans:
Income recapture can occur when debt basis is used to deduct corporate
losses. When debt basis is reduced to zero due to corporate losses,
and then payments are made against the zero-basis loam, income
recapture may occur.
Generally:
For shareholder loans evidenced by a note, additional advances
do not restore or prevent income recapture to zero-basis or low-basis
loans repaid during the year. Because additional advances are deemed
new loan, they provide the shareholder with additional basis for
deducting additional losses, but do not prevent income recapture for
the zero-basis or low-basis loans repaid during the period.
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:
If loan basis has been reduced,
but not to zero, a partial payment to the shareholder on the
loan cannot be applied solely to the basis portion. Rather, the
payment must be allocated proportionately to represent (a)
return of basis, and (b) taxable income to the shareholder (Rev.
Rul. 64-162, 1964-1 CB 304, Rev. Rul. 68-537, 1968-2 CB 372).
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.
S-Corp
shareholders' pass-thru's ordering rule 1.1367-1(g) election:
A S-Corp shareholder may elect to shift the ordering of Tier 3 and
Tier 4 items. If the election is not made, the Code strongly
suggests that there is no carryover available of the Tier 3 items.
If the election is made, the shareholder generally may get to
deduct Tier 4 items which otherwise may have to be deferred due to
lack of tax basis
Schedule K-1 instructions:
You may elect to decrease your basis under (4) prior to
decreasing your basis under (3). If you make this election, any
amount described under (3) that exceeds the basis of your stock
and debt owed to you by the corporation is treated as an amount
described under (3) for the following tax year.
To make the election, attach a statement to your timely filed
original or amended return that states you agree to the carryover
rule of Regulations section 1.1367-1(g) and the name of the S
corporation to which the rule applies. Once made, the election
applies to the year for which it is made and all future tax years
for that S corporation, unless the IRS agrees to revoke your
election.
http://www.nysscpa.org/cpajournal/1996/mar96/depts/fed_tax96.htm
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.
S corporation payroll debt obligations -
disqualifying second class of stock - Regs. §1.1361-1:
Straight Debt Safe Harbor:
Debt that meets the definition of "straight debt" is not a
second class of stock, regardless of whether such debt is classified
as equity under general tax law principles.
A straight debt instrument is a written unconditional promise to pay
(whether or not embodied in a formal note) on demand or on a
specific date a sum certain in money (§1361(c)(5)). In addition,
straight debt must meet the following requirements:
1. The interest rate and payment dates are not contingent on
profits, corporate discretion, etc.;
2. The instrument is not convertible into stock; and
3. The lender is an individual (other than a nonresident alien), an
estate, a trust that is eligible to hold S corporation stock, or a
person actively and regularly engaged in the business of lending
money (e.g., a bank).
Short-Term Unwritten Advances:
Regs.
§1.1361-1(1)(4)(ii)(B)
Unwritten advances that (1) do not exceed $10,000 in the aggregate
at any time, (2) are treated as debt by the parties, and (3) are
expected to be repaid within a reasonable time are not treated as a
second class of stock (even if considered equity under general tax
law principles).
Proportionately Held Debt:
Regs.
§1.1361-1(1)(4)(ii)(B)
Proportionately held debt includes any class of obligations
considered equity under general tax law principles and held by the
shareholders in the same proportion as the S corporation's
outstanding stock. Note that debt held by a sole shareholder of an S
corporation always meets the definition of proportionately held
debt. Thus, debt held by shareholders in the same proportions as
their stock ownership (including debt owed by the corporation to a
sole shareholder) will not be considered a second class of stock.
The regulations explicitly state that obligations held by the sole
shareholder of an S corporation are always considered
proportionately held.
One-shareholder s-corporation payroll issues:
Ken Ryan, Inc. v. Comr. (2010)
Payroll wages must not be reported solely on the 4th quarter form
941 (with the result that payment of withholding taxes are delayed
until the end of the year)
Charlotte’s Office Boutique, Inc. v. Comr. (2005)
Royalty payments must not be made in lieu of payroll wages.
(with the result that Social Security, FICA and Medicare taxes are
avoided)
http://www.irs.gov/businesses/small/article/0,,id=203100,00.html#skiptocontent
Trader Status "election":
Each year s taxpayer chooses whether to take the position of "trader
status" rather than the default position of "investor status" merely
by filing a tax return using trader status concepts rather than
investor status concepts.
The IRS has the right to challenge the taxpayer's choice on a
year-by-year basis. The documentation and support for taxpayer's
choice of filing under trader status should show that the buying and
selling of securities (and/or commodities, futures or forex) during
the year was substantial. and was carried on with continuity and
regularity. The taxpayer also should be intending to "make a
living" from the trading activity (see §1.183-2(b)(8)).
IRS Regs.
§1.183-2(b) Trade or Business:
Nine nonexclusive factors under IRS Regs. §1.183-2(b) that the IRS
looks to to determine if an activity is a "trade or business" are:
IRS Regs. §1.469-1T(e)(6) Partnership has
non-passive activity:
Non-Passive Income:
Once Trader Status is used by a pass-thru entity the income is not
considered "passive income" pursuant to IRS Regs. §1.469-1T(e)(6) and
IRS FSA 200111001 and is not considered "portfolio
income" pursuant to IRS Regs. §1.469-2T(c)(3)(ii)(D).
§1.469-1T(e)(6) Activity of
trading personal property
(i) In general. --An activity of trading personal property for the
account of owners of interests in the activity is not a passive
activity (without regard to whether such activity is a trade or
business activity (within the meaning of paragraph (e)(2) of this
section)).
(ii) Personal property. --For purposes of this paragraph (e)(6), the
term "personal property" means personal property (within the meaning
of section 1092(d), without regard to paragraph (3) thereof).
(iii) Example. --The following example illustrates the application of
this paragraph (e)(6):
Example. A partnership is a trader of stocks, bonds, and other
securities (within the meaning of section 1236(c)). The capital
employed by the partnership in the trading activity consists of
amounts contributed by the partners in exchange for their partnership
interests, and funds borrowed by the partnership. The partnership derives gross income
from the activity in the form of interest, dividends, and capital
gains. Under these facts, the
partnership is treated as conducting an activity of trading personal
property for the account of its partners. Accordingly, under this paragraph
(e)(6), the activity is not a passive activity.
§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.
IRS Regs. §1.469-5T(a) LLC has non-passive
activity:
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.
4.11.6.3
(05-13-2005)
Adoption
of a
Method
of
Accounting
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). see Rev. Proc. 99-17 Sec 5.01
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. see Rev. Proc. 99-17 Sec 5.02 and Sec 5.04
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. see Rev. Proc. 99-17 Sec 5.03(1)
(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. see Rev. Proc. 99-17 Sec 5.03 (2)
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. ___.
Rev. Proc. 99-49, Section 6 of Revenue Procedure 99-17 is superseded by Section 13 of Revenue Procedure 99-49.
Rev. Proc. 2002-9, (IRS)Section
Rev. Proc. 2002-19, Section.
Rev. Proc. 2008-52, Section .
Rev. Proc. 2009-39, Section .
Rev. Proc. 2011-14, Section .
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 Proposed Regulation Section 1.1402(a)-2
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.
(j) EFFECTIVE DATE.
Paragraphs (d), (e), (f), (g), (h), and (i) are applicable beginning
with the individual's first taxable year beginning on or after the
date this section is published as a final regulation in the Federal
Register.
[62 FR 1702, January 13, 1997]
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