Corporate Tax Rate — 35%?

The politicians are often worked up about the high corporate tax rate in the U.S. – 35% is the number you always hear.

But a recent Government Accountability Office (GAO) report points out that the “effective” tax rate paid by corporations can and often does differ from the statutory marginal rates.  GAO notes that the profitable larger U.S. corporations paid federal income taxes for 2010 at an effective rate of 12.6% of the worldwide income they reported on their financial statements.  This is slightly lower than the 13.1% rate based on current federal tax expenses they reported in those financial statements, lower still than the 21% effective rate based on actual taxes and taxable income, and far below the top statutory rate of 35%.  And including foreign, state and local corporate income taxes, these corporations paid income taxes for 2010 at an effective rate of 16.9% of their reported worldwide income.

Taxpayer Beats IRS But Gets No Costs Reimbursed

Code section 7430 generally allows taxpayers who prevail against the IRS in court to be awarded reasonable litigation and administrative costs. But in the Thousand Oaks Residential Care Home I, Inc., et al case, the Tax Court denied any recovery to the taxpayer.

IRS conceded that the taxpayer substantially prevailed with respect to the most significant issues in the case, but nonetheless the IRS was off the hook for cost reimbursement because IRS’ positions were substantially justified. And the Court agreed.

So, even though the taxpayers won the case, the costs of doing so were held to be “on them,” because the IRS did not take an unreasonable position in the matter.

Exactly What is a ‘Partnership’?

Generally speaking, an unincorporated joint venture or other contractual or co-ownership arrangement under which several participants conduct a business or investment activity and split the profits is treated as a partnership for federal tax purposes.

Consider the following eight factors which the courts have looked to relative to the question as to whether a “partnership” literally exists:

  • Agreement of the parties and their conduct in executing its terms
  • Contributions by the parties
  • Control over income and capital and right to take withdrawals
  • Whether parties were co-proprietors with mutual obligations to share losses
  • Whether a venture has been conducted in the joint names of the parties
  • Whether the parties filed partnership returns or otherwise represented to IRS or others that the parties were joint venturers
  • Whether separate books were maintained for the venture
  • Whether the parties exercised mutual control over and assumed mutual responsibilities for the venture

No single factor is conclusive in and of itself, but if more than half the factors indicate partnership status, it may generally be more difficult to defend the proposition that the activity in question is not a partnership for federal tax purposes.

California Shows No Mercy

When it comes to the imposition of penalties, that is.

In a recent decision of the Board of Equalization, serious illness was not even a sufficient basis to abate late payment, notice and demand, and estimated tax penalties in a case where one spouse was ill and the other continued to run the business in question.

Husband, in this case, was seriously sick, requiring a kidney transplant, while wife continued to serve in her capacity as vice president of the family corporation, which generated income of more than $400,000 per year.  The state figured that she was perfectly capable of managing the business affairs, and paying the taxes on time.  No “reasonable cause” here.  (Appeal of Huerta, SBE 573108, 2/26/13)

IRS Comes to Its Senses on Mexico Land Trusts

Recall that whether an organization is an “entity,” separate from its owners for Federal tax purposes doesn’t depend on whether the organization is recognized as an entity under local law.

The term “trust” refers to an arrangement under which trustees take title to property for the purpose of protecting or conserving it for the benefit of the trust beneficiaries.  For quite some time, the Mexican Federal Constitution has prohibited non-Mexican persons from directly holding title to residential real estate in areas of Mexico located within 100 kilometers of its inland borders, or 50 kilometers of its coastline, though they may hold residential real property (often just a personal residence and not even rental or business property) in a “Mexico Land Trust,” also referred to as a “fideicomiso,” with a Mexican bank after obtaining the requisite civil permits.

The question has long been pondered whether such arrangements, for U.S. purposes, mandated the filing of Forms 3520/3520-A (Annual Return to Report Transactions With Foreign Trusts/Annual Information Return of Foreign Trust With U.S. Owner).

Finally, IRS propounds (in Rev Rule 2013-14) that in general these Mexico Land Trusts are not trusts under the definitions in the IRS regulations, and the individual U.S. person owner is treated as such for U.S. tax purposes.

Whistleblowers Sequestered!

The IRS has generally referred to persons who submit information (regarding malingering taxpayers) under IRC Section 7623 as “informants,” more colloquially as “whistleblowers,” subject to operations of the “Whistleblower Office,” which administers the rules regarding how much of a reward to which a whistleblower may be entitled.

So, along come the “sequester” rules, pursuant to which Congress mandated that various government expenditures will have to be reduced.  So, guess what:  whistleblowers, too, will have to grin and bear sequester until at least September 30, 2013 (unless Congress acts sooner to change the rule), which means that whistleblower payments, just like other government expenditures, are subject to a hair cut – of 8.7% in this instance!

No Payment Means No Deduction

A recent Tax Court decision (Hargreaves) states the obvious, but is a good reminder for all.

The Court ruled that a married couple could not deduct mortgage interest that was added to the principal of their negative amortization loan, because they were cash basis taxpayers and, quite obviously, didn’t actually “pay” the amount in question.

Under the cash receipts and disbursements method of accounting, amounts representing allowable deductions generally must be taken into account for the tax year in which paid.

The delivery of a promissory note to satisfy an interest obligation, without an accompanying discharge of the note, is a mere promise to pay and not actually a payment in cash or its equivalent.

The good news in this case is that, contrary to what the IRS asserted, no 20% accuracy-related penalty was appropriate, according to the Court, which found that the taxpayer made a reasonable attempt to comply with the law and acted in good faith.

Internet Sales Tax Reform

As it looks more and more like Congress will enact some sort of Internet sales tax mandate (thereby forcing Internet business to become sales tax collectors for all states), the arguments advanced by Americans for Tax Reform seem logical, and should not be dismissed:

  • Slippery slope – Opens the door for further government intervention into the Internet and for states to reach across their borders for other taxes.
  • Too confusing – Small businesses would be forced to accommodate over 9,000 highly variable state and local tax codes and be required to settle disputes with out-of-state revenue boards, potentially in out-of-state courts.
  • Discourages tax competition – Rather than competing to lower taxes and attract businesses, states will compete to raise taxes on residents of other states.
  • Expands state tax authority – State governments will be able to tax across their borders despite clear legal and judicial precedent arguing otherwise.

May 15 Looms for Exempt Org Filers

Calendar year exempt organizations (generally Form 990-series filers) must file their 2012 returns (or extension requests) by May 15 – and, importantly, organizations will see their federal tax exemptions automatically revoked if they have not filed their annual information returns for three consecutive years.

Small exempt orgs (average annual receipts of $50,000 or less) may file an electronic notice called a Form 990-N (e-postcard) which asks merely a few basic questions.  Organizations  whose average annual receipts exceed $50,000 must file Form 990 or Form 990-EZ (Form 990-PF in the case of private foundations).

Check out IRS Form 8868 if your organization needs a filing extension by May 15.

IRS Sequester Timing

Acting IRS Commissioner Steven Miller recently informed agency employees that official “furlough” notices are forthcoming.  Five dates from May through August have been announced, with the possibility of two more days in August or September.  Agency operations will be entirely shut down on these dates, which are:

  • May 24
  • June 14
  • July 5
  • July 22
  • August 30

The White House Office of Management and Budget has said that the following broad areas of IRS discretionary activity are subject to a 5% “across the board” reduction in spending through September 30:

  • Enforcement ($267 million)
  • Operations Support ($199 million)
  • Taxpayer Service ($114 million)
  • Business Systems Modernization ($17 million)