Larry's Tax Law

BACKGROUND/PRIOR LAW

Under IRC § 708(a), a partnership is considered as a continuing entity for income tax purposes unless it is terminated. Given the proliferation of state law entities taxed as partnerships today (e.g., limited liability companies and limited liability partnerships), a good understanding of the rules surrounding termination is ever important.

Prior to the Tax Cuts and Jobs Act (“TCJA”), IRC § 708(b)(1) provided that a partnership [1] was considered terminated if:  

1.  No part of any business, financial operation, or venture of the partnership continues to be carried on by any of the partners of the partnership; or

2.  Within any 12-month period, there is a sale of exchange of 50% or more of the total interests of the partnership’s capital and profits.

BACKGROUND

On February 21, 2014, then House Ways and Means Committee Chairman Dave Camp (R-Michigan) issued a discussion draft of the “Tax Reform Act of 2014.” The proposed legislation spanned almost 1,000 pages and contained some interesting provisions, including repealing IRC § 1031, thereby prohibiting tax deferral from like-kind exchanges. Not only would taxpayers have been impacted by this proposal, but it would have turned the real estate industry upside down. Qualified intermediaries would have been put out of business. Likewise, title and escrow companies, as well as real estate advisors specializing in exchanges, would have been adversely affected by the proposal.

As indicated at the end of 2017, I intend to provide our readers with an in-depth review of the Tax Cuts and Jobs Act (“TCJA”). With the help of two of my colleagues, Steven Nofziger and Miriam Korngold, we will do this in a series of bite-size blog posts. Our goal is to not only review the technical elements of the new law, but to offer practical insights that will be helpful to tax practitioners and their clients.

Many of the provisions of the TCJA have already received significant attention by the media. Rather than start our multi-part series with any of those provisions, we decided to commence the journey with a discussion about a rather obscure provision of the new law. This provision, while it may not have received any media attention, could be a huge trap for the unwary. It also highlights several aspects of the new law that have received little discussion.

On April 11, 2017, we discussed what constitutes Tax Reform. On April 24, 2017, we explored the process by which Tax Reform will likely be created by lawmakers. In our May 3, 2017 blog post, we focused on the likely timing for Tax Reform. In this blog post, we look at what Tax reform may look like.

Like one of my favorite things in this world, namely ice cream, Tax Reform also likely comes in different flavors. For starters, we have President Trump’s campaign comments on Tax Reform. Next, we have the Republican leaders’ from the U.S. House of Representatives initial draft of a Tax Reform package. Lastly, we have the White House’s April 26, 2017 one-page memorandum that broadly outlines the President’s current vision of Tax Reform.

Let’s break Tax Reform into three broad categories, namely:

1. Estate & Gift Tax
2. Individual Income Tax
3. Corporate Income Tax

On April 11, 2017, we discussed what constitutes Tax Reform. On April 24, 2017, we explored the process by which Tax Reform will likely be created by lawmakers. In this blog post, we focus our attention on the likely timing for Tax Reform.

When will we see Tax Reform? At this point in time, it is anyone’s guess. There are lots of external factors that impact the timing and possibility that Tax Reform in any shape or form will become a reality.

New Administration Doubles Down on Tax Reform Efforts

President Trump made it clear, both during his campaign and shortly after he entered the White House, that Tax Reform is a top priority. In fact, in an address to both branches of Congress on February 28, 2017, he stated that his administration “is developing historic [Tax Reform] that will reduce the tax rate on our companies so they can compete and thrive anywhere and with anyone …. it will be a big, big cut.” In addition, he indicated that his administration will provide “massive” tax relief for the middle class.

On April 11, 2017, we discussed what constitutes Tax Reform. In this blog post, we will explore the process by which Tax Reform will likely be created. After reading this post, if it seems to you that the legislative process for making tax laws is an awful lot like “making sausage,” you are perceptively correct.

Sausage Making

The legislative process starts with the selection of special ingredients by lawmakers, who generally keep a keen eye on the intended result. The ingredients are mixed together carefully during the legislative process. Spices and other ingredients are added from various sources (e.g., input from legislative staff, the Treasury and industry). The product that results from the process is not always what was exactly intended at the start. Consequently, it may be tweaked somewhat before it is finally packaged and presented to the public.

This is the first of a series of posts on Tax Reform. In this series, I will be covering: what Tax Reform means, the legislative process for enacting it, the likely timing of its arrival, the estate & gift tax and income tax proposals already presented by the Trump administration and the U.S. House of Representatives, and possible planning strategies that businesses and individuals may wish to consider.

What Tax Reform Is 

As a starter, what exactly is “Tax Reform”? Is it something you will know if you see it? Are there objective standards as to what constitutes “Tax Reform”?

The late Senator Russell B. Long, a Democrat from Louisiana, served more than four decades in the U.S. Senate. He was Chairman of the U.S. Finance Committee from 1966 to 1981, and was very influential in shaping our tax laws during the ’60s, ’70s and ’80s. In fact, he was one of the major contributors to the Tax Reform Act of 1986.

As a footnote, the ’86 Act, enacted over thirty years ago, was the last major tax reform legislation passed by our lawmakers. So, it has been a long time since we have seen Tax Reform.

The proposed $3 billion per year tax-raising bill, Oregon Measure 97, was defeated yesterday by a 59% to 41% margin. The fight was long and bloody. Media reports that opponents and proponents together spent more than $42 million in their campaigns surrounding the tax bill.

So, What Now?

The defeat of Measure 97 eliminates the proposed 2.5% gross receipts alternative corporate tax applicable to C Corporations with annual Oregon gross receipts over $25 million. Oregon C Corporations, however, are still faced with a minimum tax based on Oregon gross receipts. The minimum tax applicable to Oregon’s C Corporations is based on gross revenues as follows:

C Corporations with Oregon annual revenues greater than $25 million may face a new minimum tax obligation – 2.5 percent of the excess – if Measure 97 passes. If a business falls within this category, there may be ways to mitigate its impact. The time to start planning, however, is now.

Background

Oregon taxes corporations under an excise tax regime.  The Oregon corporate excise tax regime was adopted in 1929.  The original legislation included what is commonly called a “minimum tax” provision.  In accordance with this provision, corporations subject to the Oregon excise tax are required to pay the greater of the tax computed under the regular corporate excise tax provision or the tax computed under the “minimum tax” provision.  Accordingly, the “minimum tax” is an “alternative” tax; it is not an “additional” tax as many commentators have recently asserted.

Originally, the Oregon corporate “minimum tax” was a fixed amount – $25.  As a result of the lobbying efforts of Oregon businesses, the “minimum tax” was eventually reduced to $10, where it remained for almost 80 years.

In 2010, Oregon voters dramatically changed the corporate “minimum tax” landscape with the passage of Measure 67.  The corporate “minimum tax” (beginning with the 2009 tax year), is no longer a fixed amount.  Rather, it is now based on Oregon sales (gross revenues).  The “minimum tax” is now:

Oregon Sales

Minimum Tax

< $500,000

$150

$500,000 to $1 million

$500

$1 million to $2 million

$1,000

$2 million to $3 million

$1,500

$3 million to $5 million

$2,000

$5 million to $7 million

$4,000

$7 million to $10 million

$7,500

$10 million to $25 million

$15,000

$25 million to $50 million

$30,000

$50 million to $75 million

$50,000

$75 million to $100 million

$75,000

$100 million or more

$100,000

S corporations are exempt from the alternative graduated tax system.  Instead, they are still subject to a fixed amount “minimum tax,” which is currently $150.

As an example, under the current corporate “minimum tax” provision, a corporation with Oregon gross sales of $150 million, but which, after allowable deductions, has a net operating loss of $25,000, would be subject to a minimum tax of $100,000.  Many corporations operating in Oregon, which traditionally have small profit margins (i.e., high gross sales, but low net income), found themselves (after Measure 67 was passed) with large tax bills and little or no money to pay the taxes.  Three possible solutions for these businesses exist:

• • Make an S corporation election (if eligible);

• • Change the entity to a LLC taxed as a partnership (if the tax cost of conversion is palatable); or

• • Move all business operations and sales outside of Oregon to a more tax-friendly jurisdiction.

Several corporations in this predicament have adopted one of these solutions.

Initiative Petition 28/ Measure 97

Measure 97 will be presented to Oregon voters this November.  If it receives voter approval, it will amend the “minimum tax” in two major ways:

• • The “minimum tax” will remain the same for corporations with Oregon sales of $25 million or less.  For corporations with Oregon sales above $25 million, however, the “minimum tax” (rather than being fixed) will be $30,001, PLUS 2.5 percent of the excess over $25 million.

• • The petition specifically provides that “legally formed and registered benefit companies” as defined in ORS 60.750 will not be subject to the higher “minimum tax.”  Rather, they will continue to be subject to the pre-Measure 97 “minimum tax” regime (as discussed above).  Caveat: The exception, as drafted, appears to only apply to Oregon benefit companies; it does not extend to foreign benefit companies authorized to do business in Oregon.

Measure 97 expressly provides that all increased tax revenues attributable to the new law will be used to fund education, healthcare and senior citizen programs.  As a result, many commentators believe the initiative has great voter appeal and will likely be approved by voters.  If Measure 97 is passed, it is slated to raise over $6 billion in additional tax revenue per biennium.

On November 2, 2015, the Bipartisan Budget Act (“Act”) was signed into law by President Barack Obama. One of the many provisions of the Act significantly impacts: (i) the manner in which entities taxed as partnerships[1] will be audited by the Internal Revenue Service (“IRS”); and (ii) who is required to pay the tax resulting from any corresponding audit adjustments. These new rules generally are effective for tax years beginning after December 31, 2017. As discussed below, because of the nature of these rules, partnerships need to consider taking action now in anticipation of the new rules.

The Current Landscape

Entities taxed as partnerships generally do not pay income tax. Rather, they compute and report their taxable income and losses on IRS Form 1065. The partnership provides each of its partners with a Schedule K-1, which allows the partners to report to the IRS their share of the partnership’s income or loss on their own tax returns and pay the corresponding tax. Upon audit, pursuant to uniform audit procedures enacted as part of the Tax Equity and Fiscal Responsibility Act of 1982 (“TEFRA”), examinations of partnerships are conducted generally under one of the following scenarios:

• • For partnerships with ten (10) or fewer eligible partners,[2] examinations are conducted by a separate audit of the partnership and then an audit of each of the partners;

• • For partnerships with greater than ten (10) partners and/or partnerships with ineligible partners, examinations are conducted under uniform TEFRA audit procedures, whereby the examination, conducted at the partnership level, is binding on the taxpayers who were partners of the partnership during the year under examination; and

• • For partnerships with 100 or more partners, at the election of the partnership, examinations may be conducted under uniform “Electing Large Partnership” audit procedures, whereby the examination, conducted at the partnership level, is binding on the partners of the partnership existing at the conclusion of the audit.

Lawmakers believed a change in TEFRA audit framework was necessary for the efficient administration of Subchapter K of the Code. If a C corporation is audited, the IRS can assess an additional tax owing against a single taxpayer—the very taxpayer under examination—the C corporation. In the partnership space, however, despite the possible application of the uniform audit procedures, the IRS is required to examine the partnership and then assess and collect tax from multiple taxpayers (i.e., the partners of the partnership). In fact, the Government Accountability Office (the “GAO”) reported in 2014 that, for tax year 2012, less than one percent (1%) of partnerships with more than $100 million in assets were audited. Whereas, for the same tax year, more than twenty-seven percent (27%) of similarly-sized corporations were audited. The GAO concluded the vast disparity is directly related to the increased administrative burden placed on the IRS under the existing partnership examination rules.