Larry's Tax Law

On April 5, 2023, Commissioner Daniel I. Werfel issued the Internal Revenue Service Inflation Reduction Act Strategic Operating Plan (“Plan”).  The Plan, which spans over 145 pages, is a roadmap to how the Service will deploy over the next decade the approximately $80 billion in supplemental funding it will receive as a result of the Inflation Reduction Act enacted by Congress last year (“IRA”).

In the Plan, Commissioner Werfel sums up the strategic goals for the IRS as follows:

“We will make it easier for taxpayers to meet their tax responsibilities and receive tax incentives for which they are eligible. We will adopt a customer-centric approach that dedicates more resources to helping taxpayers get it right the first time, while addressing issues in the simplest ways appropriate. We will address noncompliance, using data and analytics to expand enforcement in certain segments. We will become an employer of choice across government and industry. These changes will enable us to serve all taxpayers more equitably and in the ways they want to be served.”

It is a rainy day in the Pacific Northwest with chances of snow showers.  For those taxpayers that reside in the state of Washington or own highly appreciated capital assets located in the state, their day just got a bit gloomier. 

Earlier today, the Washington Supreme Court, in a 7-2 opinion, overturned the Douglas County Superior Court decision that had ruled the state capital gains tax enacted by the legislature in 2021 violates the Washington State Constitution.  

Majority Opinion

In its 50-plus page opinion written by Justice Debra L. Stevens, the majority of the court concludes:

“The court below [the Douglas County Superior Court] concluded the tax is a property tax that violates article VII’s uniformity requirement. In light of this ruling, the court did not address Plaintiffs’ additional constitutional challenges. We accepted direct review and now reverse. The capital gains tax is appropriately characterized as an excise because it is levied on the sale or exchange of capital assets, not on capital assets or gains themselves. This understanding of the tax is consistent with a long line of precedent recognizing excise taxes as those levied on the exercise of rights associated with property ownership, such as the power to sell or exchange property, in contrast to property taxes levied on property itself. Because the capital gains tax is an excise tax under Washington law, it is not subject to the uniformity and levy requirements of article VII. We further hold the capital gains tax is consistent with our state constitution’s privileges and immunities clause and the federal dormant commerce clause. We therefore reject Plaintiffs’ facial challenge to the capital gains tax and remand to the trial court for further proceedings consistent with this opinion.”

INTRODUCTION

As I have discussed in prior blog posts (March 11, 2013, April 9, 2013 and December 9, 2013), worker classification has historically been a focus of attention of various government agencies as well as others.  Misclassifying workers, even if unintentional, can create nightmares for businesses and their owners. 

The worker classification rules are not always objective, making them difficult to apply.  Additionally, the rules applicable to a particular business may vary depending on who is looking at the matter.  For example, in many cases, the laws applied by the Department of Labor (“DOL”) and the Internal Revenue Service (“IRS”) differ from the laws applied by state or local agencies.  On top of that, the laws of the states are not uniform.

As a result of the COVID-19 pandemic, we have seen a significant worldwide change in the structure of workforces caused by the emergence of the remote worker.  The number of remote workers has significantly multiplied in the last two years, adding one more factor to the worker classification analysis.  In and of itself, having workers performing services from remote locations (usually their personal residences) does not make the workers per se employees or per se independent contractors.  While the location where a worker performs services should be considered in making a classification determination (i.e., whether the business can or does control the worker), it is not a definitive factor.  Nevertheless, with a changed workforce model, which is likely here to stay, businesses should invest the time and energy in revisiting their prior worker classification conclusions to see if they remain valid today.    

2022, like the prior two years, has been difficult.  The COVID-19 pandemic and social unrest continues to be at the forefront of our existence.  On top of that, inflation and possible recessionary times are among us.

Thanks to the unwavering support of family, friends, clients, and colleagues, we are enduring through these turbulent times.  I am so grateful for these relationships!

I have had to constantly be mindful of the good things going on around us.  As American Poet Walt Whitman is accredited with saying:

By motion dated November 3, 2022, the Washington State Attorney General asked the Supreme Court of the State of Washington to allow the Washington Department of Revenue to implement and collect the capital gains tax struck down as unconstitutional by the Douglas County Superior Court, pending the high court’s ultimate ruling on the matter. 

As previously reported, the tax, which was set to go into effect on January 1, 2022 was struck down by the Douglas County Superior Court as unconstitutional.  The first tax payments under the new tax regime would be due on April 17, 2023.

Introduction

More than two decades ago, the Service announced its intention to consider simplifying the entity classification rules in Notice 95-14.  It stated:

“The Internal Revenue Service and the Treasury Department are considering simplifying the classification regulations to allow taxpayers to treat domestic unincorporated business organizations as partnerships or as associations on an elective basis. The Service and Treasury also are considering adopting similar rules for foreign business organizations. Comments are requested regarding this and other possible approaches to simplifying the regulations.”

The Service asked for public comments on simplification of entity tax classification.  It scheduled a public hearing on the matter for July 20, 1995. 

In May 1996, proposed entity classification regulations were issued by Treasury.  About seven months later, on December 17, 1996, Treasury finalized the regulations.  The regulations are found in Treasury Regulation Section 301.7701.

The regulations were clearly designed to accomplish the IRS’s stated goal – simplifying entity tax classification.  The regulations, commonly referred to as the “Check-the-Box” regulations, successfully brought an end to much of the long existing battle between taxpayers and the Service over entity tax classification.  The regulations generally became effective on January 1, 1997.  In a little over a month from now, they will be 25-years old.  

The regulations, despite judicial challenge (e.g., Littriello v. United States, 2005-USTC ¶50,385 (WD Ky. 2005), aff’d, 484 F3d 372 (6^th Cir. 2007), cert. denied, 128 S. Ct. 1290 2008)), have persevered, making the entity classification landscape free of many tax authority challenges and providing taxpayers with some objectivity and more importantly, much needed certainty.  That said, despite the simplification brought into the world of entity tax classification by the Check-the-Box regulations, for which tax practitioners applauded the government, several new hazards were created.  Whether these new hazards were intentional or unintentional is subject to debate.  Unfortunately, not all of these hazards are obvious to taxpayers and their advisors.  If taxpayers and their advisors are not extremely careful in this area, disastrous unintended tax consequences may exist.  Accordingly, a good understanding of the regulations and the consequences of making, not making or changing an entity tax classification decision is paramount.

Last month, I presented a White Paper that I authored on the regulations at the NYU 81^st Institute on Federal Taxation in New York City, and I will be presenting it again for NYU in San Diego on November 17, 2022.  The paper provides exhaustive coverage of the regulations and covers numerous nuances and traps that exist for unwary taxpayers and their advisors.  An issue which is often overlooked by practitioners is whether using the regulations to change entity status for income tax purposes is always a good idea.  While I discuss the issue in some detail in the paper, the sub-issue of whether a taxpayer should use the regulations to change the tax status of a limited liability company (“LLC”) taxed as a partnership to a corporation taxed under Subchapter S needs discussion.  I explore that sub-issue below.

The NYU 81st Institute on Federal Taxation (IFT) returns to in-person programming this year in New York City on October 23-28, 2022, and in San Diego on November 13-18, 2022. 

This year, I will be presenting my white paper “Entity Classification – The Check-The-Box Regulations Revisited."  Our discussion will cover recent developments in the law relating to entity classification, limitations under the check-the-box regulations, flexibility and planning opportunities created by the regulations, traps that exist for the unwary, and practical planning opportunities for tax advisers.

I am extremely grateful to have had the opportunity to present with IFT for more than a decade. During this year’s Institute, I will again be presenting as part of the Closely-Held Business program, chaired by my esteemed colleague Jerry David August, on the mornings of October 27 (NYC) and November 17 (San Diego). 

On August 23, 2022, the Regular Division of the Oregon Tax Court issued its opinion in Santa Fe Natural Tobacco Co. v. Department of Revenue, State of Oregon.  The court determined that the taxpayer in that case is subject to the corporate excise tax. 

The taxpayer, Santa Fe Natural Tobacco Co., required that its wholesale customers located in Oregon accept and process returned goods.  In addition, the taxpayer’s in-state sales representatives, who did not maintain inventory, routinely confirmed and processed purchase orders between Oregon retailers and wholesalers.

As previously reported, due to the COVID-19 pandemic, remote workforces currently dominate the landscape of most U.S. businesses.  In fact, in many industries, remote workforces may be the new normal post-pandemic.  Unfortunately, as workers become more mobile, the tax and human resources issues become more challenging for employers.

I was asked by Dan Feld, Principal Editor, Tax Journals, of Thomson Reuters, to author an article on this topic for the July 2022 Practical Tax Strategies Journal.  With Dan’s approval, I have provided a link to the complete article, Remote Workforces: Tax Perils and Other Traps For Unwary Employers, for my blog readers. 

The Taxpayer Advocate Service (“TAS”) is an independent body housed within the Internal Revenue Service (the “Service” or “IRS”).  Its mission is to ensure taxpayers are treated fairly by the Service and that taxpayers know and understand their rights with respect to the federal tax system.  Further, the TAS was created by Congress to help taxpayers resolve matters with the IRS that are not resolved through normal IRS procedures.  Additionally, the TAS was established to address large-scale, systemic issues that impact groups of taxpayers.

The TAS is currently led by Ms. Erin M. Collins, who joined the TAS in March 2020.  She serves as the National Taxpayer Advocate (“NTA”).  The NTA submits two reports to Congress each year, namely an “Annual Report” in January and what is called an “Objectives Report” in June.

On June 22, 2022, the NTA submitted the TAS Fiscal Year 2023 Objectives Report to Congress.  In addition to identifying the TAS’s objectives for the upcoming fiscal year, Ms. Collins sets out the good, the bad and the ugly relative to the Service’s performance during the year.  As a report card, it does not appear Ms. Collins gave the IRS all A’s.  She expressed critical comments centered primarily around three areas of customer service that include unprocessed paper-filed tax returns, delays in responding to taxpayer correspondence and failures in answering taxpayer telephone inquiries.  Whether the criticism is warranted may be debatable.