Double Taxation: A Take On All Things Taxes

Their long nightmare finally over, Chicago residents may now resume purchasing Brian Scalabrine jersey T’s free from sales tax.

From the Chicago Tribune:

Consumers who live in sales-tax states, such as Illinois, owe state sales tax on their Internet purchases, whether they pay it during virtual checkout or when they file their state income tax returns. But few actually pay unless tax is collected at checkout. That has the effect of making online purchases cheaper than those at bricks-and-mortar retailers.

In March 2011, Illinois passed the Main Street Fairness Act, informally dubbed the Amazon-tax law. Before the law, online retailers were forced to collect and remit sales taxes on purchases made by Illinois residents only if the online retailer had a “physical presence” in the state. For example, Sears must collect sales tax on virtual checkout at Sears.com because it has a headquarters and retail stores in Illinois. But Amazon.com does not have a physical presence and did not have to collect tax on checkout.

Cook County Circuit Court Judge Robert Lopez Cepero said in court Wednesday that the Illinois law violated the commerce clause of the U.S. Constitution, which limits who a state can tax, and that the law conflicted with the federal Internet Tax Freedom Act, which prohibits some types of Internet-related taxes. He directed parties to draft an order reflecting his opinion.

The quick decision Wednesday was unexpected, even to officials of the Performance Marketing Association, said PMA Executive Director Rebecca Madigan. “The judge pointed out and agreed with us that the state overreached its boundaries in trying to regulate interstate commerce,” Madigan said. “We…believe it paves the way for Internet marketing affiliates to get back in business in Illinois.” However, the battle has just begun, said David Vite, president of the Illinois Retail Merchants Association, which supports the law. “This is the first step in a very long battle,” Vite said. “We have seen local judges be overturned regularly on these kinds of questions.”

While several states have passed or are considering passing an “Amazon Tax” compelling online retailers to collect sales tax on purchases made by the state’s residents, the victory in Illinois — which comes on the heels of a similar ruling in federal court regarding an Amazon Tax instituted in 2010 in Colorado — is a strong indication that the courts may well view the tax as an overreach of state powers, and a violation of Quill v. North Dakota.

Read the full decision here.

Read Full Post »

Daniel Rood, like half of married Americans, got divorced. As part of the divorce agreement, he was ordered to pay a “non-modifiable lump sum payment” of $300,000 to his former spouse, payable at the rate of $5,000 per month.

On his 2006 tax return, Rood deducted $60,000 in alimony payments. The IRS denied the deduction.

As a reminder, I.R.C. § 215 defines “alimony”  through I.R.C. § 71 as any payment in cash if:

• Such payment is received by a spouse under a divorce or separation instrument;
• The divorce instrument doesn’t designate such payment as a payment which is not includible in gross income under I.R.C. § 71 and not allowable as a deduction under I.R.C. § 215;
• In the case of an individual legally separated from his spouse under a decree of divorce, the payee spouse and payor spouse cannot be members of the same household at the time such payment is made; and
• There is no liability to make any such payment for any period after the death of the payee spouse.

In Rood, the first three factors were clearly satisfied; what remained, however, was the uncertainty surrounding the fourth factor. Was the non-modifiable nature of Rood’s required payments such that they would survive the death of his ex-wife and render the alimony payments nondeductible?

In holding that the alimony payments were nondeductible, the Tax Court looked to Florida state law and determined that the payments were intended to survive the death of Rood’s ex-wife:

Florida law is clear that the obligation to pay lump-sum alimony granted in a divorce decree does not terminate upon the death of the payee spouse. The MSA, the final judgment, and the income deduction order all order Mr. Rood to pay nonmodifiable lump-sum alimony to Ms. Wozniak. Accordingly, we find that the payments were for a definite sum and in the nature of a final property settlement and therefore were lump-sum alimony payments under Florida law–the payments would not terminate upon the death of Ms. Wozniak and are therefore nondeductible.

This reinforces the advice my father gave me on my wedding day. “Son, ” he said, “you’re making a huge mistake.” Smart guy, the old man is.

Read Full Post »

Whenever I teach at firm-wide CPE, I elect to spend the night before the training at the hosting hotel, even when it’s located less than an hour’s drive from my house. I do this because 1) I like to remove traffic from the morning preparation equation,  and 2) I’m a spoiled, self-entitled prima donna.

Regardless, my firm typically picks up the tab for the hotel room. It’s no freebie, however; the expense is required to be included in my compensation. Why?

Ordinarily, if an employer provides property — such as a hotel room —  to an employee in the course of business, the value of the benefit is excludable from the employee’s income only if the benefit constitutes a working condition fringe under I.R.C. § 132(a)(3). In turn, the property only constitutes a working condition fringe to the employee to the extent that — if the employee had paid the expense himself — it would be deductible to the employee as a business expense under I.R.C. § 162.

Unfortunately, Treas. Reg. § 1.262-1 trumps I.R.C. § 162 and disallows a deduction for any personal, living, or family expenses. Included in this definition is the cost of any “local lodging. ” Local lodging is generally any lodging expenses that are not incurred while traveling away from home.

Applying these provisions to my facts, the payment by my firm for my hotel room would only be excludable to me as a working condition fringe to the extent that, if I paid for the hotel room myself, I could deduct the expense as an unreimbursed business expense. Because the cost of local lodging is a nondeductible personal expense, however, I would not be entitled to deduct the cost of the hotel room if I paid it directly. Thus, I have to include the value of the hotel room in my income as compensation, with my firm getting a corresponding compensation deduction.

The same result occurs if I paid for the hotel room directly, and my firm reimbursed me for the expense. While typically, reimbursements made under an accountable plan are excludable from the income of the employee, this favorable rule applies only where the expense is one that would be deductible by the employee. Since expenses for local lodging are nondeductible, I would not be entitled to tax-free reimbursement by my employer.

Expanding upon these principles further, the same result occurs to the extent of the value of any local lodging afforded to an employee or reimbursed by an employer, including weekend resort getaways, lodging to avoid a late-working employee from having to drive home, or housing for a recently relocated employee until they find something permanent. In all three cases, the value of the lodging — or any reimbursement — is included in the income of the employee.

Got all that?

Good, because its changing.

Today, the IRS issued proposed regulations under Treas. Reg. §1.162-31 and Treas. Reg. §1.262-2 that would allow an employee to either 1) have local lodging expenses paid on their behalf by their employer, or 2) be reimbursed for local lodging expenses paid out of pocket, without the value of the lodging or the reimbursement being included in the employee’s income.

Under the proposed regulations, under certain circumstances expenses for local lodging would no longer be treated as nondeductible personal expenses — but rather as deductible business expenses under Section 162 –  thus allowing for tax-free reimbursement or treatment as a working condition fringe. While the determination of whether the local lodging expenses are business rather than personal expenses will be determined under all the facts and circumstances, the critical factor is whether the taxpayer incurs the expense because of a bona fide condition or requirement of employment imposed by the taxpayer’s employer.

Under the regulations, expenses paid or incurred for local lodging that  primarily provides an individual with a social or personal benefit are not treated as business expenses, and thus continue to not be eligible to be excluded from income.

The regulations go on to provide a safe harbor, under which any local lodging expenses will be considered business expenses, such that the value of the lodging or any reimbursement are excludable from income. The safe harbor applies where:

(1) The lodging is necessary for the individual to participate fully in or be available for a bona fide business meeting, conference, training activity, or other business function;

(2) The lodging is for a period that does not exceed five calendar days and does not recur more frequently than once per calendar quarter;

(3) If the individual is an employee, the employee’s employer requires the employee to remain at the activity or function overnight; and

(4) The lodging is not lavish or extravagant under the circumstances and does not provide any significant element of personal pleasure, recreation, or benefit.

In my original fact pattern, I still wouldn’t be eligible to exclude the value of the hotel room under the safe harbor, as my stay is not required by my employer, and my liberal use of the “adult” section of the pay-per-view channel certainly constitutes a significant element of personal pleasure. In other situations, however, local lodging that was once includable in employees’ income will now be tax-free. The proposed regulations include the following examples:

Example 1. (i) Employer conducts training for its employees at a hotel near Employer’s main office. The training is directly connected with Employer’s trade or business. Some employees attending the training are traveling away from home and some employees are not traveling away from home. Employer requires all employees attending the training to remain at the hotel overnight for the bona fide purpose of facilitating the training. Employer pays the costs of the lodging at the hotel directly to the hotel and does not treat the value as compensation to the employees.

(ii) Employer has a noncompensatory business purpose for paying the lodging expenses. Employer is not paying the expenses primarily to provide a social or personal benefit to the employees. If the employees who are not traveling away from home had paid for their own lodging, the expenses would have been deductible under section 162(a) as ordinary and necessary business expenses of the employees. Therefore, the value of the lodging is excluded from the employees’ income as a working condition fringe under section 132(a) and (d).

In still other situations, however, the personal benefit inuring to the employee will continue to prevent the employee from being permitted to exclude the value of local lodging from income:

Example 4. (i) Employer hires Employee, who currently resides 500 miles from Employer’s business premises. Employer pays for temporary lodging for Employee near Employer’s business premises while Employee searches for a residence.

(ii) Employer is paying the temporary lodging expense primarily to provide a personal benefit to Employee by providing housing while Employee searches for a residence. Employer incurs the expense only as additional compensation and not for a noncompensatory business purpose. If Employee paid the temporary lodging expense, the expense would not be an ordinary and necessary employee business expense under section 162(a) because the lodging primarily provides a personal benefit to Employee. Therefore, the value of the lodging is includible in Employee’s gross income as additional compensation.

These changes are effective the date final regulations are published; but in the interim, taxpayers may apply the proposed regulations to local lodging expenses.

Read Full Post »

Mixing family and business is never a good idea. Working closely with someone you’re intertwined with on multiple levels is sure to lead to personality conflicts, financial squabbles, and in the case of Patrick and Michael Reesnick, the occasional attempted poisoning.

In 1985, Patrick Reesnick and his brother purchased an apartment building as tenants in common, and as the Tax Court put it, “that concludes our record of civil behavior between the two brothers.” Michael Reesnick accused Patrick of leaving him “holding the bag while he went out to have a fancy time,” while Patrick countered by claiming that Michael had stolen money from him and yes, “poured cleaning fluid into his drinking water.” Brotherly love at its finest.

The inevitable lawsuit ensued, and the brothers were ordered to sell the apartment building, which they did in September 2005. Rather than immediately recognize his share of the resulting gain, however, Michael Reesnick sought deferral under the “like-kind exchange” provisions of Section 1031.

As a reminder, Section 1031 provides that no gain or loss is recognized on the exchange of property held for use in a trade or business or for investment if the property is exchanged solely for property of a like kind that is also held for use in a trade or business or for investment.

In November 2005 — within the prescribed time limits of I.R.C. § 1031(a)(3) and Treas. Reg. §1.1031(k)-1(b)[1] for a good exchange–  Reesnick acquired a replacement property in the Lake Tahoe area. The property was a home that Reesnick intended to hold as a rental. He took the following steps in an attempt to find a tenant:

• Posted flyers on the home and in the surrounding neighborhoods advertising the rental;
• Met with potential renters; and
• Worked with a realtor to set the rental rate.

Despite these efforts, Reesnick was unable to find a tenant, and the home was never rented. Soon after the acquisition of the rental property, Reesnick found his financial obligations mounting, and with three properties on his personal balance sheet, something had to give.

In April 2006, Reesnick succeeded in convincing his wife to put their primary residence up for sale to free up some cash, and move into the vacant Tahoe replacement property.[2] As a result, just six months after the exchange was completed, the Reesnicks made the Tahoe home their primary residence.

As a result, the IRS disallowed the deferral of gain on Reesnick’s 2005 sale of the apartment building, arguing that a like-kind exchange did not occur because Reesnick failed to hold the Tahoe property for use in a trade or business or for investment, since 1) it was never rented, and 2) it became the Reesnick’s primary residence soon after the exchange.

In ruling against the IRS and holding that the exchange qualified for deferral under Section 1031, the Tax Court concluded that Reesnick’s intent for acquiring the replacement property must be determined at the date of replacement. Differentiating Reesnick’s facts from previous decisions, the Tax Court noted that the following factors favored the finding of a good exchange:

• Reesnick’s repeated attempts to rent the replacement property;
• The lack of personal use during the purported “rental period;”
• Prospective tenants testified that they visited the property with the intention of renting it, but could not afford the asking price; and
• Mrs. Reesnick’s testimony that she never discussed moving into the Tahoe property until after the exchange had been completed.

Lastly, Reesnick’s own brother — intending to testify for the IRS — made up for his bouts of attempted murder and inadvertently blessed the exchange by stating that Reesnick had told him on several occasions that he would never move into the Tahoe house until his kids were out of high school. Because Reesnick’s oldest son had not yet graduated at the time of the exchange, the court saw this as evidence that Reesnick’s intent at the time of the exchange was to hold the property for investment.

It should be noted, in 2008 the IRS published Revenue Procedure 2008-16, which clarified the Service’s position on like-kind exchanges where the replacement property eventually becomes the taxpayer’s primary residence. In the Procedure, the IRS provides a safe harbor for exchanges entered into after March 2008 that covers situations exactly like the one in Reesnick where a taxpayer enters into an exchange in which the replacement property is a dwelling unit. The IRS clarifies that they will not challenge the Section 1031 exchange as long as the replacement property:

• Is owned by the taxpayer for at least 24 months immediately after the exchange (the “qualifying use period”); and
• Within the qualifying use period, in each of the two 12-month periods immediately after the exchange,
• The taxpayer rents the dwelling unit to another person or persons at a fair rental for 14 days or more, and
• The period of the taxpayer’s personal use of the dwelling unit does not exceed the greater of 14 days or 10 percent of the number of days during the 12-month period that the dwelling unit is rented at a fair rental.

Keep in mind, this is merely a safe harbor, and exchanges falling outside the safe harbor — as the Reesnick’s would have courtesy of their failure to rent the property — may still be held to represent valid exchanges under a facts and circumstances test.

Read Full Post »

I joked a couple weeks ago about a bill that would afford the IRS to deny tax scofflaws a passport, but in anticipation of the inevitable controversy to come as the mainstream media catches wind of the proposal, we should probably devote a bit more attention to the bill.

While Kelly Erb over at Forbes has all the gory details, we’ll rehash the most important aspects of Senate Bill 1813: Map-21 here.

The bill, which passed the Senate on March 14th and now moves on to the House, contains a provision — hidden amongst 1,800 pages wroth of proposed legislation on topics as varied as hand-rolled cigarettes, boating safety and airplane noise —  that would grant the IRS the ability to have the government deny, revoke or limit passport rights to an individual with a “seriously delinquent tax debt” in excess of $50,000.

Contemplated as an addition to the statute at I.R.C. § 7345, a “seriously delinquent tax debt” is one for which either a lien or notice of levy have been filed by the Service. Excluded from such debts are those that are being paid under either an installment agreement or an offer in compromise, and those for which collection has been suspended or innocent spouse relief is being sought.

Because a levy or lien can be filed by the IRS before the amount of the liability is definitively determined, this aspect of the bill calls into question the Service’s ability to limit travel of U.S taxpayers without due process. Erb is right on point with her analysis:

 So let me summarize for you: if the IRS liens or levies you, the Department of State can choose to restrict your right to travel without a judicial hearing. To be clear, these aren’t cases of U.S. citizens who have been found to have committed a crime or have been proven to owe taxes. There’s no day in court. There’s no opportunity to argue a case or prove that there has been a mistake. In other words, it gives the IRS the authority to determine your future travel plans. No due process for you.

Erb goes on to make an extremely astute and accurate observation: the bill, like much of the 2012 proposed tax legislation we’ve seen to date – amounts to little more than political posturing; sacrificing a meaningful fix for the underlying problem (the tax gap) in exchange for a impactful voice-over sound bite in some Senator’s ad-campaign commercial.

Read Full Post »