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There are two basic types of business combinations – taxable and nontaxable.

Taxable Business Combinations (Asset Purchase):

In a taxable business combination, new tax bases for acquired assets and assumed liabilities are generally determined on the basis of the fair market value. The acquirer “steps up” the acquiree’s historical tax bases in the assets acquired and liabilities assumed to fair market value.  Under the U.S. federal income tax law (IRC Section 338), certain stock purchases can be treated as taxable business combinations if an election to treat the stock purchase as a taxable asset purchase is filed.

Both the seller and purchaser of a group of assets that makes up a trade or business generally must use Form 8594 to report the transaction and both must attach the form to their respective income tax returns.  The taxpayers are not required to file Form 8594 when a group of assets that makes up a trade or business is exchanged for like-kind property in a transaction to which section 1031 applies and when a partnership interest is transferred. For stock purchases treated as asset purchases under Sections 338(g) or 338(h)(10), the purchaser and seller must first file Form 8023, to make the 338 election.  Form 8883 is then filed by both the purchaser and the target to supply information relevant to the election.

There is no legal requirement that the target and acquiring company take consistent positions on their respective tax returns, and therefore each could in principle take a different position favorable to itself.  However, if they do so, the IRS is likely to discover this fact and protect itself by challenging the positions taken by both parties.  To avoid this result, acquisition agreements almost always provide that the parties will attempt to agree on an allocation of price among the assets within a relatively short time after the closing of the transaction. 

Non-Taxable Business Combinations (Stock Purchase):

In a nontaxable business combination, the acquirer assumes the historical tax basis of the acquired assets and assumed liabilities. In this case, the acquirer retains the “historic” or “carryover” tax bases in the acquiree’s assets and liabilities. Generally, stock acquisitions are treated as nontaxable business combinations (unless a Section 338 election is made). Nontaxable business combinations generally result in significantly more temporary differences than do taxable business combinations because of the carryover of the tax bases of the assets acquired and liabilities assumed. To substantiate the relevant tax bases of the acquired assets and assumed liabilities, the acquirer should review the acquired entity’s tax filings and related books and records. This information should be evaluated within the acquisition’s measurement period.

The non-taxable corporate reorganization Internal Revenue Code provisions are concerned with the form, rather than the substance, of the transaction.  Therefore, it is important to document that the correct procedures have been followed.  Regulation Section 1.368-3 sets forth which records are to be kept and which information needs to be filed with tax returns for the year that such a transaction is completed.  Each corporate party to a non-taxable reorganization must file a statement with its tax return for the year in which the reorganization occurred that contains the names and EINs of all parties, the date of the reorganization, the FMV of the assets and stock transferred, and the information concerning any related private letter rulings.  All parties must also maintain permanent records to substantiate the transaction.  While there are no statutory penalties for failure to comply with the reporting requirements, the IRS has argued that failure to comply with the requirements could indicate that a transaction was a sale and not a non-taxable reorganization.

Authored by Robert Cutolo

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Today’s post comes from Guest Blogger, Daniel Clark.

ANY business that requires their consumers to have internet access to enjoy their services will be affected by the new EU VAT digital services reform.

The new rules have been created with the intention of creating a “level playing field” for all businesses in the digital economy. These are the word of the EU’s Taxation Commissioner Algirdas Semeta who has also stated that the aim of the new EU VAT on digital services is to ensure that the digital economy “plays fair and pays fair.”

In a sense, the powers that be in Brussels, have become increasingly agitated over the influence and power of Silicon Valley multinationals within the EU.

The new rules will close the oft-used loophole of non-EU businesses setting up their European HQ in Luxembourg.  The Grand Duchy has become extremely popular due to its low-tax environment.  For some businesses – such as Amazon – the VAT rate drops as low as 3% for eBooks.  This is referred to as a ‘super-reduced’ rate.

The Silicon Valley giants have been able to do this without breaking any laws.  These new VAT rules are the European Commission’s first steps towards changing the tax culture in the EU.

So, why change VAT first?

VAT has not been as effective as the European Commission would have hoped.  It has been too easy to avoid or not comply with VAT regulations.  The main reason for this is that VAT – which was always intended to be a tax on consumption – was turned on its head and businesses took advantage.  The giants setting up in Luxembourg were doing so to take advantage of the low-tax environment because the rules allowed them to do so.  They charge the low VAT rate based on where they are located.  The key change in the new rules returns VAT to a tax on consumption and from January 2015 onwards VAT on digital services will be charged based on where the consumer is located.

This instantly eliminates any commercial advantage to setting up in a low-tax environment.

This will hurt Luxembourg

Luxembourg has already changed their VAT rates – probably because of the introduction of these new rules.  The finance ministry in Luxembourg has estimated a loss of between €600 million and €1 billion from the EU VAT on digital services reform.  That is 70% of its VAT revenue.

However, there isn’t a lot of sympathy for the Grand Duchy with many arguing that they have for too long taken advantage of the VAT system at the expense of other EU member states.

Meanwhile, EU member states with a large digital service consumer base such as the UK and Germany will benefit from the new rules.  Remember, VAT will now have to be charged based on the location of the consumer.  The rule change only affects B2C sales of digital services.  The UK, for example, has already estimated that it will benefit to the tune of €1.2 billion over four years between 2015 and 2018.

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If you are like the most of us – you have heard the term “Captive Insurance Company,” but have no idea what it means or how it works.  Most companies I deal with think they are “too small” to create a captive.  Well, not too fast – many middle market companies have reaped the benefits of creating a captive.  Discussed below, is a high-level summary of some of the benefits your business can obtain.

The use of captives is one of the best-defined strategies for closely-held and middle market companies.  They can provide a wide array of benefits for clients including lower insurance costs, improved risk management, diversified profits and tax planning opportunities.

Captives have generated much attention due to recent legislation allowing their formation in many states.  In addition, captives have been the subject of favorable rulings from regulatory agencies such as the Internal Revenue Service.

A captive is a legally bona fide insurance company.  It insures the risks of operating companies with which it shares common ownership.

Capture

Following are some of the benefits of implementing a captive insurance company:

  • Improved Insurance Program– The ability to customize a program to the operating company’s needs can result in (i) reduced costs; (ii) better claims management; (iii) stabilization of insurance rates; and (iv) the purchase of insurance at “wholesale” rates.
  • Enhance Tax Planning Opportunities

o    Income Tax. The operating company receives a deduction for bona fide insurance premium paid.  The captive receives this premium as income, but does not pay tax on it under the Code, provided those premiums are less than $1.2 million annually per captive.  The net result is that the captive converts taxable income to non-taxable income, less associated expenses and claims.

o    Estate and Gift Tax. The captive is not subject to estate or gift tax when properly structured.  Consequently, the value can pass to heirs without those taxes.

  • Improve Financials- The captive has appreciable expense and tax management benefits.  Provided the structure is compliant with any bank covenants, the overall financial solvency of Client should be improved.

Steve Talkowsky

 

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As I recover from the latest busy season, I took time to reflect on what was the most common question I was asked.  Not surprisingly, it dealt with the material participation standards under Section 469 and the interplay with the net investment income tax under Section 1411

Although material participation rules are hardly new, they were given added importance with the introduction of the new net investment tax this filing season.  This new tax forced many of us to reexamine with our clients, their participation throughout the year in business entities in which they own an interest.  To complete the new Form 8960 we needed to go through the exercise of putting various ownership interests into separate buckets of nonpassive activities and passive activities, that is, activities in which the taxpayer materially participates or does not materially participate. This lead to further discussion on issues that we have always had to deal with such as passive loss limitations, grouping elections, self-rental rules and the real estate professional exception. Various common questions arose and are discussed in general below:

Is this activity passive or nonpassive?  Usually this question arose in the context of whether or not the activity was subject to the new net investment tax.  But, the answer tends to be more important for the reason for which the rule was first enacted: to limit the allowance of passive losses to the amount of passive income for the year.  A passive activity is defined in IRC 469(c) as the conduct of a trade or business in which the taxpayer does not materially participate.  A nonpassive activity is one that is not passive, and, therefore, one in which the taxpayer materially participates.  So, meeting the requirements for material participation is key to this determination.  Material participation is briefly defined in IRC Section 469(h) as involvement in the operations of an activity on a basis which is regular, continuous and substantial.  The Temporary Regulations under Reg. 1.469-5T enumerate seven tests, any one of which can be met to satisfy material participation in an activity:

1) The individual participates in the activity for more than 500 hours during such year.

(2)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;

(3)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;

(4)The activity is a significant participation activity (within the meaning of paragraph (c) of this section) for the taxable year, and the individual’s aggregate participation in all significant participation activities during such year exceeds 500 hours;

(5)The individual materially participated in the activity (determined without regard to this paragraph (a)(5)) for any five taxable years (whether or not consecutive) during the ten taxable years that immediately precede the taxable year;

(6)The activity is a personal service activity (within the meaning of paragraph (d) of this section), and the individual materially participated in the activity for any three taxable years (whether or not consecutive) preceding the taxable year; or

(7)Based on all of the facts and circumstances (taking into account the rules in paragraph (b) of this section), the individual participates in the activity on a regular, continuous, and substantial basis during such year.

Stay tuned for more in part 2 next week…

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Withum Smith + Brown’s (“WS+B”) client base is very diverse.  During my 10+ year career I have worked with clients from multi-national consolidated groups to start-up entities. No matter how big or small the company, I often am asked: “Is my current entity choice optimal from a tax perspective?”

To help our clients better understand their choices, WS+B created a chart that highlights the differences amongst the three most common entities (C-Corporation, S-Corporation and LLC).

Aside from the tax considerations, when choosing an entity, thought should be given to the current goals, long term goals and legal issues of the company.

(Click to enlarge)

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Authored by Steve Talkowsky

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When the calendar turns to mid-March and tax season makes the leap from annoying to soul-crushing, I spend more time than I should daydreaming about goin’ all Walter White and breaking bad, only instead of cooking meth, I’d use my well-honed number-crunching skills to become an underground bookie.

Oh, what a life it would be. Instead of spending March Madness in a tiny office cranking out tax returns, I’d spend it in a giant war room complete with wall-to-wall flat screens, building my riches on the failed dreams of student athletes. I’d work the phone better than Gordon Gecko, avoiding detection by using subversive colloquialisms like “unit” and “juice.” I’d threaten to break thumbs with impunity. And I’d make money. Lots and lots of money. Because the house never loses.

The house doesn’t lose because it is (generally) indifferent to who the bettors favor. Not to get into Gambling 101, but if you bet $100 on the Seahawks + 2 ½ in the Super Bowl, you won $100, But if you bet $100 on the Broncos to cover the 2 ½ points (sucker), you lost $110. The $10 the loser pays over and above the wagered amount is the “vig.”

Thanks to the vig, bookies generally don’t care who people are betting on, as long as the bets are fairly even on both sides. And of course, bookies have the advantage of being able to move the line to make sure this happens.

When it comes to horse racing — which in my bookie fantasy world, I will  occasionally dabble in but not invest heavily – the house has an added level of protection in the form of “parimutuel wagering.” It works like so:

The entire amount wagered on a particular race is referred to as the betting pool or “handle.” The pool can then be managed to ensure that the track receives a share of the betting pool regardless of the winning horse. This share of the betting pool that the track keeps for itself is often referred to as the “takeout,” and the percentage is driven by state law, but generally ranges from 15% to 25%.

The takeout is then used to defray the track’s expenses, including purse money for the winning horses, taxes, licenses, and fees. The takeout can also be used, if needed, to cover any shortfall in the amount necessary to pay off winning bettors. To the extent any excess takeout remains after covering these two classes of obligations, the track has profit.

Once the betting pool has been reduced by the takeout, the balance is generally used to pay off any winning wagers, with the excess, once again, representing profits. Great business model, isn’t it?

Yesterday, an enterprising CPA with a raging gambling habit threatened to strike a blow for bettors everywhere when he took on the IRS in the Tax Court and argued that the portion of his wagers attributable to the “takeout” were deductible without limitation. But before we can understand the significance of the case, we need to understand some basics about the taxation of gambling.

Treatment of Gambling Expenses, In General

Section 165(d) provides that “losses from wagering transactions shall be allowed only to the extent of the gains from such transactions.” Generally, any winnings are reported on page 1 of the Form 1040, while the losses (but only to the extent of winnings) must be claimed as itemized deductions. Thus, if a bettor is one of the 66% of Americans who don’t itemize their deductions, they would effectively be whipsawed – they would be forced to recognize the gambling income, but would receive no benefit from the losses.

Section 162, however, generally allows a deduction for “all the ordinary and necessary expenses paid or incurred during the tax year in carrying on any trade or business.”

Putting these two provisions together, many bettors have taken the position that if their gambling activities are so frequent, continuous and substantial as to rise to the level of an unhealthy addiction a Section 162 trade or business, then gambling losses are deductible as Section 162 business expenses, and are not subject to the loss limitations imposed by Section 165(d). In their view, if the gambling activity constitutes a business, because the losses (along with the gains) should be reported on Schedule C, rather than itemized deductions, the losses should be permitted in full.

The courts have repeatedly shot this theory down, holding that even a professional gambler who properly reports his activity on Schedule C may only deduct losses to the extent of gains.

In a very important 2011 decision out of the Tax Court, however, the court held that while gambling losses are limited to the extent of gambling winnings, any non-loss expenses of a professional gambler engaged in a trade or business – items like automobile expenses, travel, subscriptions and handicapping data – are not subject to the Section 165(d) limitation. Thus, a professional gambler could reduce his winnings to zero by his losses, and then further deduct any non-loss business expenses, generating a net loss from the activity. (See Mayo v. Commissioner, 136 T.C. 81 (2011).)

And that brings us back to our gambling CPA.  In Lakhani v. Commissioner, 142 T.C. 8 (2014), settled yesterday, an accountant/prolific track bettor made the compelling argument that his portion of the track’s “takeout expenses” represented non-loss business expenses rather than gambling losses, and were thus deductible without limitation. The taxpayer posited that by extracting takeout from the taxpayer’s wagers and using those funds to pay the track’s operating expenses, the track was acting in the capacity of a fiduciary. The taxpayer further likened the process to that of an employer who collects payroll taxes from his employees and remits them to the IRS and state agencies. Stated in another manner, the taxpayer argued that he was paying the operating expenses of the track, with the track acting as a conduit by collecting the takeout and using the funds.

Based on this position, the taxpayer argued that he was entitled to non-loss gambling business deductions in excess of $250,000 between 2005 and 2009.

The IRS disagreed with the taxpayer’s argument, countering that because the takeout is paid from the pool remaining from losing bets, “it is inseparable from the wagering transactions,” and thus constitutes wagering losses that are subject to the limits of Section 165(d). Furthermore, the Service argued that the taxpayer could not deduct business expenses for amounts paid from the takeout by the track for taxes, fees, and licenses, etc… because these were expenses owed by the track, not the individual bettor.

The Tax Court sided with the IRS, holding that the taxpayer’s share of the takeout expenses represented wagering losses that could only be deducted to the extent of winnings under Section 165(d). In reaching this conclusion, the court differentiated between an employer remitting payroll taxes on the behalf of an employee and a track using takeout funds to pay its operating expenses.

The employee, the court stated, is ultimately responsible for his share of the payroll taxes on his wages, and it is the remittance of these taxes by the employer that discharges the employee of this obligation. To the contrary, at no point are the expenses of the track imposed on the individual bettor; they are always obligations of the track. The tracks use of the takeout to pay its expenses, the court stated, does not discharge any obligation of the bettor.

As a result, the court concluded that because the track’s expenses were never an obligation or expense of the bettor, the takeout could not qualify as the bettor’s business expense. Instead, the takeout represented an additional gambling loss by the taxpayer, and could only be deducted – when added to his other losses – to the extent of his winnings.

follow along on twitter @nittigrittytax

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Earlier today, House Ways and Means Committee Chairman Dave Camp released his long-awaited and highly anticipated proposal for tax reform. The proposal promised to present the most thorough, sweeping changes to the law since the 1986 Act, and it didn’t disappoint.

Before we begin our analysis of the plan let me start by saying that while I clearly admire Chairman Camp for his tireless push to simplify the industry in which I ply my trade, I’d be remiss if I didn’t point out the irony that in the tax world, even a proposal for “simplification” stretches to nearly 1,000 pages.

Because there’s so much to take in, we’ll be separating our analysis into two parts

Part 1: Proposal for individual tax reform

Part II: Proposal for business tax reform

Let’s get to it with Part 1, Chairman Camp’s proposal for individual tax reform.

Streamlining of Individual Income Tax Rates

Current Law

Effective January 1, 2013, we now have seven income tax rates that are applied against so-called “ordinary income,” (i.e. income from wages, business income, interest, etc…): 10%, 15%, 25%, 28%, 33%, 35%, and a top rate of 39.6%. If you’ve ever wondered how efficient this type of structure is, consider that in 2013, the 35% rate was only applied on single taxpayers with incomes in excess of $398,351 but less than $400,000. Yes, we had a tax bracket that was $1,649 wide.

Because our tax system is a progressive one, taxpayers don’t pay a flat rate of tax on all earned income; rather, as income increases, so does the tax rate applied to the income. Thus, when someone proclaims that they are in the “39.6% bracket,” that does not mean they paid 39.6% on all of their income; rather, it means they paid 39.6% on their last dollar of income. It also means that they are likely insufferable.

No matter how you slice it, a system with seven brackets – and a high of nearly 40% — is far from ideal.

Camp Solution

Camp’s proposal would consolidate the current seven brackets into three, consisting of 10%, 25%, and 35% rates. Generally, the new 10% rate would replace the old 10% and 15% brackets, meaning it would cover all income earned up to approximately $73,800 if married, $36,900 if single (for simplicy’s sake, from this point on I will refer to married versus single thresholds or limitations like so: $73,800/$36,900).

The new 25% bracket would replace the former 25%, 28%, 33% and 35% brackets, meaning single taxpayers with taxable income between $36,900 and $400,000 would pay a 25% rate on that income, while married taxpayers with taxable income between $73,800 and $450,000 would pay a 25% rate on that income.

If you happen to earn taxable income in excess of $450,000/$400,000, then you will pay a rate of 35% on the excess, as opposed to 39.6% under current law.

Excluded from this top rate of 35% — meaning it would be taxed at a top rate of 25% — would be any income earned from “domestic manufacturing activities,” which is defined as “any lease, rental, license, sale, exchange, or other disposition of tangible personal property that is manufactured, produced, grown, or extracted by the taxpayer in whole or in significant part within the United States, or (2) construction of real property in the United States as part of the active conduct of a construction trade or business.”

Click here to read the rest on Forbes

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