Posts Tagged ‘business’

Imagine you’ve spent the past decade pouring your blood, sweat and incapacitated neighbor’s social security checks into your wholly owned C corporation. Your business has evolved into a raging success, and it’s nearly all attributable to your efforts. New clients sign on because of you. Suppliers negotiate on favorable terms because of you. Your corporation has a strong name in the marketplace, and it’s all because of you.

Now the time has come to sell your beloved business, and you and the buyer agree on an asset sale. The purchase price will be $1,000,000 for everything: the inventory, the fixed assets, and the intangible assets, including the trade name and customer list.

In such a fact pattern, determining who is actually selling the intangibles is critical. If the corporation is the seller, the entire purchase price will go into the corporation where it will be subject to two levels of income tax: once when the corporation recognizes a gain on the asset sale, and a second time when the proceeds are distributed and the shareholder recognizes dividend income. Making matters worse, because C corporations do not benefit from a preferential rate on long-term capital gains, all of the corporate level income is taxed at the same rate, reaching a high of 35%.

If, on the other hand, the argument can be made that the shareholder — you — are the  owner and seller of the intangible value, well…now we’re getting somewhere. Keeping that cash out of the corporation accomplishes two things. First, the proceeds allocable to the intangibles will only be taxed once; at the individual level. Second, because an individual does benefit from the preferential tax rate afforded long-term capital gains, the proceeds will be taxed at 15%, resulting in as much as a 20% tax savings when compared to the current maximum corporate rate of 35%.

Can it be done? Can an individual shareholder of a corporation be deemed to own — and sell — the intangible assets of a corporation?

The answer is yes, and today the Tax Court added a fourth key authority  to the oft-cited triumvirate of Norwalk,[i] Martin Ice Cream,[ii] and MacDonald[iii] by holding in H&M Inc. v. Commissioner,[iv] that when a corporation’s intangible value is entirely attributable to the services of a shareholder/employee, unless the shareholder/employee has effectively transferred the intangible value to the corporation by entering into a covenant not to compete, the shareholder/employee will be deemed to the be the owner of those intangible assets, and is free to sell them in his individual capacity.

In H&M Inc., Harold Schmeets was the sole shareholder of the plaintiff corporation and apparently, the biggest wheel of the North Dakota insurance industry:

Despite the competitive market, Schmeets stood out among insurance agents in the area. He had experience in all insurance lines and all facets of running an insurance agency, including accounting, management, and employee training. He also had experience in a specialized area of insurance called bonding,1 and his agency was the only agency in the area, aside from the bank’s, that did this kind of work. There was convincing testimony that in the area around Harvey no one knew insurance better than Schmeets, and even some of his competitors called him the “King of Insurance.” We also find that when people came to Harvey Insurance to buy insurance, they were buying it from Harold Schmeets, and that he had far more name recognition as an individual than Harvey Insurance did as a firm.

Why anyone would want to give up the prestige that comes with being coined “King of Insurance” in North Dakota is beyond me, but Schmeets eventually decided it was time to sell. He’d had a long-standing relationship with a local bank, and ultimately decided to sell the assets of H&M Inc. to the bank in exchange for $20,000, payable over a period of years.

While Schmeets did not claim to have sold any intangible value directly, he did enter into a compensation package with the bank, as he took over as manager of their insurance practice for a six-year term.

On its tax return for the year of sale, H&M Inc. reported the required amount of the $20,000 proceeds under the installment method. On his personal return, Schmeets reported the compensation income earned for services provided to the buyer.

The IRS, however, took issue with this treatment, arguing that $20,000 was not nearly equal to the fair market value of the acquired assets of H&M Inc., particularly when considering the substantial goodwill created by employing the “King of Insurance.”

Instead, the Service argued that a portion of the compensation payments made by the buyer to Schmeets properly represented additional purchase price for the corporation’s assets. As such, this portion should be taxed first at the corporate level and again when distributed to Schmeets.

Schmeets countered by arguing that like the taxpayers in Martin Ice Cream and MacDonald, he personally owned any intangible value of the corporation. The Tax Court agreed:

The insurance business in Harvey is “extremely personal,” and the development of Harvey Insurance’s business before the sale was due to Schmeets’s ability to form relationships with customers and keep big insurance companies interested in a small insurance market. He grew relationships with large insurance companies that other brokers in the area didn’t.And we specifically find that when customers came to his agency, they came to buy from him–it was his name and his reputation that brought them there. We also find he had no agreement with H & M at the time of its sale that prevented him from taking his relationships, reputation, and skill elsewhere, which was precisely what he did when he began working for the bank’s renamed insurance agency…We therefore find that payments to Schmeets were not disguised purchase price payments to H & M.

What Can We Learn?

There is obviously a significant tax advantage to selling goodwill at the shareholder level as opposed to the corporate level; namely, the advantageous 15% LTCG tax rate and the single level of taxation. In order to successfully argue the position, however, the case law has taught us that certain facts must be present.

Most importantly, the success of the corporation must be directly traceable to the activities, skills, and relationships of the shareholder/employee. But this is only half the battle. In addition, the shareholder/employee must not have entered into a covenant not to compete or long-term employment agreement with the corporation, as this will effectively cause their personal relationships to become property of the corporation.

Lastly, while the Tax Court was lenient in H&M, Inc. with the corporation’s lack of attention to detail when crafting its purchase agreement, future taxpayers may not be so lucky. To safeguard against an IRS attack, a shareholder wishing to take the position that they personally own the intangible value of the corporation should enter into two agreements: one in which the corporation agrees to sell its hard assets, and a second that is entered into directly between the buyer and the shareholder, in which the buyer purchases the intangible assets directly from the shareholder who created them.

[i] TC Memo 1998-279

[ii] 110 T.C. 189

[iii]  T.C. 720

[iv] T.C. Memo 2012-290

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Now that was a debate; contentious, revealing, and filled with acrimonious exchanges between two candidates who could barely conceal their distaste for one another. If this were wrestling, Joe Biden would have concluded the night by beating Paul Ryan senseless with a coconut, a la Rowdy Roddy Piper. Tonight was, in short, everything the Obama-Romney debate wasn’t.

Before we get to the tax issues, a couple of quick thoughts:

  • What a difference it makes to have a moderator that controls the flow of the discourse and asks the questions the public wants to hear. Great job by Martha Raddatz.
  • While Obama’s campaign advisors may well have urged him to remain “Presidential,” they were apparently more than happy to take the reins off Joe Biden. Biden attacked everything we expected Obama to address: Romney’s infamous “47 percent” comment, his 13% effective tax rate, and his continued protection of the preferential tax rates afforded “carried interests” — often in an aggressive, accusing manner.  (For more on carried interests, click here).
  • While Biden’s candor was refreshing, his decorum was decidedly less so. Kudos to Paul Ryan for not getting angrier than he did with Biden’s constant laughing and gesticulating while Ryan was speaking. Ryan did strike a blow with that “I think the vice president very well knows that sometimes the words don’t come out of your mouth the right way” shot, but for whatever reason, it came off more as over-rehearsed and ill-timed than a memorable one-liner.
  • Regardless of your political leanings, it’s hard to argue that Biden didn’t have the response of the night when he replied to Ryan’s criticism of the President’s stimulus spending by pointing out that Ryan had written him letters on two occasions imploring Biden to send stimulus money to Ryan’s home state of Wisconsin. To be fair, Ryan had to know Biden’s response was coming, but he was obligated to address the Obama administration’s rampant spending.

Now, on to the tax issues addressed throughout the debate; specifically, what did voters learn about the future of tax policy?

Joe Biden and the $500 Billion Tax Cut for the Wealthy

Tax policy made its first appearance earlier than anticipated, during a discussion on unemployment. Shortly after an impassioned rant about what he perceived to be Romney and Ryan’s apathy towards 47% of Americans, Biden added:

“They’re pushing the continuation of a tax cut that will give an additional $500 billion in tax cuts to 120,000 families. And they’re holding hostage the middle class tax cut because they say we won’t pass — we won’t continue the middle class tax cut unless you give the tax cut for the super wealthy.”

Unfortunately, debates don’t come complete with citations, so the viewing public was likely left struggling to make sense of the genesis of Biden’s statistics. Lucky for you, I’ve got a winning combination of an abundance of free time and a very understanding wife, so I’ve gone ahead and done the legwork for you.

As I discussed in detail here, the Bush tax cuts are set to expire on December 31, 2012. Should that occur, the top individual tax rate will rise from 35% to 39.6%, the next highest rate will jump from 33% to 36%, and each lower bracket will experience an increase as well.

Currently, the primary point of contention between Republicans and Democrats is what to do with those top two tax rates. The President wants to allow those two highest rates to reset to 36% and 39.6%, respectively, while preserving the reduced tax rates from the Bush-era for all of the lower tax brackets. Effectively, this would raise taxes in 2013 on only those taxpayers earning in excess of $200,000 ($250,000 if married filing jointly).

Republicans, on the other hand, have refused to allow an extension of the lower tax rates unless the two highest tax brackets are extended along with them.

So where does the $500 billion come in?

According to the President’s budget for the period 2013-2022, continuing the Bush tax cuts for those earning in excess of the $200,000 threshold — approximately 2% of the population — would cost the government $968 billion in revenue. Click the image below to enlarge the chart taken from the Budget proposal.

A separate study published by the Tax Policy Center indicated that 55% of the total benefit enjoyed by those top 2% of taxpayers that would be impacted by the expiration of the 33% and 35% brackets would inure to the top 0.1% of the population. The TPC then added that the top 0.1% of the population consists of approximately 120,000 taxpayers.

From there, Biden just does some basic math. $968 billion total benefit for the top 2% x 55% enjoyed by the top 0.1% = $532 billion benefit for the top 0.1%, or 120,000 families — if the Bush tax cuts are extended for all taxpayers.

This would be a statistic repeated several times throughout the night, and it served as the foundation for the ensuing argument, in which Biden accused Ryan and Romney of holding the middle class hostage by refusing to extend the Bush tax cuts for the lower brackets, while Ryan responded by claiming that the additional $968 billion in revenue generated by allowing the cuts to expire for the top 2% wouldn’t put a dent in the deficit.

So who’s right?

Quite frankly, they both are.

There really is no compelling need to extend the Bush cuts for the top 2%, unless you are a firm believer that a lower rate will stimulate economic growth, and many are. The idea fronted by blowhards like Bill O’Reilly that if you tax “the achievers,” they’ll simply stop achieving, is spurious and laughable. Rates have been as high as 70% under the Eisenhower administration, and best I can tell, no leading minds of that era put down their pencils and said “To hell with this… I was going to invent the Atari 2600, but a 70% tax rate? Forget it. I’ll just go back to bed.”

But Ryan is also dead on in his analysis: $968 billion — assuming that number is accurate — would not make a dent in our ever-growing deficit. If the Obama administration is serious about reducing the deficit, there would have to be significant spending cuts to make up for the fact that the top 2% simply isn’t big enough to foot the additional tax bill necessary to eat away at our mounting debt.

Of course, arguing that since the $968 billion of additional revenue wouldn’t make a dent, we needn’t bother to collect it isn’t the soundest fiscal argument either, but I get Ryan’s point.  A recent study by the Tax Foundation suggested that simply by cutting the top tax rate to 28%, you could grow the GDP by 7.4% over a 5-10 year window, so perhaps Romney’s plan to cut rates and recover revenue through economic growth has merit. The problems that come with this proposal, as we’ll discuss shortly, lay in its implementation.

But here’s the real oddity of this portion of the debate: Romney’s tax plan does not involve extending the Bush tax cuts for the rich. It involves extending the tax cuts for all taxpayers, then reducing the Bush-era tax rates by an additional 20% across the board. As President Obama referenced several times during the presidential debate, this is expected to cost the government $5 trillion in tax revenue over the next decade, with nearly $2.4 trillion of that benefit going to the wealthiest 2% of taxpayers according to the now-famous Tax Policy Center study. This is a much more meaningful reduction in revenue — and potential corresponding increase to the deficit — then the $500 billion number Biden focused on.

Of course, as we discussed with regards to the previous debate and will do so again below, the Romney campaign promises to pay for any and all lost tax revenue with offsetting reductions or caps to deductions, making the $5 trillion tax cut — in their eyes — no tax cut at all. And while the two candidates did eventually get to discussing this rather important detail, it was through no impetus of their own, but rather the urging of Raddatz. Instead, the voting public had to watch the two candidates debate the merits of a tax plan that is not currently on the table, which likely only served to confuse.

How Do You Define Small Business?

Later in the night, when the discussion formally turned to tax policy, Ryan was asked by Raddatz what portion of the population would pay more, and what portion would pay less, in tax if Romney were elected. Ryan responded:

“Our entire premise of these tax reform plans is to grow the economy and create jobs. It’s a plan that’s estimated to create 7 million jobs. Now, we think that government taking 28 percent of a family and business’s income is enough. President Obama thinks that the government ought to be able to take as much as 44.8 percent of a small business’s income.”

Now, if I were sitting at home (I was) and owned a small business (I don’t), I would take this to mean that my tax rate was about to approach 50%. But there’s an issue of semantics that needs to be addressed:

When Romney and Ryan refer to “small businesses,” they are actually referring to the 36 million taxpayers who report their business income directly on their individual income tax return, and are therefore subject to the individual tax rates at the center of this debate. These business types include sole proprietorships, single-member LLCs, Subchapter S corporations, and partnerships.

What these business types have in common is that they do not pay tax to the government on their own behalf — unlike a Subchapter C corporation, which computes and pays its own tax at the corporate income tax rate — rather, the income of the business “flows through” and is taxed at the individual owner level.

But here’s the issue: of the 36 million taxpayers who own sole proprietorships, single-member LLCs, or an interest in a flow through entity, only 900,000 — or 2.5% — actually pay tax at the two highest tax rates. Stated in another manner, by allowing the Bush tax cuts to expire for those individuals earning more than $200,000, only 2.5% of all “small businesses” would actually pay higher taxes in 2013 than they do today. The other 97.5% of small business owners will pay the same 28% or lower tax rate that they pay today, assuming, of course, the Bush tax cuts are extended for all taxpayers earning less than $250,000.

Don’t believe me? Click to enlarge the chart:

And this is precisely the point Biden should have addressed. With Ryan accusing the President of raising taxes on small business owners, Biden should have been poised to react. And while he did point out that the expiration of the Bush tax cuts for the top 2% would impact only 2.5% of small businesses, he should have added that if the Republicans continue to refuse to extend the Bush tax cuts for the lower brackets, then all small business owners will pay more tax in 2013, as the current rates of 10/15/25/28/33/35% will reset to 15/28/31/36/39.6%.

The Competing Goals of Focused Deduction Elimination and Tax Reform

Soon after the small business conversation, Moderator Raddatz delivered where Jim Lehrer failed miserably in the presidential debate by asking Ryan exactly how Mitt Romney plans to pay for his proposed 20% across-the-board tax cuts. [As a reminder, the reduction in tax rates is expected to cost the government approximately $5 trillion over the next decade, but Romney has promised to offset the lost revenue with additional revenue raisers] Unfortunately, Ryan’s response was nothing more than a vague string of misdirections, devoid of the details tax policy experts — and informed voters — have long coveted:

” Look — look at what Mitt Romney — look at what Ronald Reagan and Tip O’Neill did. They worked together out of a framework to lower tax rates and broaden the base, and they worked together to fix that. What we’re saying is, here’s our framework. Lower tax rates 20 percent. We raised about $1.2 trillion through income taxes. We forego about $1.1 trillion in loopholes and deductions. And so what we’re saying is, deny those loopholes and deductions to higher-income taxpayers so that more of their income is taxed, which has a broader base of taxation..so we can lower tax rates across the board. Now, here’s why I’m saying this. What we’re saying is, here’s the framework…Mitt — what we’re saying is, lower tax rates 20 percent, start with the wealthy, work with Congress to do it…

Now, before I continue, let me remind you that I’m not an Obama guy, I’m not a Romney guy, I’m a tax guy. (in fact, I plan on voting for Kodos) And here’s why you should care about this portion of the debate if you’re a voter.

The vagueness of Romney’s plan is more than frustrating; it is also misleading. For example, a middle-class taxpayer may vote for Romney believing he is voting for a reduction in his top rate from 28% to 22.4% that will leave him with additional after-tax income. However, depending on which deductions are eliminated or capped in order to make the plan revenue neutral, the taxpayer may actually see his federal tax obligation increase, despite the reduced rates.

Because Romney and Ryan have no plan for how they will generate the additional tax revenue necessary to offset the revenue lost to the rate cuts, they can’t possibly promise anyone what the effect of their tax plan will be. They cannot guarantee that those earning in excess of $250,000 won’t see their overall tax share go down, though that hasn’t stopped them from trying. They can’t guarantee that the middle class won’t see their tax obligation increase, though that hasn’t stopped them from trying. They can’t promise any of these things, because they have no idea how the plan will work.

Just one week ago, Romney used the Presidential debate to introduce the idea of capping certain deductions rather than eliminating them, which was taken seriously enough that Bloomberg had yours truly run a bunch of numbers quantifying what a cap would mean to the middle class. Yet tonight, Ryan made no mention of this potential $17,000/$25,000/$50,000 cap, and instead focused again on eliminating deductions. Either Ryan and Romney aren’t on the same page, or, much more concerning, there is no page.

Is it mathematically possible to fully pay for a 20% reduction in tax rates by eliminating deductions? Probably, as we’ve already covered that here. Is it possible without shifting a portion of the tax burden from those earning in excess of $250,000 to those earning less than the threshold? That’s up for debate, but it would require an extreme top-down approach, where the wealthy lost all their deductions first, and even then the result is in question. But the point is, neither Romney nor Ryan can know it’s possible, because they have no plan, only a framework.

And as a voter, you must keep this in mind, because you may be enticed by the promise of a 20% reduction in your tax rate, only to discover in April 2014 that your mortgage interest or state tax deduction is of limited or of no use, and your tax obligation has actually increased over prior years.

What I find most frustrating is that the calendar has turned to October, and I still can’t formulate an opinion as to whose tax plan — Obama’s or Romney’s — I prefer, solely because I don’t know exactly what Romney’s plan entails. Obama’s plan is unappealing to me for a number of reasons — not the least of which are the potentially damaging effect on the deficit and the painful “Obamacare” surcharges — but at least it’s a known quantity.

One final thought for other tax eggheads: the idea that Ryan mentioned this plan and “tax reform” in the same breath is borderline offensive. True tax reform entails removing some of the countless loopholes from the Code for good, leaving the tax law more manageable than it was before.  What Romney and Ryan are promoting is complexity to an unimaginable degree, attempting to cap certain deductions for a certain part of the population, while leaving the deductions in the Code for other taxpayers to enjoy.

On the bright side, it would keep me swimming in business.

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President Obama issued his “to do” list to Congress on Tuesday. Hopefully, America’s Senators and Representatives can pull themselves away from their busy summers of tweeting pictures of their genitalia and (allegedly) soliciting gay sex in airport bathrooms long enough to address the President’s concerns.  

So what’s on the agenda? Nothing we haven’t seen before. More international reform that will never get passed, the extension of 100% bonus depreciation, which should be a foregone conclusion depending on what bill it’s attached to, and additional clean energy incentives. Here is the complete list, with links added to previous Double Taxation coverage on each recommendation:

 1. Reward American Jobs, Eliminate Tax Incentives To Ship Jobs Overseas: Congress needs to attract and keep good jobs in the United States by passing legislation that gives companies a new 20 percent tax credit for the cost of moving their operations back to the U.S. and pay for it by eliminating tax incentives that allow companies to deduct the costs of moving their business abroad.

Currently, if a firm shutters a production facility, moves it to another country, and incurs $15 million in expenses for breaking down assembly lines and production equipment, moving expenses to transport equipment abroad, and mothballing the Iowa facility, then under current law, the company could reduce its tax burden by $5.25 million dollars, assuming a 35 percent corporate tax rate. Under the President’s plan, this company can no longer deduct the $15 million in moving expenses, eliminating the $5.25 million tax break for shipping the facility overseas.

Consider the same firm as above, except they are moving the facility from overseas back to the U.S. If this company were to move a manufacturing plant with 800 employees back to the United States from another country, and incurred $15 million in costs from packaging and transporting equipment, and cleaning up the old facility abroad, then under the President’s plan, the company would still be able to deduct the $15 million, saving $5.25 million in taxes and on top of that would receive a 20% credit on its $15 million in expenses – or a $3 million additional income tax benefit. [Ed note: it’s hard to imagine Congress would truly permit the same costs to be both deductible and creditable, as that sort of double benefit is rarely seen in the Code.]

2. Cut Red Tape So Responsible Homeowners Can Refinance: Congress needs to pass legislation to cut red tape in the mortgage market so that responsible families who have been paying their mortgages on time can feel secure in their home by refinancing at today’s lower rates.

3. Invest in a New Hire Tax Credit For Small Businesses: Congress needs to invest in small businesses and jumpstart new hiring by passing legislation that gives a 10 percent income tax credit for firms that create new jobs or increase wages in 2012 and that extends 100 percent expensing in 2012 for all businesses.

4. Create Jobs By Investing In Affordable Clean Energy: Congress needs to help put America in control of its energy future by passing legislation that will extend the Production Tax Credit to support American jobs and manufacturing alongside an expansion of the 30 percent tax credit to investments in clean energy manufacturing (48C Advanced Energy Manufacturing Tax Credit)

5. Put Returning Veterans to Work Using Skills Developed in the Military: Congress needs to honor our commitment to returning veterans by passing legislation that creates a Veterans Job Corps to help Afghanistan and Iraq veterans get jobs as cops, firefighters, and serving their communities.

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Surprising absolutely no one, the Republican dominated House passed majority leader Eric Cantor’s tax proposal today by a 235-173 vote. The proposal, which would have given a 20% tax deduction to all businesses with fewer than 500 employees, was voted largely on party lines, with 18 Democrats voting in favor of the plan and 10 Republicans rejecting it. The plan now heads to the Democratic-controlled Senate, where it’s doomed to suffer a crushing defeat.

In other news, cheap champagne will be unscrewed in unkempt studio apartments throughout SoHo tonight, celebrating the Tax Court’s decision in Storey v. Commission, T.C. Memo 2012-115, which determined that the documentary filmmaking activity of a full-time attorney was entered into for profit, not a hobby.

In recent years, the activities of documentary filmmakers have found themselves under attack from the IRS by virtue of the “hobby loss” rules of I.R.C. § 183. While surely frustrating to the filmmakers, it’s no surprise that the IRS eventually turned their attention to documentary films. Like horse breeding and drag racing, which are already heavily litigated under the hobby loss rules, documentary filmmaking is a labor of love requiring long periods of development, with scarce profits to be found. As a result, heavy losses over a period of years are the norm, and because the basis for the films are often areas of interest to the filmmaker, elements of personal pleasure are present, strengthening the Service’s argument that the activity is in fact a hobby.

In Storey — a case the filmmaking community had been keeping its watchful, distrusting eye on, the Tax Court struck a blow for the industry by holding that a prominent lawyer who also made a successful documentary did so as a trade or business, not as a hobby.

Lee Storey was a name partner in a successful California law firm. Several years into her marriage, she discovered that her husband had formerly been a member of Up With People, the legendarily dorky group of singers whose wholesome half-time performances at Super Bowls during the ’70’s and ’80’s stand in stark contrast to the exposed nipples and middle fingers of today.

This new information about her husband’s past sparked a long-standing desire in Storey to venture into filmmaking. Up With People, she concluded, would be the perfect subject for a documentary. Storey took a sabbatical from work to study filmmaking, bought up the rights to archival Up With People footage, and started making her movie.

Storey carried on the activity in a very professional manner, hiring a bookkeeper and keeping detailed records. She attended conferences, where she networked and eventually met part of her production team. Storey used trailers and rough cuts to pitch her product, making edits based on the solicited feedback. Though she hadn’t originally planned to feature her husband in the documentary, she was encouraged to do so by her producer, and her husband eventually would up in four of the film’s 79 minutes.

In 2009, Smile ‘Til It Hurts, Storey’s film about Up With People, launched at the Slamdance Film Festival. The documentary was largely met with critical claim, though like most films in the genre, it was not profitable. Today, Storey still owns the rights to the film, and sells DVDs for $19.99 a pop.

On her 2006-2008 tax returns, Storey deducted losses from her film making activities. The IRS denied the losses, largely arguing that Storey did not make Smile ‘Til It Hurts for profit, but rather to fulfill her curiosity about her husband’s past and to tell his story.

The Tax Court disagreed. After addressing the following nine “hobby loss” regulations found at Treas. Reg. §1.183-2(a) — and discussed previously here, here, and here —  the court concluded that Storey’s filmmaking activity was entered into for profit and its losses deductible in full.

As a reminder, those factors are:

(1) the manner in which the taxpayer carried on the activity,

(2) the expertise of the taxpayer or his or her advisers,

(3) the time and effort expended by the taxpayer in carrying on the activity,

(4) the expectation that the assets used in the activity may appreciate in value,

(5) the success of the taxpayer in carrying on other similar or dissimilar activities,

(6) the taxpayer’s history of income or loss with respect to the activity,

(7) the amount of occasional profits, if any, which are earned,

(8) the financial status of the taxpayer, and

(9) whether elements of personal pleasure or recreation are involved.

Aside from factors six, seven, and eight[i], it was a clean sweep for Storey. By keeping detailed books and records, seeking advice and education regarding the best way to make her movie, spending considerable time on the film making process, and generally conducting her activity in a formal, businesslike manner, Storey was able to satisfy her burden of proving that the documentary activity was in fact a trade or business. Though the court conceded that Storey did greatly enjoy filmmaking and had used her husband in the film, these elements of personal pleasure were not sufficient to classify the activity as a hobby.

[i] The film did not generate net income during the years at issue, so factors six and seven were a no-brainer. As for factor eight, the fact that losses from the film were offsetting Storey’s considerable income from her law practice weighed against her.

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New York yogis took a break from resonating in harmony with Mother Earth to express their displeasure at a recent Department of Taxation decision that leaves their studios liable for collecting and remitting 4.5% in sales taxes on their services.

From the WSJ:

“Yoga classes have been around forever and not taxed,” said Alison West, executive director of Yoga for New York. She said the new tax policy couldn’t have come at a worse time with the industry just beginning to get back on its feet after the economic downturn, or what she termed “the yoga crisis.”

While not quite as impactful on this country’s history as the Cuban Missile Crisis, the yoga crisis is not to be dismissed, as the troubled economic times of the past four years have led to a marked reduction in downward dogs, threatening the very existence of many studios. With things finally starting to turn around, studios now must deal with having to pass on this additional sales tax to customers, which will inevitably lead to reduced attendance. And in a hard-driving city like Manhattan, it may not be in anyone’s best interest to reduce incentive for its citizens to burn off some stress, lest someone get all shooty at their work place:

Ms. West added: “It is important to the city that we have stress-relieving activities that are affordable to all levels of income. Something like this is a threat to that.”

New York studios are bracing for audits, with some larger businesses potentially facing a three-year sales tax bill exceeding $100,000.  But Yoga for New York — the world’s most relaxed, easy going lobbying group — isn’t taking this lying down:

Last Monday afternoon, more than 70 yoga managers, studio owners and instructors sat down in the lotus position to discuss the tax issue—and other troubles—at Yoga Union, a studio in the Flat iron District.  Ms. West said the atmosphere was “concerned, dynamic and productive.” “The meeting was vivid with a lot of intense questions,” she said.


Yoga for New York hasn’t yet decided whether to challenge the assessment of the sales tax in court, but apparently, it has done so in the past and been successful. For now, the group is trying to arrange meetings with state officials to discuss it, but help is not on the immediate horizon, as their schedule won’t free up until after next month’s big ultimate Frisbee championship in Central Park.

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The U.S. Supreme Court is typically charged with determining the victor of the country’s most important debates, such as Roe v. Wade, religion v. science or, which shape marshmallow should be added to boxes of Lucky Charms. So when the high court goes slumming, setting aside three days to hear debate with potentially major implications on the tax law, it’s incumbent upon every CPA to stand up and take notice.

Of course, it’s a rather busy time of year, and given the pile of Form 1040s overwhelming your desk, the events transpiring in D.C. are probably the least of your concerns. So as a bit of a public service, we’ve put together the following “heads up” for our industry peers, hopefully giving you the information you’ll need when your clients inevitably ask you for your take on the Supreme Court’s review of “Obamacare.” You can thank us after the 17th.

Q: What’s Obamacare? It sounds like a charitable organization to which I don’t contribute.  

A: On March 23, 2010, President Obama signed into law the Patient Protection and Affordable Care Act, a 2700-page bill that took aim squarely at the country’s health care practices. The reform would extend health insurance to an additional 32 million Americans while revamping one of the nation’s largest industries: prohibiting insurance companies from denying coverage due to preexisting conditions, expanding the Medicaid threshold to 133% of the poverty line, and eliminating the ability of insurers to cap an insured’s “lifetime limit” of benefits.

Q: I didn’t hear anything about tax in there, so why do I care?

A: The Act also contained several major tax provisions, one of which set off a firestorm of debate regarding its constitutionality. Beginning in 2014, I.R.C. § 5000A will require taxpayers to purchase or retain health insurance that qualifies as minimum essential coverage, and to report this information on their federal tax returns, subject to certain codified exceptions. If the taxpayer fails to maintain adequate insurance, a monthly “penalty” is imposed equal to the greater of a flat dollar amount (phased in starting at $95 in 2014) or a percentage of the taxpayer‘s income (phased in starting at 1% in 2014).

Q: Where does the “constitutionality” come in?  

A: Twenty-eight states have filed suit seeking to overturn this individual insurance mandate, challenging whether Congress is overstepping its taxing powers by imposing a penalty on individuals for failing to obtain insurance. In 2010, a Virginia federal court ruled the individual mandate unconstitutional, striking it from the Patient Protection Act but allowing the rest of the act to stand. The case was later overturned on appeal.

In early 2011, however, a Florida district court also held the individual insurance mandate unconstitutional, but refused to sever the provision from the rest of the Act, rending the entire Act unconstitutional. This time, on appeal, the verdict stood, but the appeals court disagreed on the severability of the individual mandate, allowing the rest of the Act to remain. The Department of Justice asked the Supreme Court to hear the case, which brings us to today.

Q: So what’s the Supreme Court going to decide?

A: Over the next three days, the U.S. Supreme Court will begin its review of Obamacare, an unprecedented act in the sense that it is the first time the high court has considered striking down a president’ signature legislation in the midst of his re-election campaign.  Here’s how the next few days are expected to shake out:

Today: Before the discussion of constitutionality can even get off the ground, the Supreme Court must determine whether the “penalty” under I.R.C. § 5000A for filing to obtain insurance is a “tax” or a “penalty.” If it’s truly a tax, then the current debate might be over before it gets started, courtesy of this old-timey law as explained by Bloomberg:

A 145-year-old law, the Anti-Injunction Act, says courts can’t rule on the legality of federal taxes until they are imposed. For the no-insurance penalty in the 2010 health care law, which takes effect in stages, that comes in 2015. The justices may decide it’s too soon to rule on the health law’s constitutionality.

In other words, if the penalty under I.R.C. § 5001A is held to constitute a tax, the Supreme Court might be barred from deciding the constitutionality of the insurance tax until it is actually imposed beginning in 2015.

Tomorrow: Assuming today’s hearings don’t render the remaining debate moot, tomorrow is likely to contain the most spirited arguments, as the Supreme Court will hear debate on whether the Constitution allows the government to require Americans to either get insurance, or pay a penalty.

Q: What will each side be arguing?

A: Similar to the state courts, the argument is likely to consist of the following positions:

On one side, detractors of the Patient Protection Act will insist that Congress has no authority to order someone to give up their own desire not to buy a commercial product and force them into a market they do not want to enter. The federal government, on the other hand, will defend the new law as being allowable under the Commerce Clause, the Necessary and Proper Clause, and the taxation power of the General Welfare Clause.

Q: What’s left to hear on Wednesday?

A: Wednesday could actually have far-reaching effects on the tax world. The court will hear debate about what should happen to the rest of Obamacare should the individual insurance mandate be found unconstitutional. If the Supreme Court were to strike down the entire Patient and Protection Act because the individual insurance mandate was found unconstitutional, the remaining tax provisions would die with it. As a reminder, some of the other significant tax provisions found in the Patient Protection and Affordable Care Act include the following:

  •  Starting in 2014, pursuant to I.R.C. § 4980H,  applicable large employers must provide minimum essential coverage to each full-time employee and their dependents. Failure to comply with the employer mandate will result in a penalty equal to one-twelfth of $3,000 for each month multiplied by the applicable number of full-time employees. In general, an “applicable large employer” is any employer with a work force in excess of fifty full-time employees.
  • Higher Medicare taxes will be imposed upon wealthy taxpayers beginning in 2013. Section 3101(b)(2)will be amended to include an additional tax of 0.9 percent on all income in excess of $200,000 or $250,000 for joint filers.
  • 2013 will also add to the Code I.R.C. § 1411, which creates a 3.8 percent Medicare tax on investment income in excess of $250,000 for joint filers, $125,000 for married filing separately, and $200,000 ―in any other case.

We’ll do our best to keep you apprised of any big developments.

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A few things you may have missed this weekend while watching Tiger Woods make news for reasons other than rampant infidelity or hilariously filthy text messaging for the first time in nearly three years. Of course, the real winner on the weekend was Tiger’s ex-wife, Elin, who’ll surely see a good piece of that $1,000,000 prize purse.  

Spend enough time in your Unabomber-style shack in upstate Vermont, and you’re likely to conjure any number of farcical legal arguments for not paying your income tax. Unfortunately, none of them will convince the IRS, and you’ll end up sharing a cell with Wesley Snipes.   

If you’re wealthy and have a portfolio full of dividend-paying stocks, it’s time to acknowledge that for the wealthiest individuals, tax rates on dividend income are set to triple in 2013, and maybe its time to start selling some of your high-yield holdings. Caveat: everything I know about the stock market I learned from the movie Trading Places, so I may not be the best source of advice.  

Fact: 60% percent of individual taxpayers with 2010 AGI > $1,000,000 were audited by the IRS. No joke there; if you’re pulling down over a million a year, you’d better have your ducks in a row.

Here’s 5 “smart” ways to spend a $1,000 tax refund. Personally, I’d recommend the George Best approach: Blow as much of it as you can on booze and fast women. The rest of it, feel free to just waste.

Lastly, little known fact: This woman was previously a Junior Vice President at Tax Masters.[i]

[i]  Not true. Don’t sue me.

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