June 3, 2020
Liquidating trusts without liquidation leaves S corp owner without losses. Business owners face declines in asset values as a result of Coronavirus shutdowns. As most asset losses only show up on tax returns when the asset is sold, declines in value don't by themselves do much good at tax time.
A real estate operator operating through an S corporation had a clever plan to generate tax losses from underwater properties in the wake of the 2008 recession. It unraveled yesterday in Tax Court.
The S corporation created trusts for the benefit of the creditors of his distressed properties. The properties were transferred to the trusts, and the S corporations recognized losses for the value decline as a result of the transfers.
There was a catch. The S corporation remained on the hook to the creditors as well. It continued to operate the properties, and revenues from them was applied to reduce the debt of the corporation (IDG) or it's wholly owned LLC, Gales Creek Terrace LLC. Tax Court Judge Urda explains:
As most relevant here, section 677(a)(1) considers a grantor the owner of any portion of a trust “whose income without the approval or consent of any adverse party is, or, in the discretion of the grantor or a nonadverse party, or both, may be” distributed to him or his spouse. Section 677(a) generally encompasses the portion of any trust “whose income is, or in the discretion of the grantor or a nonadverse party, or both, may be applied in discharge of a legal obligation of the grantor”
If a trust is "grantor" trust, it is ignored for income tax purposes, and any sale to to the trust is disregarded as a transfer by the taxpayer to itself. Judge Urda again:
The parties before us agree that IDG and Gales Creek Terrace LLC remained liable to Sterling and CFC, respectively, for the loans secured by Village, Plains, and Creek after the ownership of those properties had passed to the respective trusts...
As the corpus of each trust was used to satisfy the legal obligations of IDG or Gales Creek Terrace LLC, we conclude that they were owners of the respective trusts after 2009, and that the trusts therefore were not separate taxable entities as to them.
That means the $9 million or so in losses recognized when the trusts were formed aren't allowed.
The moral? Turning unrealized losses into tax deductions can be tricky. If the S corporation had in fact liquidated, distributing its assets to its owner, all losses on the assets might have been recognized. The catch? All of the gains on other assets would have also been recognized.
If you are considering an asset or debt restructure, a visit with the Eide Bailly Mergers and Acquisition specialty group can help avoid surprise loss disallowances.
Cite: 154 T.C. No. 12
How to Deal with Fraud Risk in a COVID-19 World - Doug Cash, Eide Bailly Forensic Accounting. "When people are 'out of sight' they can also be 'out of mind.' The red flags of fraud become considerably less visible and harder to identify over the phone or via a video conference call."
Navigating Changes in an Already Complicated PPP Process - Eric Yauch, Tax Notes ($). "So far, the PPP has been plagued with inconsistent guidance. Guidance on the necessary certification businesses need to receive the loans has frequently changed at the last minute, and new rules seem to create more ambiguities in the program."
11th Circuit Blesses Conservation Merit Of Golf Course - Peter Reilly, Forbes. "The Eleventh Circuit has given one of President Trump’s favorite tax deductions a boost with its decision in Champion Retreat Golf Founders LLC. When a list of Trump Charitable contributions was released, 'Various Conservation Easements' topped the list at $63,825,000 and according to this story in the Wall Street Journal, golf courses number among his many easements."
Another Tax Trap for the Unwary - Jim Maule, Mauled Again. "Not all taxpayers realize that unemployment compensation payments are gross income for federal income tax purposes, and for purposes of state income taxes in some, but not all, states."
Iowa Not Conforming to Retroactive CARES Act Provisions - Carolina Vargas Tax Notes ($). "The state 'generally conforms with tax provisions of the CARES Act to the extent they affect Iowa income taxes for tax years beginning on or after January 1, 2020,' the DOR explained in its June 1 release."
The different treatment for years beginning before 2020 arises from the quirky way Iowa addressed conformity in taxable income computations in its 2017 tax reforms. For 2018, Iowa used a 2015 version of the Internal Revenue Code. For the 2019 tax year, Iowa conformed to the Internal Revenue Code as in effect on March 24, 2018. For tax years beginning in 2020 and later, Iowa's tax law automatically conforms to federal changes.
As a result, CARES Act changes automatically apply in 2020, but the retroactive changes to 2018 and 2019 do not. These include changes to the limitations on interest deductions of Section 163(j) and limits on individual business losses under Sec. 461(l).
The Iowa General Assembly would have to pass a bill in its session that resumes today to adopt the federal CARES Act changes for 2018 and 2019. With the state expecting significant revenue declines from the COVID-19 recession, the prospects are uncertain at best.
Free link: Iowa Nonconformity: Coronavirus Aid, Relief, and Economic Security Act of 2020.
New York Lawmakers Float New Data Tax Proposal - Jared Walczak, Tax Policy Blog:
First and perhaps foremost, assessing the value of New Yorkers’ data is daunting. Even defining data is endlessly complex. An address is data. Purchase histories are data. Socioeconomic information about consumers—data.
Of all the bad ideas in 2020 tax policy, a data tax is surely one of them.
Balancing School Budgets And Tax Hikes In The Middle Of A Pandemic - Renu Zaretsky, TaxVox. "But critics say district residents hard hit by the COVID-19 pandemic and its effect on the local economy can’t afford a tax increase."
Interest offers tax savings, costs and more forms - Kay Bell, Don't Mess With Taxes. "In some cases, the interest you pay on certain loans can provide a tax break. In another, it could mean you owe Uncle Sam a bit more."
Interview: SCOTUS Deliberates Trump's Tax Returns - David Stewart and Joseph Thorndike, Tax Notes. "These are really two similar, but quite different, cases. I think what's significant about them is that both of them are asking third parties for materials related to the president - not actually asking for those materials from the president himself."
What Information Should the Tax Court Make Available Electronically to Non-Parties - Keith Fogg, Procedurally Taxing. "We have had a few prior posts, here and here, commenting on the Tax Court’s very limited electronic access to information. Since the closing of the Tax Court clerk’s office in March, the ability to access documents at the Tax Court was zero until June 1."
Many documents in non-tax cases are available at minimal cost via the PACER system, or often for free from Court Listener. Similar documents in Tax Court cases have historically required a trip to Tax Court headquarters in Washington.
Last Person to Receive Civil War-Era Pension Dies - Michael Phillips, Wall Street Journal ($). "Ms. Triplett’s father, Mose Triplett, started fighting in the war for the Confederacy, but defected to the North in 1863. That decision earned his daughter Irene, the product of a late-in-life marriage to a woman almost 50 years his junior, a pension of $73.13 a month from the Department of Veterans Affairs."
I mentioned the Tripletts' actuarial good fortune in a post last week. Rest in peace, Ms. Triplett.
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