Tax News & Views Limited Partner Lemon Pie Exception Roundup

Tax Court Sides With the IRS in Self-Employment Tax Dispute - Chandra Wallace and Kristen Parrillo, Tax Notes ($):

State law classifications don’t control who qualifies as a limited partner in determining whether distributive shares of a partnership’s ordinary business income are subject to self-employment tax, the Tax Court has ruled.

In a November 28 division opinion in Soroban Capital Partners LP v. Commissioner, the Tax Court determined that partners that actively participate in state law limited partnerships aren’t “limited partners, as such” within the meaning of section 1402(a)(13). As a result, their distributive shares of items of income and loss from the partnership must be included in net earnings from self-employment subject to tax under the Self Employment Contributions Act (SECA).

The "limited partner exception" to self-employment tax has been controversial for decades. The development of limited liability companies and other types of arrangements that are taxable as partnerships, but are not old-school limited or general partnerships, has complicated things.  The IRS proposed regulations to address the issue in 1997, but Congress enacted a temporary moratorium to block the proposal, and the IRS has not tried again. The Tax Court opinion explains (some citations omitted; my emphasis):

In 2011 we were called upon to determine the scope of the limited partner exception. We applied statutory construction principles to determine whether partners in an LLP should be considered limited partners under section 1402(a)(13). In Renkemeyer, 136 T.C. at 150, we analyzed the legislative history of section 1402(a)(13) and concluded that its intent “was to ensure that individuals who merely invested in a partnership and who were not actively participating in the partnership's business operations . . . would not receive credits towards Social Security coverage.” We further found that “[t]he legislative history . . . does not support a holding that Congress contemplated excluding partners who performed services for a partnership in their capacity as partners (i.e., acting in the manner of self-employed persons), from liability for self-employment taxes.” Lastly, we held that the partners in that case were not limited partners for purposes of section 1402(a)(13) because their “distributive shares arose from legal services . . . performed on behalf of the law firm” and not “as a return on the partners' investments.”

While partner income from partnership K-1s can be subject to self-employment tax, S corporation K-1 income is not. This has led to a body of case law where the IRS has treated S corporation distributions as compensation in cases where they believe taxpayers were abusing the rules through artificially-low salaries.

State Law Limited Partner Status is Not Controlling for Exclusion from Self-Employment Income Found at IRC §1402(a)(13) - Ed Zollars, Current Federal Tax Developments. "The Court dismissed the taxpayers' efforts to reference various other documents, upholding what it determined to be the plain meaning of the statute."

IRS supports international efforts to fight fraud during Charity Fraud Awareness Week - IRS. "The IRS supports this effort as part of its ongoing commitment to fight fraud against charities, businesses and individuals. It's estimated that charitable organizations lose 5% of their revenue each year to fraud, according to the Fraud Advisory Panel, a UK-based organization that leads the effort in organizing Charity Fraud Awareness Week, which runs from Nov. 27-Dec. 1."

US Weighing Reprieve for Automakers on EV Tax Credits - Ari Natter and Mackenzie Hawkins, Bloomberg ($):

The Biden administration has discussed granting automakers a temporary reprieve from new rules poised to limit a consumer tax credit for electric vehicles that contain certain materials from foreign adversaries, a Michigan senator said Tuesday.

Administration officials have discussed phasing in enforcement for the rules which would disqualify automobiles that use battery parts or minerals from China and other foreign adversaries from the full $7,500 incentive, Democratic Senator Debbie Stabenow said.

U.S. Debates How Much to Sever Electric Car Industry’s Ties to China - Ana Swanson and Jack Ewing, New York Times. "Carmakers like General Motors and Hyundai, spurred by the new climate law, are racing to build factories in the United States to produce batteries and process materials like lithium. But they are still years away from being able to produce an electric vehicle without materials and components from China, auto industry representatives say."

Biden to Limit Chinese Role in U.S. EV Market - Andrew Duehren, Wall Street Journal. "The White House hopes the new tax-credit rules will encourage the development of auto-supply chains in the U.S. and distance the industry from China, the most important source of clean-energy technology and a geopolitical rival. At the same time, disqualifying vehicle batteries with even minor contributions from Chinese firms could mean that few, if any, EVs would be eligible for the $7,500 credit, potentially slowing the transition away from gasoline-powered cars."

Related: What You Need to Know About the Clean Vehicle Credit.

Promising Tax Talks Face Hurdles as Taiwan Bills Go Their Own Way - Doug Sword and Cady Stanton, Tax Notes ($):

Tax talks that would combine a beefed-up child tax credit and reinstate full research and development expensing aren’t exactly sizzling, but they are picking up speed after a year in the doldrums.

Lawmakers agree that talks have heated up at least a few degrees, but they note that a legislative package would have to clear several hurdles. First, it would need to be done in time to avoid wrecking the 2024 filing season with a major tax code rewrite. It would also have to be signed off on by not just the four top taxwriters but also the four top congressional leaders. And there would have to be an agreement on whether the package would be paid for with budget offsets.

The Taiwan bill would give taxpayers with business in Taiwan relief from double taxation. Because the U.S. doesn't officially recognize Taiwan, there is no U.S. - Taiwan tax treaty. There is some talk of using the Taiwan bill as a vehicle to carry other tax provisions:

At the center of negotiations are four items: an expansion of the child tax credit beyond $2,000 per child, reinstatement of full R&D expensing, extension of 100 percent bonus depreciation to 2023 and beyond, and a loosening of net interest expensing calculations. The tightening of R&D and net interest write-offs went into effect in 2022, so the potential for retroactive changes to those two tax breaks adds complexity to talks.

Check this space Thursday for Jay Heflin's weekly update on how things are going in D.C.

Canada Digital Tax Plan Sparks US Lawmaker Reprisal Threats - Samantha Handler, Chris Cioffi, and James Munson, Blooomberg ($):

Canada introduced legislation Tuesday to enact a 3% digital services tax targeting global tech giants, triggering a swift rebuke from US lawmakers.

...

The US has strongly opposed the Canadian tax because it’s expected to mostly affect large American multinationals. US Ambassador to Canada David Cohen said in October the two countries could end up having a “big fight” if a resolution isn’t found.

Additional Transition Year for 1099-K Reporting Requirements - Jenny McGarry and Angie Ziegler, Eide Bailly. "The IRS is considering plans to change the reporting threshold to $5,000 in 2024."

IRS Union to Push for More Telework as Technology Improves - Erin Slowey, Bloomberg ($). "IRS positions that focus mostly on paper forms, such as processing paper returns and opening mail, aren’t eligible for telework. But as the IRS scans more returns into computer systems, those employees could be moved to a telework environment, National Treasury Employees Union National President Doreen Greenwald said in an interview."

Tax insurance is having a big year amid global crackdown on evaders: report - Tobias Burns, The Hill. "While tax collection initiatives are gaining momentum both in the U.S. and abroad, insurers are wagering that not all of the new enforcement measures will be successful." 

I would hate to be pricing those policies if I were an underwriter.

Year-end gifting strategies to maximize charitable impact, minimize taxes - Mandy Sutton, Eide Bailly via Sioux Falls Business Journal. "Donating stocks, bonds or mutual funds that have gained value is becoming a popular donation method. Most organizations are equipped to handle these kinds of gifts. Since nonprofits don’t pay federal taxes, they can sell the donated investments without facing taxes on the profits. This is beneficial because if the donor sold the investments and then gave cash, the donor would have to pay taxes on the gains."

Ways to avoid local and global charity scams - Kay Bell, Don't Mess With Taxes. "Yes, those affected by disasters need immediate attention and help. But you want to make sure your gift is going to do that. Scammers typically pressure people for an immediate donation. Don't do it. Don't feel rushed. Legitimate charities are happy to get a donation at any time."

IRS Warns Taxpayers To Watch Out For Scams During The Holiday Season - Kelly Phillips Erb, Forbes. "One of the schemes currently making the rounds centers on promises regarding a third round of Economic Impact Payments, or stimulus checks. The IRS says that it receives complaints daily about this scam, which has an embedded URL link that takes people to a phishing website to steal sensitive taxpayer information."

How To Handle Pre-paid Farm Expenses When a Farmer Dies - Tax School Blog. "The Tax Court disagreed with the IRS’ position and upheld the 2010 deductions, ruling that the tax benefit rule did not require those amounts to be taken into income when they were not used in production for the husband on account of his death. The surviving wife also acquired these inputs at FMV (which was deemed to be their purchase price) at the time of death under §1014. The inputs were includable assets on the husband’s Form 706 and were deemed to be taxed there."

Lesson From The Tax Court: Taxpayers Cannot Invoke The 'Augusta Rule' With Unplayable Lie - Bryan Camp, TaxProf Blog. "In Kunjlata J. Jadhav and Jalandar Y. Jadhav v. Commissioner, T.C. Memo. 2023-140 (Nov. 21, 2023) (Judge Vasquez), the taxpayers get lured by the promise of tax free income under the August Rule into making what turned out to be an unplayable lie on their tax returns.  They did not get a mulligan.  They did get penalties."

AI Doesn’t Change the Economics of Labor, Capital, & Taxes - Adam Michel, Liberty Taxed. "Contrary to that narrative, empirical evidence does not support the worker displacement theory. New taxes on capital will make achieving the positive gains promised by AI or any other future innovation less likely. If the revenue is used to fund new income‐support programs, it could also undermine labor supply."

Full Expensing to Be Made Permanent in the United Kingdom - Alex Mengden, Tax Policy Blog. "In his Autumn Statement released today, British Chancellor Jeremy Hunt announced that full expensing for (some) plant and machinery will be made permanent. This is good news for capital investment in the United Kingdom, since permanence gives investors a reliable expectation of low cost of capital and reduces the tax bias against long-term investments."

Owner of Orange County auto-repair businesses pleads guilty to filing false tax returns that omitted nearly $3 million in income - IRS (Defendant name omitted):

According to his plea agreement, Defendant owns and operates three auto-repair companies in Orange County... During the tax years 2015 through 2021, Defendant received payments for services from these companies, including in the form of checks. During this period, Defendant used a check-cashing business in Garden Grove to cash checks for services performed by these companies.

Defendant used the check-cashing business to cash approximately $2,927,265 in checks made payable to his auto-repair businesses. Defendant willfully and intentionally withheld from his tax preparer the business receipts and income these companies received in the form of checks. Instead, he only provided to his tax preparer and reported on his tax returns the business receipts and income that he had deposited into his business bank accounts.

Don't do that.

Yes. It's National Lemon Cream Pie Day! "Today we commonly call this lemon meringue pie."