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Monthly Archives: May 2019

IRS SIB Shows Sole Proprietor's Income Declined & Real Estate Makes up 49.9% of Partnership Filings

The Internal Revenue Service announced today that the Spring 2019 Statistics of Income Bulletin is now available on IRS.gov. The SOI Division produces the online Bulletinquarterly, providing the most recent data available from various tax and information returns filed by U.S. taxpayers. This issue includes articles on the following topics:

  • Sole Proprietorship Returns, Tax Year 2016--For Tax Year 2016, taxpayers reported nonfarm sole proprietorship activity on approximately 25.5 million individual income tax returns, a 1.2-percent increase from 2015. Profits fell to $328.2 billion in 2016, a 1.1-percent decrease from the previous year. In constant dollars, total nonfarm sole proprietorship profits decreased 2.4 percent in 2016. Total profits as a percentage of business receipts were 23.1 percent for 2016, the second highest level in this data series which begins in 1988. The largest percentage increase in profits was reported by the arts, entertainment and recreation sector which increased 19.6 percent or $1.9 billion.
 
  • Partnership Returns, Tax Year 2016--The number of partnerships in the United States continued to increase for Tax Year 2016. Partnerships filed more than 3.7 million returns for the year, representing more than 28 million partners. The real estate and leasing sector contained almost half of all partnerships (49.9 percent) and over a quarter of all partners (29.7 percent).
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    Final Regs Exclude U.S. Corporate Shareholders from Section 956 Application

    IRS has issued final regs that reduce the amount determined under Code Sec. 956 for certain domestic corporations that own (or are treated as owning) stock in foreign corporations. Under the regs, neither an actual dividend to a corporate U.S. shareholder, nor such a shareholder's amount determined under Code Sec. 956, will result in additional U.S. tax.

     

    Code Sec. 951(a)(1)(B) requires a U.S. shareholder of a CFC to include in gross income the amount determined under Code Sec. 956 (the "section 956 amount") with respect to the CFC to the extent not excluded from gross income under Code Sec. 959(a)(2). A U.S. shareholder's section 956 amount with respect to a CFC for a tax year is the lesser of (1) the excess (if any) of such shareholder's pro rata share of the average of the amounts of U.S. property held (directly or indirectly) by the CFC as of the close of each quarter of such tax year, over the amount of earnings and profits (E&P) described in Code Sec. 959(c)(1)(A) with respect to such shareholder, or (2) such shareholder's pro rata share of the applicable earnings of the CFC.

    The Tax Cuts and Jobs Act (TCJA) established a participation exemption system for the taxation of certain foreign income. Under Code Sec. 245A(a), as added by TCJA, in the case of any dividend received from a specified 10% owned foreign corporation by a domestic corporation which is a U.S. shareholder with respect to such foreign corporation, there is allowed as a deduction an amount equal to the foreign-source portion of such dividend. A specified 10% owned foreign corporation is defined in Code Sec. 245A(b) as any foreign corporation (other than certain passive foreign investment companies) with respect to which a domestic corporation is a U.S. shareholder.

    The purpose of Code Sec. 956 is generally to create symmetry between the taxation of actual repatriations and the taxation of effective repatriations, by subjecting effective repatriations to tax in the same manner as actual repatriations.

    However, under the participation exemption system, earnings of a CFC that are repatriated to a corporate U.S. shareholder as a dividend are typically effectively exempt from tax because the shareholder is generally afforded an equal and offsetting dividends received deduction under Code Sec. 245A.

    A section 956 inclusion of a corporate U.S. shareholder, on the other hand, is not eligible for the dividends received deduction under Code Sec. 245A (because it is not a dividend).
     
     

    In 2018, IRS issued proposed Code Sec. 956 regs. The proposed regs exclude corporate U.S. shareholders from the application of Code Sec. 956 to the extent necessary to maintain symmetry between the taxation of actual repatriations and the taxation of effective repatriations. In general, under Code Sec. 245A and the proposed regs, respectively, neither an actual dividend to a corporate U.S. shareholder, nor such a shareholder's amount determined under Code Sec. 956, will result in additional U.S. tax.

    To achieve this result, the proposed regs provide that the amount otherwise determined under Code Sec. 956 with respect to a U.S. shareholder for a tax year of a CFC is reduced to the extent that the U.S. shareholder would be allowed a deduction under Code Sec. 245A if the U.S. shareholder had received a distribution from the CFC in an amount equal to the amount otherwise determined under Code Sec. 956.

    IRS has now finalized the proposed regs. which add a rule regarding CFCs that have prior year E&P described in Code Sec. 959(c)(1) and current-year E&P described in Code Sec. 959(c)(3) that do not result in an inclusion under Code Sec. 951 or Code Sec. 951A.

    The final regs also include an ordering rule treating a hypothetical distribution as attributable first to E&P described in Code Sec. 959(c)(2), then to E&P described in Code Sec. 959(c)(3), consistent with the allocation of an amount determined under Code Sec. 956 pursuant to Code Sec. 959(f)(1). This rule, which differs from the general rule for allocation of distributions in Code Sec. 959(c) by not treating any amount as attributable to E&P described in Code Sec. 959(c)(1), is necessary to reflect the fact that the amount to which the hypothetical distribution applies is in fact a tentative section 956 amount. (Reg. §1.956-1(a)(3)(iii))

    The final regs apply to tax years of a CFC beginning on or after May 23, 2019 and to tax years of a U.S. shareholder in which or with which such tax years of the CFC end. (Reg. §1.956-1(g)(4)).

    However, consistent with the reliance allowed for the proposed regs, taxpayers may apply the final regs for tax years of a CFC beginning after Dec. 31, 2017, and for tax years of a U.S. shareholder in which or with which such tax years of the CFC end, provided that the taxpayer and United States persons that are related (within the meaning of Code Sec. 267 or Code Sec. 707) to the taxpayer consistently apply the regs with respect to all CFCs in which they are U.S. shareholders for tax years of the CFCs beginning after Dec. 31, 2017.  (Reg. §1.956-1(g)(4)).

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    TC Determined That Responsible Person Penalty Invalid for Failure to Provide Pre-Assessment Determination

    On remand from the Eleventh Circuit, the Tax Court has determined in Romano-Murphy, 152 TC No. 16, that IRS's assessment of the trust fund recovery penalty was invalid, rejecting the determination of the IRS Office of Appeals.

    Based on the Eleventh Circuit's finding that under Code Sec. 6672(b)(3)(B) and the Regs, IRS was required to issue a pre-assessment determination of liability, the Tax Court concluded that this requirement was one of the "requirements of applicable law or administrative procedure," compliance with which must be verified by the Office of Appeals in a Code Sec. 6330 collection due process (CDP) hearing.

    IRC Sec. 6672(a) imposes a 100% penalty, commonly referred to as the trust fund recovery penalty or the responsible person penalty, on "responsible persons" if they willfully fail to pay over to IRS the amount of taxes otherwise due. IRS must notify a taxpayer that he will be subject to an assessment (pre-assessment notice) before it can impose a penalty. (Code Sec. 6672(b)(1)) IRS must also wait 60 days from the date of the notice letter before making an assessment. (Code Sec. 6672(b)(2)).

    The taxpayer, Ms. Linda Romano-Murphy, was the chief operating officer of NPRN, a business that was behind in paying its 2005 employment taxes. After unsuccessfully seeking full payment from NPRN, IRS sought to recover the remaining amount due from Romano-Murphy under Code Sec. 6672(a).

    The IRS sent Romano-Murphy a Letter 1153 (pre-assessment notice) informing her that, pursuant to Code Sec. 6672(a), she, as the chief operating officer of NPRN, was personally responsible for the company's unpaid trust fund taxes. It also informed her of her right to protest the proposed assessment.

    Romano filed a timely protest with IRS. Due to some unexplained error, IRS did not forward Romano-Murphy's formal written protest to its Appeals Office, which exclusively handles taxpayers' pre-assessment protests under Code Sec. 6672(b). The Appeals Office, therefore, never considered the protest, and Romano-Murphy was not given a pre-assessment conference or a final administrative determination as to her protest.

    On October 15, 2007, having failed to address or resolve her protest, IRS made an assessment against Romano-Murphy.

    In August 2008, IRS served Romano-Murphy with notice of its intent to levy to collect the penalty for NPRN's outstanding trust fund taxes. In September 2008, Romano-Murphy filed a timely request for a CDP hearing to contest her liability under Code Sec. 6672(a).

    Romano-Murphy received a CDP hearing with the IRS Appeals Office in February 2009. At the hearing, she disputed her liability under Code Sec. 6672(a) for the assessed penalty. The Appeals Office noted during the hearing that, although Romano-Murphy had filed a timely pre-assessment protest, IRS had never given her the opportunity to dispute her liability prior to making an assessment. Because the proposed assessment had never been reviewed, the Appeals Office conducted a post-assessment review of Romano-Murphy's challenges to liability and to the amount of the penalty.

     
    IRS Appeals Concluded That She Was Liable For The Outstanding Trust Fund Taxes.

     
     

    Romano-Murphy Sought Review Of The

    Appeals Office's Determination In The Tax Court.


    The Tax Court held that Romano-Murphy was liable under Code Sec. 6672(a) for the penalty. (Romano-Murphy, TC Memo 2012-330). Romano-Murphy then filed a motion to vacate the Tax court's order.

    She argued that collection of a tax liability, pursuant to Code Sec. 6502, can only occur after an assessment has been made, and the assessment in her case was invalid because IRS had failed to give her a pre-assessment hearing and determination when she filed her timely protest, which was her right by law.

    This procedural error, Romano-Murphy argued, denied her due process and prejudiced her in a number of ways. The Tax Court denied Romano-Murphy's motion to vacate.

    The Eleventh Circuit, vacating and remanding the Tax Court decision, held that Romano-Murphy was entitled to a pre-assessment determination of her Code Sec. 6672 liability. IRS therefore erred in not providing her such a determination before making the assessment and issuing its notice of intent to levy.

    The Court disagreed with the Tax Court, which it said had, in effect, concluded that taxpayers have no statutory right to a pre-assessment hearing or to a final administrative determination of a pre-assessment protest. Romano-Murphy v. Comm., (CA 11 3/7/2016) 117 AFTR 2d 2016-934).

    The Court cited several reasons for its conclusion. Although Code Sec. 6672 does not contain a subsection concerning a pre-assessment hearing or determination of liability, Code Sec. 6672(b)(3)(B) does presuppose that there will be a pre-assessment determination at some point if a taxpayer files a timely protest.

    Further, Reg § 301.7430-3(d) provides that, when a pre-assessment protest is filed, the Appeals Office must make a determination of Code Sec. 6672 tax liability and notify the taxpayer of that determination in writing by following specific steps.

    The Eleventh Circuit remanded the case to the Tax Court to determine what action, if any, should be taken to remedy the IRS's error in assessing the penalty against the taxpayer before making a final administrative determination.

    The Tax Court, on remand, concluded that the no-assessment-before-determination requirement identified by the Eleventh Circuit was one of the "requirements of applicable law or administrative procedure," compliance with which must be verified under Code Sec. 6330(c)(1) by the Office of Appeals in an Code Sec. 6330 collection-review hearing.

    The Tax Court then held that the assessment of the trust fund recovery penalty was invalid and the Court did not sustain the determination of the IRS Office of Appeals.

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    The “See” Duction Did Not Work for Texas Restaurant Owners

    According to DoJ, a Texas couple was convicted on May 23, 2019 of conspiracy and tax charges.
     
    Michael Herman and his wife, Cynthia Herman were convicted of conspiracy to defraud the United States by impeding the Internal Revenue Service (IRS) and of filing false individual income tax returns for tax years 2010 and 2011. The jury also convicted Michael Herman of filing false 2010 through 2012 corporate income tax returns. 
     
    According to the evidence introduced at trial, the Hermans owned and operated three establishments: Cindy’s Gone Hog Wild, a restaurant and bar in Travis County, Texas, and two restaurants in Bastrop County, Texas, Cindy’s Downtown and Hasler Brothers Steakhouse.
    The Hermans skimmed cash from the restaurants by depositing only a portion of the restaurants’ cash receipts into their business bank accounts and reported only those deposits on the corporate and individual income tax returns.
    The Evidence at Trial Showed that the Hermans Failed to Deposit Approximately $570,000 in Cash Receipts into their Business Bank Accounts.
    The Hermans also paid for personal expenses out of the business accounts, including repair of their personal swimming pool, utilities for their home, and the salary of a household employee. Michael Herman signed and filed the false 2010 through 2012 income tax returns filed on behalf of Cindy’s Gone Hog Wild Inc.
    U.S. District Court Judge Xavier Rodriguez has not set a sentencing date. The Hermans each face a statutory maximum sentence of 5 (five) years in prison on the conspiracy charge and 3 (three ) years in prison on each of the false tax return charges. They also face a period of supervised release, restitution and monetary penalties.
     
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