Summary of Major Developments
Chapter 2 - S Corporations
- The increase in the application of the Kiddie Tax from children under age 18 to those
under 19 and to full-time students between the ages of 18 and 24 whose earned income
accounts for less than one-half of their support is reflected in a discussion regarding gifts
of S corporation stock to children [~§~1(g)].
- For taxable years beginning after December 31, 2006, restricted bank director stock is no
longer treated as outstanding stock of an S corporation for purposes of (a) determining
whether the S corporation has more than one class of stock; (b) determining the number
of S corporation shareholders; and (c) allocating items of S corporation income, gain, loss
and credit among the S corporation shareholders [Act 8232 of the Small Business and
Work Opportunity Tax Act of 2007].
- For years beginning after December 31, 2006, if a parent S corporation sells the stock of
its QSub and the sale terminates the QSub election (which is usually the case), the sale is
treated as a sale of an undivided interest in the assets of the QSub (based on the
percentage of stock sold) followed by a deemed transfer of the sold QSub's assets and
liabilities to a new corporation in a transaction that qualifies under ~§~351 [Act ~§~8234 of
the Small Business and Work Opportunity Tax Act of 2007].
- The IRS has issued final regulations that treat QSubs and other single-owner disregarded
entities as separate entities for purposes of employment tax and excise tax reporting. The
final regulations eliminate the disregarded entity status for federal employment tax
purposes for wages paid on or after January 1, 2009. In addition, the final regulations
eliminate the disregarded entity status for excise taxes where the liability is imposed or
the action is first required or permitted in periods beginning on or after January 1, 2008
(Reg. ~§~301.7701-2, T.D. 9356, 8/15/2007).
- The IRS has provided an additional simplified procedure for making a late S corporation
election in Rev. Proc. 2007-62, 2007-41 I.R.B. 786. This revenue procedure allows an
entity to make a late S corporation election by filing Form 2553 with a Form 1120S for
the first taxable year the entity intended to be an S corporation, provided certain
requirements are met. In addition, this revenue procedure provides simplified procedures
for an entity to make a combined late S corporation and corporate entity classification
election by filing Form 2553 with Form 1120S within 6 months after the due date of the
return (excluding extensions).
- For years beginning after May 25, 2007, capital gain from the sale of stock or securities is
no longer treated as passive investment income for purposes of computing the tax on
excessive passive investment income under ~§~1375 and the prohibition against an
S corporation having excessive passive investment income for three consecutive years
under 1362(d)(3) [~§~1362(d)(3)(C); Act ~§~8231 of the Small Business and Work
Opportunity Tax Act of 2007].
- The Tax Court has confirmed that an S corporation shareholder who gives his full
recourse note to a bank in satisfaction of a prior loan by that bank to the S corporation has
achieved basis for that note (Miller v. Comm., TC Memo 2006-125, 6/15/2006).
- The Tax Court has not allowed S corporation shareholders to receive basis for indirect
loans that were made by a general partnership also controlled by the shareholders. The
fact that the funds had moved directly from the partnership to the S corporation prevented
the shareholders from achieving basis for the loans (Ruckriegel v. Comm., TC Memo
2006-78, 4/18/2006).
- The IRS has issued proposed regulations under Reg. ~§~1.1367-2 to limit an S corporation
shareholder's open account indebtedness, net of repayments, to $10,000 at the close of
any day during the S corporation's taxable year [NPRM REG-144859-04 (4/12/2007),
corrected 5/8/2007].
- Effective May 25, 2007, an S corporation may eliminate pre-1983 earnings and profits
notwithstanding that it may not have been an S corporation for its first tax year beginning
after December 31, 1996 [Act 8235 of the Small Business and Work Opportunity Tax
Act of 2007].
- Revenue Ruling 2008-42, addresses two issues involving (key person) employer-owned
life insurance contracts. The first is whether premiums paid by an S corporation for this
type of policy (when the S corporation is directly or indirectly a beneficiary) reduce the
S corporation's AAA. The second is whether the death benefits meeting an exception
under ~§~101(j)(2) increase AAA. The ruling concludes that premiums paid by the
S corporation on an employer-owned life insurance contract (the S corporation is directly
or indirectly a beneficiary) do not reduce the S corporation's AAA. It also holds that the
benefits received by reason of the death from this type of policy that meets an exception
under ~§~101(j)(2) do not increase the S corporation's AAA.
- For tax years beginning in 2006 and 2007, an S corporation shareholder is required to
reduce the basis in their S corporation stock by the shareholder's pro rata share of the
S corporation's adjusted basis in any noncash donations the S corporation makes to
charity [Act ~§~1203(b) of the Pension Protection Act of 2006].
- Revenue Procedure 2008-18, 2008-10 IRB 573, details how a bank (including a bank
QSub) that changes from the reserve method bad debts under ~§~585 for its first tax year
with a ~§~1362(a) S election can elect under ~§~1361(g) to take the ~§~481(a) adjustment into
taxable income for the preceding tax year.
- The IRS recently released special rules providing that a two-percent shareholderemployee
of an S corporation may deduct amounts paid for insurance under ~§~162(l) (the
100% deduction for self-employed health insurance premiums) if the insurance plan was
established by the S corporation. A plan is considered established by the S corporation
under these rules if either (1) the S corporation makes the premium payments in the
current year or (2) the two-percent shareholder makes the premium payments and is then
reimbursed by the S corporation in the current year. Either way, the payments are
required to be included in the shareholder's wages and reported on the shareholder's
W-2. The IRS does not consider payments of accident and health insurance premiums to
be distributions for purposes of the single class of stock requirement of ~§~1361(b)(1)(D)
[Notice 2008-1, I.R.B. 2007-2 (12/13/2007)].
- For years beginning after December 31, 2006, an ESBT may not deduct interest paid or
accrued in connection with the acquisition of stock in an S corporation [Act 8236 of the
Small Business and Work Opportunity Tax Act of 2007, amending IRC ~§~642(c)(2)(C)].
- The IRS has issued M-3, Net Income (Loss) Reconciliation for S Corporations With Total
Assets of $10 Million or More, to be used for S corporations with $10 million or more of
total assets on Schedule L of Form 1120S, effective for tax years ending on or after
December 31, 2006. In addition, an S corporation subject to M-3 filing must notify any
partnership in which it has a 50% or greater interest, to inform the partnership of its M-3
filing responsibility.
- The Mortgage Forgiveness Debt Relief Act of 2007 imposes a new entity level penalty on
S corporations that fail to meet any information filing obligation under IRC ~§~6037. The
penalty is assessed at $85 per month (or portion thereof) times the number of persons
who were shareholders in the S corporation at any time during the tax year for each
month that the failure continues, up to a maximum of twelve months. The S corporation
may have the penalty abated for reasonable cause. The provision applies to returns
required to be filed after December 20, 2007. [Act ~§~9(j) of the Mortgage Forgiveness
Debt Relief Act of 2007, P.L 110-142, adding IRC ~§~~§~6699(a) and (c).]
- The Mortgage Forgiveness Debt Relief Act of 2007 enacted a new provision to protect
the taxpayer identity information of an S corporation shareholder. In particular, new IRC
~§~6103(e)(10) now prohibits an S corporation from disclosing any supporting schedule,
attachment or list that includes the taxpayer identity information of any person other than
the person conducting the investigation.
Chapter 3 - Section 1244 Stock, Formation of a Corporation, Personal
Service Corporations, and Limited Liability Companies
- The Tax Court determined that a CPA practice operating as a C corporation was not a
Personal Service Corporation (PSC) because about 20% of its payroll was allocable to
employees doing financial services brokerage activities rather than rendering accounting
or consulting services. As a result, the entity was not a PSC and avoided the flat 35%
corporate tax rate (Ron Lykins, Inc. v. Comm., TC Memo 2006-35, 3/2/2006).
- The Tax Court found that a Nevada firm that performed tax and bookkeeping services
was a personal service corporation and subject to the flat 35% corporate rate despite the
fact that it employed no CPAs. The court found that the taxpayer was attempting to
define accounting services too narrowly and had failed to distinguish between public
accounting services and the meaning of accounting services under ~§~448(d)(2) (Rainbow
Tax Services, Inc. v. Comm., 128 T.C. 5 (2007)).
- In a Tax Court summary opinion, the Tax Court ruled that a corporation that performed
architectural services may not take treasury stock into account in determining whether
employees who perform personal services own substantially all (i.e., at least 95%) of the
outstanding stock of the corporation, as required under ~§~448(d)(2)(B) (Robertson Strong
& Apgar Architects, PC v. Comm., TC Summary Opinion 2007-48).
Chapter 4 - Form 1120
- In the instructions for the 2006 Schedule M-3, Net Income (Loss) Reconciliation for
Corporations With Total Assets of $10 Million or More, the IRS imposed a new reporting
requirement on corporations that are subject to M-3 filing and that own, directly or
indirectly, a 50% or greater interest in a partnership on or after June 30, 2006. Those
corporations must satisfy a reporting requirement to the partnership that will require the
partnership to file its own Schedule M-3 (IRS News Release IR-2006-114, 7/20/2006).
- Effective for transactions occurring on or after January 6, 2006, transactions that create a
significant book-tax difference (i.e., a transaction in which the amount of any items of
income, gain, expense or loss reported for tax purposes differs from the gross amount of
the items reported for book purposes) are no longer required to be disclosed on Form
8886, Reportable Transaction Disclosure Statement [Notice 2006-6, IRB 2006-5, 385
(1/6/2006)].
Chapter 4 - Inventories
- Rev. Proc. 2001-23 and Rev. Proc. 97-36 both require the use of separate pools for cars
and light-duty trucks. Recognizing that the distinction between cars and light-duty trucks
has diminished significantly in recent years, the IRS released Rev. Proc. 2008-23 on
March 7, 2008. This revenue procedure allows a reseller of cars or light-duty trucks that
is using the dollar value LIFO pooling rules under Reg. ~§~1.472-8(c)(1), Rev. Proc. 2001-
23, or Rev. Proc. 97-36 to automatically change its accounting method to adopt a new
Vehicle-Pool Method.
- The IRS has announced that pending the issuance of additional published guidance, it
will not challenge a taxpayer's inclusion of negative amounts in computing additional
~§~263A costs under the simplified production or resale methods or whether a taxpayer's
may aggregate negative additional ~§~263A costs under these methods. The IRS will also
not pursue the issue if it has already been raised in examination or is currently under
consideration before Appeals or the Tax Court. The IRS will not deny a taxpayer the
right to change its accounting method because it includes negative amounts in the computation of additional ~§~263A costs or the use of a negative number for aggregate
~§~263A costs provided the taxpayer already treats the negative cost as a ~§~471 cost. The
taxpayer will be required to conform to any rules provided in future published guidance,
however [Notice 2007-29, IRB 2007-14 (3/12/2007)].
- Revenue Procedure 2008-43, IRB 2008-30, provides safe harbors through which a
taxpayer may use the rolling-average method of inventory. Historically, the Service has
not felt that this method of inventory resulted in a clear reflection of income. This was
particularly true in cases in which inventory had a long holding period, perhaps multiple
years. It was also viewed as a problematic method if costs were subject to substantial
fluctuations.
Chapter 4 - Accounting Methods
- The IRS has revised its instructions to Form 3115, Application for Change in Accounting
Method, to reflect earlier regulations allowing the use of automatic consent accounting
method change procedures for C corporations required to convert to the accrual method
of accounting by ~§~448. Under ~§~448, a C corporation is generally required to convert from
the cash method to the accrual method if its average annual gross receipts exceed $5
million for the three prior years. Under automatic consent accounting method change
procedures, the increase to income from converting to the accrual method may be spread
over four tax years [Instructions to Form 3115; Reg. ~§~1.448-1(g)(2)(i)].
- The Tax Court has ruled that computational errors by an auto dealership in its LIFO
inventory over a ten-year period represented an accounting method error. As a result, the
IRS was permitted to impose an accounting method correction that adjusted the LIFO
inventory valuation from the inception of the error, not merely for the open period under
the statute of limitations (Huffman v. Comm., 126 TC No. 17, 5/16/2006). The Sixth
Circuit has now affirmed the decision of the Tax Court in 518 F3d 357 (6th, 2008).
Chapter 4 - Installment and Deferred Payment Sales
- A private letter ruling illustrates utilization of an alternative basis recovery schedule for
the installment sale of stock of a business. The stock sale involved a contingent sale price
based on subsequent income of the business. The taxpayer was successful in receiving
IRS approval for allocating basis in proportion to the estimated amount of gross proceeds
to be received, rather than accepting the general method of reporting basis equally over
the term of the payment schedule (PLR 200603017).
- An LLC was also allowed, in PLR 200813019, to revoke an election out of the
installment method. The taxpayer had intended to engage in a ~§~1031 like-kind exchange
using a qualified intermediary, but was unable to find replacement property. The
taxpayer's accountant, who possessed all the relevant information, reported the gain on
the sale of the property in full rather than reporting it on the installment basis even though
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