IRS notices issued to small businesses on a hunch

IRS notices issued to small businesses on a hunch

    Baker Donelson Bearman Caldwell & Berkowitz PC

    USA

    September 3 2013

Many small businesses have begun to receive notices (often styled as a "Notification of Possible Income Underreporting") from the IRS as a result of the  information reported on Form 1099-K.  Although receipt of this notice does not necessarily indicate that a business is currently under audit, failure to sufficiently address the IRS's concerns or a failure to respond could result in an audit being initiated or worse, an assessment for unpaid taxes.

Form 1099-K is an information return prepared annually by banks and other financial institutions that process credit and other electronic payments to merchants (e.g., PayPal), otherwise known as payment settlement entities, or PSEs.  Generally a business should expect to receive a Form 1099-K from each of its PSEs in late January if, during the prior year, the PSE processed a minimum of 200 transactions totaling at least $20,000 in gross payments for the business.  The PSEs are also required to send a copy of each Form 1099-K to the IRS.

The notices relating to Form 1099-K were initiated by the IRS last fall and continue to be mailed to businesses.  These notices are usually sent to a business based on either a mismatch between the gross payment amount reported on Forms 1099-K and the gross income reported by the business on its federal income tax return or an unusually high proportion of its reported gross income being attributed to the payments reported on Form 1099-K, which the IRS believes indicates a strong possibility that cash and other forms of revenue have gone unreported.

Because the gross payment amount reported on Form 1099-K does not account for merchandise returns, charge-backs, sales tax or gift cards (businesses are not required to report the income from gift card sales until the card is used), there is almost always a mismatch between the gross payment amount and the gross income the business is required to report on its federal income tax return.  Likewise, the IRS's utilization of these information returns to identify cases of potential underreporting often results in unfounded fishing expeditions that can be cut short with the appropriate response.  Accordingly, businesses that receive these notices should immediately contact a tax professional familiar with these notices, and then begin the process of collecting records that relate to the period(s) in question so that a structured plan of action can be put into place and an appropriate response sent to the IRS.

The IRS delays the information reporting requirements and the employer shared responsibility penalty

The IRS delays the information reporting requirements and the employer shared responsibility penalty

    King & Spalding LLP

    Kenneth A. Raskin and Mark Kelly

    September 3 2013

On July 9, 2013, Notice 2013-45 (the "Notice") was issued to provide transition relief during 2014 from the requirements of Sections 6055, 6056 and 4980H of the Internal Revenue Code ("Code"). Code Section 6055 requires annual information reporting by insurers, self-insured employers and certain other providers of minimum essential coverage. Code Section 6056 requires annual information reporting requirements by large employers (i.e., those with 50 or more full-time equivalent employees) relating to the health insurance that the employer offers (or does not offer) to its full-time employees. Code Section 4980H requires employers to provide a minimum level of health care coverage to full-time employees or risk a shared responsibility tax penalty (otherwise known as the pay-or-play penalty).

The Notice states that information reporting requirements under Sections 6055 and 6056 will be optional for 2014, and that for 2014, no penalties will be applied for failure to comply with these information reporting requirements. This one-year delay is intended to provide employers, insurers and other reporting entities additional time to develop their systems for reporting the needed data. During this transition year, the IRS is encouraging employers, insurers and other reporting entities to voluntarily comply with the information reporting requirements (once the rules have been issued). Voluntary compliance may help entities test their systems in preparation for when reporting becomes required in 2015. Proposed rules for the Section 6055 and 6056 information reporting requirements are "expected to be published this summer."

The Notice further provides that the IRS will not assess the pay-or-play penalty under Code Section 4980H for 2014. As a result of the information reporting delay discussed above, the IRS will not have the data necessary to identify which individuals do/do not have the required minimum coverage. Since the IRS will have no efficient mechanism for determining which employers may owe a penalty for a failure to offer affordable minimum essential coverage, no employer shared responsibility payments will be assessed for 2014. However, as with the information reporting requirements, the IRS encourages employers to maintain or expand health coverage in 2014, as real-world testing of reporting systems and plan designs will contribute to a smoother transition to full implementation in 2015.

The transition relief discussed above will not delay the requirement that individuals obtain health care coverage, beginning January 1, 2014, or pay a penalty for each month they do not have coverage (the individual "shared responsibility" mandate). Nor will the transition relief affect individuals' eligibility for the premium tax credit. To receive the premium tax credit, an individual must have household income within a specified range, not be eligible for other minimum essential coverage under an eligible employer-sponsored plan that is affordable and provides minimum value, and apply for the credit by completing an application form through the state or federal health insurance "exchanges."

In addition, the Notice also makes clear that the transition relief outlined above for 2014 will have "no effect" on the effective date or applicability of other Affordable Care Act ("ACA") provisions. Thus, employers will still need to comply with the following insurance reforms and mandated benefits that are otherwise effective for 2014:

    effective as of January 1, 2014, compliance with the new cost-sharing requirements and the prohibition on waiting periods greater than 90 days 

    provide a notice to employees regarding their coverage options available through health insurance marketplaces by October 1, 2013; 

    pay the various new ACA fees. For example, the first year's fee for the Patient Centered Outcomes Research Institute (PCORI) is still due July 31, 2013, and the first year's transitional reinsurance fee applicable to health insurance issuers and self-funded health plans will still be measured based on covered lives as of November 15, 2014; and 

    report the cost of employer-sponsored health coverage on an employee's W-2 by January 31, 2014.

K&S INSIGHT: While the transition relief relieves the immediate pressure of year-end compliance, employers should not stop preparing for 2015 when full implementation will be required. For employers who have already made plan design decisions for 2014, they should consider whether, and to what extent, to voluntarily comply with the reporting requirements. As the IRS noted, voluntary compliance could help identify problems in the employer's administrative processes and will contribute to a smoother transition to full implementation in 2015. For employers who have not yet decided whether to "pay-or-play," the transition period gives them a little additional time to weigh their options.

But, employers need to recognize that the Notice 2013-45 transition relief does not postpone other administrative requirements related to the employer mandate. For example, if an employer intends to use a 12-month measurement period for purposes of determining whether variable hour employees are considered full-time employees, the employer will need to start tracking hours in just a few short months. Further, the Notice 2013-45 transition relief does not extend the transition rules for 2014 that were previously announced in the proposed regulations. These include the special rules with respect to non-calendar year plans, use of a shorter measurement period in connection with the variable hour employee safe harbor, employers contributing to multiemployer plans, determination of large-employer status based on a six consecutive month period instead of the entire 2013 year, and the extension of coverage to dependents. Without further guidance, it is not clear whether any of these transition rules will be extended during 2015.

California Lease Disclosure Requirements Regarding ADA Accessibility Now in Effect

Update

07.01.2013

Beginning July 1, 2013, California commercial leases and rental agreements must include a disclosure regarding whether the property being leased has been inspected by a Certified Access Specialist (CASp) and, if a CASp inspection has occurred, whether the property being leased has met all construction-related accessibility standards under current law.  A CASp refers to any person who has been certified pursuant to Section 4459.5 of the California Government Code.  This new lease disclosure requirement is part of a comprehensive reform package, California Senate Bill 1186, that was enacted to address concerns about the skyrocketing number of lawsuits in California alleging violations of construction-related accessibility requirements.  Many such lawsuits in California have been brought by plaintiffs or lawyers who have engaged in multiple filings under the Americans with Disabilities Act or counterpart California laws (together "ADA accessibility lawsuits"), with news reports indicating that some lawyers have filed hundreds of such actions throughout the state.

Background

Nearly 40% of the nation’s ADA accessibility lawsuits are filed in California.  Proponents of SB 1186 view this legislation as a means to provide protection to owners and operators of public accommodations from abusive litigation, while creating incentives for commercial property owners to make ADA enhancements to improve accessibility.  The law provides that owners of properties that were inspected by a CASp inspector and met applicable standards for accessibility may stay ADA accessibility lawsuits and engage in an early evaluation conference.  A property owner may also be able to argue for greatly reduced minimum statutory damages (i.e., a reduction from $4,000 to $1,000 per offense) if the alleged violations are cured within 60 days of the owner being served with a complaint.

In addition to these accessibility inspection disclosure requirements, SB 1186 also introduces several other restrictions to rein in plaintiffs’ lawyers, including a ban on pre-litigation demand letters that request the payment of money for construction-related ADA violations and provisions intended to reduce the likelihood that a plaintiff can generate multiple claims by making numerous visits to the same business known to have barriers to access.  In addition, the law contains protections for businesses defined as "small business[es]," including a stay of litigation and the reduction of statutory damages (even without a CASp inspection) for violations that are corrected within 30 days of the small business being served with a complaint.

Lease Disclosure Requirement

California Civil Code Section 1938 (which codifies a portion of SB 1186) provides that "[a] commercial property owner or lessor shall state on every lease form or rental agreement executed on or after July 1, 2013, whether the property being leased or rented has undergone inspection by a Certified Access Specialist (CASp), and, if it has, whether the property has or has not been determined to meet all applicable construction-related accessibility standards pursuant to Section 55.53."

It is important to note that Section 1938 does not require that a CASp inspection be completed on the property being leased; rather, it requires disclosure as to whether a CASp inspection has been completed and, if it has, whether the property being leased meets the accessibility standards.  Civil Code Section 55.53(f) confirms that a person’s election not to complete a CASp inspection "shall not be admissible to prove that person’s lack of intent to comply with the law."  This suggests that a statement in a lease that there has been no CASp inspection would not be admissible in an ADA accessibility lawsuit.

Practical Considerations

Property owners should consider performing a property-by-property analysis to determine whether to have a CASp inspection performed on their property.  The decision whether to get a CASp inspection involves balancing the condition of the property and the potential extent and cost of addressing any identified barriers to accessibility against the potential expense of litigation and the statutory benefits provided by the new law for properties undergoing a CASp inspection.  The timing of obtaining a CASp inspection also may depend in part on whether redevelopment or property upgrades are planned, which would allow accessibility improvements to be made in the normal course of such work.

There is little precedent under the new law to indicate whether the statutory benefits provided by having a pre-litigation CASp inspection will actually reduce litigation expense for owners and tenants.  One California court has ruled that the early evaluation and stay provisions are not applicable to actions under federal ADA laws. In addition, ADA accessibility lawsuits often identify specific accessibility barriers relating to parking restrictions, or similar exterior features, that can be corrected without incurring undue burden or expense.  If the new law does succeed in reducing filings by serial filers as intended, however, future claims may be more serious and more difficult to resolve efficiently.  Over time, property owners may be well-advised to work with a CASp inspector to preemptively identify and address accessibility violations on their property.

A property owner’s decision as to whether to have a CASp inspection completed on a property should also take into account the practical benefits of the litigation protections afforded under the new law if a CASp inspection is completed.  The litigation advantages of having a CASp inspection are limited:  the CASp inspection does not provide a complete defense to a violation of ADA accessibility requirements but rather gives the owner a stay of litigation and a settlement conference, along with limitations on statutory damages in some cases.  Such benefits may be of little practical consequence in ADA accessibility lawsuits brought by serial filers, which often settle quickly and without formal discovery.  However, if, as noted above, the new law results in only the more serious lawsuits being brought, the protections offered to a property owner who completes a CASp inspection may be useful.

Finally, because tenants are also subject to ADA accessibility lawsuits, tenants may require property owners to have a CASp inspection completed and accessibility violations corrected prior to executing a lease or rental agreement.  On the other hand, if no CASp inspection has been completed for the property being leased, a sophisticated tenant may be reluctant to insist on a CASp inspection because the landlord may require that the tenant bear at least a portion of the cost of making any improvements found to be necessary.  If the tenant will be completing the tenant improvements, landlords will be reluctant to undertake accessibility corrections that may be subsequently impacted by the tenant improvements.  Landlords and tenants may also more clearly define their respective ADA compliance obligations in leases.  Local real estate market conditions will play a role in these negotiations between landlords and tenants.

© 2013 Perkins Coie LLP

U. S. Supreme Court unanimously upholds creditability of UK windfall tax

    McDermott Will & Emery

    Justin Jesse, Martha Groves Pugh, James A. Riedy, PC and Kevin Spencer

    United Kingdom, USA

    May 23 2013

   

In a rare unanimous decision with potentially far-reaching impact on taxpayers claiming foreign tax credits, the Supreme Court of the United States ruled that a “windfall tax” imposed by the United Kingdom was creditable under IRC Section 901.

On May 20, 2013, in a rare unanimous decision with potentially far-reaching impact on taxpayers claiming foreign tax credits, the Supreme Court of the United States ruled that a “windfall tax” imposed by the United Kingdom was creditable under Internal Revenue Code (IRC) Section 901.  This decision definitively establishes the principles to be applied when determining whether a foreign tax is creditable under Section 901, expressly favoring a “substance-over-form” evaluation of a foreign tax’s economic impact.

The UK windfall tax was enacted in 1997 as a means to recoup excess profits earned by 32 UK utility and transportation companies once owned by the government.  During the 1980s and 1990s, the UK sold several government-owned utility companies to private parties.  After privatization, the UK Government prohibited these companies from raising rates for an initial period of time.  Because only rates and not profits were regulated, many of these companies were able to greatly increase their profits by becoming more efficient.  The increased profitability of these companies drew public attention and became a hot political issue in the United Kingdom, which ultimately resulted in Parliament enacting a windfall tax designed to capture the excess or “windfall” profits earned by these companies during the years they were prohibited from raising rates.  The tax was 23 percent of any “windfall” earned by such companies, which was calculated by subtracting the price for which the company was sold by the United Kingdom from an imputed value based on the company’s average annual profits.  Both PPL Corporation and Entergy Corporation owned interests in two of these 32 privatized companies and took a U.S. tax credit for the windfall taxes paid to the United Kingdom.

IRC Section 901 grants U.S. citizens and corporations an income tax credit for “the amount of any income, war profits and excess-profits taxes paid or accrued during the taxable year to any foreign country or to any possession of the United States.”  Whether a foreign tax is creditable for U.S. income tax purposes is based upon the “predominant standard for creditability” laid out in Treasury Regulation §1.901-2.  Under that approach, a foreign tax is an income tax “if and only if the tax, judged on the basis of its predominant character,” satisfies three tests.  The foreign tax must be imposed on realized income (i.e., income that has already been earned), the basis of gross receipts (i.e., revenue) and net income (i.e., gross receipts less significant costs and expenditures).  See Treas. Reg. §1.901-2(a)(3).

The Supreme Court’s decision resolved a split between the U.S. Courts of Appeals for the Third and Fifth Circuits on how to apply the predominant standard for the creditability test set forth in the regulations.  The Third and Fifth Circuits took opposite views of two U.S. Tax Court decisions, PPL Corp.  v. Commissioner, 135 T.C. 304 (2010), and Entergy Corp.  v. Commissioner, T.C. Memo. 2010-197, which both held in favor of the taxpayers that the practical effect of the UK windfall tax, the circumstances of its adoption and the intent of the members of Parliament who enacted it evidenced that the substance of the tax was to tax excess profits, and therefore was creditable.

In PPL Corp. v. Commissioner, 665 F.3d 60 (3d Cir. 2011), the Third Circuit reversed the Tax Court, refusing to consider the practical effect of the UK windfall tax and the intent of its drafters.  Instead, the court focused solely on the text of the UK statute, which in its estimation was a tax on excess value and not on profits.  In contrast, in Entergy Corp. v. Commissioner, 683 F.2d 233 (5th Cir. 2012), the Fifth Circuit affirmed the Tax Court, finding that the tax’s practical effect on the taxpayer demonstrated that the purpose of the tax was to tax excess profits.  The court explained that Parliament’s decision to label an “entirely profit-driven figure a ‘profit-making value’ must not obscure the history and actual effect of the tax.”

In its decision, the Supreme Court agreed with both the Fifth Circuit and the Tax Court.  In applying the rules of the Treasury Regulations, the Supreme Court reinforced the three basic principles to determine whether a tax is creditable.  First, a tax that functions as an income tax in most instances will be creditable even if a “handful of taxpayers” may be affected differently.  This means that the controlling factor is the tax’s predominate character.  Second, the economic effect of the tax, and not the characterization or structure of the tax by the foreign government, is controlling on whether the tax is an income tax.  This extends the principle of “substance over form” to the characterization of a foreign tax.  Third, a tax will be an income tax if it reaches net gain or profits.  Applying these principles to the PPL case, the Supreme Court found that the predominate character of the windfall tax was that of an excess profit tax and was therefore creditable.

The PPL decision will likely have far-reaching affects on courts that wrestle with whether certain taxes paid overseas are creditable for U.S. income tax purposes.

Attempt to complete a reverse exchange fails before California State Board of Equalization

    Loeb & Loeb LLP

    May 20 2013

 

In Appeal of Patricia Bragg (SBE, November 2012), the California State Board of Equalization (SBE) determined that the taxpayer had failed in its attempt to complete a reverse like-kind Section 1031 exchange. In a reverse exchange, the taxpayer locates a property he wishes to purchase before he locates a buyer for the property he currently owns and wishes to sell. To ensure that the property the taxpayer wishes to purchase will not be sold in the interim, the taxpayer needs to find a friendly party or exchange intermediary to purchase the new property on his behalf and hold it until he can sell his current property. When he locates a buyer for his current property, he can sell it through the exchange intermediary and receive the replacement property from the intermediary to complete his exchange.

Naturally, the exchange intermediary does not want to incur any economic risk in connection with the purchase and holding of the real property that the taxpayer eventually wishes to acquire. The lack of risk creates the tax problems inherent in these transactions. Under the tax law, the like-kind exchange does not work if the taxpayer is considered to be the economic owner of the replacement property prior to the time he sells his current property. The exchange intermediary normally wants to transfer all of the risks and burdens and benefits of ownership of the replacement property to the taxpayer immediately through their contractual arrangement.

In the Bragg case, the intermediary did a good job of transferring these burdens to the taxpayer. The agreement between the taxpayer and the intermediary provided, first, that the intermediary would sell the replacement property to the taxpayer at the intermediary’s cost to purchase the property plus the costs it incurred while it owned the property. The property was purchased with a loan that was guaranteed by the taxpayer, and the intermediary was not likely to make or lose any money by owning the property beyond the fee it charged. Second, the taxpayer was required to insure the property and pay the property taxes and other expenses of the property during the period the intermediary owned the property. Third, the taxpayer leased the property from the intermediary, but all rent that was paid by the taxpayer was credited to the purchase price when the taxpayer purchased the property from the intermediary. Fourth, the intermediary agreed that it would not further encumber the property during its period of ownership. Fifth, the taxpayer agreed to indemnify the intermediary against any loss or expense related to the purchase, ownership, or sale of the property; and sixth, if the taxpayer did not purchase the property from the intermediary after one year, the intermediary could terminate the exchange agreement and compel the taxpayer to purchase the property. Based on the above, the SBE determined that the taxpayer was the economic owner of the property from the date of the intermediary’s acquisition, so the taxpayer did not receive this property in exchange for his current property.

While reverse exchanges are difficult, they are not impossible, and the IRS has established a safe-harbor procedure through which a taxpayer can accomplish a reverse exchange. The safe-harbor rules are contained in Rev. Proc. 2000-37, as later modified by Rev. Proc. 2004-51. As with a regular exchange through an exchange intermediary, the intermediary must be unrelated to the taxpayer. The key criterion is that the intermediary must transfer the property to the taxpayer within 180 days after it acquires the property — in effect, the same 180-day period the taxpayer has to acquire replacement property in a regular exchange after it sells its property. The taxpayer did not observe the 180-day limit in the Bragg case, so the taxpayer could not rely on the safe harbor.

If a taxpayer observes the 180-day limit, most of the factors that caused the taxpayer’s exchange in Bragg to fail would be permitted. For example, the taxpayer can guarantee the loan the intermediary uses to purchase the property or can even loan the intermediary the purchase funds. The taxpayer can lease the property from the intermediary or manage the property. The price the taxpayer will pay to purchase the property can be fixed in the agreement. Rev Proc. 2004-51 imposes the additional restriction that the taxpayer cannot own the replacement property before it is owned by the exchange intermediary.

While a reverse exchange can be done outside of the safe harbor, it is much more difficult because few intermediaries are willing to take the risks necessary to make them the economic owner for tax purposes.