Baldwin Haspel Burke & Mayer LLC

BHBM Tax Law Alert 04/25/2012


Eligible Shareholder

In a recent case, Taproot Administrative Services, Inc. v. Comm’r., 109 A.F.T.R.2d 2012-1446 (9th Cir. 2012), the Ninth Circuit Court of Appeals affirmed the Tax Court’s decision that a Roth IRA is not an eligible shareholder of an S corporation. Under IRC § 1361, generally individuals, estates, certain exempt organizations and certain trusts (QSSTs and ESBTs) are eligible S corporation shareholders.  The Taproot case was decided before Treas. Reg. §1.1361-1(h)(1)(vii) was promulgated.  Treas. Reg. §1.1361-1(h)(1)(vii) now provides that individual retirement accounts (including Roth IRAs) are not eligible S corporation shareholders subject to certain exceptions.

Second Class of Stock

In order to make an election to be treated as an S corporation pursuant to IRC §1361(b), an otherwise eligible entity must only have one (1) class of stock outstanding.  There are numerous regulations and cases debating whether certain instruments or obligations constitute a second class of stock.  In a recent case, Santa Clara Valley Housing Group, Inc. v. U.S., 109 A.F.T.R.2d 2012-554 (N.D. Cal. 2012), the court examined the second class of stock safe harbor provisions concerning warrants.  Treas. Reg. §1.1361-1(l)(4) contains the rules treating certain instruments, obligations or arrangements as a second class of stock.  Generally, a call option, warrant or similar instrument issued by a corporation is treated as a second class of stock if taking into account all of the facts and circumstances, the call option is substantially certain to be exercised and has a strike price substantially below the fair market value of the underlying stock on the date that the call option is issued.

In finding that the warrants in question did not constitute a second class of stock, the court in Santa Clara focused on the safe harbor provisions contained in Treas. Reg. §1.1361-1(l)(4)(iii)(C).  The safe harbor provides that a call option is not treated as a second class of stock if, on the date the call option is issued, the strike price of the call option is at least ninety percent (90%) of the fair market value of the underlying stock on that date.

S Corporations Liable for Employment Taxes

In a recent case, Donald G. Cave, a Professional Law Corp., v. Comm’r, 109 A.F.T.R.2d 2012-1504 (5th Cir. 2012), the Fifth Circuit affirmed the Tax Court’s decision that associate attorneys were employees of an S corporation law firm.  As a result the S corporation was liable for past due employment taxes, penalties and interest.

This is one in a long line of cases involving the determination of whether an individual is an employee or an independent contractor.  In this case, the court focused on the common law factors illustrating whether a worker is a common law employee.  The IRS and courts generally examine numerous factors, sometimes described as a twenty (20) factor test, in ultimately determining whether a worker is an employee or an independent contractor.

In this case, the Tax Court originally concluded, and the Fifth Circuit affirmed, that the associate attorneys were employees rather than independent contractors because of the high degree of control that the corporation exercised over the associate attorneys.  Employee-independent contractor cases are factually intensive and can wreak financial havoc on companies in the form of past due employment taxes, penalties and interest on employers.


Portability Election

IRC §2010(c) allows the estate of a decedent who is survived by a spouse to make a portability election, which allows the surviving spouse to use the decedent spouse’s unused exclusion amount for transfers during life and at death.  The portability election only applies to married individuals dying after 2010.  One of the requirements for the portability election is that the executor of the estate of the first spouse to die must file a Form 706, even if the decedent spouse’s estate was less than the applicable exclusion amount.  If the executor of the decedent spouse’s estate does not file a Form 706, then the unused exclusion amount of the decedent spouse will not transfer to the surviving spouse.

Generally, an executor has nine (9) months to file a Form 706 from the date of death of a decedent.  The executor of an estate can request an automatic six (6) month extension of time to file by filing Form 4768.  IRS Notice 2012-21 grants a six (6) month extension of time to file Form 706 until fifteen (15) months after the decedent’s date of death for decedents dying after 12/31/10 and before 7/1/11 if the executor failed to timely file Form 4768.  In order to qualify for this extension, the executor must file a fully completed Form 4768 and the Form 706 within fifteen (15) months of the decedent’s date of death.

A Not So Lucky Lottery Winner

In the Dickerson case, T.C. Memo 2012-60, the taxpayer established an S corporation shortly after winning the lottery.  The taxpayer and her family were the shareholders of the corporation.  The taxpayer then transferred the lottery ticket to the S corporation, which ultimately claimed the lottery prize.  The IRS determined that the taxpayer made a gift as a result of the transfer to the S corporation and issued a deficiency notice for $771,000 for gift tax owed.

The court evaluated the facts of the case and found that the taxpayer had no family contract which required the taxpayer to transfer the ticket.  The court also found that there were no predetermined sharing percentages or voting rights, and there was no pooling of money of the family members for the purchase of lottery tickets.  The court concluded that the transfer to the S corporation was a gift because the taxpayer transferred property to a corporation for less than adequate consideration.


Fractional Aircraft Ownership Programs Fuel Surtax

The IRS recently issued IRS Notice 2012-27 which provides guidance on the tax imposed by IRC §4043 on fuel used in a fractional program aircraft.  IRC §4043 imposes a $0.141 per-gallon tax for fuel used in a fractional program aircraft after March 31, 2012: (1) for the transportation of a qualified fractional owner with respect to the fractional ownership aircraft program of which such aircraft is a part; or, (2) with respect to the use of such aircraft on account of such qualified fractional owner, including use in a deadhead service.

Generally, a fractional ownership aircraft program is a system of aircraft ownership and exchange that involves a single program manager that manages a fleet of aircrafts on behalf of fractional owners.  The program entitles the fractional owner to fly on any of the aircrafts in the fleet regardless of whether the owner has an ownership interest in the aircraft in which the owner flies.

The IRS Notice provides some of the specific definitions and citations essential to fractional aircraft ownership programs.  The IRS Notice provides that fractional ownership program managers must report the tax imposed by IRC §4043 on Form 720, and taxpayers liable for the tax must make deposits semimonthly.

Employer Identification Numbers

The Treasury Department has recently issued proposed regulations which would require taxpayers that receive employer identification numbers to provide updated information to the IRS in a manner and frequency required by certain forms, instructions or other appropriate guidance.  To date, the Treasury Department and the IRS have not issued the proposed methods of updating the required information.  As of now, the Treasury Department has requested comments from practitioners on the best methods for obtaining this information.


Several IRS officials have recently announced that the IRS is currently reorganizing its audit operations.  The IRS is attempting to streamline audits for the nation’s largest companies through the use of new forms like the Schedule UTP and the establishment of new resolution programs.  While the IRS will likely have some type of presence at the nation’s largest taxpayers, the goal of the IRS is to devote more resources to audits for mid-sized taxpayers, including S corporations, partnerships and smaller C corporations.  The IRS is also increasing the size of its international auditors due to the increasing volume and complexity of international transactions.


The Louisiana Department of Economic Development has recently amended the research and development tax credit program rules due to changes in the statutes governing the research and development tax credit (La. R. S. 47:6015).  Specifically, the Louisiana Department of Economic Development has amended certain provisions of the Louisiana Administrative Code contained in Sections 2901-2911 regarding the research and development tax credit programs.  The amendments include, without limitation, certain changes to definitions contained in La. Admin. Code 13:I:2903, the exclusion of certain expenditures from research and development programs, and the extension of the research and development tax credit program through December 31, 2019.

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