Tuesday, April 30, 2019
A good number of the readers of this blog are tax practitioners. As a result, during tax season, significant developments tend to go unnoticed if they don’t directly impact client tax prep work currently. With today’s post, I take a brief look at what happened in federal tax while the tax season was raging on.
Some current developments in federal tax – that’s the topic of today’s post.
Obamacare Individual Mandate
For those of you who attended a tax seminar that I did last year, you heard me discuss the pending litigation concerning the constitutionality of Obamacare. Because Chief Justice Roberts hinged the Constitutionality of the law on the individual mandate (contained in I.R.C. §5000A) being a tax and, therefore, within the taxing authority of the Congress, if that tax is eliminated the law becomes Constitutionally suspect. National Federation of Independent Business v. Sebelius, 567 U.S. 519 (2012). At least that’s the argument that I mentioned was being made in court and that we could expect a federal court decision on that issue. The reason for the court challenge, of course, was because of the elimination by the Tax Cuts and Jobs Act (TCJA) of the individual mandate “tax” effective for months beginning after 12/31/18. Indeed, that opinion came out in late 2018 before the tax season began in Texas v. United States, No. 4:18-cv-00167-O, 2018 U.S. Dist. LEXIS 211547 (N.D. Tex. Dec. 14, 2018). The court noted that the payment was distinct from the individual mandate and determined that the individual mandate was no longer constitutional as of 1/1/2019 because it would no longer trigger any tax. In addition, because the individual mandate was the linchpin of the entire law, the provision could not be severed from the balance of the law. As a result, the court reasoned, as of January 1, 2019, Obamacare no longer has any constitutional basis and is invalidated as unconstitutional. The case is on appeal.
Since this ruling in December, two other courts have determined that the individual mandate is a tax. In re Cousins, No. 18-10739, 2019 Bankr. LEXIS 1156 (Bankr. E.D. La. Apr. 10, 2019), held that the provision was a tax for purposes of the bankruptcy Code. The Bankruptcy Code, in accordance with 11 U.S.C. §1328(a), allows a debt to be discharged unless it is listed as a priority claim in 11 U.S.C. §507(a). Priority taxes cannot be discharged, but a penalty amount is dischargeable. In this case, the debtors (a married couple) filed a proof of claim that included a $2,085 mandate assessment which the debtors claimed was dischargeable as a penalty. The IRS disagreed, citing National Federation of Independent Business v. Sebelius, 567 U.S. 519 (2012) in which the U.S. Supreme Court concluded that the assessment was a tax for constitutional purposes and cited the Bankruptcy Code in making its determination. The court also found that refusing to purchase health insurance and instead paying an assessment didn't constitute an "unlawful act," which was a strong indication that the individual mandate was not a penalty. In addition, the legislative history implied that the individual mandate was a tax since Congress referred multiple times to how it would raise revenue, the court said. Thus, the assessment was a nondischrgeable tax and was entitled to priority under 11 U.S.C. §507(a)(8) and the court denied the debtors’ objection to the IRS claim. The same result was reached in United States v. Chesteen, No. 18-2077, 2019 U.S. Dist. LEXIS 29346 (E.D. La. Feb. 25, 2019).
IRS Provides “Guidance” on How Farm Income Averaging Interacts With the QBID
In an item posted to its website shortly after the tax filing deadline, the IRS attempted to provide guidance on the Qualified Business Income Deduction (QBID) and a farmer (or fisherman) that makes an election under I.R.C. §1301 to average income. Under a farm income averaging election, a farm taxpayer’s income tax liability is the sum of the I.R.C. §1 tax computed on taxable income reduced by “elected farm income” (EFI) plus the increase in tax imposed by I.R.C. §1 that would result if taxable income for the three prior years were increased by an amount equal to one-third of the EFI. The IRS has stated that "[i]n figuring the amount [of the]... Qualified Business Income Deduction, income, gains, losses, and deductions from farming or fishing should be taken into account, but only to the extent that deduction is attributable to your farming or fishing business and included in elected farm income on line 2a of Schedule J (Form 1040)."
This appears to be saying that if an income averaging election is made, the taxpayer must use EFI to calculate the QBID. With the “guidance,” the IRS appears to be attempting to construe I.R.C. §199A(c)(3)(A)(ii) in this situation. The IRS may need to issue a further clarification. Elected Farm Income May Be Used To Figure Qualified Business Income Deduction, IRS Website, Apr.19, 2019
S Corporations and the Self-Employed Health Insurance Deduction
Just a few days ago, the IRS confirmed the position that many tax practitioners believed was correct with respect to S corporations and the deduction for self-employed health insurance. I.R.C. §1372 says that, for purposes of applying the provisions of the I.R.C. that relate to employee fringe benefits, an S corporation is treated as a partnership. Likewise, any 2 percent (as defined in I.R.C. §318 as owning more than two percent of the corporate stock) S corporation shareholder is treated as a partner in the partnership in accordance with I.R.C. §1372. An S corporation can deduct the cost of accident and health insurance premiums that the S corporation pays for or furnishes on behalf (i.e., reimburses) of its 2 percent shareholders. The two percent shareholders must include the amounts in gross income in accordance with Notice 2008-1, 2008-2 IRB 251 (i.e., the S corporation reports the amounts as wages on the shareholder’s W-2) provided that the shareholder meets the requirements of I.R.C. §162(l) and the S corporation establishes the plan providing medical care coverage.
Under the facts of C.C.A. 2019012001 (Dec. 21, 2019), a taxpayer owned 100 percent of an S corporation which employed the taxpayer’s family member. The family member is a two-percent shareholder under the attribution rules of I.R.C. §318. The S corporation provides a group health plan for all employees, and the amounts paid by the S corporation under the plan are included in the family members gross income. Provided the requirements of I.R.C. §162(l) are satisfied, the IRS determined that the family member could claim a deduction for the amounts the S corporation paid. Thus, the family member could convert what might be a nondeductible expense (because of either the 10 percent floor for medical expenses or because the family member takes the standard deduction) into an above-the-line deduction.
SALT Deduction Guidance
In early April, the IRS provided guidance on how the $10,000 limitation on the deduction of state and local taxes (SALT) under the TCJA and I.R.C. §280A work in conjunction with each other. For a taxpayer with SALT deductions at or exceeding $10,000, or who chooses to take the standard deduction, none of the SALT relating to the taxpayer’s business use of the home are treated as expenses under I.R.C. §280A(b). However, expenses relating to the taxpayer’s exclusive use of a portion of the taxpayer’s personal residence for business purposes remain deductible under I.R.C. §280A(b) or (c) or under another exception to the general rule of disallowance in I.R.C. §280A. The same rationale applies to other deductions that are subject to various limitations or disallowances, including home mortgage interest and casualty losses. For instance, interest on a mortgage balance exceeding the acquisition debt limitations becomes an I.R.C. §280A(c) limited expense when claiming a home office deduction. IRS Program Manager Technical Advice 2019-001 (Dec. 7, 2018).
Ministerial Housing Allowance
In mid-March, the appellate court issued it’s decision on the Constitutionality of the ministerial housing allowance of I.R.C. §107(2) that excludes from gross income a minister's rental allowance paid to the minister as part of compensation for a home that the minister owns. The plaintiff, an atheist organization, challenged the constitutionality of the provision. The trial court agreed, but the appellate court reversed. The appellate court noted that while the exclusion of housing provided for the convenience of the employer provision was not made available to ministers of the gospel, the Congress soon provided an exclusion for church-provided ministerial housing as well as the cash allowance provision of I.R.C. §107(2) at issue in this case. The appellate court determined that the provision was simply an additional provision providing tax exemption to employees that having a work-related housing requirement. The appellate court viewed a categorial exemption for ministers as requiring much less government “entanglement” in religion than lumping ministers under the general employer-provided housing exclusion of I.R.C. §119. The appellate court also noted the long history of tax exemption for religious organizations, and deemed this long history of significance and that I.R.C. §§107(1)-(2) continued that history. Gaylor, et al., v. Mnuchin, No. 18-1277 (7th Cir. Mar. 15, 2019), rev’g., Gaylor v. Mnuchin, 16-cv-215-bbc, 2017 U.S. Dist. LEXIS 165957 (W.D. Wisc. Oct. 6, 2017).
That’s just a bit of what happened in federal tax during tax season while many of you had your head down plowing through this trying tax season.