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December 18, 2008

Federal Headlines

Capital Contributions to S Corporation Did Not Increase Tax Bases in Loans (Nathel, TC)

 

The Tax Court upheld deficiency determinations against two brothers whose capital contributions to two S corporations did not increase or restore their tax bases in loans they had made to the S corporations. The capital contributions, instead, increased their tax bases in their stock in the S corporations, resulting in additional ordinary income to the brothers when they received loan repayments from the S corporations.

 

The brothers had attempted to allocate the capital contributions such that they increased their tax bases in the loans in order to use the increased tax bases in the loans to offset ordinary income. However, Reg. §1.118-1 specifically provides that capital contributions do not constitute income to an S corporation under Code Sec. 1366(a)(1) and, therefore, such contributions to capital may not be treated as items of income used in calculating any "net increase" (as defined in Code Sec. 1367(b)(2)(B)) to increase or restore a shareholder's tax basis in loans to an S corporation.

 

The brothers also argued that the capital contributions were made to obtain a release of personal guarantees on bank loans and, as such, the contribution amounts should be deductible as ordinary losses under Code Sec. 165(c). The argument failed because the shareholders had not guaranteed the loans for the purpose of making a profit, nor was the release of the guarantees the sole purpose for which the capital contributions were made.

I. Nathel, 131 TC No. 17, Dec. 57,617

Other References:

 

Code Sec. 1366

 

CCH Reference - 2008FED ¶32,084.22

 

CCH Reference - 2008FED ¶32,084.325

 

Code Sec. 1367

 

CCH Reference - 2008FED ¶32,101.25

 

Tax Research Consultant

 

CCH Reference - TRC BUSEXP: 48,108

CCH Reference - TRC SCORP: 402.05

 

School Not Entitled to Refund of Penalties; Failures to File and Pay Not Due to Reasonable Cause (St. Paul Cathedral School, DC Wash.)

 

A private, nonprofit Catholic school was denied a refund of penalties for failure to file federal employment tax returns, to make required tax deposits and to pay its federal employment taxes. The school failed to show that its failures were due to reasonable cause and not willful neglect.

 

The school exercised ordinary business care and prudence by providing for its tax obligations to be discharged by an employee. However, it failed to show that it was unable to pay its taxes (due to lack of funds or disability) or that it would have suffered undue hardship if the taxes had been paid on the dates due. The individual responsible for filing returns and paying taxes was not the school's CEO or CFO, but was an employee subject to the authority of others who failed to adequately supervise her. Although the school was in financial trouble, it failed to contradict evidence that it had access to accounts with sufficient funds available during all the relevant periods to pay the taxes.

St. Paul Cathedral School, DC Wash., 2009-1 USTC ¶50,109

Other References:

 

Code Sec. 6651

 

CCH Reference - 2008FED ¶39,475.455

 

CCH Reference - 2008FED ¶39,475.57

 

Code Sec. 6656

 

CCH Reference - 2008FED ¶39,585.27

 

CCH Reference - 2008FED ¶39,585.62

 

Tax Research Consultant

 

CCH Reference - TRC PENALTY: 3,062

CCH Reference - TRC PENALTY: 3,304

 

Senate Tax Aide Predicts Congress Will Pass Early Stimulus Bill for Obama to Sign

 

A tax aide to a Republican member of the Senate Finance Committee (SFC) predicted that the new Congress will act quickly in January 2009 to pass stimulus legislation and have it ready for President Barack Obama to sign when he takes office. The SFC could see a markup scheduled for as early as January 8, even before the committee finishes organizing itself, although it would be unusual to have legislation ready for the new president to sign. The aide spoke to practitioners on December 17 at a BNA Tax Management Luncheon held at Buchanan, Ingersoll & Rooney in Washington, D.C.

 

With the new president not yet in office, there is a void in leadership, the aide said. SFC Chairman Max Baucus, D-Mont., aims for the committee to have a role in stimulus legislation and wants a tax element in it. House Speaker Nancy Pelosi, D-Calif., has predicted a stimulus package of $600 billion, including $200 million in tax provisions. Both Republicans and Democrats support tax aid to the states, infrastructure help and food stamp increases.

 

The aide believes that a second round of stimulus checks is unlikely. There are proposals for a payroll tax holiday, but that might not help people looking for work. The Republicans would prefer that bonus depreciation be extended.

 

Sen. Orrin Hatch, R-Utah, is supporting expanded net operating loss (NOL) relief, such as an increase in the carryback period from two years to at least four years. Some may propose a 10- to 15-year carryback period, to move the proposal. An increased carryback period would help companies that have already maximized their carrybacks and cannot benefit from carryforwards since they are operating at a loss. Similarly, tax credits for wind and other renewable energy development do not help companies with losses. One company has called for a refundable credit, the aide noted.

 

Hatch supports a permanent research credit, which he believes would have a stimulus effect. There is no discussion of a capital loss carryback for individuals, but there is some support for increasing the current $3,000 limit on deductible losses.

 

Because a stimulus bill probably will not be governed by pay-as-you-go (PAYGO) requirements for offsets, Senate members may want to expand the bill's scope to include middle-class tax cuts or estate tax relief, for example. Unlike the Senate, the aide pointed out, the House may be more deferential to the new president, since it is generally governed by majority rule, without requiring the support of 60 members.

Subsequent Measures

 

As soon as the economy starts to improve, Congress will shift its focus to reining in deficits, the aide predicted. The congressional Blue Dogs want a statutory requirement for PAYGO, rather than just an in-house rule. The aide expects Congress to impose some discipline on tax bills, but Republicans and Democrats may debate whether spending cuts or raising taxes is the appropriate solution. At some point, Congress will be looking for more revenue, which could come from tax increases, changes to the carried interest rules or codification of the economic substance doctrine.

 

Both sides support estate tax reform, although they may differ on the exemption level and the rates. The aide believes that Congress will want to address the estate tax in 2009, and he expects action to be taken.

 

Obama supports both tax cuts and increases. His chief of staff, Rahm Emanuel, initially said that the new administration does not want to wait but, since then, Obama has backed off on imposing new increases while economic stimulus is a concern. It is an open question whether Congress will take action on the 2001 tax cuts that are set to expire at the end of 2010.

 

Congress is ready to talk about health care reform, the aide stated. Both Baucus and Sen. Edward M. Kennedy, D-Mass., are very interested. Reform could include changes to the health insurance exclusion. One proposal for a cap would raise $350 billion over 10 years. This is viewed as a health care issue, not as tax reform. Republicans will insist that any savings be plowed back into health reform, rather than used to support other spending measures, the aide said.

 

It is not clear that Congress is ready to move on broader tax reform, the aide indicated, even with reform proposals from the House Ways and Means Committee. The president must take the lead, but Obama has not said much on this subject. More education is also needed. There has been no talk of 1986-type reform, involving a broadening of the tax base.

 

By Brant Goldwyn, CCH News Staff

State Headlines

New Mexico --Sales and Use Tax: U.S. Supreme Court Asked Whether Non-Sales Acts of Third Party Can Create Nexus

 

A remote seller has asked the U.S. Supreme Court whether New Mexico may impose its gross receipts tax on the seller's sales into the state based solely on the activities of a third-party contractor that provides post-sale services to New Mexico buyers. The seller has told the Court that an answer is needed to resolve a split of state court authority over the scope of Tyler Pipe, 483 U.S. 232 (1987) and Scripto, Inc., 362 U.S. 207 (1960).

 

The Texas-based seller is an Internet- and mail-order retailer of computers. It offered service contracts to buyers for on-site repair of its computers in New Mexico by a third-party contractor. The New Mexico Taxation and Revenue Department audited the seller and imposed an assessment for gross receipts tax on sales of its computers to New Mexico residents. The seller challenged the assessment on the basis that it does not have a physical presence in New Mexico and, therefore, lacked the requisite substantial nexus with the state that would impose a collection obligation consistent with Commerce Clause requirements.

 

The New Mexico Court of Appeals held that the third-party contractor's activities helped the seller establish and maintain a market in New Mexico. Therefore, the seller, through its relationship with the contractor and the contractor's activities in New Mexico, had a substantial nexus with the state and, consequently, the Department's imposition of gross receipts tax did not violate the Commerce Clause. (TAXDAY, 2008/06/09, S.12) The seller argued unsuccessfully that, under Tyler Pipe and Scripto, a third party must be engaged in sales-related activities in order to establish substantial nexus for a seller. The contractor in this case was not engaged in sales solicitations. However, the Court of Appeals held that the fact that the U.S. Supreme Court has not yet addressed the question of whether a third party's non-sales activities in the taxing state can create nexus does not mean that the high court has held that such activities cannot provide such nexus. The New Mexico Supreme Court denied review.

 

Subscribers to CCH Tax Research NetWork can view the petition.

 

 

Dell Marketing L.P. v. New Mexico Taxation and Revenue Department, U.S. Supreme Court, Dkt. 08-770, petition for certiorari filed December 15, 2008

 

North Carolina --Personal Income, Sales and Use Taxes: Constitutional Challenge to Google Incentives Dismissed

 

The North Carolina Superior Court has dismissed an action that challenged the constitutionality of a sales and use tax exemption for eligible Internet data centers as well as the initial approval of a grant equal to 75% of the state personal income tax withholding derived from the creation of new jobs. The suit, filed by the North Carolina Institute for Constitutional Law (NCICL), challenged: (1) legislation enacted in 2006 that grants a sales and use tax exemption for sales of electricity used at an eligible Internet data center and eligible business property to be located and used at such a center; and (2) a Job Development Investment Grant (JDIG) initially approved for Google but never finalized, to facilitate the construction of a data center to support Google's online operations and create jobs. The suit claimed that these actions violated the state constitution in that the tax benefits and other economic incentives or subsidies accrued to Google's private financial benefit and that Google was provided these benefits merely for operating its own private business and not in exchange for any public service. The plaintiffs, who sued in their individual capacities as North Carolina residents and taxpayers, alleged that the legislation was enacted solely to encourage Google to construct an Internet data facility in Lenoir, in Caldwell County, North Carolina.

 
No Violation of Public Purpose Clause

 

The court held that the incentives did not violate the Public Purpose Clause of the state constitution. The challenged governmental activity (i.e., the incentives offered to Google and others similarly situated) constituted an economic development program designed to encourage the construction of Internet service provider and Web portal facilities in economically distressed counties in the state. That purpose is within the proper scope of governmental authority to stimulate the economy, promote job creation, and increase the tax base. Moreover, despite the plaintiff's arguments that the incentives inure to Google's sole benefit and do not benefit the public generally, the court found that an act that promotes the welfare of a state or local government and its citizens is for a public purpose. As such, the incentives satisfy the Public Purpose Clause as a matter of law because they are directly aimed at furthering the general economic welfare of the people.

 
No Violation of Exclusive Emoluments Clause

 

The plaintiffs also challenged the incentives package as violative of the Exclusive Emoluments Clause of the state constitution, which holds that no person is entitled to exclusive or separate emoluments or privileges from the community but in consideration of public services. The court noted prior decisions that held that where an incentive was determined to promote the public benefit under the Public Purpose Clause, it necessarily is not an exclusive emolument. Since the court had already concluded that the incentives offered to Google and others similarly situated comport with the Public Purpose Clause as a matter of law, they were bound to conclude that the incentives do not violate the Exclusive Emoluments Clause.

 
No Personal Rights Deprivation or Discrimination

 

Lastly, the plaintiffs also alleged that the incentives were contrary to a provision of the state constitution that requires that taxing power be exercised in a just and equitable manner. In each of these causes of action, the plaintiffs claimed they had suffered a deprivation of personal rights or a type of discrimination. The plaintiffs, individual taxpayers who were not manufacturers or Google competitors, did not allege a specific injury that they themselves suffered or would suffer or any deprivation of rights guaranteed to them. Even if the plaintiffs, as citizens and taxpayers, suffered an increased tax burden as a result of incentives obtained by Google, that is insufficient as a matter of law to create standing for such causes of action. The court held that the plaintiffs failed to demonstrate that they belonged to a class that is prejudiced by the operation of the incentive legislation and the JDIG grant, and as such, they lacked standing to bring claims for relief under this constitutional provision.

 
Appeal Filed

 

According to counsel for the NCICL, a Notice of Appeal of the dismissal was filed on December 12, 2008.

Munger v. North Carolina, North Carolina Superior Court, No. 07 CVS 11756, November 14, 2008, ¶202-431; Telephone Interview, counsel for North Carolina Institute for Constitutional Law, December 17, 2008

 

Other References:

 

Explanations at ¶61-610

 

Utah --Sales and Use Tax: Tax Rate for Non-Nexus Filers Changes January 1

 

Effective January 1, 2009, the tax rate for sales of non-food items shipped into Utah by sales and use tax filers who do not have a direct or representational presence within Utah ("non-nexus" sellers) is the full combined state and local rate for the delivery location. For 2008, a statewide tax rate of 5.9% applied to sales of non-food items shipped into Utah by non-nexus sellers.

 

Subscribers to CCH Tax Research NetWork can view information released by the Utah State Commission on the change.

 

 

Tax Bulletin 12-08, Utah State Tax Commission, December 15, 2008

 
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