WASHINGTON TAX UPDATE

Transcription

1 WASHINGTON TAX UPDATE SEPTEMBER 7, 2011 Welcome to Washington Tax Update, where you will find useful information about taxes, including current events in our nation s capital, as well as informed opinions and predictions about what is expected to happen. Tax Look Inside Tax Planning Tip of the Week IRS Courts What s New from the IRS What s New from the Courts It Bears Repeating Tax Laughs Congress

2 tax planning tip of the week IRS grants tax deadline relief to taxpayers affected by hurricane On Sept. 1, 2011, the IRS announced that it is granting taxpayers whose preparers were affected by Hurricane Irene until Sept. 22 to file returns normally due Sept. 15. Your preparer must be located in an area that was under an evacuation order or a severe weather warning because of Hurricane Irene, even if the preparer is located outside of the federally declared disaster areas. This relief, which primarily applies to corporations, partnerships and trusts that previously obtained a tax filing extension, is available regardless of your location. It does not apply to any tax payment requirements. The IRS also announced that certain taxpayers in North Carolina, New Jersey, New York, Vermont and Puerto Rico will receive tax relief, and other locations are expected to be added in coming days, following additional damage assessments by the Federal Emergency Management Agency (FEMA). You should monitor newsroom/article/0,,id=108362,00.html for updates.

3 The tax relief postpones certain tax filing and payment deadlines to Oct. 31, It includes corporations and businesses that previously obtained an extension until Sept. 15, 2011, to file their 2010 returns and individuals and businesses that received a similar extension until Oct. 17. It also includes the estimated tax payment for the third quarter of 2011, which would normally be due Sept. 15. Full details, including the start date for the relief in various locations, and information on how to claim a disaster loss by amending a prior-year tax return, can be found in tax relief announcements for individual states. The tax relief is part of a coordinated federal response to the damage caused by the hurricane and is based on local damage assessments by FEMA. For information on disaster recovery, visit tax planning tip of the week

4 what s new from the IRS When must tax be withheld from retirement distributions? The IRS has released a summary of the rules governing under what conditions retirement plan distributions are subject to withholding. The summary is contained in the Summer 2011 edition of the IRS Retirement News for Employers. Distributions from an employer-sponsored retirement plan may or may not be subject to withholding depending on the nature of the payment. In some cases, withholding is mandatory and, in others, the recipient can elect to have no withholding taken out. Eligible rollover distributions The payor of any designated distribution that is an eligible rollover distribution must generally withhold an amount equal to 20 percent of the distribution. A designated distribution is a distribution or payment from, or under: An employer deferred-compensation plan An IRA or individual retirement annuity A commercial annuity An eligible rollover distribution generally is a plan distribution from an eligible retirement plan, other than: A periodic distribution A minimum required distribution A hardship distribution

5 Eligible rollover distributions are not subject to withholding if expected distributions to an individual are less than $200 for the year. Also, 20 percent withholding generally applies only to any previously untaxed amount of an eligible rollover distribution. Most important, no withholding is required if the plan directly rolls over, in a trustee-to-trustee transfer, the eligible rollover distribution amount to another qualified retirement plan or IRA. Periodic payments Periodic payments are made at regular intervals for more than one year, such as an annuity. The payor of a periodic payment that is not an eligible rollover distribution must withhold from the payment as if it were a wage payment for the appropriate payroll period. Generally, the plan administrator must withhold at the rate for a married individual with three withholding exemptions. However, recipients have the right and must be so informed by the plan administrator to: Elect no withholding or elect to have a different amount withheld, by filing Form W-4P, Withholding Certificate for Pension or Annuity Payments, with the plan administrator; and Revoke the election at any time.

6 Nonperiodic payments A nonperiodic payment is a distribution that usually is not made at regular intervals and is not an eligible rollover distribution. Examples of nonperiodic payments are: Distributions of excess annual additions Distributions of excess contributions and excess aggregate contributions from most plans if made within 2½ months after the end of the plan year Hardship distributions Loans treated as distributions Nonperiodic payments generally are subject to 10 percent withholding. However, the recipient may elect no withholding or have a different amount withheld by filing a Form W-4P with the plan administrator. Special situations Special rules apply to: Distributions made because of recognized disasters Distributions delivered outside the United States or U.S. possessions Certain noncash distributions, including employer securities A participant s accrued benefit offset because of a defaulted loan For distributions from designated Roth accounts in 401(k), 403(b) or 457(b) plans, there is no withholding for a qualified distribution from a designated Roth account because the distribution is not taxable. If a nonqualified distribution is made from such an account, withholding is required only from any distributed earnings that the recipient must include in gross income. Read more at what s new from the IRS

7 what s new from the courts Court rules on income classification for sale of trade secrets A court of appeals has upheld a Tax Court decision that a sausage manufacturer received ordinary income, rather than capital gain, when it settled a lawsuit involving trade secrets. In the early 1980s, C&F Packing Co., Inc. (C&F), developed a process for making and freezing pre-cooked sausage that had the appearance and taste of home-cooked sausage. C&F applied for and obtained a patent protecting its new process. In 1985, Pizza Hut expressed an interest in using sausage made by the C&F process if C&F would agree to share the process with Pizza Hut s other sausage suppliers so that Pizza Hut could offer its customers a uniform product. The two companies signed an agreement in which C&F disclosed to Pizza Hut information relating to the C&F process, and Pizza Hut promised confidentiality. C&F also entered into separate confidential licensing agreements with several of Pizza Hut s other suppliers. Pizza Hut failed to buy sufficient quantities of sausage from C&F and allegedly it has never admitted wrongdoing divulged crucial information regarding the C&F process to IBP, Inc., another meat processing company with which C&F had not signed a confidentiality or licensing agreement. IBP replicated the C&F process, set its prices below C&F s and began selling large quantities of sausage to Pizza Hut. C&F eventually filed suit against both Pizza Hut and IBP, alleging that Pizza Hut misappropriated its trade secrets, causing C&F to suffer lost profits, lost opportunities, and operating losses and expenditures.

8 Pizza Hut and C&F settled the trade secret misappropriation claim with a cash payment to C&F. C&F characterized its $6.12 million as gain from a trade secret sale and reported the entire amount as long-term capital gain. The IRS determined that the settlement was ordinary income. In court, C&F raised three arguments in support of the position that the settlement proceeds should be taxed as long-term capital gain: 1. Relying on cases that held that moneys received for injury or damage to capital assets are taxable as capital gain, C&F argued that the settlement was payment for damage to trade secrets, which are capital assets. 2. Recognizing that long-term capital gain is defined in terms of the sale or exchange of capital assets, C&F asserted that the settlement payment represented the culmination of a sale or exchange of the trade secrets related to the C&F process. 3. Looking to the portion of the tax law that treats as capital gain income attributable to the termination of certain rights or obligations, C&F contended that Pizza Hut made the settlement payment to terminate C&F s rights under the confidentiality agreement the parties signed in The Tax Court and the Court of Appeals rejected all three arguments and sustained the IRS s determination that the settlement proceeds should be taxed as ordinary income. In essence, both courts relied on the origin of the claim doctrine and viewed the payment as compensating C&F for lost profits. Lost profits result in ordinary income rather than capital gain. (Freda, et. al. v. Commissioner, 108 AFTR 2d 2011-XXXX, Aug. 26, 2011)

9 it bears repeating New businesses can deduct startup expenses, says IRS The costs associated with starting up a new business, as well as the costs of forming a new corporation or partnership, receive special treatment under the tax law. Startup costs You may deduct startup expenses in the amount of the lesser of the actual expenses or $5,000, reduced by the amount by which the expenses exceed $50,000. Organization costs A corporation or partnership may deduct organizational expenses in the same amount. In both cases, costs not currently deducted may be amortized ratably over 180 months. The IRS has released final regulations on the deduction of the startup expenses incurred in the year a taxpayer begins an active trade or business, or of the organizational expenses of a corporation or partnership in the year in which it begins business. The regulations provide that a taxpayer wishing to capitalize startup and organizational costs must affirmatively elect to do so. Otherwise, the taxpayer is deemed to have elected to amortize the startup or organizational costs. The text of the final regulations is at T.D

10 tax laughs Can you imagine being so rich that you forgot $3.4 million? Apparently, that is what happened to Stephen Woodsum. In 2006, Woodsum and his wife had adjusted gross income of almost $33 million. That year, they filed 27 state income tax returns and a joint federal income tax return. As one might expect, the couple hired an experienced tax preparer and handed over more than 160 information returns, including various Schedules K-1 and Forms The resulting federal return contained no less than 115 pages. There seems to be no disagreement that included among the 160+ information documents turned over to the preparer was a Form 1099-MISC from Deutsche Bank reporting a $3.4 million gain. But somehow, the gain never made it into the 115-page tax return. When the IRS alerted Woodsum that the gain had been overlooked, he promptly agreed and paid the $521,473 additional tax due. The only problem was that the IRS also wanted a $104,295 accuracy-related penalty that Woodsum objected to.

11 Woodsum claimed that he should not be penalized because he took every reasonable step to file a complete and accurate return: He hired a competent, experienced preparer. He provided the preparer with all the relevant information, including the Form 1099 in question. He met with the preparer to review the return before signing it. He filed the return on time. He paid the tax shown on the return and the additional amount requested by the IRS. Unfortunately for Woodsum, the judge believed that overlooking $3.4 million showed he was not diligent in reviewing the finished return. The judge noted that Woosum showed a watchful eye when managing his investments, but his review of his tax return was so casual that a half-million-dollar understatement of tax slipped between the cracks. Fine: A bribe paid by a rich man to escape the lawful penalty of his crime. Henry Lewis Mencken

12 Courts Tax IRS Congress The technical information in this newsletter is necessarily brief. No final conclusion on these topics should be drawn without further review and consultation. Please be advised that, based on current IRS rules and standards, the information contained herein is not intended to be used, nor can it be used, for the avoidance of any tax penalty assessed by the IRS CPAmerica International