Ferguson Grand Jury Presents an Opportunity
. . . from the perspective of a legal mind, that is. Please excuse this off-topic post, but the Ferguson, Missouri recently decided not to indict. Twitter and other social media are buzzing with commentary about the protesters, opinions about racism, and knee-jerk reactions. All is based on very little evidence.
Fortunately, Margie Freivogel from the local NPR station posted a link on Twitter to the actual transcripts of the Grand Jury itself. http://apps.stlpublicradio.org/ferguson-project/evidence.html.
Irrespective of subject matter, the law should be about an adversarial matching of facts and evidence against the democratically created rules of law. The ultimate conclusion about a case-civil or criminal-ought to be decided by impartial citizens (sometimes a judge) based on the most credible presentation of the case.
The Ferguson grand jury was given the state's strongest case. Police, investigators, and prosecutors presented all that they could. This was done without a defense attorney fighting back. The rules of evidence are much less strict, so more information was presented than that could be presented in a criminal trial. The jury voted against indictment. That is, they found no probable cause for a murder or manslaughter prosecution of Darren Wilson. Prior to this, a prosecutor (likely a whole team of them) also determined that there was no probable cause to indict.
So before you endorse the federal government's promise to investigate or indict for civil rights violations (a third review of Mr. Wilson's fault in the matter), ask yourself whether you support the rule of law and justice based on evidence (please read the transcripts), or a result based on prejudice, hype, and mob mentality.
Last week, the IRS clarified its new position on IRA rollovers. One-a-year Limit on Rollovers, IR 2014-107 (Nov. 10, 2014). In short, the IRS will only allow one rollover per year between a person's IRAs-"An individual could not make an IRA-to-IRA rollover if he or she had made such a rollover involving any of the individual’s IRAs in the preceding 1-year period." Internal Rev. Bulletin 2014-16 (Apr. 14, 2014). The IRS will begin to follow the Tax Court's interpretation of the applicable IRA laws as set out in Bobrow v. IRS, T.C. Memo 2014-21 (Jan. 28, 2014) in January 2015.
Powell v. IRS, T.C. Memo. 2014-235 (Nov. 17, 2014).
Monday’s Powell v. IRS is yet another small business case (S Corporation) in which many tax incentives were at issue. Code sections 162 (trade or business expenses), 166 (bad debt deduction), 1001 (capital gains), 1372(employee benefits in an S Corp), and many more are discussed in the case. As no new legal interpretations are offered in this Memorandum Opinion, it is a good read for any small business owner.
The discussion of 162 trade or business expense deductions (beginning on page 7) is particularly instructive for new business owners. New enterprises cost a lot of time and money in the start-up phase. Code sections 162 and 212 account for the costs of doing business by creating deductions for “ordinary and necessary expenses paid or incurred during the taxable year in carrying on a trade or business.” Powell, at p. 7. Most notably, “A taxpayer is not carrying on a trade or business under section 162(a) until the business is functioning as a going concern and performing the activities for which it was organized.” Id. at p. 7. These deductions mean that Congress only taxes the new money-the profit.
In this case, the Powells had a Virginia S Corporation in the petroleum industry. They began a side business in North Carolina for growing and selling beer hops. The Powells purchased some land, unsuccessfully grew and sold hops, and sold the land a substantial loss. Powell, at p. 4. They attempted to deduct (on a 1040 Schedule C) related to their beer hop growing business. Id. at p. 8. The IRS denied that this was a proper use of the 162 deduction because the taxpayers were merely preparing to engage in business, but not actually “carrying on” a business at that time. Although Mr. Powell had purchased realty, incorporated his business for this purpose, planted some hops, and contacted buyers, the Tax Court agreed that he was not actively engaged in a trade or business because it wasn’t conducted with sufficient continuity and regularity. Id. at p. 9.
The IRS's tax forms and schedules always contain the official, updated dollar thresholds for each tax year. Consequently, the only reason to track these numbers in the abstract is for tax planning purposes and building your base of tax trivia knowledge:
The top marginal tax rate of 39.6 % affects singles whose income exceeds $413,200 ($464,850 for married taxpayers filing a joint return), up from $406,750 and $457,600, respectively. The other marginal rates – 10, 15, 25, 28, 33 and 35 % – and the related income tax thresholds are described in Rev Proc 2014-61.
The standard deduction has grown to $6,300 for singles and married persons filing separate returns and $12,600 for married couples filing jointly, up from $6,200 and $12,400, respectively, for tax year 2014. The standard deduction for heads of household rises to $9,250, up from $9,100.
. . .
The personal exemption for tax year 2015 is up to $4,000, from the 2014 exemption of $3,950. However, the exemption is subject to a phase-out that begins with adjusted gross incomes of $258,250 ($309,900 for married couples filing jointly). It phases out completely at $380,750 ($432,400 for married couples filing jointly.)
. . .
The 2015 maximum Earned Income Credit amount is $6,242 for taxpayers filing jointly who have 3 or more qualifying children, up from a total of $6,143 for tax year 2014. The revenue procedure has a table providing maximum credit amounts for other categories, income thresholds and phaseouts.
Estates of decedents who die during 2015 have a basic exclusion amount of $5,430,000, up from a total of $5,340,000 for estates of decedents who died in 2014.
For 2015, the exclusion from tax on a gift to a spouse who is not a U.S. citizen is $147,000, up from $145,000 for 2014.
For 2015, the foreign earned income exclusion breaks the six-figure mark, rising to $100,800, up from $99,200 for 2014.
The annual exclusion for gifts remains at $14,000 for 2015.
Cavallaro v. IRS, T.C. Memo 2014-189 (Sept. 17, 2014).
The legal formalities of business entities and modern wealth transfer techniques must be understood and respected to minimize tax exposure when structuring wealth transfers between generations. The case of Cavallaro v. IRS, published by the Tax Court last month (September 2014), demonstrates the potentially dire consequences of failing to recognize the legal significance of new business entity formation and properly planning for the transfer of wealth between generations. There, the patriarch (Mr. Cavallaro) embodied the American small business dream—a trade school graduate who could barely read, but who formed a family tool-making company (Knight Tool Co.) which was eventually so successful that it supported his family, created the impetus for his three sons to go to college, and eventually provided professional employment opportunities for he and his family members. Id. at pp. 6-8.
As an adult, the youngest of the Cavallaro sons assisted his father and the Knight engineers in developing a new liquid-dispensing machine, the CAM/ALOT. Id. at pp. 9-10. The liquid-dispensing machine eventually became the bread and butter of Knight. Id. at pp. 11-12. But Mr. and Mrs. Cavallaro decided to refocus their company on tool making again in the late 1980s. So their sons, led by Ken Cavallaro (the oldest), were allowed to use the CAM/A LOT as the core product of a new corporation—Camelot Systems, Inc. Id. at p. 13.
At the time, the family thought a transfer of the CAM/A LOT had been successfully and informally made such that that Mr. Cavallaro and his old company—Knight—could continue to shepherd his sons and their new company—Camelot—without the formalities required of arms-length transaction. The fallacy of that assumption had real, if still unknown, consequences at the time. The implications of the attempted 1987 transfer finally manifested themselves in 1995 when the family attempted a tax-free merger of Knight Tool with Camelot (presumably under IRC § 368). When the dust settled, Mr. and Mrs. Cavallaro (who had formerly owned 100% of Knight and its intellectual property) ended up with 38 shares (19%) of the surviving Camelot Corporation; their sons equal shares of the remaining 162 (81%). Id. at pp. 32-33. This kind of ownership transfer is a red flag for the IRS and tax planners.
The error lay with the legal experts who failed to recognize the tax implications of the 1987 transaction. Specifically, a diligent search should have been conducted regarding the ownership of the CAM/A LOT technology in 1987, which was the most valuable item changing hands. See Id. at p. 55. Only then could proper planning avoid triggering the income or gift tax between 1987 and 1995 with the help of appropriate wealth-transfer tools.
The mistake was practical more so than legal. Good attorneys treat the factual details of their work with the utmost respect. With proper diligence, the law can be correctly applied to the facts. With good evidence at one’s disposal, there are many appropriate practical and legal mechanisms by which such a wealth transfer such as this is possible. Assuming Mr. and Mrs. Cavallaro could have continued operating Knight from 1987 to 2014 instead of participating in litigation, there would have been an additional 27 years to structure and execute a wealth transfer plan that would, at the very least, have reduced the $13 million tax bill they now face. The best way to do this, that also existed in 1987, would have been by means of an Employee Stock Ownership Plan (ESOP).
ESOPs allow business owners to reduce their proportionate investment in their company and build a diversified portfolio of other assets (like regularly traded securities) without immediately triggering gains that suck much-needed cash out of their going business concerns. This incentive could have been utilized here if Knight Co. had set up an ESOP trust. The Cavallaro parents could have designated themselves as the initial ESOP trustees. From there, a bank loan to the ESOP could have been used to purchase a large portion of the Cavallaro parents’ stock (say 30%). To receive preferable tax treatment, he Cavallaros would have also had to reinvest the money they received from this transaction into a diversified portfolio of stocks and bonds in U.S. companies. As such, a properly structured and qualified ESOP would have allowed the Cavallaros to avoid recognizing income tax gain on the sale until the replacement securities were sold. At the same time, Knight could have begun making tax-deductible contributions to the ESOP to repay the loan. Ultimately, the three Cavallaro sons could have continued working for Knight and developing the CAM/ALOT technology under the supervision of Mr. Cavallaro. The sons would also have benefitted from their respective interests in the ESOP at retirement, disability or death.
Although additional planning and structuring would be needed so the Cavallaro boys’ families could reduce income and gift/estate taxes when the sons ultimately received money from the ESOP, even a small reduction in the taxable amount transferred between two separate companies (30% in this example) of the $29.6 million (see p. 46) trapped within Knight would have greatly improved the tax positioning of the Cavallaros as it was ultimately determined to be in this case. Moreover, the use of modern gift and estate tax exemption and deduction amounts could have been further used to reduce the tax bill. In short, modern small and moderate sized business owners need to pay attention to wealth structuring and tax planning from early on in their careers to proactively reduce or eliminate unexpected future tax bills.
Cantor v. IRS, T.C. Summary Opinion 2014-103 (Nov. 6, 2014).
The Tax Court put out a couple cases last Thursday (11/6), none friday. Cantor v. IRS, TC Summary Op 2014-103 does a bit of an injustice to blue collar businessmen. There, taxpayer was in the business of automotive, residential, and commercial glass install/repair. He also owned some rental property connected with his business. Taxpayer attempted to deduct his losses from his realty activities, but the IRS and TC allowed the Sec. 469 passive investment loss limitations to stop him. The injustice was that the Court focused on a narrow distinction of Taxpayer's activities--separating installation activities from what it construed to be actual construction. He, like other tradesmen making ends meet don't track their time between activities like lawyers (and former lawyers--TC judges). See pp. 10-11. So Taxpayer's attempt to deduct losses for his realty (which were really just costs of doing business) was disallowed basically because he doesn't keep 6-minute records of his activities. Pretty harsh record-keeping requirement if you ask me.
Kernan v. IRS, T.C. Memo 2014-228 (Nov. 3, 2014).
Tax denier cases (i.e. the IRS has no authority over me, so I’m not paying taxes) are entertaining for attorneys because of the crazy antics such litigants (often pro-se) pull. Monday's Kernan v. IRS, T.C. Memo 2014-228 (Nov. 3, 2014) is one such case in which the petitioner refused to pay taxes, citing IRC Sec. 6001 language which, to his credit, makes it sound like the IRS needs to serve notice of annual 1040 filing requirements before taxes are due from taxpayers. But any case in which a litigant refuses to obey even the court’s word limit stipulations is probably not going to go well for him. Mr. Kernan’s briefs were struck because he obliterated the 75 page limit despite agreeing to it before the judge. He prevented his own “novel” arguments from even being before the court.
Also notable from this case:
"Judges impose page limits for a reason. They force parties to hone their arguments and to state those arguments succinctly. Page limits cause, or should cause, parties to dispense with arguments of little or no merit in favor of those arguments that have a better chance of carrying the day. They encourage parties to avoid redundancy. And repetition.
"Parties often are quite creative in their efforts to circumvent page limits. Among the most blatant methods is to put material into an appendix and to not count that appendix as falling within the page limits. Another is to incorporate another document by reference. . . . "
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