This Insights blog is Part 2 of a 3-Part series focused on the unrelated business income tax rules for the nonprofit organization that is tax-exempt pursuant to section 501(c)(3) of the Internal Revenue Code (the “Code”).

Part 1—Tax Exemption and Unrelated Business Income Tax (UBIT): The Framework—provided an overview of the organizational and operational tests of section 501(c)(3) of the Code and alluded to the trigger for unrelated business income rules.

This Part 2 dives deeper into the unrelated business income tax rules.

Summary of Unrelated Business Income Tax Laws and Regulations

Generally, a tax-exempt organization must pay income tax on income classified as unrelated business income. 26 U.S.C. § 511(a). An unrelated trade or business is any trade or business, regularly carried on, the conduct of which is not substantially related to the organization’s exempt purpose. 26 U.S.C. § 513(a). Modifications, exclusions, and exceptions exist.

Section 512 of the Code contains several exceptions and about 20 modifications to general rule for taxation of unrelated business taxable income. Section 512 excludes from the definition of unrelated business taxable income from passive investments, royalties, and rent from real property and personal property rented with real property, provided no more than an incidental amount of the rent payment is allocated to the rental of the personal property.

The applicability of a particular exception or modification will depend on the numerous facts and circumstances of the income-driving trade or business in issue, the type of organization that conducts such trade or business, and other factors contained in or required by the Code and related Treasury Regulations.

General Rule of Unrelated Business Taxable Income

If an organization that is exempt from federal income taxes under section 501(a) of the Code produces income from an unrelated trade or business, that income is called unrelated business income and is taxable, unless a modification, exclusion or exception applies. See 26 U.S.C. §§ 511(a)(1), 512-514; see also IRS Unrelated Business Income Tax (providing guidance on the subject).

“Unrelated Trade or Business” and “Unrelated Trade or Business Taxable Income”

Generally, an activity is an unrelated business if the activity meets three requirements: (1) it is a trade or business, (2) it is regularly carried on and (3) it is not substantially related to furthering the exempt purposes of the organization.

Section 513 of the Code defines an unrelated trade or business as “any trade or business the conduct of which is not substantially related (aside from the need of such organization for income or funds or the use it makes of the profits derived) to the exercise or performance by such organization of its charitable, educational, or other purpose or function constituting the basis for its exemption under section 501[.]” See 26 U.S.C. § 513(a).

The term “unrelated business taxable income” means the gross income derived by any organization from any “unrelated trade or business” (as defined in section 513) regularly carried on by the organization, less applicable deductions connected with the carrying on of such trade or business, computed with the modifications in subsection 512(b). See 26 U.S.C. § 512(a)(1).

Regularly Carried On

Whether a trade or business for these purposes is “regularly carried on” is determined by evaluation of the frequency and continuity with which the activities productive of the income are conducted and the manner in which those activities are pursued. Specific business activities of an exempt organization will ordinarily be deemed to be “regularly carried on” if, for example, “they manifest a frequency and continuity, and are pursued in a manner, generally similar to comparable commercial activities of nonexempt organizations.” 26 C.F.R. § 1.513-1(c)(1).

What is “regular” from a timing or performance perspective depends on the industry involved, any non-exempt market performance of similar activities, and the type of activity. The Treasury Regulations provide these rules and examples:

Where income producing activities are of a kind normally conducted by nonexempt commercial organizations on a year-round basis, the conduct of such activities by an exempt organization over a period of only a few weeks does not constitute the regular carrying on of trade or business. For example, the operation of a sandwich stand by a hospital auxiliary for only 2 weeks at a state fair would not be the regular conduct of trade or business. However, the conduct of year-round business activities for one day each week would constitute the regular carrying on of trade or business. Thus, the operation of a commercial parking lot on Saturday of each week would be the regular conduct of trade or business. Where income producing activities are of a kind normally undertaken by nonexempt commercial organizations only on a seasonal basis, the conduct of such activities by an exempt organization during a significant portion of the season ordinarily constitutes the regular conduct of trade or business. For example, the operation of a track for horse racing for several weeks of a year would be considered the regular conduct of trade or business because it is usual to carry on such trade or business only during a particular season.

Id. at § 1.513-1(c)(2)(i).

Exceptions to “Unrelated Trade or Business”

Certain activities are expressly excepted from the meaning of “unrelated trade or business.” For the exceptions to apply, the organization and the activity producing the income must be evaluated.

For example, “unrelated trade or business” does not include (1) qualified fair or exposition public entertainment activities of certain organizations which regularly conduct, as one of its substantial exempt purposes, an agricultural and educational fair or exposition; (2) qualified convention and trade show activities that attract persons in an industry generally as well as members of the public for the purpose of displaying industry products or to simulate interest in the particular industry. Qualified hospital services, qualified bingo games, and, of course, certain pole-rental activities are also excluded from the meaning of “unrelated trade or business” for organizations described in these carve outs set forth in section 513. See id. at § 513(d)-(h).

Qualified sponsorship payments are also excepted from the meaning of “unrelated trade or business.” A “qualified sponsorship payment” is any payment made by any person engaged in a trade or business with respect to which there is no arrangement or expectation that such person will receive any substantial return benefit other than the use or acknowledgement of the name or logo of such person’s trade or business in connection with the activities of the organization that receives such payment. Limitations apply, such as conditioning the payment on factors relating to the degree of public exposure to a particular event. See id. at § 513(i)-(i)(3).

Modifications to “Unrelated Business Taxable Income”

“Except as otherwise provided in this subsection, the term “unrelated business taxable income” means the gross income derived by any organization from any unrelated trade or business (as defined in section 513) regularly carried on by it, less the deductions allowed . . . which are directly connected with the carrying on of such trade or business, both computed with the modifications provided in subsection (b).” 26 U.S.C. § 512(a)(1) (emphasis added).  Generally, gross income from an unrelated trade or business, and the applicable deductions related to that income, are computed the same way in which corporate income taxes are calculated. See 26 U.S.C. §§ 511(a) (corporate rates applicable), 162 (trade or business expenses), 167 (depreciation).

There are about 20 modifications contained in subsection 512(b). They include the following:

• Dividends and Interest. Subsection section 512(b)(1) excludes dividends, interest income, and payments with respect to securies loans, amounts received or accrued as consideration for entering into agreements to make loans, and annuities, and all deductions directly connected with such income.
• Royalties. Subsection 512(b)(2) excludes all royalties, and all deductions directly connected with such income.
• Rents Attributable to Real Property. Subsection 512(b)(3)(A)(i) excludes from unrelated business taxable income rents attributable to real property, provided that an exception to the exclusion does not apply, including the debt-financed property exception.
• Rents from Personal Property. Subsection 512(b)(3)(A)(ii) excludes from unrelated business taxable income all rents from personal property leased with such real property, if the rents attributable to such personal property are an incidental amount of the total rents received or accrued under the lease (and provided that an exception to the exclusion does not apply).
• Research. Income from research performed for any federal or state governmental agency, or from research performed by a college, university, or hospital for any person is excluded. id. at § 512(b)(7)-(9).
• $1,000 Deduction. With limited exception, the Code permits a specific deduction of $1,000 of any unrelated business taxable income. And, in the case of a diocese or convention of churches, there is also allowed, with respect to each individual church, a specific deduction equal to the lower of $1,000 or the gross income derived from any unrelated trade or business regularly carried on by such individual church.
• Controlled Entities and Receipts from Foreign Corporations. Subsection 512(b)(13) provides special rules and modifications to unrelated business taxable income for amounts received from controlled entities.

Exceptions to the Modifications Applicable to Real Property and Personal Property

In the case of personal property leased with real property (which is commonly referred to as a “mixed lease”) the rental income is excludable from unrelated business taxable income if the rents that are attributable to the personal property are not more than 10% of the total rents received under the lease. See 26 C.F.R. § 1.512(b)-1(C)(2)(ii)(b). Moreover, the exclusions from unrelated business taxable income for rental income in subsection 512(b)(3)(A) (i.e., rents from real property and personal property) shall not apply: (i) if more than 50 percent of the total rent received or accrued under the lease is attributable to personal property, or (ii) if the determination of the amount of such rent depends in whole or in part on the income or profits derived by any person from the property leased (other than an amount based on a fixed percentage or percentages of receipts or sales). See 26 U.S.C. § 512(b)(3)(B)(i).

Debt-Financed Property Exceptions to the Modifications

As noted above, subsection 512(b)(3)(A)(i) excludes from unrelated business taxable income rents attributable to real property. However, exceptions apply. Section 514 of the Code provides special (and complex) rules for inclusion of income derived from real property that is debt-financed. The term “debt-financed property” means any property which is held to produce income and with respect to which there is an acquisition indebtedness at any time during the taxable year. See id. at § 514(b)(1).

When income is derived through the use of borrowed funds, section 514 is triggered, and the income—while perhaps once excluded or modified for taxation purposes by section 511, 512, or 513—may be brought back into the taxable category. See id. at § 514(a)-(b).

If, for example, a church receives leases debt-financed property to a third party for a purpose that is not substantially related to the exempt purposes of the church, the rent from that activity is likely includable in unrelated business taxable income.

Similarly, if an exempt organization purchases securities with borrowed funds, the dividends or interest earned on those securities is likely subject to the unrelated business taxable income rules. (Exceptions apply, such as in the case of tax-exempt bond issuances or tax-exempt loans, but that is a whole other can of tax worms for another future blog.)

Exceptions to Unrelated Business Income Tax Rules

In addition to the modifications, section 513 of the Code expressly excepts any trade or business—

• in which substantially all the work in carrying on such trade or business is performed for the organization without compensation [e., a volunteer-run business]; or
• which is carried on by the organization primarily for the convenience of its members, students, patients, officers, or employees; or
• which is the selling of merchandise, substantially all of which has been received by the organization as gifts or contributions [e., sale of donated goods].

See id. at § 513(a)-(a)(3).

Closing of Part 2

That is a wrap for this Part 2 – Tax Exemption and Unrelated Business Income Tax (UBIT): Rules, Modifications and Exceptions. Stay tuned for Part 3 of this 3-Part series where we will dive deeper into these unrelated business income rules and what is meant by a trade or business that is “substantially related” to a tax-exempt organization’s exempt purposes. See Continuing Life Communities Thousand Oaks LLC v. Comm’r, T.C. Memo. 2022-31 |April 6, 2022 |Holmes, J. | Dkt. No. 4806-15 (“One way to think about tax law is to view it as a series of general rules qualified by exceptions, and exceptions to those exceptions, and exceptions to those exceptions to those exceptions.”).

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The Branch Profits Tax

The branch profits tax is imposed on foreign corporations engaged in a U.S. trade or business through a branch, rather than a subsidiary.  The branch profits tax is imposed in addition to any tax on income that is effectively connected[1] to the conduct of the business.

In other words, under the branch profits tax, foreign corporations with U.S. branches are, in theory at least, subject to two levels of tax: (i) At the entity level when the U.S. branch earns income, and (ii) at the shareholder level when the earnings are deemed to be repatriated.

In effect, the branch profits tax treats the U.S. branch of a foreign corporation as if it were a subsidiary—at least for purposes of taxing the repatriation of profits.  This puts the earnings and profits of a foreign corporation’s branch that are deemed to be repatriated to its home office on equal footing with the earnings and profits of a U.S. subsidiary that are paid out as a dividend to its foreign parent.  By treating a branch’s profits as though they were remitted to the foreign corporation, the branch profits tax effectively eliminates the advantage of operating as a U.S. branch rather than a subsidiary with respect to the repatriation of profits.

The Taxation of a Foreign Corporation’s Effectively Connected Income, Generally

Foreign corporations that have a trade or business in the U.S. may be subject to tax on the income that is effectively connected with that U.S. trade or business at normal corporate tax rates. A foreign corporation has effectively connected income if it is engaged in a trade or business within the U.S. and has income connected to that trade or business. For example, a foreign corporation that performs services in the U.S. is engaged in a trade or business in the U.S. and has effectively connected income.

The Branch Profits Tax, Generally

The branch profits tax was enacted under the Tax Reform Act of 1986.  It was intended to put a U.S. branch of a foreign corporation on par with a U.S. subsidiary of a foreign corporation.

The branch profits tax imposes a 30% tax (or lower rate under an applicable treaty) on the after-tax earnings of a foreign corporation’s U.S. trade or business that are not deemed to be reinvested in that U.S. trade or business. The branch profits tax is imposed on the “dividend equivalent amount.” As such, the branch profits tax treats a U.S. branch of a foreign corporation as if it were a subsidiary of a foreign corporation.

The branch profits tax is imposed in addition to the tax imposed by section 882 on effectively connected income.

Note that the termination or incorporation of a U.S. trade or business, or the liquidation or reorganization of a foreign corporation or its domestic subsidiary, may impact the branch profits tax.

The Dividend Equivalent Amount

The term “dividend equivalent amount” is defined as a foreign corporation’s effectively connected earnings and profits, with certain adjustments. The dividend equivalent amount is similar to dividends paid by a subsidiary either out of current E&P not yet invested or out of accumulated E&P invested in subsidiary assets.

To determine the dividend equivalent amount, we start with the effectively connected earnings and profits.  Effectively connected earnings and profits are the earnings and profits (or deficits) determined under section 312 and Treasury Regulations that are attributable to effectively connected income (within the meaning of the Treasury Regulations).[2] Because the phrase effectively connected income includes income treated as effectively connected, income that is effectively connected income under section 842(b) (minimum net investment income of an insurance business) or 864(c)(7) (gain from property formerly held for use in a U.S. trade or business) gives rise to effectively connected earnings and profits. Effectively connected earnings and profits also includes earnings and profits attributable to effectively connected income of a foreign corporation earned through a partnership, and through a trust or estate. For purposes of section 884, gain on the sale of a U.S. real property interest by a foreign corporation that has made an election to be treated as a domestic corporation under section 897(i) will also give rise to effectively connected earnings and profits.

Generally, the effectively connected earnings and profits are adjusted (up or down) to reflect increases or decreases in the branch’s investment in United States assets (i.e., its U.S. net equity).  The dividend equivalent amount is reduced by the increase in a U.S. branch’s U.S. net equity.  It is increased by a U.S. branch’s decrease in U.S. net equity.

U.S. net equity equals U.S. assets minus U.S. liabilities.  The Treasury Regulations provide elaborate rules for the calculation of U.S. net equity.

There are two ways to increase U.S. net equity: use the profits to purchase additional U.S. assets or to reduce U.S. liabilities. Branch income that is reinvested in qualifying branch (U.S.) assets is not considered repatriated to the foreign home office.

On the other hand, if branch income is not reinvested in qualifying U.S. assets, then it is deemed repatriated.

Tax Treaties

The United States is a signatory to more than 60 income tax treaties.  With some exceptions, a qualifying foreign corporation that is a resident of a country with which the United States has an income tax treaty and that has a dividend equivalent amount.

Our Freeman Law interactive tax treaty map provides a link to tax treaty materials for each U.S. treaty partner:

If the foreign corporation satisfies the limitation on benefits provisions of the applicable tax treaty with respect to the dividend equivalent amount, the foreign corporation will not be subject to the branch profits tax on that amount (or will qualify for a reduction in the amount of tax with respect to such amount) if—

(i) The foreign corporation is a qualified resident of such country for the taxable year;[3] or

(ii) The limitation on benefits provision, or an amendment to that provision, entered into force after December 31, 1986.

A foreign corporation that, in any taxable year, is a qualified resident of a country with which the United States has an income tax treaty in effect solely because it meets the requirements of § 1.884–5(b) and (c) (relating, respectively, to stock ownership and base erosion) is exempt from the branch profits tax or subject to a reduced rate of branch profits tax pursuant to a treaty with respect to the portion of its dividend equivalent amount for the taxable year attributable to accumulated effectively connected earnings and profits only if the foreign corporation is a qualified resident of the treaty country under the Treasury Regulations, in whole or in part, in a consecutive 36–month period that includes the taxable year of the dividend equivalent amount. A foreign corporation that fails the 36–month test is exempt from the branch profits tax or subject to the branch profits tax at a reduced rate with respect to accumulated effectively connected earnings and profits (determined on a last-in-first-out basis) accumulated only during prior years in which the foreign corporation was a qualified resident of such country.

Foreign corporations should also analyze whether they have Form 5472 or other reporting obligations.

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[1]For purposes of the branch profits tax, under applicable regulations the term “effectively connected income” means income that is effectively connected with the conduct of a trade or business in the United States and income that is treated as effectively connected with the conduct of a trade or business in the United States under any provision of the Code. The term effectively connected income also includes all income that is or is treated as effectively connected with the conduct of a U.S. trade or business whether or not the income is included in gross income (for example, interest income earned with respect to tax-exempt bonds).

[2] The term “ECEP” does not include any earnings and profits attributable to—

(i) Income excluded from gross income under section 883(a)(1) or 883(a)(2) (relating to certain income derived from the operation of ships or aircraft);

(ii) Income that is ECI by reason of section 921(d) or 926(b) (relating to certain income of a FSC and certain dividends paid by a FSC to a foreign corporation or nonresident alien) that is not otherwise ECI;

(iii) Gain on the disposition of a U.S. real property interest described in section 897(c)(1)(A)(ii) (relating to certain interests in a domestic corporation);

(iv) Income that is ECI by reason of section 953(c)(3)(C) (relating to certain income of a captive insurance company that a corporation elects to treat as ECI) that is not otherwise ECI;

(v) Income that is exempt from tax under section 892 (relating to certain income of foreign governments); and

(vi) Income that is ECI by reason of section 882(e) (relating to certain interest income of banks organized under the laws of a possession of the United States) that is not otherwise ECI.

[3] Note that if a foreign corporation is a qualified resident only with respect to one of its trades or businesses in the United States, i.e., the trade or business that is an integral part of its business conducted in its country of residence, and not with respect to another, the treaty exceptions may only apply to that portion of its dividend equivalent amount attributable to the trade or business for which the foreign corporation is a qualified resident.

Unlike FDAP income, the United States taxes effectively connected income (“ECI”) on a net basis.  Effectively connected income is income that is effectively connected with the conduct of a U.S. trade or business.  It also includes gains from the disposition of U.S. real property under FIRPTA, which are treated as ECI.

Generally, when determining whether income constitutes effectively connected income, the IRS employs two tests: (i) the asset-use test; and (ii) the business-activities test.  The asset-use test looks to whether the income or gain is derived from assets used in, or held for use in, the conduct of the trade or business in the United States.  The business-activities test looks to whether the activities of the trade or business were conducted in the United States and were a material factor in the realization of the income or gain at issue.

What is Effectively Connected Income?

Generally, when a foreign person is engaged in a trade or business in the United States, all income from sources within the United States connected with the conduct of that trade or business is considered to be effectively connected income. This applies even if there is no connection between the income and the trade or business being carried on in the United States during the tax year. Among the more common traps, partners in a partnership and beneficiaries of an estate or trust are treated as engaged in a U.S. trade or business if the partnership, estate, or trust is so engaged.

A taxpayer is generally considered to be engaged in a U.S. trade or business when they perform personal services in the United States. Whether the taxpayer is engaged in a trade or business in the United States depends on the nature of the taxpayer’s activities.

What Income is Effectively Connected with a U.S. Trade or Business?

In the case of U.S.-source capital gain and U.S.-source income that would be subject to gross-basis U.S. taxation, whether the income is ECI generally depends upon whether the income is derived from assets used in or held for use in the conduct of the U.S. trade or business and whether the activities of the U.S. trade or business were a material factor in the realization of the amount (the “asset use” and “business activities” tests).  All other U.S.-source non-FDAP income is treated as effectively connected income.

The following categories of income are usually considered to be connected with a trade or business in the United States:

• If the taxpayer is a member of a partnership that at any time during the tax year is engaged in a trade or business in the United States, they are considered to be engaged in a trade or business in the United States.
• A taxpayer is usually engaged in a U.S. trade or business when they perform personal services in the United States.
• A taxpayer is considered to be engaged in a trade or business in the United States if they are temporarily present in the United States as a nonimmigrant on an “F,” “J,” “M,” or “Q” visa. The taxable part of any U.S. source scholarship or fellowship grant received by a nonimmigrant in “F,” “J,” “M,” or “Q” status is treated as effectively connected with a trade or business in the United States.
• If the taxpayer owns and operates a business in the United States selling services, products, or merchandise, the taxpayer is, with certain exceptions, engaged in a trade or business in the United States. For example, profit from the sale in the United States of inventory property purchased either in this country or in a foreign country is effectively connected trade or business income.
• Gains and losses from the sale or exchange of U.S. real property interests (whether or not they are capital assets) are taxed as if the taxpayer was engaged in a trade or business in the United States.
• Income from the rental of real property may be treated as ECI if the taxpayer elects to do so.

A foreign person’s income from foreign sources generally is considered to be ECI only if the person has an office or other fixed place of business within the United States to which the income is attributable and the income is in one of the following categories: (1) rents or royalties for the use of patents, copyrights, secret processes or formulas, good will, trademarks, trade brands, franchises, or other like intangible properties derived in the active conduct of the trade or business; (2) interest or dividends derived in the active conduct of a banking, financing, or similar business within the United States or received by a corporation the principal business of which is trading in stocks or securities for its own account; or (3) income derived from the sale or exchange (outside the United States), through the U.S. office or fixed place of business, of inventory or property held by the foreign person primarily for sale to customers in the ordinary course of the trade or business, unless the sale or exchange is for use, consumption, or disposition outside the United States and an office or other fixed place of business of the foreign person in a foreign country participated materially in the sale or exchange. Foreign-source dividends, interest, and royalties are not treated as effectively connected income if the items are paid by a foreign corporation more than 50 percent (by vote) of which is owned directly, indirectly, or constructively by the recipient of the income.

Prior-Year Activity

Income, gain, deduction, or loss for a particular year generally is not treated as effectively connected income if the foreign person is not engaged in a U.S. trade or business in that year.  If, however, income or gain taken into account for a taxable year is attributable to the sale or exchange of property, the performance of services, or any other transaction that occurred in a prior taxable year, the income or gain is effectively connected income if the income or gain would have been treated as such in the prior year. If any property ceases to be used or held for use in connection with the conduct of a U.S. trade or business and the property is disposed of within 10 years after the cessation of that activity, the income or gain attributable to the disposition of the property is effectively connected income if the income or gain would have been treated as such had the disposition occurred immediately before the property ceased to be used or held for use in connection with the conduct of a U.S. trade or business.         

FIRPTA 

A foreign person’s gain or loss from the disposition of a U.S. real property interest (“USRPI”) is treated as effectively connected income.  Thus, a foreign person subject to tax on such a disposition is required to file a U.S. tax return. In the case of a foreign corporation, the gain from the disposition of a USRPI may also be subject to the branch profits tax at a 30-percent rate (or lower treaty rate).

The payor of income that FIRPTA treats as ECI is generally required to withhold U.S. tax from the payment.  The foreign person can request a refund with its U.S. tax return, if appropriate, based on that person’s overall tax liability for the taxable year.         

Branch Profits Taxes

Under the branch profits tax, the United States imposes a tax of 30 percent on a foreign corporation’s “dividend equivalent amount.”  The dividend equivalent amount is generally equal to the earnings and profits of a U.S. branch of a foreign corporation attributable to its ECI. Limited categories of earnings and profits attributable to a foreign corporation’s ECI are excluded in calculating the dividend equivalent amount.

In arriving at the dividend equivalent amount, a branch’s effectively connected earnings and profits are adjusted to reflect changes in a branch’s U.S. net equity (i.e., the excess of the branch’s assets over its liabilities, taking into account only amounts treated as connected with its U.S. trade or business).

What is a U.S. Trade or Business?

Whether a foreign person is engaged in a U.S. trade or business is a factual question.  Characterization as a U.S. trade or business depends upon whether the activity rises to the level of a trade or business, whether a trade or business has sufficient connections to the United States, and whether the relationship between the foreign person and persons performing activities in the United States for the foreign person is sufficient to attribute those activities to the foreign person. Special rules govern whether trading in stock or securities or commodities constitutes the conduct of a U.S. trade or business.

Tax Treaties 

The United States is a signatory to more than 60 income tax treaties.  For eligible foreign persons, U.S. tax treaties restrict the application of net-basis U.S. taxation. Under each treaty, the United States is permitted to tax business profits only to the extent those profits are attributable to a U.S. permanent establishment of the foreign person. The threshold level of activities that constitute a permanent establishment is generally higher than the threshold level of activities that constitute a U.S. trade or business. For example, a permanent establishment typically requires the maintenance of a fixed place of business over a significant period of time.

Our Freeman Law interactive tax treaty map provides a link to tax treaty materials for each U.S. treaty partner:

Effectively Connected Income is Taxed on a “Net” Basis

The Tax Code allows deductions against effectively connected income and it is taxed at the graduated rates that apply to U.S. citizens and resident aliens or lesser rates under a tax treaty.

Taxable ECI is computed by taking into account deductions associated with the gross ECI. Regulations address the allocation and apportionment of deductions between ECI and other income. Specific rules provide for the allocation and apportionment of certain items, such as research expenditures, legal and accounting fees, income taxes, losses on dispositions of property, and net operating losses.

International and Offshore Tax Compliance Attorneys

Need help with tax issues? Contact us as soon as possible to discuss your rights and the ways we can assist in your defense. We handle all types of cases, including complex international & offshore tax compliance. Schedule a consultation or call (214) 984-3000 to discuss your international tax concerns or questions. 

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The right move at the right time can mean the difference between the right outcome and the wrong one. Strategic victories are no accident. We begin thinking through the end game from day one. And we have tactical trial experience built on strategic approaches that keep the big picture in mind.

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Freeman’s skilled trial counsel regularly resolves sophisticated business disputes, representing clients in courthouses and arbitration throughout Texas and across the country. We are business-minded and client-centric. Our client’s objectives drive our strategy. We offer skilled and practical insight to vindicate and defend our clients and their causes during high-stakes disputes.

We represent clients in complex business divorces, offering practical, innovative solutions to complex issues. Our business divorce representations include:

• Closely-held business disputes
• “Buy-sell” agreement disputes
• Breaches of partnership fiduciary duties
• Embezzlement
• Books-and-records requests
• Business valuation disputes

The Right Litigation Model

We were built to take on anything—from the largest law firms to the Department of Justice. And we are rewriting the odds in complex, high-stakes litigation one case at a time. We leverage technological advances; eschew wasteful staffing; and employ collaborative, end-result-driven litigation systems that avoid knowledge segregation and enhance ideation.

We represent a paradigm shift—a change in the historic litigation model. We believe that the trial boutique model simply outperforms the large-firm approach. The ability to scale trial preparation has never been greater. Intelligently designed law firm models can not only go up against the largest firms and parties, they can—and should—win. Indeed, the boutique model offers advantages that larger firm models simply can’t match.

Authentic

We pledge transparency and authenticity, bringing candid, pull-no-punches trial strategies that home-in on the issues that matter. Though often overlooked, authenticity is the single most impactful virtue in a trial lawyer. Without it, the best-laid plans and preparations are lost. When the issues are make-or-break, trust our attorneys to see them through.

Legal acumen

Our attorneys bring big-firm talent and backgrounds, think-tank intellect, and analytical precision. Our trial attorneys are not only skilled advocates, they are steeped in substantive expertise gained from years of experience in the trenches. We provide sophisticated representation and penetrating legal acumen.

Driven

Our firm’s founding principles and vision of exceptionalism permeate throughout our litigation and trial practice. We are driven by uncompromising attention to detail and a desire to exceed expectations.

Ready for the Moments that Matter

Every Freeman attorney participates in the firm’s Trial College, a rigorous training program focused on trial advocacy and procedure. Our attorneys are experienced, trial-honed, and ready for the moments that matter.

Any Time, Any Place

We eschew a siloed-specialist focus; rather, we employ a cross-functional, integrated multi-disciplinary and team approach to the practice of law and litigation. Siloed, narrowly focused attorneys inevitably view client’s disputes through an every-problem-is-a-nail framework, missing the forest for the trees. We cultivate judgment and an appreciation for the bigger picture. After all, litigation, though at times necessary, is a means to an end.

Bet-The-Company Business Divorces

Litigation can represent an existential threat. When business divorces threaten mission-critical interests, jeopardizing years of work and investment, clients turn to our trial attorneys and our insightful counsel. When everything is on the line, Freeman steps up to it for you.

In an evolving and increasingly complex environment, businesses face unprecedented challenges and risks. Freeman represents clients in complex business disputes, including fraud, breach-of-contract, fiduciary duty, and other disputes. With our historic background in white-collar litigation—both civil and criminal—we are uniquely positioned to represent clients in matters involving embezzlement, fraudulent transfers, fiduciary breaches, and other complex financial disputes.

Our skilled trial counsel regularly resolve sophisticated business disputes, representing clients in courthouses and arbitration throughout Texas and across the country. Many matters entrusted to us require managing outside factors and mitigating collateral consequences, such as parallel regulatory investigations. We offer skilled and practical insight to navigate our clients and their causes during high-stakes disputes.

Even successful long-term business relationships can break down and suffer from “irreconcilable differences.” When this occurs between co-owners of business entities, they may desire to undertake a unilateral or mutually agreed “business divorce.” There are complex legal, tax, accounting and other issues at play in these situations, and success requires a team that understands these multi-disciplinary issues.

Co-owners desiring to separate their investment from a going concern may not always be able to withdraw or separate their capital from the business. A threshold consideration for owners of a minority stake is whether the owner has a withdrawal right, a right to sell the minority interest to a third party, or a right to force a dissolution, redemption, or a buyout. Alternatively, a majority owner might prefer to continue to manage and control a business without being encumbered by a bothersome minority interest owner. Preserving value can require ensuring that offers and other conduct in connection with a buyout (or a “squeeze-out” attempt) are consistent with any fiduciary duties that apply because of an owner’s position in the company, or as a result of special circumstances.

Just like with a marriage, a business divorce may be brought on by a number of issues, including: disputes regarding personal or business issues; inactive or unproductive business partners, and the financial or personal problems of an owner. These situations can impact a company’s ability to operate and its owners’ futures and livelihoods. In a business divorce, the goal should be to reach the best resolution as possible.

Even when owners of a business agree in principle that they desire to separate subject to finalization of detailed agreements, a solid understanding of background law, negotiation dynamics, and a client’s business and personal interests are key to achieving the best price or distribution of assets possible. Freeman Law’s well-rounded team of litigators, tax, and transactional lawyers, including dual credential attorney-CPAs understand these concerns. Common issues to address when seeking to split up a business involve the following, for example: (1) the value of the business and whether to hire expert appraisers; (2) employee relationships, contracts, and whether any necessary confidentiality agreements are in place, (3) whether to conduct a forensic investigation into key or all aspects of the business; (4) tax issues and planning; (5) ownership of intellectual property; (5) any terms and conditions governing future collaboration or business competition; and (6) determining how to deal with unresolved issues such as outstanding contracts or unresolved liabilities or litigation.

Our firm stands ready to litigate business divorce issues, and when appropriate, to negotiate resolutions and business divorce agreements (or vice versa). Our skilled trial counsel regularly resolve sophisticated business disputes, representing clients in courthouses and arbitration throughout Texas and across the country.

We are trial boutique, positioned to represent clients in business divorce litigation.  We are:

• Recognized and Sophisticated.We are a sophisticated boutique trial firm, hyper focused on advancing our clients’ litigation interests in litigation between business owners.  Our trial attorneys have been recognized nationally and internationally, including being named to U.S. News and World Report’s Best Lawyers in America list, Super Lawyers, and recognized by Chambers & Partners as among the leading attorneys in the United States, as well as recognized as the “Leading Tax Controversy Litigation Attorney of the Year” for the State of Texas.
• Multi-Disciplinary and Qualified.Our litigation attorneys include former government trial attorneys, former law clerks to federal judges, law professors, and dual-credentialed CPAs with deep experience in complex financial reporting, accounting, and fraud.  Nearly one-third of our attorneys serve as law professors at tier-one law schools.
• Freeman is a “Go-To” Litigation Firm—Trial Counsel for the Cases that Count. Our business divorce attorneys are versed in business litigation and disputes between co-owners. Well-versed in high-stakes litigation, our attorneys are trial-ready and battle tested; we’re ready when you are.
• We Try Cases.  We Win Cases. We are committed to delivering world-class counsel in the courtroom using bold, tactical, state-of-the-art approaches to litigation.  Our attorneys bring big-firm talent, think-tank intellect, and analytical precision.
• Strategic. Our experienced litigators employ creative, trial-tested strategies that position clients for courtroom success.  We craft detailed strategies and trial plans designed to convey the most impactful, psychologically moving themes and storylines—moving juries to action.
• Clear and Focused. We are client-focused problem solvers. Tireless advocates that work best under pressure, we are committed for the long haul, and relentless in our pursuit of justice. Our award-winning attorneys make the complex clear, bringing the issues and facts into focus with perspective and clarity.
• Legal acumen. Our attorneys bring big-firm talent and backgrounds, think-tank intellect, and analytical precision.  Our trial attorneys are not only skilled advocates, they are steeped in substantive expertise gained from years of experience in the trenches.  We provide sophisticated representation and penetrating legal acumen.
• Driven. Our firm’s founding principles and vision of exceptionalism permeate throughout our litigation and trial practice.  We are driven by uncompromising attention to detail and a desire to exceed expectations.
• Ready for the Moments that Matter. Every Freeman attorney participates in the firm’s Trial College, a rigorous training program focused on trial advocacy and procedure.  Our attorneys are experienced, trial-honed, and ready for the moments that matter.

Recent developments, such as the Tax Cuts & Jobs Act (TCJA) and the OECD’s Base Erosion and Profits Shifting (BEPS) initiative, have forced multinational businesses to re-evaluate global strategies and the tax impact of doing business abroad.   Navigating the risk of a permanent establishment remains among the most important international tax risks.

While a nonresident alien or foreign corporation engaged in a trade or business in the United States is generally subject to taxation on its net taxable income that is effectively connected with the conduct of the U.S. trade or business, the rules are different (or at least, can be) when a resident of a treaty country conducts the business.  Where a tax treaty is applicable, the concept of a permanent establishment—and whether income is attributable to that permanent establishment—replaces the concept of effectively connected income as the governing standard.

Generally, a business enterprise that is a resident in one treaty country will only be taxed on its business profits by the other country if it carries on its business operations through a permanent establishment.  Where a permanent establishment exists, the business enterprise is potentially subject to tax by the host country to the extent of its profits that are allocable to the permanent establishment.

Whether a permanent establishment exists generally depends upon whether the business conducts activities that are attributable to a fixed place of business in the treaty country.  Some categories of locations and activities give rise to a “per se” permanent establishment.  A business may also have a deemed permanent establishment—regardless of whether it has a fixed place of business in the treaty country—as a result of its contractual activities.

What is a Permanent Establishment?

As used in the U.S. model treaty, a permanent establishment is a fixed place of business through which the taxpayer’s business is wholly or partly carried on.

Generally, the place of business must be “fixed” in the sense of a particular building or physical location through which the enterprise conducts its business. It must, however, be foreseeable that the enterprise’s use of the building or other physical location will be more than temporary.

A permanent establishment includes (though is not at all limited to) the following examples:

• a place of management,
• a branch,
• an office,
• a factory,
• a workshop, and
• a mine, oil or gas well, quarry or other place of extraction of natural resources 

What is a “Branch”?

The Tax Court has addressed the meaning of the term “branch,” at least for purposes of section 954(d)(d), providing that it should be given its customary meaning as a “[d]ivision, office, or other unit of business located at a different location from [the] main office or headquarters” or as an office in a different location than the parent company. If the taxpayer maintains a branch in a treaty county, it has a PE in that county.

Foreign Agents and Permanent Establishments

A foreign enterprise will also be considered to have a U.S. permanent establishment as a result of activities undertaken on its behalf by a dependent agent who has and habitually exercises in the United States an authority to conclude relevant contracts that are binding on the foreign enterprise. A foreign enterprise will not, however, be deemed to have a permanent establishment in the United States merely because it carries on business in the United States through a broker, general commission agent, or any other agent of an independent status, provided that such person is acting in the ordinary course of his business as an independent agent.

Activities that are Generally Not a Permanent Establishment

U.S. tax treaties typically provide that several common categories of activities will generally not be classified as a “permanent establishment.”  Those categories generally include the following:

1. the use of facilities solely for the purpose of storage, display or delivery of goods or merchandise belonging to the enterprise;
2. the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display or delivery;
3. the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise;
4. the maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise, or of collecting information, for the enterprise;
5. the maintenance of a fixed place of business solely for the purpose of carrying on, for the enterprise, any other activity of a preparatory or auxiliary character;
6. the maintenance of a fixed place of business solely for any combination of the activities mentioned in subparagraphs (a) through (e) of this paragraph, provided that the overall activity of the fixed place of business resulting from this combination is of a preparatory or auxiliary character.

The Impact of a Permanent Establishment

A foreign enterprise conducting business in the United States through a permanent establishment will, under a tax treaty, be taxed in the United States on its profits attributable to that permanent establishment.

This treatment is consistent across the OECD model treaty, the U.N. model treaty, and the U.S. model treaty:

• The OECD model tax treaty provides that the profits of an enterprise “shall be taxable” only in the country of which the enterprise is a national “unless the enterprise carries on business in [another country] through a permanent establishment situated therein.”[1]
• The UN Model Treaty similarly provides that the profits of an enterprise are taxable in a country only if “the enterprise carries on business in [that country] through a permanent establishment situated therein.” [2]
• The U.S. Model Tax Treaty contains similar provisions barring taxation absent a permanent establishment. [3]

International and Offshore Tax Compliance Attorneys

Need help with tax issues? Contact us as soon as possible to discuss your rights and the ways we can assist in your defense. We handle all types of cases, including complex international & offshore tax compliance. Schedule a consultation or call (214) 984-3000 to discuss your international tax concerns or questions. 

[1] OECD, Model Tax Convention on Income and on Capital: Condensed Version 2017, art. 7(1).

[2] UN, Model Double Taxation Convention Between Developed and Developing Countries, art. 7(1).

[3] Compare United States Model Income Tax Convention, art. 7 (“Profits of an enterprise of a Contracting State shall be taxable only in that Contracting State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein.”) with U.S.-UK Tax Treaty, art. 7 (“The business profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the business profits of the enterprise may be taxed in the other State but only so much of them as are attributable to that permanent establishment.”).

The Tax Court in Brief August 23 – August 27, 2021

Freeman Law’s “The Tax Court in Brief” covers every substantive Tax Court opinion, providing a weekly brief of its decisions in clear, concise prose.

For a link to our podcast covering the Tax Court, in Brief, download here or check out other episodes of The Freeman Law Project.

Tax Litigation: The Week of August 23 – August 27, 2021

• Estate of Charles P. Morgan, Deceased, Roxanna L. Morgan, Personal Representative and Roxanna L. Morgan v. Comm’r, T.C. Memo 2021-104
• Vera v. Comm’r, 157 T.C. No. 6 

Estate of Charles P. Morgan, Deceased, Roxanna L. Morgan, Personal Representative and Roxanna L. Morgan v. Comm’r, T.C. Memo 2021-104

August 23, 2021 | Pugh, J. | Dkt. No. 592-18

Tax Dispute Short Summary:  The case analyzed whether activities carried to acquire a business rise to the level of a trade or business, and thus, whether related expenses are deductible. Additionally, the case discusses the framework applicable to establish reasonable cause based on reliance on a tax professional.

Mr. Morgan (the petitioner) was a real estate developer. During the 1983-2009 period he actively owned and was involved in various real estate companies. During the 2009 financial crisis, his real estate companies were severely impacted because of lack of liquidity and eventually, his creditors requested the appointment of a receiver. Upon the appointment, the receiver was in sole control of the petitioner’s companies, and he was prohibited from incurring expenses on behalf of the companies that were under the receiver’s control.

As a consequence of the above, the petitioner spent vacation time and later decided to start a new business, through a single-member LLC, Legacy. The purpose of his new venture was to acquire a business. Petitioner recorded his time spent working as “business search” and deducted various expenses related to the search of a possible target acquisition. Aside from Legacy, petitioner also owned another entity, Falcon, that was used to hold and operate an aircraft. Legacy paid consulting fees to Falcon, and Falcon’s expenses were related to the use and maintenance of the aircraft. Legacy deducted the consulting fee paid to Falcon. Finally, petitioner claimed Net Operating Losses (NOL) for both Legacy and Falcon, derived from previous years. The IRS disallowed the expenses and issued a notice of deficiency and imposed a penalty under section 6662 (underpayment due to negligence or substantial understatement of income tax).

The Tax Court determined that petitioner business of searching for target acquisition did not constitute a trade or business because no business had been started yet. Therefore the expenses were rejected. However, the Court rejected the imposition of the 6662 penalty because the petitioner showed reasonable cause based on reliance on a tax professional.

Tax Litigation Key Issues: Whether the acquisition of a business constitutes itself a trade or business?

Primary Holdings: The search of an active or existing trade or business is not a trade or business. Related expenses fall within Section 195(c)(1)(A)(i) as start-up expenses rather than expenses related to a trade or business.

Key Points of the Tax Laws:

Section 162 allows taxpayers to deduct expenses paid or incurred on any trade or business. To determine the existence of a trade or business, three main factors are relevant: carrying the activity for profit, that the taxpayer is regularly and actively involved in the activity and that the activity has actually commenced. See Weaver v. Commissioner, T.C. Memo. 2004-108 , 2004 WL 938293 , at *6 ; McManus v. Commissioner, T.C. Memo 1987-457 , 1987 Tax Ct. [54 T.C.M. (CCH) 475], Memo LEXIS 454, at *20. To properly commence a business, the taxpayer must engage in such business. See Cabintaxi Corp. v. Commissioner, 63 F. 3d 614 , 620-621 (7th Cir. 1995), aff’g in part, rev’g in part, and remanding T.C. Memo. 1994-316.

If there is no business yet, Section 195(a) provides that no deduction is allowed for start-up expenses. Legislative history includes as start-up expenses those incurred in the study and choose of potential business, and those to prepare to begin that business. See H. Rept. 96-1278 , at 10-11 (1980), 1980- 2 C.B. 709, 712; S. Rept. 96-1036, at 11-12 (1980), 1980 U.S.C. C.A.N. 7293, 7301. If taxpayer has yet not decided to enter into a business or which business to enter, any expenses is considered as an investigatory cost under Section 195(c). Once the business is chosen, and the business starts functioning as a going concern and performs the activities for which it was organized, any expense incurred falls within Section 162, because there is an existing trade or business.

In this particular case, petitioner argued that his expenses were deductible under Section 162 under two theories. First, petitioner argued that his homebuilding activities never ceased. The Court determined that this argument was without merit because the taxpayer considered himself as no longer carrying a homebuilding business (based on his testimony) and also, because the receivership terms clearly stated that the taxpayer could not be engaged in his previous business.

Second, taxpayer argued that the search for a new trade or business to acquire was itself an active trade or business. The Court rejected this argument for both entities, Legacy and Falcon. For Legacy, the Court ruled that the business investigation expenses that were claimed, fell within the start-up expenditures of Section 195(c)(1)(A)(i) as “amounts paid or incurred in connection with investigating the creation or acquisition of an active trade or business”. These included paid employees and outside consultants. This argument was supported by the fact that no business was acquired by petitioner. For Falcon, the Court concluded that such entity did not lease the aircraft and only income came from petitioner and Legacy, thereby no trade or business existed.

In sum, the Court concluded that no trade or business was carried by both Legacy and Falcon and rejected the related expenses.

The Court also ruled on NOLs related to the trade or business which were rejected based on the same conclusion that there was no trade or business for both Legacy and Falcon. A determination for partnership was also made and followed the same conclusion as above (no existence of trade or business).

Finally, as for the Section 6662(a) penalty, the Court determined that reasonable cause existed in this case because the taxpayer relied on professional advice, and the adviser was a competent professional with sufficient expertise to justify reliance, the taxpayer provided all necessary and accurate information to the adviser and the taxpayer actually relied in good faith on the adviser’s judgment. See Alt. Health Care Advocates v. Commissioner, 151 T.C. 225 , 246 (2018); Neonatology Assocs., P.A. v. Commissioner, 115 T.C. 43 , 99 (2000), aff’d, 299 F.3d 221 (3d Cir. 2002). In this case, the tax preparer, a CPA, was professionally licensed and knew the petitioners’ personal and business affairs. Secondly, petitioner provided necessary and accurate information to his tax adviser and third, petitioner relied on his tax adviser, because he had been preparing his returns for over a decade.

Tax Court Motion:  This case is relevant especially in certain business ventures, for example, SPACs (Special Purpose Acquisition Ventures), whose main purpose is to acquire an existing venture. Special consideration must be given to the determination as to whether a trade or business exists in those cases and if not, determine the most appropriate manner on how to characterize the expenses related.

This case is also relevant to understand the general framework of establishing reasonable cause, which usually applies in multiple settings around the Code.

Vera v. Comm’r, 157 T.C. No. 6 

August 23, 2021 | Buch, J. | Dkt. No. 9921-19

Tax Dispute Short Summary:

• For 2010 and 2013, the years at issue, Petitioner Vera filed joint returns with her (then) spouse. For 2010, the Commissioner determined a deficiency that was assessed as a joint liability. For 2013, the tax shown on the return was not paid in full, resulting in an underpayment of tax. The Commissioner assessed the tax liability and associated penalties.
• In early 2015, Petitioner filed a request for innocent spouse relief relating solely to the 2013 underpayment. She submitted Form 8857, Request for Innocent Spouse Relief, setting forth her grounds for relief. In March 2016, the Commissioner issued a final determination denying relief to Petitioner, writing that she did not meet the requirements for relief.
• Petitioner challenged the Commissioner’s determination in Court, and that determination was ultimately dismissed for lack of jurisdiction.
• Several months later, Petitioner submitted a request for relief for 2010, but in that request, she also re-raised her 2013 liability. The Commissioner denied the request for relief in a Final Appeals Determination Letter (dated March 14, 2019). The header of that letter specified only 2010 as the tax year, but the substance of the letter denied the request for relief as to both the 2010 and 2013 tax years. It read:
  • For tax year 2010, the information we have shows that you didn’t meet the requirements for relief.
  • For tax year 2010, you didn’t have a reasonable expectation that the person you filed the joint return with would or could pay the tax.
  • For tax year 2013, you didn’t comply with all income tax laws for the tax years that followed the years that are the subject of your claim.
• Petitioner filed a timely petition challenging the Commissioner’s determination. She used the Tax Court’s petition form (T.C. Form 2 as revised in November 2018). Line 3 of the form requests: “Provide the year(s) or period(s) for which the NOTICE(S) was/were issued.” Petitioner wrote “Tax Year 2010, Tax Year 2013.”
• Petitioner included in her petition a copy of the Commissioner’s notice, as well as a statement of facts that also mentioned both 2010 and 2013.
• The Commissioner filed a motion to dismiss for lack of jurisdiction as to tax year 2013. He averred the following in his motion:
  • that the March 14, 2019, determination is not a second determination for 2013,
  • that a second request for innocent spouse relief is available only when seeking to allocate a deficiency, and
  • that because the 2013 liability is an underpayment, it cannot be subject to a second election for relief

Tax Litigation Key Issue:

• Whether the Court has jurisdiction to determine the appropriate relief available to a Petitioner who has received the Commissioner’s final determination denying innocent spouse relief on the merits.

Primary Holding: 

When the Commissioner issues a final determination denying innocent spouse relief on the merits, the Tax Court has jurisdiction to determine the appropriate relief available, even if the Commissioner had previously denied relief. The Court’s jurisdiction extends to both the 2010 and 2013 tax years, as the substance of the Commissioner’s final determination unambiguously denied innocent spouse relief as to both years.

Key Points of the Laws:

• R.C. § 6015(e) grants tax courts the jurisdiction to determine the appropriate relief with regard to a taxpayer’s petition for innocent spouse relief.
• Final determination letters issued under § 6015 are not subject to any statutory or regulatory form or content requirements.
• A predicate to the Court’s jurisdiction pursuant to § 6015(e) is the mailing of a final determination.
• Although § 6015(e)(1)(A)(i)(I) refers to a final determination, nothing in that provision prohibits the Commissioner from issuing more than one final determination as to a given tax year.
• The regulations clarifying § 6015 limit claimants to a single qualified request for a given year. Income Tax Regs § 1.6015-1(a)(2) , (h)(5).
  • A qualified request is defined as the “first timely claim for relief.” para. (h)(5).
  • Moreover, the “requesting spouse is entitled to only one final administrative determination of relief.” Income Tax Regs § 1.6015-5 (c)(1).
• But these regulations leave open the possibility for the Commissioner to issue a second final determination. See Income Tax Regs Secs. 1.6015-1(h)(5) , 1.6015-5(c)(1) , 1.6015-3 (stating that if a requesting spouse changes marital status, the regulations permit a second claim, resulting in a second final determination); see also Internal Revenue Manual (IRM) pt. 25.15.17.7(1) (Mar. 5, 2019) (allowing for a second claim when a “delay or error” imposes an “unfair burden” on the requesting spouse and the Commissioner exercises his discretion to issue a second final determination).
• The Internal Revenue Manual provides following instructions with respect to final determinations:
  • A second determination issued under these limited circumstances grants the requesting spouse the right to petition the Tax Court. I.R.M. 25.15.17.7.
  • Upon request, the Commissioner also may reconsider previous requests. pt. 25.15.17.5(1).
  • If he determines relief is appropriate, the Commissioner may change his final determination as to the previous requests. pt. 25.15.17.5(3). However, I.R.M. pt. 25.15.17.5 specifically cautions agents that reconsideration decisions should not be issued through final determination letters.
  • While the I.R.M. does not carry the force of law, but courts have considered it when understanding the Commissioner’s procedures
  • The I.R.M. instructs the Commissioner to issue a Letter 3657C (No Consideration Innocent Spouse) to taxpayer petitioners when taxpayers submit a second request for relief concerning the same tax year. IRM pt. 25.15.17.4(4) (Mar. 5, 2019).
• However, where, as here, the Commissioner issues a second final determination as to any tax year, then the requesting spouse has the right to petition the Tax Court for a determination of relief. See IRM pt. 25.15.17.7.
  • This is all the more true when the Final Determination Letter unambiguously relates solely to the merits of relief for the prior tax years, and does not describe a rejection on the basis of an improper second request.
• Moreover, courts have jurisdiction to review final determinations issued in error. This rule applies in the context of final determination letters pertaining to: (1) innocent spouse relief, (2) whistleblower awards, (3) deficiencies, and (4) collections.
• If the Petitioner taxpayer timely files a petition and the notice of final determination serves as the predicate for the court’s jurisdiction, then the court will first look to the face of the notice. Courts will only look beyond the face of the notice if it is ambiguous or inconsistent.

Tax Court Motion:

• When a taxpayer submits a second request for innocent spouse relief concerning the same tax year, the I.R.M. instructs the Commissioner to issue a Letter 3657C (No Consideration Innocent Spouse).
• If instead, the Commissioner issues a second final determination as to any tax year, then the requesting spouse has the right to petition the Tax Court, and the Tax Court has jurisdiction to determine, the appropriate relief.

Tax Court Litigation Attorneys

Need assistance litigating in the U.S. Tax Court? Freeman Law’s tax attorneys are experienced litigators with trial-tested litigation skills and in-depth substantive tax knowledge, having collectively litigated hundreds of cases before the U.S. Tax Court. Our tax controversy lawyers have extensive experience in Tax Court matters involving partnership audits and litigation under both the TEFRA and BBA regimes, international tax penalties, foreign trusts, valuation, reasonable compensation disputes, unreported income, fraud penalties, other tax penalties, and many other matters. We draw on our experience and wealth of tax knowledge to advise and guide clients through the entire tax controversy process, building the right strategy to resolve tax controversies from day one. Schedule a consultation or call (214) 984-3000 to discuss your Tax Court concerns or questions. 

Section 280E of the Internal Revenue Code prohibits taxpayers who are engaged in the business of trafficking certain controlled substances (including, most notably, marijuana) from deducting typical business expenses associated those activities.  Section 280E, which was enacted in 1982 during the so-called War on Drugs, has become increasingly relevant for cannabis (marijuana) businesses. The marijuana industry has grown substantially in recent years and is projected to take in more than $25 billion annually by 2025.  This revenue growth has been driven by an increasing number of states opting to legalize marijuana.  But despite this trend towards legalization at the state level, marijuana remains illegal under federal law—it is classified as a Schedule I controlled substance under the Comprehensive Drug Abuse Prevention and Control Act of 1970, 21 U.S.C. §801–971 (1970), (“Controlled Substances Act” or “CSA”), raising the specter of section 280E.

By enacting section 280E, Congress sought to reverse a then-recent Tax Court decision: The 1981 landmark case of Edmondson v. Commissioner.  In that case, the Tax Court allowed a trafficker of amphetamines, cocaine, and cannabis to deduct ordinary and necessary business expenses related to an illicit drug business.[1] The expenses included rent, packaging, telephone, automobile expenses and the purchase of a small scale.[2] In response,[3] Congress enacted Section 280E,[4] preventing businesses engaged in certain illegal activities from recovering costs related to controlled substances or claiming associated business deductions[5]—that is, disallowing deductions that would otherwise be available under Section 162.

Generally, Section 162(a) allows a taxpayer to deduct ordinary and necessary expenses paid or incurred during the tax year in carrying on any trade or business.[6] Deductions under Section 162, however, are, as the adage goes, “matters of legislative grace” and “Congress [may generally] condition, limit, or deny deductions from gross income in arriving at the net which is to be taxed.”[7] Section 280E provides that:

No deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances (within the meaning of schedule I and II of the Controlled Substances Act) which is prohibited by Federal law or the law of any State in which such trade or business is conducted.[8]

Marijuana is classified as a Schedule I controlled substance under the Controlled Substances Act, rendering marijuana businesses subject to section 280E.  The Senate Report accompanying the enactment of Section 280E elaborated on the legislative intent behind the provision:

All deductions and credits for amounts paid or incurred in the illegal trafficking in drugs listed in the Controlled Substances Act are disallowed. To preclude possible challenges on constitutional grounds, the adjustment to gross receipts with respect to effective costs of goods sold is not affected by this provision of the bill.

REP. NO. 97-494 (Vol. I), at 309 (1982).

In short, Section 280E prohibits a taxpayer who is engaged in trafficking a Schedule I or II controlled substance (such as cannabis, i.e., ‘marijuana,’ which is listed as ‘marihuana’ on Schedule I)[9] from taking tax deductions or credits—except for the adjustment to offset gross receipts by the cost of goods sold (COGS)—when determining gross income.[10]Notably, Section 280E disallows deductions for expenses that are not illegal per se (such as: rent, salaries, and telephone expenses).[11]

THE THREE ELEMENTS OF 280E

Section 280E applies where three elements are present: (1) a controlled substance; (2) trafficking; and (3) a trade or business.[12]

I. Controlled Substance

Section 280E denies deductions and credits for amounts paid or incurred in carrying on the trade or business of trafficking controlled substances (within the meaning of Schedules I and II of the CSA), in violation of federal or state law.[13] Despite legalization in at least 31 states (and the District of Columbia) and approval for medical use in nine states, federal law continues to classify cannabis as a “controlled substance” under schedule I of the CSA.[14]  Section 280E, therefore, prohibits tax deductions and credits attributable to the trade or business of trafficking in cannabis.

II. Trafficking

The Tax Court has defined “trafficking” by reference to the verb “traffic,” taking the definition from Webster’s Third New International Dictionary to mean “to engage in commercial activity: buy and sell regularly.”[15] Thus, the purchase and sale of cannabis constitutes trafficking even when permitted by state law.[16] By defining “trafficking” in this manner, the court has cast a wide net.  Indeed, most, if not all, commercial activity with respect to cannabis would appear to fall under section 280E’s definition of trafficking.

III. Trade or Business

Whether a taxpayer’s activities constitute a trade or business is an issue that draws upon a host of case law precedents and generally looks to the level of activity, continuity of that activity, and period over which the taxpayer has engaged in that activity.  Although a cannabis business is illegal under federal law,[17] a taxpayer is nonetheless required to pay federal income tax on the taxable income derived from a cannabis trade or business.  Section 61(a), in other words, does not differentiate between income derived from legal sources and income derived from illegal sources. [18]

TWO LANDMARK CASES

Californians Helping to Alleviate Medical Problems, Inc., v. C.I.R. (2007) (“CHAMP”)

A California public benefit corporation that provided medical cannabis to patients with debilitating diseases, pursuant to state statute, and provided non-cannabis-related counseling and caregiving services to its members, challenged the IRS’s disallowance of all of its ordinary and necessary business expenses.[19] While the tax court held that the taxpayer’s provision of medical cannabis constituted “trafficking”[20] within the meaning of section 280E, the court held that the taxpayer’s caregiving services were a separate trade or business sufficient for the purposes of business expense deductions.[21] The court reached this holding based on legislative history expressing that Section 280E was not intended to preclude taxpayers from deducting expenses attributable to a trade or business other than that of illegal trafficking in controlled substances simply because the taxpayer was also involved in trafficking a controlled substance.[22] Notably, the government conceded that §280E does not prohibit a taxpayer from claiming COGS related to the trafficked substance.[23]

Canna Care, Inc. v. C.I.R. (2015)

Canna Care (“Canna”) was a mutual benefit corporation and pursuant to California law, was prohibited from distributing cannabis for profit. The IRS determined deficiencies in Canna’s federal income tax and Canna challenged the IRS’s disallowance of deductions for operating expenses that it incurred in operating a medical cannabis dispensary that was permitted by California law.[24] The tax court held that Canna, unlike CHAMP, was a single-business venture and that it was engaged in the trade or business of trafficking in controlled substances (here, medical cannabis).[25] Thus, Canna’s operating expenses were held not to be deductible.[26]

Canna reaffirmed two key aspects of 280E in relation to cannabis businesses. First, despite legalization across the country, cannabis is still a controlled substance under federal law and, as such, the Tax Court will continue to characterize taxpayers engaged in cannabis-related business activities as being engaged in trafficking within the meaning of section 280A. Second, a taxpayer engaged in the trade or business of selling cannabis falls under Section 280E and cannot claim business deductions other than the cost of goods sold with respect to that trade or business.

Takeaways

Section 280E is a federal statute that bars any business, or portion of its business, engaged in trafficking a Schedule I or II controlled substance (such as cannabis) from deducting non-COGS related deductions or credits for federal tax purposes. Case law, however, provides businesses that have separate and distinct cannabis and non-cannabis operations with an opportunity to structure their operations in a manner that mitigates the impact of section 280A.  Such taxpayers should consult an experienced tax attorney to ensure that they structure operations in an optimal manner and comply with the latest case law interpreting section 280E.

Freeman Law Tax Attorneys

Freeman Law aggressively represents clients in tax litigation at both the state and federal levels. When the stakes are high, clients rely on our experience, knowledge, and talent to help them navigate all levels of the tax dispute lifecycle—from audits and examinations to the courtroom and all levels of appeals. Schedule a consultation or call (214) 984-3000 to discuss your tax needs. 

[1] See Edmondson v. C.I.R., 42 T.C.M. (CCH) 1533 (T.C. 1981), acq. in part and nonacq. in part recommended by I.R.S. AOD- 1982-82 (IRS AOD Oct. 15, 1982)

[2] Id.

[3] S. REP. NO. 97-494 (Vol. I), supra at 309 (1982) (“There is a sharply defined public policy against drug dealing. To allow drug dealers the benefit of business expense deductions at the same time that the U.S. and its citizens are losing billions of dollars per year to such persons…”)

[4] 26 U.S.C.A. § 280E

[5] 26 U.S.C.A. § 280E

[6] 26 U.S.C. § 162(a) (emphasis added).

[7] See Alpenglow Botanicals, LLC v. United States, 894 F.3d 1187, 1199 (10th Cir. 2018) (citations omitted) (internal quotation marks omitted).

[8] In the Comprehensive Drug Abuse Prevention and Control Act of 1970, 21 U.S.C. §801–971 (1970), (“Controlled Substances Act” or “CSA”), Congress created a regime to curtail the unlawful manufacture, distribution, and abuse of dangerous drugs (“controlled substances”). Congress assigned each controlled substance to one of five lists (Schedule I through Schedule V). See §812 of the CSA. Schedule I includes: (a) opiates; (b) opium derivatives (e.g., heroin; morphine); and (c) hallucinogenic substances (e.g., LSD; marihuana (a/k/a marijuana); mescaline; peyote).

[9] 21 U.S.C.A. § 812, Schedule I (c)(10) (West).

[10] S. REP. NO. 97-494 (Vol. I), at 309 (1982).

[11] 26 U.S.C. § 162(c); 26 U.S.C.A. § 280E.

[12] See Canna Care, Inc. v. Comm’r of Internal Revenue, 694 Fed. Appx. 570 (9th Cir. 2017).

[13] See §812 of the CSA.

[14] See “2019 FEDERAL TAX UPDATE FOR BUSINESS RETURNS”, Sharon Kreider and Vern Hoven, Spring Business 2019.pdf.

[15] Californians Helping to Alleviate Med. Problems, Inc. v. C.I.R., 128 T.C. 173, 182 (2007).

[16] Id. See also, Alpenglow, at 1206; Beck v. Comm’r, 110 T.C.M. (CCH) 141, *5–6 (2015); Olive v. Comm’r, 792 F.3d 1146, 1149 (9th Cir. 2015).

[17] 21 U.S.C.A. § 841(D) (detailing penalties in dealing in less than 50kg (about 100lbs) of cannabis (‘marihuana’) or 50 or more plants.).

[18] See James v. United States, 366 U.S. 213, 218 (1961).

[19] Californians Helping to Alleviate Med. Problems, Inc. v. C.I.R., 128 T.C. 173, 174 (2007) (“CHAMP”).

[20] Id. at 182 (The tax court chose to utilize Webster’s Dictionary and apply the gerund “trafficking” by reference to the verb “traffic”, which as relevant herein denotes “to engage in commercial activity: buy and sell regularly”.)

[21] Id. at 178. (The court distinguished and allocated the company’s expenses into two primary businesses; one that focused on providing ‘caregiving services’ and a second that was tied directly to cannabis distribution. The ordinary and necessary business expenses associated with the caregiving portion (about 18/25 of the expenses including: salaries, wages, employee benefits, employee training, meals and entertainment, parking and tolls, rent, and laundry and cleaning) were held to be legally deductible. Id. at 185. The remaining expenses (about 7/25^t of the expenses) associated with the cannabis distribution were disallowed entirely).

[22] Id. at 182.

[23] Id. at 178 (n. 4).

[24] Canna Care, Inc. v. C.I.R., 110 T.C.M. (CCH) 408 (T.C. 2015), aff’d sub nom. Canna Care, Inc. v. Comm’r of Internal Revenue, 694 Fed. Appx. 570 (9th Cir. 2017).

[25] Id. at *5.

[26] Id.

All About IRS Offers in Compromise

An economic downturn increases the ability for thousands of Americans to settle their outstanding tax debt with the IRS.  That means that for many, now may be the time to take advantage of the economic uncertainty and to position themselves for a successful tax settlement—and a fresh start.

An offer in compromise (OIC) is an agreement between a taxpayer and the Internal Revenue Service (IRS) to settle a tax liability for less than the full amount owed.[1]  For many taxpayers, the IRS’s Offer in Compromise program is a path toward a fresh start. To qualify, a taxpayer must submit an offer package (including all required documentation and forms) that meets IRS criteria.  Taxpayers should take care to comply with all applicable IRS criteria—submitting a non-compliant or rejected offer may harm the taxpayer’s position or ability to submit a subsequent offer with success.

Section 7122 of the Code provides broad authority to the Secretary to compromise any case arising under the internal revenue laws, as long as the case has not been referred to the Department of Justice for prosecution or defense.

The IRS will accept an offer in compromise when it is unlikely that the tax liability can be collected in full and the amount offered reasonably reflects the taxpayer’s “collection potential,” a term of art that is defined in IRS regulations. The goal of an offer in compromise is to collect such amounts as early and efficiently as possible.  Taxpayers with significant tax debts can potentially take advantage of the IRS’s Offer in Compromise Program and a skilled tax attorney can help navigate the regulatory complexities and position a taxpayer for the best possible settlement with the IRS.

Official IRS policies provide that an Offer in Compromise is a tool for providing taxpayers with a “fresh start” and reaching a resolution that is in the best interest of both the taxpayer and the IRS:

The ultimate goal [of the Offer in Compromise Program] is a compromise which is in the best interest of both the taxpayer and the Service.   Acceptance of an adequate offer will also result in creating for the taxpayer an expectation of and a fresh start toward compliance with all future filing and payment requirements.

Thus, acceptance of an offer in compromise conclusively settles the liability of the taxpayer, absent fraud or mutual mistake.[2] Compromise with one taxpayer, however, does not extinguish the liability of any person not named in the offer who is also liable for the tax to which the offer relates. The Service may therefore continue to take action to collect from any person not named in the offer.

An offer to compromise a tax liability must be submitted in writing on the IRS’s Form 656, Offer in Compromise.  None of the standard terms can be removed or altered, and the form must be signed under penalty of perjury. The offer should include the legal grounds for compromise, the amount the taxpayer proposes to pay, and the payment terms.  Payment terms include the amounts and due dates of the payments. The offer should also contain any other information required by Form 656 or IRS regulations.

An offer to compromise a tax liability should set forth the legal grounds for compromise and should provide enough information for the Service to determine whether the offer fits within its acceptance policies.  There are three categories for OIC relief: (1) Doubt as to liability; (2) Doubt as to collectability; and (3) Promotion of effective tax administration.

(1) Doubt as to liability

Doubt as to liability exists where there is a genuine dispute as to the existence or amount of the correct tax liability under the law. Doubt as to liability does not exist where the liability has been established by a final court decision or judgment concerning the existence of the liability.

An offer to compromise based on doubt as to liability generally will be considered acceptable if it reasonably reflects the amount the Service would expect to collect through litigation. This analysis includes consideration of the hazards of litigation that would be involved if the liability were litigated. The evaluation of the hazards of litigation is not an exact science and is within the discretion of the Service.

(2) Doubt as to collectability

Doubt as to collectability exists in any case where the taxpayer’s assets and income cannot satisfy the full amount of the liability.

An offer to compromise based on doubt as to collectability generally will be considered acceptable if it is unlikely that the tax can be collected in full and the offer reasonably reflects the amount the Service could collect through other means, including administrative and judicial collection remedies. See Policy Statement P-5-100. This amount is the reasonable collection potential of a case. In determining the reasonable collection potential of a case, the Service will take into account the taxpayer’s reasonable basic living expenses. In some cases, the Service may accept an offer of less than the total reasonable collection potential of a case if there are special circumstances.

(3) Promotion of effective tax administration

The Service may compromise to promote effective tax administration where it determines that, although collection in full could be achieved, collection of the full liability would cause the taxpayer economic hardship. Economic hardship is defined as the inability to pay reasonable basic living expenses. See § 301.6343-1(d). No compromise may be entered into on this basis if the compromise of the liability would undermine compliance by taxpayers with the tax laws.

An offer to compromise based on economic hardship generally will be considered acceptable when, even though the tax could be collected in full, the amount offered reflects the amount the Service can collect without causing the taxpayer economic hardship. The determination to accept a particular amount will be based on the taxpayer’s individual facts and circumstances.

If there are no other grounds for compromise, the Service may compromise to promote effective tax administration where a compelling public policy or equity considerations identified by the taxpayer provide a sufficient basis for compromising the liability. Compromise will be justified only where, due to exceptional circumstances, collection of the full liability would undermine public confidence that the tax laws are being administered in a fair and equitable manner. The taxpayer will be expected to demonstrate circumstances that justify compromise even though a similarly situated taxpayer may have paid his liability in full. No compromise may be entered into on this basis if compromise of the liability would undermine compliance by taxpayers with the tax laws.

An offer to compromise based on compelling public policy or equity considerations generally will be considered acceptable if it reflects what is fair and equitable under the particular facts and circumstances of the case.

Under §7122(c) factors such as equity, hardship, and public policy will be considered in certain circumstances where granting an offer in compromise will promote effective tax administration. The legislative history of this provision (H. Conf. Rep. 599, 105th Cong., 2d Sess. 289 (1998)) states that:

the conferees expect that the present regulations will be expanded so as to permit the IRS, in certain circumstances, to consider additional factors (i.e., factors other than doubt as to liability or collectibility) in determining whether to compromise the income tax liabilities of individual taxpayers. For example, the conferees anticipate that the IRS will take into account factors such as equity, hardship, and public policy where a compromise of an individual taxpayer’s income tax liability would promote effective tax administration. The conferees anticipate that, among other situations, the IRS may utilize this new authority, to resolve longstanding cases by forgoing penalties and interest which have accumulated as a result of delay in determining the taxpayer’s liability. The conferees believe that the ability to compromise tax liability and to make payments of tax liability by installment enhances taxpayer compliance. In addition, the conferees believe that the IRS should be flexible in finding ways to work with taxpayers who are sincerely trying to meet their obligations and remain in the tax system. Accordingly, the conferees believe that the IRS should make it easier for taxpayers to enter into offer-in-compromise agreements, and should do more to educate the taxpaying public about the availability of such agreements.

The IRS will generally take into account a number of circumstances bearing on potential economic hardship, including:

• The taxpayer’s age, employment status and history, ability to earn, number of dependents, and status as a dependent of someone else;
• The amount reasonably necessary for food, clothing, housing (including utilities, home-owner insurance, home-owner dues, and the like), medical expenses (including health insurance), transportation, current tax payments (including federal, state, and local), alimony, child support, or other court-ordered payments, and expenses necessary to the taxpayer’s production of income (such as dues for a trade union or professional organization, or child care payments which allow the taxpayer to be gainfully employed);
• The cost of living in the geographic area in which the taxpayer resides;
• The amount of property exempt from levy which is available to pay the taxpayer’s expenses;
• Any extraordinary circumstances such as special education expenses, a medical catastrophe, or natural disaster; and
• Any other factor that the taxpayer claims bears on economic hardship and brings to the attention of the director.

The following non-exclusive list of factors support (but are not conclusive of) a determination that collection would cause economic hardship:

• Taxpayer is incapable of earning a living because of a long term illness, medical condition, or disability, and it is reasonably foreseeable that taxpayer’s financial resources will be exhausted providing for care and support during the course of the condition;
• Although taxpayer has certain monthly income, that income is exhausted each month in providing for the care of dependents with no other means of support; and
• Although taxpayer has certain assets, the taxpayer is unable to borrow against the equity in those assets and liquidation of those assets to pay outstanding tax liabilities would render the taxpayer unable to meet basic living expenses.

Making the Offer

The offer should include all information necessary to verify the grounds for compromise. Except for offers to compromise based solely on doubt as to liability, this includes financial information provided in a manner approved by the Service. Individual or self-employed taxpayers must submit a Form 433-A, Collection Information Statement for Wage Earners and Self-Employed Individuals, together with any attachments or other documentation required by the Service. Corporate or other business taxpayers must submit a Form 433-B, Collection Information Statement for Businesses, together with any attachments or other documentation required by the Service. The Service may require the corporate officers or individual partners of a business taxpayer to complete a Form 433-A.

A Pending Offer

Section 6331(k)(1) generally prohibits the IRS from making a levy on a taxpayer’s property or rights to property while an offer to compromise a liability is pending with the Service, for 30 days after the rejection of an offer to compromise, or while an appeal of a rejection is pending. The statute of limitations on collection is suspended while levy is prohibited. An offer to compromise becomes pending when it is accepted for processing. The Service accepts an offer to compromise for processing when it determines that: the offer is submitted on the proper version of Form 656 and Form 433-A or B, as appropriate; the taxpayer is not in bankruptcy; the taxpayer has complied with all filing and payment requirements listed in the instructions to Form 656; the taxpayer has enclosed the application fee, if required; and the offer meets any other minimum requirements established by the Service. A determination that the offer meets these minimum requirements means that the offer is processable.

Returned Offers

If an offer to compromise accepted for processing does not contain sufficient information to permit the Service to evaluate whether the offer should be accepted, the Service will request that the taxpayer provide the needed additional information.  If the taxpayer does not submit the additional information that the Service has requested within a reasonable time period after such a request, the Service may return the offer to the taxpayer. The Service also may return the offer after it has been accepted for processing if:

1. The Service determines that the offer was submitted solely to delay collection;
2. The taxpayer fails to file a return or pay a liability;
3. The taxpayer files for bankruptcy;
4. The offer is no longer processable; or
5. The offer was accepted for processing in error. 

The Taxpayer’s Ability to Pay

Courts have held that the “[t]he IRS may reject an offer-in-compromise because the taxpayer’s ability to pay exceeds the compromise proposal.”[3]  Under IRS procedures, the agency will not accept a compromise that is less than the reasonable collection value of the case, absent a showing of special circumstances. See Rev. Proc. 2003–71(2). The IRS considers the reasonable collection value of a case to be the funds available after the taxpayer meets basic living expenses. Id.

The IRS determines the taxpayer’s ability to pay based on the tax liabilities (assessed and unassessed) due at the time the offer is submitted.

When the IRS receives an offer in compromise submission, the IRS will generally complete an initial calculation to determine if the taxpayer can fully pay the tax debt through an installment agreement based on the IRS’s applicable guidelines.  If the initial calculation indicates that the taxpayer cannot full pay the tax through an installment agreement, the IRS will continue its OIC investigation to determine the taxpayer’s reasonable collection potential (RCP).

In determining whether an offer reasonably reflects collection potential, the IRS takes into consideration amounts that might be collected from (1) the taxpayer’s assets, (2) the taxpayer’s present and projected future income, and (3) third parties (e.g., persons to whom the taxpayer had transferred assets). Although most doubt as to collectability offers only involve consideration of the taxpayer’s equity in assets and future disposable income over a fixed period of time, the IRS on occasion also will consider whether the taxpayer should be expected to raise additional amounts from assets in which the taxpayer’s interest is beyond the reach of enforced collection (e.g., interests in property located in foreign jurisdictions or held in tenancies by the entirety).

Taxpayer Documents

If during the IRS’s OIC investigation, the financial information provided by the taxpayer becomes older than 12 months and it appears significant changes have occurred, the IRS will generally request updated information.  If the taxpayer’s circumstances have significantly changed since the submission of the OIC (for example, a change of employment, loss of job, etc.), the IRS will generally seek updated information.

Equity in Assets

The IRS will seek to determine the taxpayer’s equity in his or her assets.  In doing so, the IRS may, among other steps, review the following documents to determine whether there are undisclosed assets or income and to assist in valuing the property:

1. Divorce decrees or separation agreements to determine the disposition of assets in the property settlements;
2. Homeowners or renters insurance policies and riders to identify high value personal items such as jewelry, antiques, or artwork;
3. Financial statements recently provided to lending institutions or others to identify assets or income that may not have been revealed on the CIS.

Ongoing Businesses

For an ongoing business, the IRS may make field calls to validate the existence and value of business assets and inventory.  The IRS may follow other special procedures related to an on-going business, and in some situations, the IRS may accept offers for less than the business’s RCP.

Net Realizable Equity

For offer in compromise purposes, a taxpayer’s assets are valued at net realizable equity (NRE).

Net realizable equity is defined as the quick sale value (QSV) less amounts owed to secured lien holders with priority over the federal tax lien, if applicable, and applicable exemption amounts

The QSV is defined as an estimate of the price a seller could get for the asset in a situation where financial pressures motivate the owner to sell in a short period of time, usually 90 calendar days or less. Generally, the QSV is less than the fair market value (FMV) of the asset.

Generally, QSV is calculated at 80% of FMV.  IRS guidance provides that a higher or lower percentage may be applied in determining QSV when appropriate, depending on the type of asset and current market conditions. If, based on the current market and area economic conditions, it is believed that the property would quickly sell at full FMV, then the IRS may consider QSV to be the same as FMV. This is occasionally found to be true in real estate markets where real estate is selling quickly at or above the listing price. If the IRS believes that the value chosen represents a fair estimate of the price a seller could get for the asset in a situation where the asset must be sold quickly (usually 90 calendar days or less) then the IRS may use a percentage other than 80%. Generally, it is the policy of the IRS to apply QSV in valuing property for offer purposes.

When a particular asset has been sold (or a sale is pending) in order to fund the offer, the IRS will not provide for a reduction for QSV. Instead, it will verify the actual sale price, ensuring that the sale is an arms-length transaction, and use that amount as the QSV. The IRS may allow for a reduction for the costs of the sale and the expected current-year tax consequence to arrive at the NRE of the asset.

Jointly Held Assets

When taxpayers submit separate offers but have jointly-owned assets, the IRS will generally allocate equity in the assets equally between the owners. However, the IRS will allocate the equity in a different manner under certain circumstances: If the joint owners demonstrate that their interest in the property is not equally divided, the IRS will allocate the equity based on each owner’s contribution to the value of the asset.

If the joint owners have joint and individual tax liabilities included in the offer in compromise, the IRS will generally apply the equity in assets first to the joint liability and then to the individual liability.

For property held as tenancies by the entirety when the tax is owed by only one spouse, the taxpayer’s portion is usually considered to be 50% of the property’s NRE.   However, applicable state law, such as community property and registered domestic partnership laws, may impact property ownership rights and may change the taxpayer’s interest in assets that should be included in RCP for offer in compromise purposes.

Assets Held By Others as Transferees, Nominees, or Alter Egos

The IRS will also conduct an investigation to determine what degree of control the taxpayer has over assets and income that are in the possession of others, particularly when the offer will be funded by a third party.

The IRS will seek to determine whether there are any transferee, nominee, or alter ego issues present.   If the IRS determines that the taxpayer has a beneficial interest in assets or income streams that are held by a transferee, nominee, or alter ego, the IRS will reflect the value of such assets or interest in the RCP.

Cash

When determining an individual taxpayer’s RCP, the IRS will generally utilize the amount of cash listed on the taxpayer’s Form 433-A (OIC) for the amount of cash in the taxpayer’s bank accounts, though it will reduces such amount by $1,000.

When determining a business taxpayer’s RCP, the IRS will generally utilize the amount listed on the Form 433-B(OIC) for the amount of cash in the taxpayer’s bank account.  The $1,000 reduction applicable to individual bank accounts is not applicable with respect to business taxpayers.

The IRS will review the taxpayer’s checking account statements over a reasonable period of time, generally three months for wage earners and six months for taxpayers who are non-wage earners. The IRS will seek to ascertain whether there is unusual activity, such as deposits in excess of reported income, withdrawals, transfers, or checks for expenses not reflected on the CIS.

If a taxpayer offers the balances of certain accounts—for example, certificate of deposit, savings bonds, etc.—to fund the proposed offer, the IRS may allow for any penalty for early withdrawal and allow for expected current year tax consequences with respect to the account withdrawal.

Securities and Stocks of Closely Held Entities

Financial securities are considered an asset and the IRS includes their value in its determination of the taxpayer’s the RCP.

If the taxpayer proposes to liquidate an investment in order to fund the proposed offer in compromise, the IRS will allow for the associated fees in addition to any penalty imposed on the taxpayer for early withdrawal, as well as the expected current year tax consequences.

In order to determine the value of “closely held” stock that is not traded publicly or for which there is no established market, the IRS may consider the following methods to value the stock:

• a recent annual report to stockholders.
• recent corporate income tax returns.
• an appraisal of the business as a going concern by a qualified and impartial appraiser.

IRS standards provide that when a taxpayer holds only a negligible or token interest in the stock, or has made no investment and exercises no control over the corporate affairs, it is permissible to assign no value to the stock.

The IRS may be skeptical when a taxpayer claims that they have no interest in a closely held corporation or family owned business but the facts indicate that their interest may have been transferred or assigned.  Under such circumstances, the IRS will generally conduct additional investigative measures.

There are additional considerations when it comes to offers involving closely held entities:

• Compensation to Corporate Officers – The IRS may not allow wages and/or other compensation, (i.e., draws) paid to corporate officers in excess of applicable expenses allowable per National and Local standards as business expenses. The officer’s ownership interest in the business and any control over the compensation received is generally a consideration in the IRS’s determination of whether the officer compensation is deemed excessive.
• Stock Holder Distributions and Repayment of Loans to Officers – Because these expenses are discretionary in nature, the IRS may evaluate distributions of this nature made after the incurrence of the outstanding tax liability under the “dissipated asset” provisions. Loans to officers are generally considered an account receivable and valued according to their collectability. If the IRS believes that the taxpayer may be receiving income from loans and that their wages are not reasonable, the IRS may consider a referral to the Examination Division.
• Stock Held by Beneficial Owner – The value of stock ownership in a closely held corporation/LLC is generally included in the RCP of a taxpayer submitting an offer to compromise their individual liabilities.

Virtual Currency.  The taxpayer may have in interest or ownership in virtual currency (e.g. bitcoin). A virtual currency is an electronic currency that isn’t legal tender and isn’t issued by a government. For tax purposes, the transactions are treated as an exchange of property. The IRS will generally include the value of virtual currency in the taxpayer’s RCP. The value will generally be determined in the same manner as a publicly traded stock.

Life Insurance

The IRS will may treat life insurance differently depending upon the type and nature of the insurance policy.  The IRS will seek to identify the type of insurance, the conditions for borrowing or cancellation, and the current loan and cash values on the policy.

Under IRS guidance, life insurance as an investment (e.g., whole life) is generally not considered “necessary.”

When determining the value in a taxpayer’s insurance policy, consider:

• If the taxpayer will retain the insurance policy then the equity is considered to be the cash surrender value
• If the taxpayer will sell the policy to help fund the proposed offer, then the taxpayer’s “equity” is considered to be the amount that the taxpayer will receive from the sale of the policy. Documentation from a broker may be required to verify the selling price and related expenses.
• If the taxpayer will borrow on the policy to help fund the proposed offer, then the taxpayer’s “equity” is considered to be the cash loan value less any prior policy loans or automatic premium loans required to keep the contract in force.

The IRS will generally allow reasonable premiums for term life insurance policies as a necessary expense.

If the taxpayer has a whole life policy, the IRS will generally allow a reasonable amount of the premiums that is attributable to the death benefit under the policy.

Retirement or Profit-Sharing Plans

Funds held in a retirement or profit-sharing plan are considered an asset and must be valued for purposes of the offer in compromise.

The IRS considers does not consider contributions to voluntary retirement plans to be a necessary expense.  The IRS provides for a number of rules based upon the type of account at issue:

Furniture, Fixtures, and Personal Effects

The IRS will generally accept the taxpayer’s declared value of household goods unless there are articles of extraordinary value, such as antiques, artwork, jewelry, or collector’s items.  In such cases, the IRS may even personally inspect the assets.

There is a statutory exemption from IRS levies that applies to a number of items, including the taxpayer’s furniture and personal effects. This exemption amount is updated on an annual basis.  This exemption applies only to individual taxpayers.

The property is owned jointly with any person who is not liable for the tax, the IRS will determine the value of the taxpayer’s proportionate share of property before allowing the levy exemption.

While the furniture or fixtures used in a business may not qualify for the personal effects exemption, they may qualify for the levy exemption as tools of a trade.

If the property has a valid encumbrance with priority over the NFTL, the IRS will allow the encumbrance in addition to the statutory exemption.

Motor Vehicles, Airplanes, and Boats

Equity in motor vehicles, airplanes, and boats is included in the taxpayer’s RCP. The general rule for determining Net Realizable Equity applies when determining equity in these assets. However, unusual assets such as airplanes and boats may require an appraisal to determine FMV.

In most cases, the IRS will discounted at 80% of FMV to arrive at the QSV for a vehicle.

The IRS will exclude $3,450 per car from the QSV of vehicles owned by the taxpayer and used for work, the production of income, and/or the welfare of the taxpayer’s family (up to two cars for joint taxpayers and one vehicle for a single taxpayer).

Note that when assets in this category are used for business purposes, they may be considered income producing assets.

Real Estate

The IRS will seek to verify the FMV of real property. FMV is defined as the price at which a willing seller will sell, and a willing buyer will pay, for the property, given time to obtain the best and highest possible price. The IRS will seek to verify the type of ownership through warranty and mortgage deeds, and may seek to verify or determine the FMV of the property through various sources, including:

• The value listed on real estate tax assessment statements.
• Market comparables.
• Recent purchase prices.
• An existing contract to sell.
• Recent appraisals.
• A homeowner’s insurance policy.

The equity in real estate is included when calculating the taxpayer’s RCP to determine an acceptable offer amount.

Note, however, that there may be circumstances in which an offer under ETA or Doubt as to Collectibility with Special Circumstances (DATCSC) may be appropriate for an amount which does not include some or all of the real property equity.

For real estate and other related property held as tenancies by the entirety when the tax is owed by only one spouse, the IRS usually treats the taxpayer’s portion as 50% of the property’s NRE.

Accounts and Notes Receivable

Accounts and notes receivable are considered assets unless the IRS makes a determination to treat them as part of the taxpayer’s income stream when they are required for the production of income. When the IRS determins that liquidation of a receivable would be detrimental to the continued operation of an otherwise profitable business, the receivable may be treated as future income.

Accounts Receivable – The value of accounts receivable to be included in the taxpayer’s RCP may be adjusted based on the age of the account.  Accounts receivable that are current (i.e. less than or equal to 90 days past due is generally considered current for these purposes) generally may be discounted at Quick Sale Value (QSV), if the taxpayer presents accounting or industry rules or other substantiation providing for devaluation of such accounts. If the account is determined to be delinquent it may be discounted appropriately based on the age of the receivable and the potential for collection.

When the receivables have been sold at a discount or pledged as collateral on a loan, the IRS will apply the provisions of IRC 6323(c) to determine the lien priority of commercial transactions and financing agreements.

The IRS may closely examine accounts of significant value that the taxpayer is not attempting to collect, or that are receivable from officers, stockholders, or relatives.

In order to determine the value of a note receivable, the IRS may consider, among other things, the following:

• Whether it is secured and if so by what asset(s),
• What is collectible from the borrower, and
• If it could be successfully levied upon.

Income-Producing Assets

When an offer includes business assets, the IRS conducts an analysis to determine if certain assets are essential for the production of income. When it has been identified that an asset or a portion of an asset is necessary for the production of income, the IRS will adjust the income or expense calculation for the taxpayer to account for the loss of income stream if the asset was either liquidated or used as collateral to secure a loan to fund the offer.

The IRS will generally use the following procedures when valuing income-producing assets:

As a general rule, equity in income-producing assets will not be added to the taxpayer’s RCP of a viable, ongoing business, unless the IRS determines that the assets are not critical to business operations.  However, the IRS will include equity in real property in the calculation of RCP.

Moreover, even though rental property, owned by the taxpayer, may produce income, the IRS will generally include the equity in the taxpayer’s RCP.  However, an adjustment to the taxpayer’s future income value may be appropriate if the taxpayer will be borrowing against or selling the property to fund the proposed offer.

The following examples provides some guidance with respect to the treatment of equity and income produced by assets:

Example:

(1) A business depends on a machine to manufacture parts and cannot operate without this machine. The equity is $100,000. The machine produces net income of $5,000 monthly. The RCP should include the income produced by the machine, but not the equity. Equity in this machine will generally not be included in the RCP because the machine is needed to produce the income, and is essential to the ability of the business to continue to operate.

The IRS considers it to be in the government’s best interests to work with taxpayer in this situation to maintain business operations.

Based on a taxpayer’s specific circumstances, there may instances where the IRS will treat the income producing assets in a Subchapter S corporation in a similar manner to assets owned by a taxpayer’s sole proprietorship business.  Factors that are considered in this analysis include:

• Type of business activity
• Taxpayer’s occupation
• Current income received from the corporation as salary and the amount of future income that the taxpayer will receive
• Current income received from corporation as dividend
• Ability of the taxpayer to sell their interest in the corporation

Inventory, Machinery, Equipment, and Tools of the Trade

Inventory, machinery, and equipment may be considered income-producing assets.  In order to determine the value of business assets, the IRS may use the following:

• For assets commonly used in many businesses, such as automobiles and trucks, the value may be determined by consulting trade association guides.
• For specialized machinery and equipment suitable for only certain applications, the IRS may consult a trade association guide, secure an appraisal from a knowledgeable and impartial dealer, or contact the manufacturer.
• When the property is unique or difficult to value and no other resource will meet the need, the IRS may utilize the services of an IRS valuation engineer.
• The IRS may ask the taxpayer to secure an appraisal from a qualified business appraiser.

There is a statutory exemption from levy that applies to an individual taxpayer’s tools used in a trade or business, which the IRS will allow in addition to any encumbrance that has priority over the NFTL. Whether an automobile is a tool of the trade depends on the taxpayer’s trade. The levy exemption amount is updated on an annual basis.

Business as a Going Concern

The IRS may evaluate a business as a going concern when determining the RCP of an operating business that is owned individually or by a corporation, partnership, or LLC. The IRS recognizes that a business may be worth more than the sum of its parts when sold as a going concern.

To determine the value of a business as a going concern, the IRS will consider the value of its assets, future income, and intangible assets such as:

• Ability or reputation of a professional.
• Established customer base.
• Prominent location.
• Well known trade name, trademark, or telephone number.
• Possession of government licenses, copyrights, or patents.

Generally, the difference between what an ongoing business would realize if sold on the open market as a going concern and the traditional RCP analysis is attributable to the value of these intangibles.

Dissipation of Assets

The inclusion of dissipated assets in the calculation of the reasonable collection potential (RCP) is no longer applicable, except where it can be shown that the taxpayer sold, transferred, encumbered or otherwise disposed of assets in an attempt to avoid the payment of the tax liability or used the assets or proceeds (other than wages, salary, or other income) for other than the payment of items necessary for the production of income or the health and welfare of the taxpayer or their family, after the tax has been assessed or during a period of up to six months prior to or after the tax assessment.

The evaluation of a taxpayer’s interest in property held as a nominee, transferee, or alter ego is evaluated separately from the determination of whether the taxpayer may have dissipated an asset in an attempt to avoid the payment of tax.

Generally, the IRS uses a three-year time frame to determine if it is appropriate to include a dissipated asset in the taxpayer’s RCP.

Even if the transfer and/or sale took place more than three years prior to the offer submission, the IRS may deem it appropriate to include an asset in the calculation of RCP if the asset transfer and/or sale occurred during a period of up to six months prior to or after the assessment of the tax liability. If the asset transfer took place upon notice of or during an examination, the IRS may not apply these time frames based on the circumstances of the case. Where the IRS is considering the inclusion of a dissipated asset, it may also look at whether the funds were used for health/welfare of the family or production of income.

Note that if the tax liability at issue did not exist prior to the transfer or the transfer occurred prior to the taxable event giving rise to the tax liability, generally, a taxpayer cannot be said to have dissipated the assets in disregard of the outstanding tax liability.

If a taxpayer withdraws funds from an IRA to invest in a business opportunity but does not have any tax liability prior to the withdrawal, the IRS will not consider the funds to have been dissipated.

Any tax paid as a result of the sale of dissipated assets may be allowed as a reduction to the value placed on the dissipated asset.

Retired Debt

Retired debt is considered an expected change in necessary or allowable expenses. The necessary/allowable expenses may decrease after the retirement of the debt, which would change the taxpayer’s ability to pay. 

For example, required child support payments may stop before the future income period ends. Under IRS standards, these retired payments would generally increase the taxpayer’s ability to pay.

Future Income

Future income is defined by IRS guidance as an estimate of the taxpayer’s ability to pay based on an analysis of gross income, less necessary living expenses, for a specific number of months into the future.

As a general rule, the IRS uses the taxpayer’s current income in the analysis of the taxpayer’s future ability to pay.  This may include situations where the taxpayer’s income has been recently reduced based on a change in occupation or employment status.

The IRS will also consider the taxpayer’s overall general circumstances, including age, health, marital status, number and age of dependents, level of education or occupational training, and work experience.

Depending on the circumstances, the IRS may place a different value on future income than current or past income indicates.  The IRS may also seek to secure a future income collateral agreement based on the taxpayer’s earnings potential.

Allowable Expenses

Allowable expenses consist of necessary and conditional expenses.  Allowable expenses are discussed below.

Necessary Expenses

A necessary expense is one that is necessary for the production of income or for the health and welfare of the taxpayer’s family.  The national and local expense standards serve as guidelines in determining a taxpayer’s basic living expenses.

Taxpayers are allowed the National Standard Expense amount for their family size, without a need to substantiate the amount actually spent.[4]  However, if the total amount claimed is more than the total allowed by the National Standards, the taxpayer is required to provide documentation to substantiate and justify that the allowed expenses are inadequate to provide basic living expenses.

National Standards

The IRS’s Offer in Compromise Program was impacted by a 1995 IRS initiative designed to ensure uniform treatment of similarly situated taxpayers. In administering its collection operations, including both the installment agreement program and the compromise program, the IRS has always permitted taxpayers to retain funds to pay reasonable living expenses.

In 1995, the IRS adopted and published national and local standards for determining allowable expenses, which were designed to apply to all collection actions, including offers to compromise. National expense standards were derived from the Bureau of Labor Statistics Consumer Expenditure Survey and were promulgated for expense categories such as food, clothing, personal care items, and housekeeping supplies. Local expense standards derived from Census Bureau data were promulgated for housing, utilities, and transportation.

The IRS allowable expense criteria play an important role in determining whether taxpayers are candidates for an offer in compromise.

Housing and Utilities

When determining a taxpayer’s housing and utility expense, the IRS seeks to use an amount that provides for basic living expenses. The IRS requires that deviations from the expense standards be verified, reasonable, and documented.

Transportation Expenses

Transportation expenses are considered necessary when they are used by taxpayers and their families to provide for their health and welfare and/or the production of income.

The transportation standards are designed to account for loan or lease payments—referred to as ownership costs—and additional amounts for operating costs broken down by Census Region and Metropolitan Statistical Area. Operating costs include maintenance, repairs, insurance, fuel, registrations, licenses, inspections, parking and tolls.

Ownership Expenses – Expenses are allowed for the purchase or lease of a vehicle. Taxpayers are generally allowed the local standard or the amount actually paid, whichever is less, unless the taxpayer provides documentation to verify and substantiate that the higher expenses are necessary.

Operating Expenses – The IRS will generally allow the full operating costs portion of the local transportation standard, or the amount actually claimed by the taxpayer, whichever is less. Substantiation for this allowance is generally not required unless the amount claimed is more than the total allowed by any of the transportation standards.

A taxpayer who commutes long distances to reach his place of employment, he may be allowed greater than the standard operating expenses, as the additional operating expense would generally meet the production of income test.

If the taxpayer has a vehicle that is over eight years old or has reported mileage of 100,000 miles or more, an additional monthly operating expense of $200 will generally be allowed per vehicle (up to two vehicles when a joint offer is submitted).

Other Expenses

Other expenses may be allowed in determining the value of future income for IRS offer purposes. The expense, however, generally must meet the necessary expense test by providing for the health and welfare of the taxpayer and/or his or her family or must be for the production of income. This is determined based on the facts and circumstances of each case.

Generally, the repayment of loans incurred to fund the offer and secured by the taxpayer’s assets will be allowed, if the asset is necessary for the health and welfare of the taxpayer and/or their family, i.e. taxpayer’s residence, and the repayment amount is reasonable. The same rule applies whether the equity is paid to the IRS before the offer is submitted or will be paid upon acceptance of the offer.

Minimum payments on student loans guaranteed by the federal government are allowed for the taxpayer’s post-high school education. Proof of payment, however, must generally be provided. If student loans are owed, but no payments are being made, the IRS may not allow them, unless the non-payment is due to circumstances of financial hardship, e.g. unemployment, medical expenses, etc.

Education expenses are generally allowed only for the taxpayer and only if it they are required as a condition of present employment. Expenses for dependents to attend colleges, universities, or private schools may not be allowed by the IRS unless the dependents have special needs that cannot be met by public schools.

Child support payments for natural children or legally adopted dependents may generally be allowed based on the taxpayer’s situation. A copy of the court order and proof of payments should be provided as part of the offer submission. If no payments are being made, the IRS may not allow the expense, unless the nonpayment was due to temporary job loss or illness.

The IRS will generally not allow payments for expenses, such as college tuition or life insurance for children, made pursuant to a court order. The IRS’s position is that the fact that the taxpayer may be under court order to make payments with respect to such expenses does not change the character of the expense. Therefore, the fact that a taxpayer is under court order to provide a payment may not elevate that expense to allowable status as an offer expense, if the Service would not otherwise allow it.

Generally, charitable contributions are not allowed in the RCP calculation. However, charitable contributions may be an allowable expense if they are a condition of employment or meet the necessary expense test.

Payments being made to fund or repay loans from voluntary retirement plans will generally not be allowed by the IRS. Taxpayers who cannot repay these loans will have a tax consequence in the year that the loan is declared in default and that consequence should be estimated and allowed as an additional tax expense on the IET for the required number of months necessary to cover the additional tax consequence.

Current taxes are allowed regardless of whether the taxpayer made them in the past or not. If an adjustment to the taxpayer’s income is made, an adjustment of the tax liability must also be made. Current taxes include federal, state, and local taxes. In a wage earner situation, allow the amount shown on the pay stub. If the current withholding amount is insufficient or was recently adjusted to substantially over-withhold, the tax expenses should be based on the actual tax expense.

Shared Expenses

Generally, the IRS will only a taxpayer the expenses that the taxpayer is required to pay. Consideration must be given to situations where the taxpayer shares expenses with another. Shared expenses may exist in one of two situations:

• An offer is submitted by a taxpayer who shares living expenses with another individual who is not liable for the tax.
• Separate offers are submitted by two or more persons who owe joint liabilities and/or separate liabilities and who share the same household.

Generally, the assets and income of a non-liable person are excluded from the computation of the taxpayer’s ability to pay. Treasury Reg. 301.7122-1 (c) (2) (ii) (A) only applies in non-liable situations.

Calculation of Future Income

Future income is defined as an estimate of the taxpayer’s ability to pay based on an analysis of gross income, less necessary living expenses, for a specific number of months into the future. The number of months used depends on the payment terms of the offer.

Note:

Generally, the amount to be collected from future income is calculated by taking the projected gross monthly income, less allowable expenses, and multiplying the difference by the number of months applicable to the terms of offer.

For lump sum cash and periodic payment offers, when there are less than 12 or 24 months remaining on the statutory period for collection, the IRS will use the number of months remaining on the statutory period for collection.

Calculation of Future Income – Cultivation and Sale of Marijuana in Accordance with State Laws

The value of future income when a taxpayer is involved in the cultivation and sale of marijuana, in accordance with applicable state laws, should be based on the following guidance:

1. The IRS will determine the taxpayer’s gross income over a specific time period (normally annually);
2. The IRS will limit allowable expenses consistent with Internal Revenue Code Section 280E, where a taxpayer may not deduct any amount for a trade or business where the trade or business (or the activities which comprise such trade or business) consists of trafficking in controlled substances;

Since only expenses that are allowable based on current federal law will be included in determining future income value, the taxpayer’s most recent income tax return is generally the most appropriate document to use when completing the income/expense table.

Limited Liability Companies (LLC) Issues

Offers in compromise from a LLC involve unique issues, especially when the liabilities include employment or excise taxes.

The classification of the LLC for federal tax purposes is important.  Yet, classification of the LLC for federal tax purposes does not negate state law provisions concerning the legal status of the LLC. For example:

• Classification of an LLC as a partnership does not mean the member/owners have liability for LLC debts as would be the case in a state law partnership.
• Under certain circumstances, an LLC may be disregarded as an entity separate from its owner. This classification does not mean that an LLC owned by an individual is the equivalent of a sole proprietorship.

Financial Analysis of an LLC

As with any entity, the IRS will require sufficient information to make an informed decision on the acceptability of the taxpayer’s compromise proposal.  This requires a financial statement from the LLC, as well as employment tax liabilities for wages paid prior to January 1, 2009, where the classification of the LLC is a disregarded entity even though the LLC is not the liable taxpayer.

The IRS will generally also seek financial information of all member owners, except when a member owner holds only a negligible or token interest, has made no or minimal investment and exercises no control over the corporate affairs unless other factors are present to indicate the information is necessary to determine the acceptability of the taxpayer’s offer.

Financial Analysis of a Partnership Interest

Since the taxpayer’s interest in any asset should be included in RCP, if the taxpayer has any interest in a partnership, the IRS will make a determination of the appropriate value to include in an acceptable offer amount. The taxpayer’s interest in a partnership may be as a general or limited partner.

Generally, the value of the taxpayer’s interest would either be the taxpayer’s share of the underlying assets or the value of the transferable interest. The determination of the correct valuation may also be based on other factors, including whether the taxpayer is a general partner, how the taxpayer’s interest was acquired, how the assets of the partnership were acquired, the taxpayer’s relationship to the other partners, and the liquidity of the transferable interest.

Offer in Compromise Submitted on Cases Involving Collection Statute Expiration Date Extensions

Taxpayers that previously extended the CSED in connection with an installment agreement may request approval of an OIC.

Payment Terms

Payment terms are negotiable, but the IRS will request that they provide for payment of the offered amount in the least time possible. If a taxpayer is planning to sell asset(s) to fund all or a portion of the offer, the payment terms for the offer may need to provide for immediate payment of the amounts received from the sale. If the taxpayer is planning to borrow a portion of the money, the payment terms of the offer may need to provide for payment of the borrowed portion at the time the funds are received.

For those taxpayers who agree to shorter payment terms, fewer months of future income are required:

While a periodic payment offer is being evaluated by the Service, the taxpayer is required to make subsequent proposed periodic payments as they become due. Even though there is no requirement that the payments be made monthly or in equal amounts, the IRS will base offer payments on the taxpayer’s specific situation and ability to pay. While the calculation of RCP and consideration of any special circumstances will ultimately assist the IRS in determining an acceptable offer amount, the IRS is not bound by the offer amount or the terms proposed by the taxpayer.

The Law

Offers in Compromise are generally and primarily governed by I.R.C. section 7122 and the regulations thereunder.  We have provided the current versions of those most relevant authorities below:

 I.R.C. Sec. 7122

(a)Authorization.  The Secretary may compromise any civil or criminal case arising under the internal revenue laws prior to reference to the Department of Justice for prosecution or defense; and the Attorney General or his delegate may compromise any such case after reference to the Department of Justice for prosecution or defense.

(b)Record.  Whenever a compromise is made by the Secretary in any case, there shall be placed on file in the office of the Secretary the opinion of the General Counsel for the Department of the Treasury or his delegate, with his reasons therefor, with a statement of—

(1) The amount of tax assessed,

(2) The amount of interest, additional amount, addition to the tax, or assessable penalty, imposed by law on the person against whom the tax is assessed, and

(3) The amount actually paid in accordance with the terms of the compromise.

Notwithstanding the foregoing provisions of this subsection, no such opinion shall be required with respect to the compromise of any civil case in which the unpaid amount of tax assessed (including any interest, additional amount, addition to the tax, or assessable penalty) is less than $50,000. However, such compromise shall be subject to continuing quality review by the Secretary.

(c)Rules for submission of offers-in-compromise

(1)Partial payment required with submission

(A)Lump-sum offers

(i)In general

The submission of any lump-sum offer-in-compromise shall be accompanied by the payment of 20 percent of the amount of such offer.

(ii)Lump-sum offer-in-compromise

For purposes of this section, the term “lump-sum offer-in-compromise” means any offer of payments made in 5 or fewer installments.

(B)Periodic payment offers

(i)In general

The submission of any periodic payment offer-in-compromise shall be accompanied by the payment of the amount of the first proposed installment.

(ii)Failure to make installment during pendency of offer

Any failure to make an installment (other than the first installment) due under such offer-in-compromise during the period such offer is being evaluated by the Secretary may be treated by the Secretary as a withdrawal of such offer-in-compromise.

(2)Rules of application

(A)Use of payment

The application of any payment made under this subsection to the assessed tax or other amounts imposed under this title with respect to such tax may be specified by the taxpayer.

(B)Application of user fee

In the case of any assessed tax or other amounts imposed under this title with respect to such tax which is the subject of an offer-in-compromise to which this subsection applies, such tax or other amounts shall be reduced by any user fee imposed under this title with respect to such offer-in-compromise.

(C)Waiver authority

The Secretary may issue regulations waiving any payment required under paragraph (1) in a manner consistent with the practices established in accordance with the requirements under subsection (d)(3).

(3)Exception for low-income taxpayers

Paragraph (1), and any user fee otherwise required in connection with the submission of an offer-in-compromise, shall not apply to any offer-in-compromise with respect to a taxpayer who is an individual with adjusted gross income, as determined for the most recent taxable year for which such information is available, which does not exceed 250 percent of the applicable poverty level (as determined by the Secretary).

(d)Standards for evaluation of offers

(1)In general

The Secretary shall prescribe guidelines for officers and employees of the Internal Revenue Service to determine whether an offer-in-compromise is adequate and should be accepted to resolve a dispute.

(2)Allowances for basic living expenses

(A)In general

In prescribing guidelines under paragraph (1), the Secretary shall develop and publish schedules of national and local allowances designed to provide that taxpayers entering into a compromise have an adequate means to provide for basic living expenses.

(B)Use of schedules

The guidelines shall provide that officers and employees of the Internal Revenue Service shall determine, on the basis of the facts and circumstances of each taxpayer, whether the use of the schedules published under subparagraph (A) is appropriate and shall not use the schedules to the extent such use would result in the taxpayer not having adequate means to provide for basic living expenses.

(3)Special rules relating to treatment of offersThe guidelines under paragraph (1) shall provide that—

(A) an officer or employee of the Internal Revenue Service shall not reject an offer-in-compromise from a low-income taxpayer solely on the basis of the amount of the offer,

(B)in the case of an offer-in-compromise which relates only to issues of liability of the taxpayer—

(i) such offer shall not be rejected solely because the Secretary is unable to locate the taxpayer’s return or return information for verification of such liability; and

(ii) the taxpayer shall not be required to provide a financial statement, and

(C) any offer-in-compromise which does not meet the requirements of subparagraph (A)(i) or (B)(i), as the case may be, of subsection (c)(1) may be returned to the taxpayer as unprocessable.

(e)Administrative review.  The Secretary shall establish procedures—

(1) for an independent administrative review of any rejection of a proposed offer-in-compromise or installment agreement made by a taxpayer under this section or section 6159 before such rejection is communicated to the taxpayer; and

(2) which allow a taxpayer to appeal any rejection of such offer or agreement to the Internal Revenue Service Independent Office of Appeals.

(f)Deemed acceptance of offer not rejected within certain period.  Any offer-in-compromise submitted under this section shall be deemed to be accepted by the Secretary if such offer is not rejected by the Secretary before the date which is 24 months after the date of the submission of such offer. For purposes of the preceding sentence, any period during which any tax liability which is the subject of such offer-in-compromise is in dispute in any judicial proceeding shall not be taken into account in determining the expiration of the 24-month period.

(g)Frivolous submissions, etc.  Notwithstanding any other provision of this section, if the Secretary determines that any portion of an application for an offer-in-compromise or installment agreement submitted under this section or section 6159 meets the requirement of clause (i) or (ii) of section 6702(b)(2)(A), then the Secretary may treat such portion as if it were never submitted and such portion shall not be subject to any further administrative or judicial review.

(Aug. 16, 1954, ch. 736, 68A Stat. 849; Pub. L. 94–455, title XIX, § 1906(b)(13)(A), Oct. 4, 1976, 90 Stat. 1834; Pub. L. 104–168, title V, § 503(a), July 30, 1996, 110 Stat. 1461; Pub. L. 105–206, title III, § 3462(a), (c)(1), July 22, 1998, 112 Stat. 764, 766; Pub. L. 109–222, title V, § 509(a), (b), May 17, 2006, 120 Stat. 362, 363; Pub. L. 109–432, div. A, title IV, § 407(d), Dec. 20, 2006, 120 Stat. 2962; Pub. L. 113–295, div. A, title II, § 220(y), Dec. 19, 2014, 128 Stat. 4036; Pub. L. 116–25, title I, §§ 1001(b)(1)(F), 1102(a), July 1, 2019, 133 Stat. 985, 986.)

Treas. Reg. Sec. 301.7122-1 Compromises.

(a) In general

(1) If the Secretary determines that there are grounds for compromise under this section, the Secretary may, at the Secretary’s discretion, compromise any civil or criminal liability arising under the internal revenue laws prior to reference of a case involving such a liability to the Department of Justice for prosecution or defense.

(2) An agreement to compromise may relate to a civil or criminal liability for taxes, interest, or penalties. Unless the terms of the offer and acceptance expressly provide otherwise, acceptance of an offer to compromise a civil liability does not remit a criminal liability, nor does acceptance of an offer to compromise a criminal liability remit a civil liability.

(b) Grounds for compromise –

(1) Doubt as to liability. Doubt as to liability exists where there is a genuine dispute as to the existence or amount of the correct tax liability under the law. Doubt as to liability does not exist where the liability has been established by a final court decision or judgment concerning the existence or amount of the liability. See paragraph (f)(4) of this section for  special rulesapplicable to rejection of offers in cases where the Internal Revenue Service (IRS) is unable to locate the taxpayer‘s return or return information to verify the liability.

(2) Doubt as to collectibility. Doubt as to collectibility exists in any case where the taxpayer‘s assets and income are less than the full amount of the liability.

(3) Promote effective tax administration.

(i) A compromise may be entered into to promote effective tax administration when the Secretary determines that, although collection in full could be achieved, collection of the full liability would cause the  taxpayer economic hardship within the meaning of § 301.6343-1.

(ii) If there are no grounds for compromise under paragraphs (b)(1), (2), or (3)(i) of this section, the IRS may compromise to promote effective tax administration where compelling public policy or equity considerations identified by the  taxpayer provide a sufficient basis for compromising the liability. Compromise will be justified only where, due to exceptional circumstances, collection of the full liability would undermine public confidence that the  tax laws are being administered in a fair and equitable manner. A  taxpayer proposing compromise under this paragraph (b)(3)(ii) will be expected to demonstrate circumstances that justify compromise even though a similarly situated  taxpayer may have paid his liability in full.

(iii) No compromise to promote effective tax administration may be entered into if compromise of the liability would undermine compliance by  taxpayers with the  tax laws.

(c) Special rules for evaluating offers to compromise –

(1) In general. Once a basis for compromise under paragraph (b) of this section has been identified, the decision to accept or reject an offer to compromise, as well as the terms and conditions agreed to, is left to the discretion of the Secretary. The determination whether to accept or reject an offer to compromise will be based upon consideration of all the facts and circumstances, including whether the circumstances of a particular case warrant acceptance of an amount that might not otherwise be acceptable under the Secretary’s policies and procedures.

(2) Doubt as to collectibility –

(i) Allowable expenses. A determination of doubt as to collectibility will include a  determination of ability to pay. In determining ability to pay, the Secretary will permit  taxpayers to retain sufficient funds to pay basic living expenses. The determination of the amount of such basic living expenses will be founded upon an evaluation of the individual facts and circumstances presented by the  taxpayer‘s case. To guide this  determination, guidelines published by the Secretary on national and local living expense standards will be taken into  account.

(ii) Nonliable spouses –

(A) In general. Where a taxpayer is offering to compromise a liability for which the  taxpayer‘s spouse has no liability, the assets and income of the nonliable spouse will not be considered in determining the amount of an adequate offer. The assets and income of a nonliable spouse may be considered, however, to the extent property has been transferred by the  taxpayer to the nonliable spouse under circumstances that would permit the IRS to effect collection of the taxpayer‘s liability from such property (e.g., property that was conveyed in fraud of creditors), property has been transferred by the  taxpayer to the nonliable spouse for the  purpose of removing the property from consideration by the IRS in evaluating the compromise, or as provided in paragraph (c)(2)(ii)(B) of this section. The IRS also may  requestinformation regarding the assets and income of the nonliable spouse for the  purpose of verifying the amount of and responsibility for expenses claimed by the  taxpayer.

(B) Exception. Where collection of the taxpayer‘s liability from the assets and income of the nonliable spouse is permitted by applicable  state law (e.g., under  state community property laws), the assets and income of the nonliable spouse will be considered in determining the amount of an adequate offer except to the extent that the  taxpayer and the nonliable spouse demonstrate that collection of such assets and income would have a material and adverse impact on the standard of living of the  taxpayer, the nonliable spouse, and their dependents.

(3) Compromises to promote effective tax administration –

(i)  Factors supporting (but not conclusive of) a determination that collection would cause economic hardship within the meaning of paragraph (b)(3)(i) of this section include, but are not limited to –

(A) Taxpayer is incapable of earning a living because of a long term illness, medical condition, or disability, and it is reasonably foreseeable that  taxpayer‘s financial resources will be exhausted providing for care and support during the course of the condition;

(B) Although taxpayer has certain monthly income, that income is exhausted each month in providing for the care of dependents with no other means of support; and

(C) Although taxpayer has certain assets, the  taxpayer is unable to borrow against the equity in those assets and liquidation of those assets to pay outstanding  tax liabilities would render the  taxpayer unable to meet basic living expenses.

(ii) Factors supporting (but not conclusive of) a determination that compromise would undermine compliance within the meaning of paragraph (b)(3)(iii) of this section include, but are not limited to –

(A) Taxpayer has a history of noncompliance with the filing and  payment requirements of the Internal Revenue Code;

(B) Taxpayer has taken deliberate  actions to avoid the  payment of taxes; and

(C) Taxpayer has encouraged others to refuse to comply with the  tax laws.

(iii) The following examples illustrate the types of cases that may be compromised by the Secretary, at the Secretary’s discretion, under the economic hardship provisions of paragraph (b)(3)(i) of this section:

Example 1.

The taxpayer has assets sufficient to satisfy the tax liability. The taxpayer provides full time care and assistance to her dependent child, who has a serious long-term illness. It is expected that the taxpayer will need to use the equity in his assets to provide for adequate basic living expenses and medical care for his child. The taxpayer’s overall compliance history does not weigh against compromise.

Example 2.

The taxpayer is retired and his only income is from a pension. The taxpayer’s only asset is a retirement account, and the funds in the account are sufficient to satisfy the liability. Liquidation of the retirement account would leave the taxpayer without an adequate means to provide for basic living expenses. The taxpayer’s overall compliance history does not weigh against compromise.

Example 3.

The taxpayer is disabled and lives on a fixed income that will not, after allowance of basic living expenses, permit full payment of his liability under an installment agreement. The taxpayer also owns a modest house that has been specially equipped to accommodate his disability. The taxpayer’s equity in the house is sufficient to permit payment of the liability he owes. However, because of his disability and limited earning potential, the taxpayer is unable to obtain a mortgage or otherwise borrow against this equity. In addition, because the taxpayer’s home has been specially equipped to accommodate his disability, forced sale of the taxpayer’s residence would create severe adverse consequences for the taxpayer. The taxpayer’s overall compliance history does not weigh against compromise.

(iv) The following examples illustrate the types of cases that may be compromised by the Secretary, at the Secretary’s discretion, under the public policy and equity provisions of paragraph (b)(3)(ii) of this section:

Example 1.

In October of 1986, the taxpayer developed a serious illness that resulted in almost continuous hospitalizations for a number of years. The taxpayer’s medical condition was such that during this period the taxpayer was unable to manage any of his financial affairs. The taxpayer has not filed tax returns since that time. The taxpayer’s health has now improved and he has promptly begun to attend to his tax affairs. He discovers that the IRS prepared a substitute for return for the 1986 tax year on the basis of information returns it had received and had assessed a tax deficiency. When the taxpayer discovered the liability, with penalties and interest, the tax bill is more than three times the original tax liability. The taxpayer’s overall compliance history does not weigh against compromise.

Example 2.

The taxpayer is a salaried sales manager at a department store who has been able to place $2,000 in a tax-deductible IRA account for each of the last two years. The taxpayer learns that he can earn a higher rate of interest on his IRA savings by moving those savings from a money management account to a certificate of deposit at a different financial institution. Prior to transferring his savings, the taxpayer submits an e-mail inquiry to the IRS at its Web Page, requesting information about the steps he must take to preserve the tax benefits he has enjoyed and to avoid penalties. The IRS responds in an answering e-mail that the taxpayer may withdraw his IRA savings from his neighborhood bank, but he must redeposit those savings in a new IRA account within 90 days. The taxpayer withdraws the funds and redeposits them in a new IRA account 63 days later. Upon audit, the taxpayer learns that he has been misinformed about the required rollover period and that he is liable for additional taxes, penalties and additions to tax for not having redeposited the amount within 60 days. Had it not been for the erroneous advice that is reflected in the taxpayer’s retained copy of the IRS e-mail response to his inquiry, the taxpayer would have redeposited the amount within the required 60-day period. The taxpayer’s overall compliance history does not weigh against compromise.

(d) Procedures for submission and consideration of offers –

(1) In general. An offer to compromise a tax liability pursuant to section 7122 must be submitted according to the procedures, and in the form and manner, prescribed by the Secretary. An offer to compromise a  tax liability must be made in writing, must be signed by the  taxpayer under  penalty of perjury, and must contain all of the information prescribed or requested by the Secretary. However,  taxpayers submitting offers to compromise liabilities solely on the basis of doubt as to liability will not be required to provide financial statements.

(2) When offers become pending and return of offers. An offer to compromise becomes pending when it is accepted for processing. The IRS may not accept for processing any offer to compromise a liability following reference of a case involving such liability to the Department of Justice for prosecution or defense. If an offer accepted for processing does not contain sufficient information to permit the IRS to evaluate whether the offer should be accepted, the IRS will request that the  taxpayer provide the needed additional information. If the  taxpayer does not submit the additional information that the IRS has  requested within a reasonable time period after such a  request, the IRS may return the offer to the  taxpayer. The IRS may also return an offer to compromise a  tax liability if it determines that the offer was submitted solely to delay collection or was otherwise nonprocessable. An offer returned following acceptance for processing is deemed pending only for the period between the date the offer is accepted for processing and the date the IRS returns the offer to the  taxpayer. See paragraphs (f)(5)(ii) and (g)(4) of this section for rules regarding the effect of such returns of offers.

(3) Withdrawal. An offer to compromise a tax liability may be withdrawn by the  taxpayer or the  taxpayer‘s representative at any time prior to the IRS’ acceptance of the offer to compromise. An offer will be considered withdrawn upon the IRS’ receipt of written notification of the withdrawal of the offer either by personal delivery or certified mail, or upon  issuance of a letter by the IRS confirming the  taxpayer‘s intent to withdraw the offer.

(e) Acceptance of an offer to compromise a tax liability.

(1) An offer to compromise has not been accepted until the IRS issues a written notification of acceptance to the taxpayeror the  taxpayer‘s representative.

(2) As additional consideration for the acceptance of an offer to compromise, the IRS may request that  taxpayer enter into any collateral agreement or post any  security which is deemed necessary for the protection of the  interests of the United States.

(3) Offers may be accepted when they provide for payment of compromised amounts in one or more equal or unequal installments.

(4) If the final payment on an accepted offer to compromise is contingent upon the immediate and simultaneous release of a  tax lien in whole or in part, such  payment must be made in accordance with the forms, instructions, or procedures prescribed by the Secretary.

(5) Acceptance of an offer to compromise will conclusively settle the liability of the taxpayer specified in the offer. Compromise with one  taxpayer does not extinguish the liability of, nor prevent the IRS from taking  action to collect from, any  person not named in the offer who is also liable for the  tax to which the compromise relates. Neither the  taxpayer nor the Government will, following acceptance of an offer to compromise, be permitted to reopen the case except in instances where –

(i) False information or documents are supplied in conjunction with the offer;

(ii) The ability to pay or the assets of the taxpayer are concealed; or

(iii) A mutual mistake of material fact sufficient to cause the offer agreement to be reformed or set aside is discovered.

(6) Opinion of Chief Counsel. Except as otherwise provided in this paragraph (e)(6), if an offer to compromise is accepted, there will be placed on file the opinion of the Chief Counsel for the IRS with respect to such compromise, along with the reasons therefor. However, no such opinion will be required with respect to the compromise of any civil case in which the unpaid amount of tax assessed (including any  interest, additional amount, addition to the  tax, or assessable penalty) is less than $50,000. Also placed on file will be a statement of –

(i) The amount of tax assessed;

(ii) The amount of interest, additional amount, addition to the  tax, or assessable  penalty, imposed by law on the  personagainst whom the  tax is assessed; and

(iii) The amount actually paid in accordance with the terms of the compromise.

(f) Rejection of an offer to compromise.

(1) An offer to compromise has not been rejected until the IRS issues a written notice to the  taxpayer or his representative, advising of the rejection, the reason(s) for rejection, and the right to an appeal.

(2) The IRS may not notify a taxpayer or  taxpayer‘s representative of the rejection of an offer to compromise until an independent  administrative review of the proposed rejection is completed.

(3) No offer to compromise may be rejected solely on the basis of the amount of the offer without evaluating that offer under the provisions of this section and the Secretary’s policies and procedures regarding the compromise of cases.

(4) Offers based upon doubt as to liability. Offers submitted on the basis of doubt as to liability cannot be rejected solely because the IRS is unable to locate the taxpayer‘s return or return information for verification of the liability.

(5) Appeal of rejection of an offer to compromise –

(i) In general. The taxpayer may administratively appeal a rejection of an offer to compromise to the IRS Office of Appeals (Appeals) if, within the 30-day period commencing the day after the date on the letter of rejection, the  taxpayerrequests such an  administrative review in the manner provided by the Secretary.

(ii) Offer to compromise returned following a determination that the offer was nonprocessable, a failure by the taxpayer to provide requested information, or a determination that the offer was submitted for purposes of delay. Where a determination is made to return offer documents because the offer to compromise was nonprocessable, because the  taxpayer failed to provide  requested information, or because the IRS determined that the offer to compromise was submitted solely for  purposes of delay under paragraph (d)(2) of this section, the return of the offer does not constitute a rejection of the offer for  purposes of this provision and does not entitle the  taxpayer to appeal the matter to Appeals under the provisions of this paragraph (f)(5). However, if the offer is returned because the  taxpayer failed to provide  requested financial information, the offer will not be returned until a managerial review of the proposed return is completed.

(g) Effect of offer to compromise on collection activity –

(1) In general. The IRS will not levy against the property or rights to property of a taxpayer who submits an offer to compromise, to collect the liability that is the subject of the offer, during the period the offer is pending, for 30 days immediately following the rejection of the offer, and for any period when a timely filed appeal from the rejection is being considered by Appeals.

(2) Revised offers submitted following rejection. If, following the rejection of an offer to compromise, the taxpayermakes a good faith revision of that offer and submits the revised offer within 30 days after the date of rejection, the IRS will not levy to collect from the  taxpayer the liability that is the subject of the revised offer to compromise while that revised offer is pending.

(3) Jeopardy. The IRS may levy to collect the liability that is the subject of an offer to compromise during the period the IRS is evaluating whether that offer will be accepted if it determines that collection of the liability is in jeopardy.

(4) Offers to compromise determined by IRS to be nonprocessable or submitted solely for purposes of delay. If the IRS determines, under paragraph (d)(2) of this section, that a pending offer did not contain sufficient information to permit evaluation of whether the offer should be accepted, that the offer was submitted solely to delay collection, or that the offer was otherwise nonprocessable, then the IRS may levy to collect the liability that is the subject of that offer at any time after it returns the offer to the  taxpayer.

(5) Offsets under section 6402. Notwithstanding the evaluation and processing of an offer to compromise, the IRS may, in accordance with section 6402, credit any overpayments made by the taxpayer against a liability that is the subject of an offer to compromise and may offset such overpayments against other liabilities owed by the  taxpayer to the extent authorized by section 6402.

(6) Proceedings in court. Except as otherwise provided in this paragraph (g)(6), the IRS will not refer a case to the Department of Justice for the commencement of a proceeding in court, against a person named in a pending offer to compromise, if levy to collect the liability is prohibited by paragraph (g)(1) of this section. Without regard to whether a person is named in a pending offer to compromise, however, the IRS may authorize the Department of Justice to file a counterclaim or third-party complaint in a refund action or to join that  person in any other proceeding in which liability for the  tax that is the subject of the pending offer to compromise may be established or disputed, including a suit against the United  States under 28 U.S.C. 2410. In addition, the United  States may file a claim in any bankruptcy proceeding or insolvency  action brought by or against such  person.

(h) Deposits. Sums submitted with an offer to compromise a liability or during the pendency of an offer to compromise are considered deposits and will not be applied to the liability until the offer is accepted unless the taxpayer provides written authorization for application of the payments. If an offer to compromise is withdrawn, is determined to be nonprocessable, or is submitted solely for  purposes of delay and returned to the  taxpayer, any amount tendered with the offer, including all installments paid on the offer, will be refunded without  interest. If an offer is rejected, any amount tendered with the offer, including all installments paid on the offer, will be refunded, without  interest, after the conclusion of any review sought by the taxpayer with Appeals. Refund will not be required if the  taxpayer has agreed in writing that amounts tendered pursuant to the offer may be applied to the liability for which the offer was submitted.

(i) Statute of limitations –

(1) Suspension of the statute of limitations on collection. The statute of limitations on collection will be suspended while levy is prohibited under paragraph (g)(1) of this section.

(2) Extension of the statute of limitations on assessment. For any offer to compromise, the IRS may require, where appropriate, the extension of the statute of limitations on assessment. However, in any case where waiver of the running of the statutory period of  limitations on assessment is sought, the  taxpayer must be notified of the right to refuse to extend the period of  limitations or to limit the extension to particular issues or particular periods of time.

(j) Inspection with respect to accepted offers to compromise. For provisions relating to the inspection of returns and accepted offers to compromise, see section 6103(k)(1).

(k) Effective date. This section applies to offers to compromise pending on or submitted on or after July 18, 2002.

[T.D. 9007, 67 FR 48029, July 23, 2002; 67 FR 53879, Aug. 20, 2002]

[1] An accepted offer in compromise is properly analyzed as a contract between the parties. United States v. Donovan, 348 F.3d 509, 512-13 (6th Cir. 2003); Roberts v. United States , 242 F.3d 1065 (Fed. Cir. 2001); Timms v. United States, supra at 833-36; United States v. Lane, 303 F.2d 1,4 (5th Cir. 1962); Robbins Tire & Rubber Co. Inc. v. Commissioner,  52 T.C. 420, 436 (1969). Consequently, an OIC, like certain other agreements between the Commissioner and taxpayers, is governed by general principles of contract law. Cf. Duncan v. Commissioner , 121 T.C. 293, 296, (2003) (contract law applied to stipulated arbitration agreement); Bankamerica Corp. v. Commissioner, 109 T.C. 1, 12 (1997) (contract law applied to stipulations of fact); Dorchester Indus., Inc. v. Commissioner, 108 T.C. 320, 330 (1997) (contract law applied to settlement agreement), aff’d without published opinion, 208 F.3d 205 (3d Cir. 2000); Woods v. Commissioner,  92 T.C. 776,780 (1989) (contract law applied to agreement to extend the period for making assessments). Courts have routinely held that OICs are valid and binding contracts. See Timms v. United States, supra at 492; Waller v. United States, 767 F. Supp. 1042, 1044-45 (E.D. Cal. 1991); Seattle-First Nat’l Bank v. United States, 44 F.Supp. 603, 610 (E.D. Wash. 1942), aff’d , 136 F.2d 676 (9th Cir. 1943), aff’d, 321 U.S. 583 (1944); Lang-Kidde Co. v. United States, 2 F. Supp 768,769 (Ct. CI. 1933).

[2] Generally, an acceptance of an OIC will conclusively settle the liability of the taxpayer specified in the OIC, absent fraud or mutual mistake. Dutton v. Commissioner, 122 T.C. 133, 138 (2004); Treas. Reg.  § 301-7122-1(e)(5). See also Estate of Jones v. Commissioner, 795 F.2d 566, 573-74 (6th Cir. 1986), aff’g, T.C. Memo. 1984-53; Timms v. United States, 678 F.2d 831,833 (9th Cir. 1982).  CCA LEG-142031-08, 11/17/2008

[3] Murphy v. Comm’r of Internal Revenue, 469 F.3d 27, 33 (1st Cir. 2006)

[4] Generally, the total number of persons allowed for national standard expenses should be the same as those allowed as dependents on the taxpayer’s current year income tax return. There may be reasonable exceptions.

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The Tax Court in Brief December 13 – 18, 2021

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Tax Litigation: The Week of December 13 – December 18, 2021

• Antonyan, et. al. v. Comm’r, TC Memo. 2021-138 | December 13, 2021 | Nega, J. | Dkt. No. 13741-18
• Mitchel Skolnick and Leslie Skolnick, et al., v. Comm’r, T.C. Memorandum 2021-139| December 16, 2021 | Lauber, J. | Dkt. Nos. 24649-19, 24650-16, 24980-16

Tax Court Case:

Antonyan, et. al. v. Comm’r, TC Memo. 2021-138

December 13, 2021 | Nega, J. | Dkt. No. 13741-18

• Opinion

Short Summary: In 2012 or 2013, Mr. Antonyan purchased 10 acres in the middle of the Mojave Desert, around 1 mile away from any road. Mr. Antonyan intended to develop the property’s natural resources and, ultimately, rent parcels of the property to farmers for organic farming.  He called this venture “Paradise Acres.” Mr. Antonyan devised a business plan for Paradise Acres, according to which he would undertake the following steps: 1) build a barn-like structure on the property; 2) obtain USDA certification that the property complied with organic farming standards; 3) install an irrigation system on the property; and 4) build an access road to the property.

Prior to 2015, Mr. Antonyan had partially installed a water tank and rainwater collection system on the property, explored and mapped the property, and experimented with growing certain plants on the property. He also used the property for recreational activities.

In 2015 Mr. Antonyan began construction on the barn-like structure. He purchased building materials, rented a commercial truck and tractor-trailer to transport materials to the property, created an unpaved road to access the property, and hired workers to assist in building the structure. During this time, Mr. Antonyan could only work on the property on weekends because of his full-time job as an engineer.

Mr. Antonyan and Ms. Safaryan (the “Petitioners”) filed a joint income tax return for 2015. Attached to this return was a Schedule C for Paradise Acres.  The Schedule C reported no gross income and claimed deductions for car and truck expenses, travel expenses, start-up costs, and amortization. The Petitioners had not attempted to claim deductions in connection with Paradise Acres in previous years.

On May 11, 2018, the Internal Revenue Service issued a notice of deficiency for 2015 to the Petitioners disallowing the Petitioners’ Schedule C deductions.

Key Issues:

• (1) Were the Petitioners entitled to deduct expenses relating to Paradise Acres as ordinary and necessary trade or business expenses under Section 162 in 2015?
• (2) Were the Petitioners entitled to deduct start-up costs and amortization expenses relating to Paradise Acres as start-up expenses for an active trade or business under Section 195 in 2015?

Primary Holdings:

• The Petitioners were not entitled to deduct expenses relating to Paradise Acres as ordinary and necessary trade or business expenses under Section 162. Mr. Antonyan’s activities in connection with Paradise Acres in 2015 did not amount to a trade or business but were, instead, merely activities taken to set up a trade or business. Mr. Antonyan had not completed any of the steps set forth in his business plan by the end of 2015, which indicated that the Paradise Acres venture was not an active trade or business in that year. Even assuming that none of the steps in the business plan were necessary to rent the property, the Petitioners still failed to produce any credible evidence that Mr. Antonyan was actively engaging with potential customers to rent the property during 2015.
• The Petitioners were not entitled to deduct start-up costs and amortization expenses relating to Paradise Acres as start-up expenses for an active trade or business under Section 195 in 2015. Per the reasoning set out above, the Paradise Acres venture was not an active trade or business in 2015.

Key Points of Law:

• A taxpayer may deduct all ordinary and necessary expenses paid or incurred in carrying on a trade or business during the taxable year. I.R.C. § 162(a).
• To be deductible under Section 162, expenses must relate to a trade or business functioning when the expenses were incurred. See Hardy v. Commissioner, 93 T.C. 684, 687 (1989). Until then, expenses are not “ordinary and necessary” expenses deductible under Section 162 but rather start-up expenses subject to the requirements of Section 195. Id. at 687-88.
• Whether a taxpayer is presently engaged in a trade or business is determined by examining the facts and circumstances, including: (1) whether the taxpayer intends to earn a profit from the activity; (2) whether the taxpayer is regularly and actively involved in the activity; and (3) whether the taxpayer has begun the activity. See Woody v. Commissioner, T.C. Memo. 2009-93, aff’d, 403 F. App’x 519 (D.C. Cir. 2010).
• Activities taken to set up a business (such as exploration and experimentation) do not indicate that a business has commenced and is presently a going concern. See McKelvey v. Commissioner, T.C. Memo. 2002-63.
• A taxpayer is allowed to deduct certain start-up expenses in the taxable year in which the taxpayer begins an active trade or business in an amount equal to the lesser of the amount of start-up expenses or $5,000, reduced (but not below zero) by the amount by which such expenses exceed $50,000. I.R.C. § 195(b)(1)(A). Any remaining start-up expenses are deducted ratably over the 15-year period beginning with the month in which the active trade or business begins. Id. § 195(b)(1)(B).

Insight: Antonyan highlights the basic requirements for being able to deduct expenses under Section 162 and Section 195. It also demonstrates the importance of keeping records relating to trade or business activities in order to prove up the existence of a trade or business within a given year and the possible consequences of failing to adhere to a business plan.

Tax Court Case:

Mitchel Skolnick and Leslie Skolnick, et al., v. Comm’r, T.C. Memorandum 2021-139

December 16, 2021 | Lauber, J. | Dkt. Nos. 24649-19, 24650-16, 24980-16

• Opinion

Short Summary:  The main issue, in this case, is whether the taxpayers’ horse breeding activity was operated with the intent to make a profit under section I.R.C. 183 during the 2010-2013 period (the tax years). Additionally, the case discussed if the losses generated in the horse activity of the taxpayers were deductible as carryforwards to the tax years.

Mitchel Skolnick and Eric Freeman (the taxpayers) were co-owners of Bluestone Farms, an LLC taxed as a partnership for federal tax purposes. Bluestone Farms was engaged in the breeding of Standardbred horses. Since its incorporation, Bluestone incurred in considerable losses despite the various business plans prepared by Mr. Skolnick which envisioned a future gain. The losses continued to accrue during the 2010-2013 period. Bluestone did not derive any gain until 2016, when it sold its breeding rights in one of its horses.

Mr. Skolnick (owner of 70% of Bluestone) performed high-level activities in Bluestone, such as nominal supervision of the employees of Bluestone. He was not involved in de the day-to-day operation of the breeding activity. Mr. Freeman (owner of 15% of Bluestone) had no direct involvement in Bluestone’s operations.

The taxpayers’ CPA advised that Bluestone’s losses were deductible on their personal tax returns during the tax years. The IRS issued a notice of deficiency, and a timely petition was filed by each taxpayer.

Tax Court Key Issues:

Whether the taxpayers’ horse activities were engaged with the intent to make a profit as provided by section 183 of the I.R.C. As a follow-up question, whether the taxpayers were entitled to the NOL carryforwards derived from their horse activities.

Primary Holdings: The taxpayers horse activities were not engaged in for profit.

Key Points of Law:

The Tax Court determined that the horse activities of the taxpayers were not engaged with the intent to make a profit, as provided by I.R.C. 183. Section 183 provides that all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business. I.R.C. § 183. If the activity is not engaged in for profit, no deduction is allowed except to the extent of gross income derived from the activity. I.R.C. § 183(b). The taxpayer must have an actual and honest objective of making a profit. See Hulter v. Commissioner, 91 T.C. 371, 392 (1988). To make such determination, the Court loos at objective facts rather than the taxpayer’s assertions. See Keanini v. Commissioner, 94 T.C. 41 , 46 (1990).

As a corollary of the above, losses are not allowable for an activity that a taxpayer carries on… primarily for sport, as a hobby, or for recreation. Treas. Reg. § 1.183-2(a). Consequently, “hobby losses” are not allowed.

In the case of activities involving the breeding, training, showing, or racing of horses, it is presumed that the taxpayer is engaged in an activity for profit if the activity produces gross income in excess of deductions for any 2 out of 7 consecutive years ending with the tax year. I.R.C. § 183(d).

If the safe harbor is not applicable, the Regulations provide with a list of factors that are relevant to ascertain the existence of the intent to earn a profit. Treas. Reg. § 1.1832(b). In this case, the Court discussed all these 9 factors as follows:

1. Manner in which the taxpayer conducts the activity. The activity must be carried in a businesslike manner which may indicate the activity is engaged in for profit. Treas. Reg. § 1.183-2(b)(1). “Businesslike manner” is suggested by the maintenance of books and records and a plausible business plan. Ibid. In this case, the taxpayers maintained voluminous records of their horse activities. However, such records had critical gaps, such as lack of documentation of the initial contributions made by the taxpayers. More relevantly, such records were not used to improve profitability and implement techniques for controlling expenses and increase income.
   • Additionally, the taxpayers did not have a current business plan (the more recent was in 2004).
   • Also, Bluestone’s activities were insensitive to costs and there was a blending of business and personal elements (such as some expenses made for the benefit of the personal residence of Mr. Skolnick or the use of business credit cards by the spouse of Mr. Skolnick to incur in personal expenses). The Court determined that the taxpayers did not carry their activity in businesslike manner and weighed this factor against them.

2. Expertise of the taxpayer or his advisers. If the taxpayer consults with industry experts and studies accepted business practices when preparing for an activity, that may suggest a profit motive. Treas. Reg. § 1.183-2(b)(2). In this case, the taxpayers had previous experience in the horse business and given that they consulted with various experts about their activities, the Court found this factor in favor of the petitioners.
3. Time and effort spent by the taxpayer in carrying on the activity. Devotion of considerable time to an activity may indicate a profit motive, particularly if the activity does not have a substantial personal or recreational aspect. Treas. Reg. § 1.183-2(b)(3). In this case, Mr. Skolnick was not a hands-on manager but rather he exercised high-level supervision. Mr. Freeman barely visited the farm. This factor was deemed as neutral by the Court.
4. Expectation that assets used in the activity may appreciate in value. Profit includes appreciation in the value of assets, such as land. Treas. Reg. § 1.183-2(b)(4). If the taxpayer engages in farming of the land, the farming and the holding of the land are considered as a single activity only if the farming activity reduces the net cost of carrying the land. Treas. Reg. § 1.183-1(d)(1). In this case, the Court found that Bluestone held its farm properties to profit from the increase in value. However, such intent to profit is different from the intent to profit of the horse-breeding activities. Thus, appreciation in land is irrelevant in this case.
   • As for the appreciation in the value of the horse, the petitioners did not provide a reliable foundation to support a potential appreciation. See Skolnick I, 117 T.C.M. (CCH) at 1321. Finally, although the taxpayers showed a single success with the appreciation of a horse, such was deemed as not conclusive to establish that the whole operation was subject to appreciation

5. Success of the taxpayer in carrying on other similar or dissimilar activities. The previous business activities of the taxpayers were not related to horse breeding. This factor was deemed neutral by the Court.
6. Taxpayer’s history of income or losses with respect to the activity. Long period of losses can indicate lack of a profit motive. Treas. Reg. § 1.182-2(b)(6). This does not apply if the losses are due to customary business risks or unforeseen or fortuitous circumstances beyond the control of the taxpayer. In this case, the taxpayers incurred continuing losses since the incorporation of Bluestone until 2016. Also, the 2008 financial crisis is not an impediment to establish the lack of profit motive because the losses were generated much before such event and continued during the economic recovery. This factor weighed against the taxpayers.
7. Amount of occasional profits, if any. An occasional small profit from an activity generating large losses, would not generally be determinative that the activity is engaged in for profit. Treas. Reg. § 1.183-2(b)(7). Here, Bluestone only generated a small profit in 2016. Compared to the amount of losses, such profit was not enough to make the activity profitable. The factor was weighed in favor of the IRS.
8. Financial status of the taxpayer. If the taxpayer has substantial income or capital from sources other than the activity subject to inquiry, it may indicate lack of profit intent. Treas. Reg. § 1.183-2(b)(8). Here, the taxpayers had substantial capital from other sources (income from family trust). This factor was weighed against the taxpayers.
9. Elements of personal pleasure or recreation. If the taxpayer derives personal pleasure from an activity, or finds it recreational, it may suggest lack of intent of a profit. Treas. Reg. § 1.183-2(b)(9). However, “suffering has never been made a prerequisite to deductibility.” See Jackson v. Commissioner, 59 T.C. 312 , 317 (1972). But the activity of raising and racing horses is of a sporting and recreational nature. Treas. Reg. § 1.183-2(c), example 3. In this case, although Mr. Skolnick did not derive personal pleasure from the horse breeding activity, he and his partner enjoyed the buying and selling horses. Moreover, Mr. Skolnick’s residence within the property of Bluestone and the various expenses incurred with Bluestone funds to maintain such property enhanced his enjoyment of this activity.

Based on the above analysis, the Tax Court determined that the taxpayers’ activities were not engaged in for profit.

As for the NOL from previous years, the taxpayer bears the burden of establishing both the existence of the NOL and the amount of any loss that may be carried over to the subject years. Rule 142(a)(1); United States v. Olympic Radio & Television, Inc., 349 U.S. 232 , 235 (1955); Green v. Commissioner, T.C. Memo. 2003-244 , 86 T.C.M. (CCH) 273, 274-275.

In the case of NOLs incurred by a pass-through entity, the entity must prove that (1) the entity incurred NOLs, (2) he had a sufficient basis in the entity to absorb the NOLs, and (3) the NOLs were properly carried forward to the years at issue. See Jasperson v. Commissioner, T.C. Memo. 2015-186, 110 T.C.M. (CCH) 304 , 306 , aff’d, 658 F. App’x 962 (11th Cir. 2016). Taxpayers cannot rely solely on their own income tax returns to establish that losses were actually sustained. See Wilkinson v. Commissioner, 71 T.C. 633 , 639 (1979); Power v. Commissioner, T.C. Memo. 2016-157 , 112 T.C.M. (CCH) 241, 245. In this case, the taxpayers did not support the existence of the NOL in previous years, thus, the NOLs were disallowed.

As for the accuracy-related penalty assessed under Section 6662(a) the Court determined that the taxpayers established reasonable cause by relying on the advice of a professional. I.R.C. § 6664(c)(1). Their CPA was a competent professional with multiple years of experience, the taxpayers provided all the records to the CPA, and they relied on his advice that Bluestone’s losses were deductible.

Insight:  This case confirms previous cases related to the deductibility of “hobby losses.” In these “horse cases,” the taxpayer has a very difficult threshold to overcome to properly show the existence of the profit intent. This case presents a guide to taxpayers as to how to conduct their business particularly in activities that are “joyful” in itself.

Tax Court Litigation Attorneys

Need assistance litigating in the U.S. Tax Court? Freeman Law’s tax attorneys are experienced litigators with trial-tested litigation skills and in-depth substantive tax knowledge, having collectively litigated hundreds of cases before the U.S. Tax Court. Our tax controversy lawyers have extensive experience in Tax Court matters involving partnership audits and litigation under both the TEFRA and BBA regimes, international tax penalties, foreign trusts, valuation, reasonable compensation disputes, unreported income, fraud penalties, other tax penalties, and many other matters. We draw on our experience and wealth of tax knowledge to advise and guide clients through the entire tax controversy process, building the right strategy to resolve tax controversies from day one. Schedule a consultation or call (214) 984-3000 to discuss your Tax Court concerns or questions.

This article discusses Business Disparagement under Texas law. This article does not discuss the tort of defamation or slander of title. Although similar to defamation or slander of title, the false assertion in a business disparagement case instead harms the economic interests of the business.[1] Texas law refers to this type of action as “business disparagement”[2] while the Restatement refers to it as “injurious falsehood.”[3]

The Elements of Business Disparagement in Texas

To prove an action for business disparagement under Texas law, the plaintiff must establish five elements: (1) that the defendant published disparaging words, (2) the words were false, (3) the defendant published the words with malice, (4) without privilege, and (5) the plaintiff must prove special damages.[4] These elements are more stringent than those of defamation because disparagement protects against pecuniary loss.[5]

Disparaging Words

A plaintiff must first prove that the defendant published disparaging words to a third party about the plaintiff’s economic interests.[6]  The Restatement Second of Torts asserts that words are disparaging (1) if they cast doubt upon the quality or ownership of another’s land, chattels or intangible things, or upon the existence or extent of his property in them, and (2) that the defendant intended the words to cast doubt, or a third party reasonably understood the words to cast doubt.[7] Moreover, the Restatement rule notes that the disparagement may be by an expression of opinion or a statement of fact.[8]

Falsity

To prove an action for business disparagement, a plaintiff must plead and prove that the published words were false.[9] In a business disparagement case, there is no presumption of falsity; instead, the plaintiff has the burden of proving the falsity of the publication as part of its cause of action and, likewise, the defendant has no such burden to prove the publication is true.[10] However, a showing by the defendant of the substantial truth of a publication negates the essential element of falsity, and thus entitles the defendant to summary judgment.[11]

Malice

To prove an action for business disparagement, the plaintiff must prove that the defendant published the disparagement with actual malice. Proof of actual malice can be put forward in several different ways, but requires sufficient evidence to permit the conclusion that, at the time of publication, the defendant either: knew the statement was false, “acted with ill will or intended to interfere in the economic interest of the plaintiff,” entertained serious doubts as to the truth of the publication, or “acted with reckless disregard” for the truth.[12]

Actual malice, in this context, “is a term of art.” In the words of the Forbes court, it is not ill will, spite, or evil motive.[13] When the plaintiff in a business disparagement cause of action is a public official or figure, that plaintiff has the burden of proving by clear and convincing evidence that the disparaging words were published with knowledge that they were false or with reckless disregard as to whether or not they were true.[14]

A public figure, however, cannot satisfy the malice requirement merely by demonstrating the defendant’s ill will or intent to interfere with its economic interests.[15] In contrast, a private individual may demonstrate malice merely through the defendant’s “negligence.”[16] Note, however, that a media defendant’s poor choice of words or content, without evidence of deliberate falsity, does not amount to actual malice under Texas law.[17]

Privilege

In the context of business disparagement, privilege means that the defendant has some form of recognized legal immunity that protects them, even from the consequences of making a defamatory statement with malice.[18] In general, privilege may be absolute or conditional.[19] However, because conditional or qualified privilege would be defeated by a finding of malice, and malice is a necessary element of a business disparagement cause of action, such privileges are irrelevant in the context of business disparagement.[20] An absolute privilege, however, is applicable and may more properly be thought of as an immunity because it is based on the personal position or status of the actor.[21]

Special Damages

Texas law requires proof that the disparagement caused a direct pecuniary loss.[22] Proof of special damages is perhaps the most essential element in a business-disparagement claim—as without proof of special damages, there is no claim.[23]  Special damages are pecuniary losses that the plaintiff has suffered that have been realized or liquidated (e.g., loss of specific sales).[24] Furthermore, the disparaging communication in question must play a substantial part in inducing others not to deal with the plaintiff with the result that special damage, in the form of the loss of trade or other dealings, is established.[25] Finally, Texas courts have held that the pecuniary loss must be greater than the attorney fees incurred to bring the business-disparagement claim.[26]

Remedies

A plaintiff in an action for business disparagement can recover actual damages representing commercial harm or pecuniary loss to the plaintiff’s economic interests.[27] Actual damages in a business-disparagement action are “special damages” and must be specifically pleaded.[28] Other remedies include expense of counteracting publication, exemplary damages, equitable relief, interest, court costs, but notably not attorney fees or damages for personal injury.[29] Plaintiffs can also recover damages for the loss of a specific sale, loss of credit, or even loss of business if its business was completely destroyed.[30] The measure of damages for the loss of business is the market value of the business on the date of the loss rather than the loss of expected profits.[31]

Defenses

Defenses against a business disparagement action include limitations, proportionate responsibility, immunity and privilege.

Limitations

The limitations period for an action for business disparagement is two years.[32]  But when the sole basis of a business-disparagement claim is a defamatory injury to reputation and there is no evidence of special damages, the one-year statute of limitations for defamation applies.[33]

Proportionate Responsibility

The defendant can assert the defense that the plaintiff’s own acts or omissions caused or contributed to the plaintiff’s injury.[34]

Immunity & Privilege

Privilege as a defense to a business-disparagement claim, is supported by the Restatement which states that “the defendant has the burden of proving … the publication was absolutely or conditionally privileged.”[35] A defendant in a business-disparagement action can assert any absolute privileges that would be available in a defamation action.When the privilege is absolute, the actor’s motivation is irrelevant.[36] Such immunity, however, attaches only to a limited and select number of situations which involve the administration of the functions of the branches of government, and thus is only applicable in the business-disparagement claim when the defendant is a public official or figure.[37] The absolute privileges in defamation and business disparagement are “in all respects the same.”[38] This is not the case, however, for conditional or qualified privilege. Because conditional or qualified privilege would be defeated by a finding of malice, and malice is a necessary element of a business disparagement cause of action, a defendant cannot assert the defense of a common-law qualified privilege.[39]

Business Litigation Attorney

Need assistance in managing the business tax audit process? Freeman Law’s representations include disputes involving a variety of claims, such as breaches of fiduciary duty, business torts and other commercial disputes, partnership disputes, misrepresentation, deceptive trade practices act (“DTPA”) violations, tortious interference, extortion, Texas Theft Statute violations, civil conspiracy, and cyber and computer violations. We offer value-driven services and provide practical solutions to complex tax issues. Schedule a consultation or call (214) 984-300 to discuss our business litigation services. 

[1] Hurlbut v. Gulf Atl. Life Ins., 749 S.W.2d 762, 766 (Tex.1987); Waste Mgmt. of Tex., Inc. v. Tex. Disposal Sys. Landfill, Inc., 434 S.W.3d 142, 152 (Tex. 2014) (defining pecuniary and non-pecuniary harm).

[2] Id.

[3] Restatement (Second) of Torts § 623A, comment a (1977).

[4] Hurlbut, 749 S.W.2d at 766; Innovative Block v. Valley Builders Sup., 603 S.W.3d 409, 417 (Tex.2020); San Angelo Cmty. Med. Ctr., LLC v. Leon, 03-19-00229-CV, 2021 WL 1680194, at *8 (Tex. App.—Austin Apr. 29, 2021, no pet. h.).

[5] Hurlbut, 749 S.W.2d at 766.

[6] Id.

[7] Restatement (Second) of Torts § 629 (1977).

[8] Restatement (Second) of Torts § 629, comment a (1977); but see First Amendment of the United States Constitution and Art. I, § 8 of the Texas Constitution (note that statements of opinion are not actionable under the Lanham Act because opinions are protected.)

[9] Hurlbut, 749 S.W.2d at 766.

[10] Astoria Indus. of Iowa, Inc. v. SNF, Inc., 223 S.W.3d 616, 625 (Tex. App.—Fort Worth 2007, pet. denied), abrogated by Dallas Symphony Ass’n, Inc. v. Reyes, 571 S.W.3d 753 (Tex. 2019).

[11] See Granada Biosciences, Inc. v. Forbes, Inc., 49 S.W.3d 610 (Tex. App. Houston 14th Dist. 2001), order withdrawn, (Sept. 26, 2002) and judgment rev’d on other grounds, 124 S.W.3d 167 (Tex. 2003).

[12] Granada, 49 S.W.3d at 617; Bentley v. Bunton, 94 S.W.3d 561, 591 (Tex.2002).

[13] Forbes Inc. v. Granada Biosciences, Inc., 124 S.W.3d 167, 171 (Tex. 2003) (internal citations omitted).

[14] Forbes, 124 S.W.3d at 170.

[15] Id.

[16] Id.

[17] Bose Corp. v. Consumers Union of U.S., Inc., 466 U.S. 485, 490, 104 S. Ct. 1949, 1954, 80 L. Ed. 2d 502 (1984).

[18] Hurlbut, 749 S.W.2d at 768.

[19] Id.

[20] Granada, 49 S.W.3d at 619.

[21] Id.

[22] Johnson v. Hosp. Corp. of Am., 95 F.3d 383, 391 (5th Cir. 1996) (citing Hurlbut, 749 S.W.2d at 767).

[23] Waste Mgmt., 434 S.W.3d at 155; Hurlbut, 749 S.W.2d at 767.

[24] Hurlbut, 749 S.W.2d at 767.

[25] Id.

[26] C.P. Interests, Inc. v. California Pools, Inc., 238 F.3d 690, 696 (5th Cir.2001).

[27] Hurlbut, 749 S.W.2d at 767.

[28]Id.

[29] Hurlbut, 749 S.W.2d at 767; Dallas Symphony, 571 S.W.3d at 753; Dwyer v. Sabine Mining Co., 890 S.W.2d 140, 143 (Tex.App.—Texarkana 1994, writ denied) (damages for mental distress and injury to reputation are not recoverable in action for business disparagement).

[30] Hurlbut, 749 S.W.2d at 767.

[31] Id.

[32] Glassdoor, Inc. v. Andra Grp., 575 S.W.3d 523, 527 (Tex.2019).

[33] Nath v. Texas Children’s Hosp., 446 S.W.3d 355, 370 (Tex.2014).

[34] Tex. Civ. Prac. & Rem. Code Ann. § 33.000-4.

[35] Restatement Second, Torts § 651(2).

[36] Hurlbut, 749 S.W.2d at 768.

[37] Id.

[38] Restatement Second, Torts § 635, comment a.

[39] Granada 49 S.W.3d at 619, citing Hurlbut, 749 S.W.2d at 768.

On March 18, 2020, the Families First Coronavirus Response Act became law.  It is effective for paid sick leave or expanded family and medical leave taken between April 1, 2020, and December 31, 2020. Freeman Law first wrote on this legislation here.

Recently, the U.S. Department of Labor has issued helpful guidance via frequently asked questions and answers. Those can be found here and are also reproduced below for the reader’s convenience.

DEFINITIONS 

“Paid sick leave” – means paid leave under the Emergency Paid Sick Leave Act. 

“Expanded family and medical leave” – means paid leave under the Emergency Family and Medical Leave Expansion Act. 

QUESTIONS & ANSWERS 

1. What is the effective date of the Families First Coronavirus Response Act (FFCRA), which includes the Emergency Paid Sick Leave Act and the Emergency Family and Medical Leave Expansion Act? 

The FFCRA’s paid leave provisions are effective on April 1, 2020, and apply to leave taken between April 1, 2020, and December 31, 2020. 

2. As an employer, how do I know if my business is under the 500-employee threshold and therefore must provide paid sick leave or expanded family and medical leave? 

You have fewer than 500 employees if, at the time your employee’s leave is to be taken, you employ fewer than 500 full-time and part-time employees within the United States, which includes any State of the United States, the District of Columbia, or any Territory or possession of the United States. In making this determination, you should include employees on leave; temporary employees who are jointly employed by you and another employer (regardless of whether the  jointly-employed employees  are maintained on only your or another employer’s payroll); and day laborers supplied by a temporary agency (regardless of whether you are the temporary agency or the client firm if there is a continuing employment relationship). Workers who are independent contractors under the Fair Labor Standards Act (FLSA), rather than  employees, are not considered employees for purposes of the 500-employee threshold. 

Typically, a corporation (including its separate establishments or divisions) is considered to be a single employer and its employees must each be counted towards the 500-employee threshold. Where a corporation has an ownership interest in another corporation, the two corporations are separate employers unless they are  joint employers under the FLSA  with respect to certain employees. If two entities are found to be joint employers, all of their common employees must be counted in determining whether paid sick leave must be provided under the Emergency Paid Sick Leave Act and expanded family and medical leave must be provided under the Emergency Family and Medical Leave Expansion Act. 

In general, two or more entities are separate employers unless they meet the  integrated employer test  under the Family and Medical Leave Act of 1993 (FMLA). If two entities are an integrated employer under the FMLA, then employees of all entities making up the integrated employer will be counted in determining employer coverage for purposes of expanded family and medical leave under the Emergency Family and Medical Leave Expansion Act. 

3. If I am a private sector employer and have 500 or more employees, do the Acts apply to me? 

No. Private sector employers are only required to comply with the Acts if they have fewer than 500 employees.[1] 

4. If providing child care-related paid sick leave and expanded family and medical leave at my business with fewer than 50 employees would jeopardize the viability of my business as a going concern, how do I take advantage of the small business exemption? 

To elect this small business exemption, you should document why your business with fewer than 50 employees meets the criteria set forth by the Department, which will be addressed in more detail in forthcoming regulations. 

You should not send any materials to the Department of Labor when seeking a small business exemption for paid sick leave and expanded family and medical leave. 

5. How do I count hours worked by a part-time employee for purposes of paid sick leave or expanded family and medical leave?A part-time employee is entitled to leave for his or her average number of work hours in a two-week period. Therefore, you calculate hours of leave based on the number of hours the employee is normally scheduled to work. If the normal hours scheduled are unknown, or if the part-time employee’s schedule varies, you may use a six-month average to calculate the average daily hours. Such a part-time employee may take paid sick leave for this number of hours per day for up to a two-week period, and may take expanded family and medical leave for the same number of hours per day up to ten weeks after that. 

If this calculation cannot be made because the employee has not been employed for at least six months, use the number of hours that you and your employee agreed that the employee would work upon hiring. And if there is no such agreement, you may calculate the appropriate number of hours of leave based on the average hours per day the employee was scheduled to work over the entire term of his or her employment. 

6. When calculating pay due to employees, must overtime hours be included? 

Yes. The Emergency Family and Medical Leave Expansion Act requires you to pay an employee for hours the employee would have been normally scheduled to work even if that is more than 40 hours in a week.  

However, the Emergency Paid Sick Leave Act requires that paid sick leave be paid only up to 80 hours over a two-week period. For example, an employee who is scheduled to work 50 hours a week may take 50 hours of paid sick leave in the first week and 30 hours of paid sick leave in the second week. In any event, the total number of hours paid under the Emergency Paid Sick Leave Act is capped at 80. 

If the employee’s schedule varies from week to week, please see the answer to  Question 5, because the calculation of hours for a full-time employee with a varying schedule is the same as that for a part-time employee. 

Please keep in mind the daily and aggregate caps placed on any pay for paid sick leave and expanded family and medical leave as described in the answer to Question 7. 

Please note that pay does not need to include a premium for overtime hours under either the Emergency Paid Sick Leave Act or the Emergency Family and Medical Leave Expansion Act. 

7. As an employee, how much will I be paid while taking paid sick leave or expanded family and medical leave under the FFCRA? 

It depends on your normal schedule as well as why you are taking leave. 

If you are taking paid sick leave because you are unable to work or telework due to a need for leave because you (1) are subject to a Federal, State, or local quarantine or isolation order related to COVID-19; (2) have been advised by a health care provider to self-quarantine due to concerns related to COVID-19; or (3) are experiencing symptoms of COVID-19 and are seeking medical diagnosis, you will receive for each applicable hour the greater of: 

• your  regular rate of pay, 
• the federal minimum wage in effect under the FLSA, or 
• the applicable State or local minimum wage. 

In these circumstances, you are entitled to a maximum of $511 per day, or $5,110 total over the entire paid sick leave period. 

If you are taking paid sick leave because you are: (1) caring for an individual who is subject to a Federal, State, or local quarantine or isolation order related to COVID-19 or an individual who has been advised by a health care provider to self-quarantine due to concerns related to COVID-19; (2) caring for your child whose school or place of care is closed, or child care provider is unavailable, due to COVID-19 related reasons; or (3) experiencing any other substantially-similar condition that may arise, as specified by the Secretary of Health and Human Services, you are entitled to compensation at 2/3 of the greater of the amounts above. 

Under these circumstances, you are subject to a maximum of $200 per day, or $2,000 over the entire two week period. 

If you are taking expanded family and medical leave, you may take paid sick leave for the first ten days of that leave period, or you may substitute any accrued vacation leave, personal leave, or medical or sick leave you have under your employer’s policy. For the following ten weeks, you will be paid for your leave at an amount no less than 2/3 of your  regular rate of pay  for the hours you would be normally scheduled to work. The  regular rate of pay  used to calculate this amount must be at or above the federal minimum wage, or the applicable state or local minimum wage. However, you will not receive more than $200 per day or $12,000 for the twelve weeks that include both paid sick leave and expanded family and medical leave when you are on leave to care for your child whose school or place of care is closed, or child care provider is unavailable, due to COVID-19 related reasons. 

To calculate the number of hours for which you are entitled to paid leave, please see the answers to Questions 5-6 that are provided in this guidance. 

8. What is my regular rate of pay for purposes of the FFCRA? 

For purposes of the FFCRA, the regular rate of pay used to calculate your paid leave is the average of your  regular rate  over a period of up to six months prior to the date on which you take leave.[2] If you have not worked for your current employer for six months, the regular rate used to calculate your paid leave is the average of your regular rate of pay for each week you have worked for your current employer. 

If you are paid with commissions, tips, or piece rates, these amounts will be incorporated into the above calculation to the same extent they are included in the calculation of the regular rate under the FLSA. 

You can also compute this amount for each employee by adding all compensation that is part of the regular rate over the above period and divide that sum by all hours actually worked in the same period. 

9. May I take 80 hours of paid sick leave for my self-quarantine and then another amount of paid sick leave for another reason provided under the Emergency Paid Sick Leave Act? 

No. You may take up to two weeks—or ten days—(80 hours for a full-time employee, or for a part-time employee, the number of hours equal to the average number of hours that the employee works over a typical two-week period) of paid sick leave for any combination of qualifying reasons. However, the total number of hours for which you receive paid sick leave is capped at 80 hours under the Emergency Paid Sick Leave Act.  

10. If I am home with my child because his or her school or place of care is closed, or child care provider is unavailable, do I get paid sick leave, expanded family and medical leave, or both—how do they interact? 

You may be eligible for both types of leave, but only for a total of twelve weeks of paid leave. You may take both paid sick leave and expanded family and medical leave to care for your child whose school or place of care is closed, or child care provider is unavailable, due to COVID-19 related reasons. The Emergency Paid Sick Leave Act provides for an initial two weeks of paid leave. This period thus covers the first ten workdays of expanded family and medical leave, which are otherwise unpaid under the Emergency and Family Medical Leave Expansion Act unless you elect to use existing vacation, personal, or medical or sick leave under your employer’s policy. After the first ten workdays have elapsed, you will receive 2/3 of your  regular rate of pay  for the hours you would have been scheduled to work in the subsequent ten weeks under the Emergency and Family Medical Leave Expansion Act. 

Please note that you can only receive the additional ten weeks of expanded family and medical leave under the Emergency Family and Medical Leave Expansion Act for leave to care for your child whose school or place of care is closed, or child care provider is unavailable, due to COVID-19 related reasons. 

11. Can my employer deny me paid sick leave if my employer gave me paid leave for a reason identified in the Emergency Paid Sick Leave Act prior to the Act going into effect? 

No. The Emergency Paid Sick Leave Act imposes a new leave requirement on employers that is effective beginning on April 1, 2020. 

12. Is all leave under the FMLA now paid leave? 

No. The only type of family and medical leave that is paid leave is expanded family and medical leave under the Emergency Family and Medical Leave Expansion Act when such leave exceeds ten days. This includes only leave taken because the employee must care for a child whose school or place of care is closed, or child care provider is unavailable, due to COVID-19 related reasons. 

13.  Are the paid sick leave and expanded family and medical leave requirements retroactive? 

No. 

14. How do I know whether I have “been employed for at least 30 calendar days by the employer” for purposes of expanded family and medical leave? 

You are considered to have been employed by your employer for at least 30 calendar days if your employer had you on its payroll for the 30 calendar days immediately prior to the day your leave would begin. For example, if you want to take leave on April 1, 2020, you would need to have been on your employer’s payroll as of March 2, 2020. 

If you have been working for a company as a temporary employee, and the company subsequently hires you on a full-time basis, you may count any days you previously worked as a temporary employee toward this 30-day eligibility period.   

15. What records do I need to keep when my employee takes paid sick leave or expanded family and medical leave? 

Private sector employers that provide paid sick leave and expanded family and medical leave required by the FFCRA are eligible for reimbursement of the costs of that leave through refundable tax credits.  If you intend to claim a tax credit under the FFCRA for your payment of the sick leave or expanded family and medical leave wages, you should retain appropriate documentation in your records. You should consult Internal Revenue Service (IRS) applicable forms, instructions, and information for the procedures that must be followed to claim a tax credit, including any needed substantiation to be retained to support the credit. You are not required to provide leave if materials sufficient to support the applicable tax credit have not been provided.

If one of your employees takes expanded family and medical leave to care for his or her child whose school or place of care is closed, or child care provider is unavailable, due to COVID-19, you may also require your employee to provide you with any additional documentation in support of such leave, to the extent permitted under the certification rules for conventional FMLA leave requests. For example, this could include a notice that has been posted on a government, school, or day care website, or published in a newspaper, or an email from an employee or official of the school, place of care, or child care provider.  

16. What documents do I need to give my employer to get paid sick leave or expanded family and medical leave? 

You must provide to your employer documentation in support of your paid sick leave as specified in applicable IRS forms, instructions, and information. 

Your employer may also require you to provide additional in support of your expanded family and medical leave taken to care for your child whose school or place of care is closed, or child care provider is unavailable, due to COVID-19-related reasons. For example, this may include a notice of closure or unavailability from your child’s school, place of care, or child care provider, including a notice that may have been posted on a government, school, or day care website, published in a newspaper, or emailed to you from an employee or official of the school, place of care, or child care provider. Your employer must retain this notice or documentation in support of expanded family and medical leave, including while you may be taking unpaid leave that runs concurrently with paid sick leave if taken for the same reason.

Please also note that all existing certification requirements under the FMLA remain in effect if you are taking leave for one of the existing qualifying reasons under the FMLA. For example, if you are taking leave beyond the two weeks of emergency paid sick leave because your medical condition for COVID-19-related reasons rises to the level of a serious health condition, you must continue to  provide medical certifications  under the FMLA if required by your employer. 

17. When am I able to telework under the FFCRA? 

You may telework when your employer permits or allows you to perform work while you are at home or at a location other than your normal workplace. Telework is work for which normal wages must be paid and is not compensated under the paid leave provisions of the FFCRA. 

18. What does it mean to be unable to work, including telework for COVID-19 related reasons? 

You are unable to work if your employer has work for you and one of the COVID-19 qualifying reasons set forth in the FFCRA prevents you from being able to perform that work, either under normal circumstances at your normal worksite or by means of telework. 

If you and your employer agree that you will work your normal number of hours, but outside of your normally scheduled hours (for instance early in the morning or late at night), then you are able to work and leave is not necessary unless a COVID-19 qualifying reason prevents you from working that schedule. 

19. If I am or become unable to telework, am I entitled to paid sick leave or expanded family and medical leave? 

If your employer permits teleworking—for example, allows you to perform certain tasks or work a certain number of hours from home or at a location other than your normal workplace—and you are unable to perform those tasks or work the required hours because of one of the qualifying reasons for paid sick leave, then you are entitled to take paid sick leave.  

Similarly, if you are unable to perform those teleworking tasks or work the required teleworking hours because you need to care for your child whose school or place of care is closed, or child care provider is unavailable, because of COVID-19 related reasons, then you are entitled to take expanded family and medical leave. Of course, to the extent you are able to telework while caring for your child, paid sick leave and expanded family and medical leave is not available. 

20. May I take my paid sick leave or expanded family and medical leave intermittently while teleworking? 

Yes, if your employer allows it and if you are unable to telework your normal schedule of hours due to one of the qualifying reasons in the Emergency Paid Sick Leave Act. In that situation, you and your employer may agree that you may take paid sick leave intermittently while teleworking. Similarly, if you are prevented from teleworking your normal schedule of hours because you need to care for your child whose school or place of care is closed, or child care provider is unavailable, because of COVID-19 related reasons, you and your employer may agree that you can take expanded family medical leave intermittently while teleworking. 

You may take intermittent leave in any increment, provided that you and your employer agree. For example, if you agree on a 90-minute increment, you could telework from 1:00 PM to 2:30 PM, take leave from 2:30 PM to 4:00 PM, and then return to teleworking. 

The Department encourages employers and employees to collaborate to achieve flexibility and meet mutual needs, and the Department is supportive of such voluntary arrangements that combine telework and intermittent leave. 

21. May I take my paid sick leave intermittently while working at my usual worksite (as opposed to teleworking)? 

It depends on why you are taking paid sick leave and whether your employer agrees. Unless you are teleworking, paid sick leave for qualifying reasons related to COVID-19 must be taken in full-day increments. It cannot be taken intermittently if the leave is being taken because: 

• You are subject to a Federal, State, or local quarantine or isolation order related to COVID-19; 
• You have been advised by a health care provider to self-quarantine due to concerns related to COVID-19; 
• You are experiencing symptoms of COVID-19 and seeking a medical diagnosis; 
• You are caring for an individual who either is subject to a quarantine or isolation order related to COVID-19 or has been advised by a health care provider to self-quarantine due to concerns related to COVID-19; or 
• You are experiencing any other substantially similar condition specified by the Secretary of Health and Human Services. 

Unless you are teleworking, once you begin taking paid sick leave for one or more of these qualifying reasons, you must continue to take paid sick leave each day until you either (1) use the full amount of paid sick leave or (2) no longer have a qualifying reason for taking paid sick leave. This limit is imposed because if you are sick or possibly sick with COVID-19, or caring for an individual who is sick or possibly sick with COVID-19, the intent of FFCRA is to provide such paid sick leave as necessary to keep you from spreading the virus to others.  

If you no longer have a qualifying reason for taking paid sick leave before you exhaust your paid sick leave, you may take any remaining paid sick leave at a later time, until December 31, 2020, if another qualifying reason occurs. 

In contrast, if you and your employer agree, you may take paid sick leave intermittently if you are taking paid sick leave to care for your child whose school or place of care is closed, or whose child care provider is unavailable, because of COVID-19 related reasons. For example, if your child is at home because his or her school or place of care is closed, or child care provider is unavailable, because of COVID-19 related reasons, you may take paid sick leave on Mondays, Wednesdays, and Fridays to care for your child, but work at your normal worksite on Tuesdays and Thursdays. 

The Department encourages employers and employees to collaborate to achieve maximum flexibility. Therefore, if employers and employees agree to intermittent leave on less than a full work day for employees taking paid sick leave to care for their child whose school or place of care is closed, or child care provider is unavailable, because of COVID-19-related reasons, the Department is supportive of such voluntary arrangements. 

22. May I take my expanded family and medical leave intermittently while my child’s school or place of care is closed, or child care provider is unavailable, due to COVID-19 related reasons, if I am not teleworking? 

Yes, but only with your employer’s permission. Intermittent expanded family and medical leave should be permitted only when you and your employer agree upon such a schedule. For example, if your employer and you agree, you may take expanded family and medical leave on Mondays, Wednesdays, and Fridays, but work Tuesdays and Thursdays, while your child is at home because your child’s school or place of care is closed, or child care provider is unavailable, due to COVID-19 related reasons, for the duration of your leave. 

The Department encourages employers and employees to collaborate to achieve flexibility. Therefore, if employers and employees agree to intermittent leave on a day-by-day basis, the Department supports such voluntary arrangements. 

23. If my employer closed my worksite before April 1, 2020 (the effective date of the FFCRA), can I still get paid sick leave or expanded family and medical leave?   

No. If, prior to the FFCRA’s effective date, your employer sent you home and stops paying you because it does not have work for you to do, you will not get paid sick leave or expanded family and medical leave but you may be eligible for unemployment insurance benefits. This is true whether your employer closes your worksite for lack of business or because it is required to close pursuant to a Federal, State, or local directive. You should contact your State workforce agency or State unemployment insurance office for specific questions about your eligibility. For additional information, please refer to this link.

It should be noted, however, that if your employer is paying you pursuant to a paid leave policy or State or local requirements, you are not eligible for unemployment insurance. 

24. If my employer closes my worksite on or after April 1, 2020 (the effective date of the FFCRA), but before I go out on leave, can I still get paid sick leave and/or expanded family and medical leave? 

No. If your employer closes after the FFCRA’s effective date (even if you requested leave prior to the closure), you will not get paid sick leave or expanded family and medical leave but you may be eligible for unemployment insurance benefits. This is true whether your employer closes your worksite for lack of business or because it was required to close pursuant to a Federal, State or local directive. You should contact your State workforce agency or State unemployment insurance office for specific questions about your eligibility. For additional information, please refer to this link.

25. If my employer closes my worksite while I am on paid sick leave or expanded family and medical leave, what happens? 

If your employer closes while you are on paid sick leave or expanded family and medical leave, your employer must pay for any paid sick leave or expanded family and medical leave you used before the employer closed. As of the date your employer closes your worksite, you are no longer entitled to paid sick leave or expanded family and medical leave, but you may be eligible for unemployment insurance benefits. This is true whether your employer closes your worksite for lack of business or because the employer was required to close pursuant to a Federal, State or local directive. You should contact your State workforce agency or State unemployment insurance office for specific questions about your eligibility. For additional information, please refer to this link.

26. If my employer is open, but furloughs me on or after April 1, 2020 (the effective date of the FFCRA), can I receive paid sick leave or expanded family and medical leave? 

No. If your employer furloughs you because it does not have enough work or business for you, you are not entitled to then take paid sick leave or expanded family and medical leave. However, you may be eligible for unemployment insurance benefits. You should contact your State workforce agency or State unemployment insurance office for specific questions about your eligibility. For additional information, please refer to this link.

27. If my employer closes my worksite on or after April 1, 2020 (the effective date of the FFCRA), but tells me that it will reopen at some time in the future, can I receive paid sick leave or expanded family and medical leave? 

No, not while your worksite is closed. If your employer closes your worksite, even for a short period of time, you are not entitled to take paid sick leave or expanded family and medical leave. However, you may be eligible for unemployment insurance benefits. This is true whether your employer closes your worksite for lack of business or because it was required to close pursuant to a Federal, State, or local directive. You should contact your State workforce agency or State unemployment insurance office for specific questions about your eligibility. For additional information, please refer to this link. If your employer reopens and you resume work, you would then be eligible for paid sick leave or expanded family and medical leave as warranted. 

28. If my employer reduces my scheduled work hours, can I use paid sick leave or expanded family and medical leave for the hours that I am no longer scheduled to work?  

No. If your employer reduces your work hours because it does not have work for you to perform, you may not use paid sick leave or expanded family and medical leave for the hours that you are no longer scheduled to work. This is because you are not prevented from working those hours due to a COVID-19 qualifying reason, even if your reduction in hours was somehow related to COVID-19. 

You may, however, take paid sick leave or expanded family and medical leave if a COVID-19 qualifying reason prevents you from working your full schedule. If you do, the amount of leave to which you are entitled is computed based on your work schedule before it was reduced (see  Question 5). 

29. May I collect unemployment insurance benefits for time in which I receive pay for paid sick leave and/or expanded family and medical leave? 

No. If your employer provides you paid sick leave or expanded family and medical leave, you are not eligible for unemployment insurance. However, each State has its own unique set of rules; and  DOL recently clarified additional flexibility to the States  (UIPL 20-10) to extend partial unemployment benefits to workers whose hours or pay have been reduced. Therefore, individuals should contact their State workforce agency or State unemployment insurance office for specific questions about eligibility. For additional information, please refer to this link. 

 30. If I elect to take paid sick leave or expanded family and medical leave, must my employer continue my health coverage? If I remain on leave beyond the maximum period of expanded family and medical leave, do I have a right to keep my health coverage? 

If your employer provides group health coverage that you’ve elected, you are entitled to continued group health coverage during your expanded family and medical leave on the same terms as if you continued to work. If you are enrolled in family coverage, your employer must maintain coverage during your expanded family and medical leave. You generally must continue to make any normal contributions to the cost of your health coverage. See WHD Fact Sheet 28A. 

If you do not return to work at the end of your expanded family and medical leave, check with your employer to determine whether you are eligible to keep your health coverage on the same terms (including contribution rates). If you are no longer eligible, you may be able to continue your coverage under the Consolidated Omnibus Budget Reconciliation Act (COBRA). COBRA, which generally applies to employers with 20 or more employees, allows you and your family to continue the same group health coverage at group rates. Your share of that cost may be higher than what you were paying before but may be lower than what you would pay for private individual health insurance coverage. (If your employer has fewer than 20 employees, you may be eligible to continue your health insurance under State laws that are similar to COBRA. These laws are sometimes referred to as “mini COBRA” and vary from State to State). Contact the Employee Benefits Security Administration to learn about health and retirement benefit protections for dislocated workers.  

If you elect to take paid sick leave, your employer must continue your health coverage. Under the Health Insurance Portability and Accountability Act (HIPAA), an employer cannot establish a rule for eligibility or set any individual’s premium or contribution rate based on whether an individual is actively at work (including whether an individual is continuously employed), unless absence from work due to any health factor (such as being absent from work on sick leave) is treated, for purposes of the plan or health insurance coverage, as being actively at work. 

31. As an employee, may I use my employer’s preexisting leave entitlements and my FFCRA paid sick leave and expanded family and medical leave concurrently for the same hours? 

No. If you are eligible to take paid sick leave or expanded family and medical leave under the FFCRA, as well as paid leave that is already provided by your employer, unless your employer agrees you must choose one type of leave to take. You may not simultaneously take both, unless your employer agrees to allow you to supplement the amount you receive from paid sick leave or expanded family and medical leave under the FFCRA, up to your normal earnings, with preexisting leave. For example, if you are receiving 2/3 of your normal earnings from paid sick leave or expanded family and medical leave under the FFCRA and your employer permits, you may use your preexisting employer-provided paid leave to get the additional 1/3 of your normal earnings so that you receive your full normal earnings for each hour. 

32. If I am an employer, may I supplement or adjust the pay mandated under the FFCRA with paid leave that the employee may have under my paid leave policy? 

If your employee chooses to use existing leave you have provided, yes; otherwise, no. Paid sick leave and expanded family medical leave under the FFCRA is in addition to employees’ preexisting leave entitlements, including Federal employees. Under the FFCRA, the employee may choose to use existing paid vacation, personal, medical, or sick leave from your paid leave policy to supplement the amount your employee receives from paid sick leave or expanded family and medical leave, up to the employee’s normal earnings. Note, however, that you are not entitled to a tax credit for any paid sick leave or expanded family and medical leave that is not required to be paid or exceeds the limits set forth under Emergency Paid Sick Leave Act and the Emergency Family and Medical Leave Expansion Act.  

However, you are not required to permit an employee to use existing paid leave to supplement the amount your employee receives from paid sick leave or expanded family and medical leave. Further, you may not claim, and will not receive tax credit, for such supplemental amounts. 

33. If I am an employer, may I require an employee to supplement or adjust the pay mandated under the FFCRA with paid leave that the employee may have under my paid leave policy? 

No. Under the FFCRA, only the employee may decide whether to use existing paid vacation, personal, medical, or sick leave from your paid leave policy to supplement the amount your employee receives from paid sick leave or expanded family and medical leave. The employee would have to agree to use existing paid leave under your paid leave policy to supplement or adjust the paid leave under the FFCRA. 

34. If I want to pay my employees more than they are entitled to receive for paid sick leave or expanded family and medical leave, can I do so and claim a tax credit for the entire amount paid to them? 

You may pay your employees in excess of FFCRA requirements. But you cannot claim, and will not receive tax credit for, those amounts in excess of the FFCRA’s statutory limits.  

35. I am an employer that is part of a multiemployer collective bargaining agreement, may I satisfy my obligations under the Emergency Family and Medical Leave Expansion Act through contributions to a multiemployer fund, plan, or program? 

You may satisfy your obligations under the Emergency Family and Medical Leave Expansion Act by making contributions to a multiemployer fund, plan, or other program in accordance with your existing collective bargaining obligations. These contributions must be based on the amount of paid family and medical leave to which each of your employees is entitled under the Act based on each employee’s work under the multiemployer collective bargaining agreement. Such a fund, plan, or other program must allow employees to secure or obtain their pay for the related leave they take under the Act. Alternatively, you may also choose to satisfy your obligations under the Act by other means, provided they are consistent with your bargaining obligations and collective bargaining agreement. 

36. I am an employer that is part of a multiemployer collective bargaining agreement, may I satisfy my obligations under the Emergency Paid Sick Leave Act through contributions to a multiemployer fund, plan, or program? 

You may satisfy your obligations under the Emergency Paid Sick Leave Act by making contributions to a multiemployer fund, plan, or other program in accordance with your existing collective bargaining obligations. These contributions must be based on the hours of paid sick leave to which each of your employees is entitled under the Act based on each employee’s work under the multiemployer collective bargaining agreement. Such a fund, plan, or other program must allow employees to secure or obtain their pay for the related leave they take under the Act. Alternatively, you may also choose to satisfy your obligations under the Act by other means, provided they are consistent with your bargaining obligations and collective bargaining agreement. 

37. Are contributions to a multiemployer fund, plan, or other program the only way an employer that is part of a multiemployer collective bargaining agreement may comply with the paid leave requirements of the FFCRA? 

No. Both the Emergency Paid Sick Leave Act and the Emergency Family and Medical Leave Expansion Act provide that, consistent with its bargaining obligations and collective bargaining agreement, an employer may satisfy its legal obligations under both Acts by making appropriate contributions to such a fund, plan, or other program based on the paid leave owed to each employee. However, the employer may satisfy its obligations under both Acts by other means, provided they are consistent with its bargaining obligations and collective bargaining agreement. 

38. Assuming I am a covered employer, which of my employees are eligible for paid sick leave and expanded family and medical leave? 

Both of these new provisions use the  employee definition  as provided by the Fair Labor Standards Act, thus all of your U.S. (including Territorial) employees who meet this definition are eligible including full-time and part-time employees, and “joint employees” working on your site temporarily and/or through a temp agency. However, if you employ a health care provider or an emergency responder you are not required to pay such employee paid sick leave or expanded family and medical leave on a case-by-case basis. And certain small businesses may exempt employees if the leave would jeopardize the company’s viability as a going concern. See  Question 58  below. 

There is one difference regarding an employee’s eligibility for paid sick leave versus expanded family and medical leave. While your employee is eligible for paid sick leave regardless of length of employment, your employee must have been employed for 30 calendar days in order to qualify for expanded family and medical leave. For example, if your employee requests expanded family and medical leave on April 10, 2020, he or she must have been your employee since March 11, 2020. 

39. Who is a covered employer that must provide paid sick leave and expanded family and medical leave under the FFCRA? 

Generally, if you employ fewer than 500 employees you are a covered employer that must provide paid sick leave and expanded family and medical leave. For additional information on the 500 employee threshold, see  Question 2. Certain employers with fewer than 50 employees may be exempt from the Act’s requirements to provide certain paid sick leave and expanded family and medical leave. For additional information regarding this small business exemption, see  Question 4  and  Questions 58 and 59  below. 

Certain public employers are also covered under the Act and must provide paid sick leave and expanded family and medical leave. For additional information regarding coverage of public employers, see  Questions 52-54  below. 

40. Who is a son or daughter? 

Under the FFCRA, a “son or daughter” is your own child, which includes your biological, adopted, or foster child, your stepchild, a legal ward, or a child for whom you are standing in loco parentis—someone with day-to-day responsibilities to care for or financially support a child. For additional information about in loco parentis, see  Fact Sheet #28B: Family and Medical Leave Act (FMLA) leave for birth, placement, bonding or to care for a child with a serious health condition on the basis of an “in loco parentis” relationship. 

In light of Congressional direction to interpret definitions consistently, WHD clarifies that under the FFCRA a “son or daughter” is also an adult son or daughter (i.e., one who is 18 years of age or older), who (1) has a mental or physical disability, and (2) is incapable of self-care because of that disability. For additional information on requirements relating to an adult son or daughter, see  Fact Sheet #28K  and/or call our toll free information and help line available 8 am–5 pm in your time zone, 1-866-4US-WAGE (1-866-487-9243). 

41. What do I do if my employer, who I believe to be covered, refuses to provide me paid sick leave? 

If you believe that your employer is covered and is improperly refusing you paid sick leave under the Emergency Paid Sick Leave Act, the Department encourages you to raise and try to resolve your concerns with your employer. Regardless of whether you discuss your concerns with your employer, if you believe your employer is improperly refusing you paid sick leave, you may call 1-866-4US-WAGE (1-866-487-9243). WHD is responsible for administering and enforcing these provisions. If you have questions or concerns, you can contact WHD by phone or visit their website.  Your call will be directed to the  nearest WHD office  for assistance to have your questions answered or to file a complaint. In most cases, you can also file a lawsuit against your employer directly without contacting WHD. If you are a public sector employee, please see the answer to  Question 54. 

42. What do I do if my employer, who I believe to be covered, refuses to provide me expanded family and medical leave to care for my own son or daughter whose school or place of care has closed, or whose child care provider is unavailable, for COVID-19 related reasons? 

If you believe that your employer is covered and is improperly refusing you expanded family and medical leave or otherwise violating your rights under the Emergency Family and Medical Leave Expansion Act, the Department encourages you to raise and try to resolve your concerns with your employer. Regardless whether you discuss your concerns with your employer, if you believe your employer is improperly refusing you expanded family and medical leave, you may call WHD at 1-866-4US-WAGE (1-866-487-9243) or visit their website. Your call will be directed to the  nearest WHD office  for assistance to have your questions answered or to file a complaint. If your employer employs 50 or more employees, you also may file a lawsuit against your employer directly without contacting WHD. If you are a public sector employee, please see the answer to  Question 54. 

43. Do I have a right to return to work if I am taking paid sick leave or expanded family and medical leave under the Emergency Paid Sick Leave Act or the Emergency Family and Medical Leave Expansion Act? 

Generally, yes. In light of Congressional direction to interpret requirements among the Acts consistently, WHD clarifies that the Acts require employers to provide the same (or a nearly equivalent) job to an employee who returns to work following leave. 

In most instances, you are entitled to be restored to the same or an equivalent position upon return from paid sick leave or expanded family and medical leave. Thus, your employer is prohibited from firing, disciplining, or otherwise discriminating against you because you take paid sick leave or expanded family and medical leave. Nor can your employer fire, discipline, or otherwise discriminate against you because you filed any type of complaint or proceeding relating to these Acts, or have or intend to testify in any such proceeding. 

However, you are not protected from employment actions, such as layoffs, that would have affected you regardless of whether you took leave. This means your employer can lay you off for legitimate business reasons, such as the  closure of your worksite. Your employer must be able to demonstrate that you would have been laid off even if you had not taken leave. 

Your employer may also refuse to return you to work in your same position if you are a highly compensated  “key” employee  as defined under the FMLA, or if your employer has fewer than 25 employees, and you took leave to care for your own son or daughter whose school or place of care was closed, or whose child care provider was unavailable, and all four of the following hardship conditions exist:  

• your position no longer exists due to economic or operating conditions that affect employment and due to COVID-19 related reasons during the period of your leave; 
• your employer made reasonable efforts to restore you to the same or an equivalent position; 
• your employer makes reasonable efforts to contact you if an equivalent position becomes available; and 
• your employer continues to make reasonable efforts to contact you for one year beginning either on the date the leave related to COVID-19 reasons concludes or the date 12 weeks after your leave began, whichever is earlier. 

44. Do I qualify for leave for a COVID-19 related reason even if I have already used some or all of my leave under the Family and Medical Leave Act (FMLA)? 

If you are an eligible employee, you are entitled to paid sick leave under the Emergency Paid Sick Leave Act regardless of how much leave you have taken under the FMLA. 

However, if your employer was covered by the FMLA prior to April 1, 2020, your eligibility for expanded family and medical leave depends on how much leave you have already taken during the 12-month period that your employer uses for FMLA leave. You may take a total of 12 workweeks for FMLA or expanded family and medical leave reasons during a 12-month period. If you have taken some, but not all, 12 workweeks of your leave under FMLA during the current  12-month period determined by your employer, you may take the remaining portion of leave available. If you have already taken 12 workweeks of  FMLA  leave during this 12-month period, you may not take additional expanded family and medical leave.  

For example, assume you are eligible for preexisting FMLA leave and took two weeks of such leave in January 2020 to undergo and recover from a surgical procedure. You therefore have 10 weeks of FMLA leave remaining. Because expanded family and medical leave is a type of FMLA leave, you would be entitled to take up to 10 weeks of expanded family and medical leave, rather than 12 weeks. And any expanded family and medical leave you take would count against your entitlement to preexisting FMLA leave. 

If your employer only becomes covered under the FMLA on April 1, 2020, this analysis does not apply. 

45. May I take leave under the Family and Medical Leave Act over the next 12 months if I used some or all of my expanded family and medical leave under the Emergency Family and Medical Leave Expansion Act? 

It depends. You may take a total of 12 workweeks of leave during a 12-month period under the FMLA, including the Emergency Family and Medical Leave Expansion Act. If you take some, but not all 12, workweeks of your expanded family and medical leave by December 31, 2020, you may take the remaining portion of FMLA leave for a serious medical condition, as long as the total time taken does not exceed  12 workweeks in the 12-month period. Please note that expanded family and medical leave is available only until December 31, 2020; after that, you may only take FMLA leave. 

For example, assume you take four weeks of Expanded Family and Medical Leave in April 2020 to care for your child whose school is closed due to a COVID-19 related reason. These four weeks count against your entitlement to 12 weeks of FMLA leave in a 12-month period. If you are eligible for preexisting FMLA leave and need to take such leave in August 2020 because you need surgery, you would be entitled to take up to eight weeks of FMLA leave. 

However, you are entitled to paid sick leave under the Emergency Paid Sick Leave Act regardless of how much leave you have taken under the FMLA. Paid sick leave is not a form of FMLA leave and therefore does not count toward the 12 workweeks in the 12-month period cap. But please note that if you take paid sick leave concurrently with the first two weeks of expanded family and medical leave, which may otherwise be unpaid, then those two weeks do count towards the 12 workweeks in the 12-month period. 

46. If I take paid sick leave under the Emergency Paid Sick Leave Act, does that count against other types of paid sick leave to which I am entitled under State or local law, or my employer’s policy? 

No. Paid sick leave under the Emergency Paid Sick Leave Act is in addition to other leave provided under Federal, State, or local law; an applicable collective bargaining agreement; or your employer’s existing company policy. 

47. May I use paid sick leave and expanded family and medical leave together for any COVID-19 related reasons?   

No. The Emergency Family and Medical Leave Expansion Act applies only when you are on leave to care for your child whose school or place of care is closed, or whose child care provider is unavailable, due to COVID-19 related reasons. However, you can take paid sick leave under the Emergency Paid Sick Leave Act for numerous other reasons. 

48. What is a full-time employee under the Emergency Paid Sick Leave Act?  

For purposes of the Emergency Paid Sick Leave Act, a full-time employee is an employee who is normally scheduled to work 40 or more hours per week. 

In contrast, the Emergency Family and Medical Leave Expansion Act does not distinguish between full- and part-time employees, but the number of hours an employee normally works each week will affect the amount of pay the employee is eligible to receive. 

49. What is a part-time employee under the Emergency Paid Sick Leave Act?  

For purposes of the Emergency Paid Sick Leave Act, a part-time employee is an employee who is normally scheduled to work fewer than 40 hours per week. 

In contrast, the Emergency Family and Medical Leave Expansion Act does not distinguish between full- and part-time employees, but the number of hours an employee normally works each week affects the amount of pay the employee is eligible to receive. 

50. How does the “for each working day during each of the 20 or more calendar workweeks in the current or preceding calendar” language in the FMLA definition of “employer” work under the Emergency Family and Medical Leave Expansion Act? 

The language about counting employees over calendar workweeks is only in the FMLA’s definition for employer. This language does not apply to the Emergency Family and Medical Leave Expansion Act for purposes of expanded family and medical leave. Employers should use the number of employees on the day the employee’s leave would start to determine whether the employer has fewer than 500 employees for purposes of providing expanded family and medical leave and paid sick leave. See  Question 2  for more information. 

51. I’ve elected to take paid sick leave and I am currently in a waiting period for my employer’s health coverage. If I am absent from work on paid sick leave during the waiting period, will my health coverage still take effect after I complete the waiting period on the same day that the coverage would otherwise take effect? 

Yes. If you are on employer-provided group health coverage, you are entitled to group health coverage during your paid sick leave on the same terms as if you continued to work. Therefore, the requirements for eligibility, including any requirement to complete a waiting period, would apply in the same way as if you continued to work, including that the days you are on paid sick leave count towards completion of the waiting period. If, under the terms of the plan, an individual can elect coverage that becomes effective after completing the waiting period, the health coverage must take effect once the waiting period is complete.  

52. I am a public sector employee. May I take paid sick leave under the Emergency Paid Sick Leave Act? 

Generally, yes. You are entitled to paid sick leave if you work for a public agency or other unit of government, with the exceptions below. Therefore, you are probably entitled to paid sick leave if, for example, you work for the government of the United States, a State, the District of Columbia, a Territory or possession of the United States, a city, a municipality, a township, a county, a parish, or a similar government entity subject to the exceptions below. The Office of Management and Budget (OMB) has the authority to exclude some categories of U.S. Government Executive Branch employees from taking certain kinds of paid sick leave. If you are a Federal employee, the Department encourages you to seek guidance from your respective employers as to your eligibility to take paid sick leave. 

Further, health care providers and emergency responders may be excluded by their employer from being able to take paid sick leave under the Act. See  Questions 56-57  below. These coverage limits also apply to public-sector health care providers and emergency responders. 

53. I am a public sector employee. May I take paid family and medical leave under the Emergency Family and Medical Leave Expansion Act? 

It depends. In general, you are entitled to expanded family and medical leave if you are an employee of a non-federal public agency. Therefore, you are probably entitled to paid sick leave if, for example, you work for the government of a State, the District of Columbia, a Territory or possession of the United States, a city, a municipality, a township, a county, a parish, or a similar entity. 

But if you are a Federal employee, you likely are not entitled to expanded family and medical leave. The Act only amended Title I of the FMLA; most Federal employees are covered instead by Title II of the FMLA. As a result, only some Federal employees are covered, and the vast majority are not. In addition, the Office of Management and Budget (OMB) has the authority to exclude some categories of U.S. Government Executive Branch employees with respect to expanded and family medical leave. If you are a Federal employee, the Department encourages you to seek guidance from your respective employers as to your eligibility to take expanded family and medical leave. 

Further, health care providers and emergency responders may be excluded by their employer from being able to take expanded family and medical leave under the Act. See  Questions 56-57  below. These coverage limits also apply to public-sector health care providers and emergency responders. 

54. What do I do if my public sector employer, who I believe to be covered, refuses to provide me paid sick leave or expanded family and medical leave? 

If you believe that your public sector employer is covered and is improperly refusing you paid sick leave under the Emergency Paid Sick Leave Act or expanded family and medical leave under the Emergency Family and Medical Leave Expansion Act, the Department encourages you to raise your concerns with your employer in an attempt to resolve them. Regardless whether you discuss your concerns with your employer, if you believe your employer is improperly refusing you paid sick leave or expanded family and medical leave, you may call WHD at 1-866-4US-WAGE (1-866-487-9243) or visit their website. Your call will be directed to the  nearest WHD office  for assistance to have your questions answered or to file a complaint.    

In some cases, you may also be able to file a lawsuit against your employer directly without contacting WHD. Some State and local employees may not be able to pursue direct lawsuits because their employers are immune from such lawsuits. For additional information, see the WHD website and/or call WHD’s toll free information and help line available 8am–5pm in your time zone, 1-866-4-US-WAGE (1-866-487-9243). 

55. Who is a “health care provider” for purposes of determining individuals whose advice to self-quarantine due to concerns related to COVID-19 can be relied on as a qualifying reason for paid sick leave? 

The term “health care provider,” as used to determine individuals whose advice to self-quarantine due to concerns related to COVID-19 can be relied on as a qualifying reason for paid sick leave, means a licensed doctor of medicine, nurse practitioner, or other health care provider permitted to issue a certification for purposes of the FMLA. 

56. Who is a “health care provider” who may be excluded by their employer from paid sick leave and/or expanded family and medical leave? 

For the purposes of employees who may be exempted from paid sick leave or expanded family and medical leave by their employer under the FFCRA, a health care provider is anyone employed at any doctor’s office, hospital, health care center, clinic, post-secondary educational institution offering health care instruction, medical school, local health department or agency, nursing facility, retirement facility, nursing home, home health care provider, any facility that performs laboratory or medical testing, pharmacy, or any similar institution, employer, or entity. This includes any permanent or temporary institution, facility, location, or site where medical services are provided that are similar to such institutions.  

This definition includes any individual employed by an entity that contracts with any of the above institutions, employers, or entities institutions to provide services or to maintain the operation of the facility. This also includes anyone employed by any entity that provides medical services, produces medical products, or is otherwise involved in the making of COVID-19 related medical equipment, tests, drugs, vaccines, diagnostic vehicles, or treatments. This also includes any individual that the highest official of a state or territory, including the District of Columbia, determines is a health care provider necessary for that state’s or territory’s or the District of Columbia’s response to COVID-19. 

To minimize the spread of the virus associated with COVID-19, the Department encourages employers to be judicious when using this definition to exempt health care providers from the provisions of the FFCRA. 

57. Who is an emergency responder? 

For the purposes of employees who may be excluded from paid sick leave or expanded family and medical leave by their employer under the FFCRA, an emergency responder is an employee who is necessary for the provision of transport, care, health care, comfort, and nutrition of such patients, or whose services are otherwise needed to limit the spread of COVID-19. This includes but is not limited to military or national guard, law enforcement officers, correctional institution personnel, fire fighters, emergency medical services personnel, physicians, nurses, public health personnel, emergency medical technicians, paramedics, emergency management personnel, 911 operators, public works personnel, and persons with skills or training in operating specialized equipment or other skills needed to provide aid in a declared emergency as well as individuals who work for such facilities employing these individuals and whose work is necessary to maintain the operation of the facility. This also includes any individual that the highest official of a state or territory, including the District of Columbia, determines is an emergency responder necessary for that state’s or territory’s or the District of Columbia’s response to COVID-19. 

To minimize the spread of the virus associated with COVID-19, the Department encourages employers to be judicious when using this definition to exempt emergency responders from the provisions of the FFCRA. 

58. When does the small business exemption apply to exclude a small business from the provisions of the Emergency Paid Sick Leave Act and Emergency Family and Medical Leave Expansion Act? 

An employer, including a religious or nonprofit organization, with fewer than 50 employees (small business) is exempt from providing paid sick leave and expanded family and medical leave due to school or place of care closures or child care provider unavailability for COVID-19 related reasons when doing so would jeopardize the viability of the small business as a going concern.  A small business may claim this exemption if an authorized officer of the business has determined that: 

1. The provision of paid sick leave or expanded family and medical leave would result in the small business’s expenses and financial obligations exceeding available business revenues and cause the small business to cease operating at a minimal capacity;   
2. The absence of the employee or employees requesting paid sick leave or expanded family and medical leave would entail a substantial risk to the financial health or operational capabilities of the small business because of their specialized skills, knowledge of the business, or responsibilities; or
3. There are not sufficient workers who are able, willing, and qualified, and who will be available at the time and place needed, to perform the labor or services provided by the employee or employees requesting paid sick leave or expanded family and medical leave, and these labor or services are needed for the small business to operate at a minimal capacity. 

59. If I am a small business with fewer than 50 employees, am I exempt from the requirements to provide paid sick leave or expanded family and medical leave? 

A small business is exempt from certain paid sick leave and expanded family and medical leave requirements if providing an employee such leave would jeopardize the viability of the business as a going concern. This means a small business is exempt from mandated paid sick leave or expanded family and medical leave requirements only if the: 

• employer employs fewer than 50 employees; 
• leave is requested because the child’s school or place of care is closed, or child care provider is unavailable, due to COVID-19 related reasons; and 
• an authorized officer of the business has determined that at least one of the three conditions described in Question 58 is satisfied. 

The Department encourages employers and employees to collaborate to reach the best solution for maintaining the business and ensuring employee safety.  

[1] If you are a Federal employee, you are eligible to take paid sick leave under the Emergency Paid Sick Leave Act.  But only some Federal employees are eligible to take expanded family and medical leave under the Emergency Family and Medical Leave Expansion Act. Your eligibility will depend on whether you are covered under Title I or Title II of the Family Medical Leave Act. Federal employees should consult with their agency regarding their eligibility for expanded family and medical leave. The Office of Personnel and Management will provide information on federal employee coverage. Additional FAQs regarding public sector employers will be forthcoming. 

[2] If you are a Federal employee, the State or local minimum wage would be used to calculate the wages owed to you only if the Federal agency that employs you has broad authority to set your compensation and has decided to use the State or local minimum wage. 

Business Tax Planning Lawyer

Need assistance in managing the business planning processes? Freeman Law advises clients with corporate and other entity formations and reorganizations. Restructuring entities—through conversions, mergers, and liquidations—can involve particularly complex tax and regulatory considerations. Freeman Law provides experienced tax and business counsel, helping our clients achieve their organizational goals in a tax-efficient manner. Schedule a consultation or call (214) 984-3000 to discuss your corporate structuring or business and tax planning concerns. 

Section 199A Roadmap

Perhaps no other provision of the Tax Cuts and Jobs Act of 2017 has given rise to more speculation, debate, and consternation than new Section 199A. The complex maze that is Section 199A introduces a set of rules and formulas that determine when a taxpayer qualifies to deduct 20 percent of certain income from “pass-through” trades or businesses. The provision, which was designed to bring parity to such income, has a widespread application—and many unresolved issues. It is widely anticipated that the IRS will issue guidance in the near future. If and when that guidance is issued, this column will provide a second installment on this topic, diving deeper into the gray areas. For now, however, what follows is a practical roadmap without detours.

The General Rule

Section 199A generally provides individuals, trusts, and estates with a deduction equal to 20 percent of the taxpayer’s “Combined Qualified Business Income (Combined QBI).” The phrase Combined QBI is generally defined as the aggregate of the “deductible amount” (described below) for each “qualified trade or business” that flows to the taxpayer. Read the prior sentence carefully, because it contains an important point: Combined QBI is determined on a “trade or business”-by-“trade or business” basis. Unfortunately, what constitutes a distinct “trade or business” for Section 199A purposes is not entirely clear from the statute.

Qualified Trades or Businesses and Specified Service Trades or Businesses

As a general rule, the phrase “qualified trade or business” does not include a “specified service trade or business (SSTB)” or the trade or business of performing services as an employee. Thus, again as a general rule, income from an SSTB is not eligible for the 20-percent deduction under Section 199A.

An SSTB is any trade or business that involves the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees. An SSTB also includes any trade or business that involves the performance of services that consist of investing and investment management, trading, or dealing in securities (as defined in Section 475(c)(2)), partnership interests, or commodities (as defined in Section 475(e)(2)).

While income from an SSTB is generally not eligible for the 20-percent deduction, there is an exception for taxpayers with taxable income below certain threshold amounts. The threshold amount is $157,500 (and $315,000 for taxpayers filing married filing joint). As a result, taxpayers with taxable income below this threshold are not prohibited from taking the 20-percent deduction for income derived from activities that would otherwise be classified as an SSTB. For taxpayers with taxable income over the applicable threshold amount but less than $207,500 (or $415,000 for taxpayers filing married filing joint), the SSTB exclusion is “phased in,” allowing a partial benefit. Once a taxpayer’s taxable income exceeds these amounts, the SSTB rule effectively prohibits any Section 199A deduction for income that is attributable to the SSTB.

Qualified Business Income

The definition of “qualified business income” is central to the Section 199A deduction analysis. QBI is statutorily defined to include the net amount of “qualified items of income, gain, deduction, and loss with respect to any qualified trade or business of the taxpayer.” This amount includes all such items (income, gain, deduction, and loss) to the extent they are “effectively connected” with the conduct of a trade or business within the United States and included or allowed in determining taxable income for the year. It specifically excludes, however, qualified investment income, including dividends, capital gain or loss, investment interest, commodities gains or losses, foreign currency gains or losses, and certain annuity amounts; REIT dividends, qualified cooperative dividends, and qualified publicly traded partnership income; reasonable compensation paid to the taxpayer for services for the trade or business; Section 707(c) guaranteed payments paid to the taxpayer for services performed for the trade or business; or Section 707(a) payments to the taxpayer for service performed for the trade or business.

The Deductible Amount

After determining the separate and distinct qualifying trades and businesses and their QBI, the next step in the Section 199A analysis is to determine the “deductible amount,” if any, that flows from such trades or businesses to the taxpayer in order to compute the taxpayer’s Combined QBI. The “deductible amount” for each “qualified trade or business” is generally equal to the QBI with respect to the qualified trade or business, although such amount is limited to the greater of (i) 50-percent of W-2 wages with respect to the qualified trade or business (the “W-2 Wage Limitation”) or (ii) the sum of 25 percent of the W-2 wages with respect to the qualified trade or business, plus 2.5 percent of the unadjusted basis immediately after acquisition of all qualified property (the “Alternative Limitation”). In other words, the deductible amount for each trade or business cannot exceed the greater of these two possible limitations.

By way of example, if a qualified trade or business has (i) QBI of $100; (ii) W-2 wages of $150; and (iii) qualified property with an unadjusted basis of $200, then the “deductible amount” with respect to that trade or business would be $75. The deductible amount is calculated as the lesser of QBI ($100) or the limitation amount, which is equal to the greater of two amounts: (i) the W-2 Wage Limitation, which is 50-percent of $150 and thus equals $75 in the example; and (ii) the Alternative Limitation, which here is $42.50 (25 percent of W-2 wages, which is $37.5, plus 2.5 percent of the unadjusted basis of qualified property, which is $5). The greater of the two possible limitations ($75 or $37.5) is, therefore, $75; and the lesser of QBI ($100) and the applicable limitation ($75) is $75, leaving a “deductible amount” of—you guessed it—$75.

The Limitations

For purposes of the W-2 Wage Limitation, W-2 wages are defined as total wages paid by the qualified trade or business that are subject to withholding, elective deferrals, and deferred compensation with respect to the employment of employees. “W-2 wages” do not include any amount that is not properly allocable to QBI, nor do they include any amount that is not properly included in a return filed with the Social Security Administration on or before the 60th day after the due date for such a return.

The term “qualified property” is defined as tangible property with respect to any qualified trade or business of a character that is subject to depreciation allowance under section 167 and that meets three tests: (i) it is held by, and available for use in, the qualified trade or business at the close of the tax year; (ii) it is used at any point during the tax year in the production of QBI; and (iii) the depreciable period for the property has not ended before the close of the tax year. Notably, for these purposes, the property’s “depreciable period” is defined as ending the later of the date that is 10 years from the date it was first placed in service by the taxpayer or the last day of the last full year in the applicable recovery period that would apply to the property under section 168.

Limitations on the Limitations

The limitations don’t always apply. Specifically, the W-2 Wage Limitation and the Alternative Limitation do not apply—that is, they do not limit the “deductible amount”—whenever the taxpayer’s taxable income is below a threshold amount. That threshold amount is $157,500 (and doubled to $315,000 for taxpayers filing married filing joint). Thus, taxpayers with taxable income below the applicable threshold amount are simply not subject to these limitations.

For taxpayers with taxable income exceeding these threshold amounts, the limitations are “phased in.” Thus, the limitations are partially “phased in” over the next $50,000 of taxable income (or $100,000 for married individuals filing jointly) that exceeds the applicable threshold amount; they apply in full, however, for taxpayers with taxable income over the sum of the threshold amount and the “phase-in” amount (i.e., over $207,500 or $415,000 for married individuals filing jointly).

Conclusion

Section 199A introduced a Byzantine set of rules and formulas that determine when a taxpayer qualifies to deduct 20 percent of certain income derived from pass-through trades or businesses. Its provisions, which were designed to bring parity to pass-through trade or business income, leave many open questions and have been the subject to much debate. The foregoing article provides an overview of its complex provisions. As for the many subtle and unanswered questions, expect to see guidance from the IRS in the near future addressing a number of those provisions. At that time, we intend to take up the task of further fleshing out those provisions in this column.

As published by Jason B. Freeman in Today’s CPA Magazine.

Representation in Tax Audits & Appeals

Need assistance in managing the audit process? Freeman Law’s team of attorneys and dual-credentialed attorney-CPAs regularly represents taxpayers before the IRS and Texas Comptroller. Our team also provides tax return-related representations and helps taxpayers navigate state tax laws. Our Firm offers value-driven services and provides practical solutions to complex issues. Schedule a consultation or call (214) 984-3000 to discuss our tax representation services.

Just before the turn of the new year, Congress passed—and the president signed—the Tax Cuts and Jobs Act of 2017 (“TCJA”).  The TCJA represents the most extensive rewrite of the U.S. tax code in over 30 years.  The new act contains a number of important provisions that will impact business tax planning for years to come.  Below are some highlights from the business-related provisions that practitioners need to know.

21% Corporate Rate. The new act eliminates the progressive corporate tax rate system, which imposed a 35-percent maximum tax rate.  In its place, it provides a flat 21-percent corporate rate.  This change, which is not set to phase out, will play a significant role in choice-of-entity decisions.

Corporate Alternative Minimum Tax.  The new law repeals the corporate Alternative Minimum Tax for tax years beginning after December 31, 2017.

Dividend Received Deduction. The TCJA reduces the general corporate dividends received deduction rates.  Existing law generally provides corporate taxpayers with a dividend received deduction equal to 70 percent of dividends received from another corporation; 80 percent of dividends received from a 20-percent owned corporation; and 100 percent of dividends received from a corporation that is a member of the same affiliated group.  The new act reduces the general corporate dividends received deduction to 50 percent, and reduces the deduction applicable to 20-percent owned corporations to 65 percent.

Cost Recovery.  The new act allows for first-year “bonus” depreciation of 100 percent of the cost of qualifying property.  The 100-percent bonus depreciation rate is phased down to 80 percent beginning in 2023 and is ultimately phased out by 2027.  Notably, under the new act, used property that was not previously used by the taxpayer and that is not acquired from a related party may be eligible for bonus depreciation.

The new act also expands the availability of section 179 expensing, increasing the maximum amount that can be deducted under section 179 to $1 million and raising the dollar-for-dollar phase-out threshold to $2,500,000.

Net Operating Losses. The new law limits future net operating loss deductions to 80 percent of taxable income with respect to losses arising in tax years that begin after December 31, 2017.  Existing law generally provides for a two-year carryback and 20-year carryforward for NOLs.  The new law, however, does not allow for carrybacks with respect to losses arising after December 31, 2017.  Instead, it allows for an indefinite carryforward period.  Thus, taxpayers will be required to separately track NOLs from prior periods.

Section 174 Research and Experimentation.  The new act provides that research and experimental expenditures incurred in tax years beginning after December 31, 2021 must be capitalized and amortized over a five-year period.  These changes mark a significant break from current law, which permits taxpayers to immediately expense, amortize, or capitalize such expenditures.  In addition, under the new law, certain research and experimental expenditures that are attributable to research conducted outside the United States are required to be capitalized and amortized over a 15-year period.

Accounting Methods. The act expands the availability of the cash method of accounting for corporations with average gross receipts over a three-year period that do not exceed $25 million.  It also eliminates the requirement to comply with the inventory tracking rules and the Section 263A Uniform Capitalization rules for producers and resellers that meet the $25 million test.

Limitation on Net Interest Deduction.  The new act replaces the “Earnings Stripping Rules” under section 163(j).  In their place, it provides a new limitation on deductible interest.  The new limitation disallows a deduction for net business interest expense in excess of 30 percent of adjusted taxable income plus floor plan financing interest. However, the new limitation does not apply to taxpayers that have average annual gross receipts of less than $25 million. Notably, certain taxpayers, such as certain real estate businesses and farming businesses, may elect out of the interest expense limitation.  Such electing businesses are required to use the alternative depreciation system with respect to certain property.

Excessive Employee Remuneration.   The TCJA expands and strengthens the section 162(m) limitation on the deduction of compensation paid by publicly traded corporate employers to covered employees. The act expands the definition of “covered employee” to include both the principal executive officer and principal financial officer, as well as the three most highly compensated officers for the tax year required to be reported on the company’s proxy statement. It also adopts a new once-a-covered-employee, always-a-covered-employee rule.  Perhaps most notably, the act eliminates the exception for commissions and performance-based compensation.

20% Deduction for Combined Qualified Business Income.  The TCJA provides for a deduction, under new Code section 199A, of up to 20 percent of certain pass-through income.  The deduction is designed to provide relief to owners of pass-through businesses, which include partnerships, S-corporations, and sole proprietorships.  Notably, the deduction phases out after 2025, a consideration that may factor into the choice-of-entity calculus.

The deduction is generally equal to the taxpayer’s “combined qualified business income.” (Technically, there is fine print, and for some taxpayers the calculation is slightly more complicated.)  The deduction, however, cannot exceed the taxpayer’s taxable income (reduced by net capital gain) for the year.  It is not taken into account to compute adjusted gross income, and is available to both itemizing and non-itemizing taxpayers.

“Combined qualified business income” is generally equal to 20 percent of the taxpayer’s qualified business income (“QBI”) with respect to each qualified trade or business.  QBI is defined as the net amount of qualified items of income, gain, deduction, and loss with respect to any qualified trade or business of the taxpayer.  The amount of QBI for each qualified trade or business that is taken into account, however, is limited to the greater of (a) 50 percent of the W-2 wages paid with respect to the qualified trade or business or (b) the sum of 25 percent of the W-2 wages paid with respect to the qualified trade or business plus 2.5 percent of the unadjusted basis, immediately after acquisition, of all qualified property.  (These limitations do not apply for taxpayers with taxable income below certain thresholds—$157,500 for single taxpayers and $315,000 for married filing joint taxpayers—and are “phased-in” for taxpayers with taxable income exceeding such thresholds.)  The allowable amount must be calculated and added together for each qualified trade or business to determine the taxpayer’s “combined qualified business income.”

Notably, the section 199A deduction is not available with respect to income from a “specified service trade or business” for taxpayers with taxable income over certain thresholds ($207,500 for single and $415,000 for married filing joint taxpayers).  A specified service trade or business generally includes any trade or business involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees.  The deduction for such income—income from a “specified service trade or business”—begins to be phased out for single taxpayers with taxable income over $157,500 and married filing joint taxpayers with taxable income over $315,000; it is completely phased out (i.e., unavailable) when such taxpayers reach the thresholds mentioned above ($207,500 for single and $415,000 for married filing joint taxpayers).

Loss Limit.  The new law disallows “excess business losses” for non-corporate taxpayers.  An “excess business loss” is defined as the amount by which the taxpayer’s total deductions attributable to the taxpayer’s trades or businesses exceed the total gross income from those trades or business plus $250,000 (or $500,000 for married filing joint taxpayers).

Section 1031.  The new law scales back the scope of like-kind exchanges under section 1031.  It eliminates 1031 deferral for exchanges of tangible personal property and intangible property.  Thus, like-kind deferral is limited to exchanges of real property, and is not allowed for exchanges of real property held primarily for sale.

Carried Interest.  The new law provides for an extended, three-year holding period in order to qualify for long-term capital gain treatment on the sale of certain partnership interests.  More particularly, it provides that the sale of certain profits interests in a partnership that were received in exchange for the performance of services constitutes short-term capital gain unless held for three years or longer. The rule applies to interests in partnerships engaged in raising or returning capital, and (1) either investing in (or disposing of) certain assets (or identifying certain assets for investing or disposition), or (2) developing certain assets.

International Tax Provisions.  The new law fundamentally changes the international tax landscape, marking a shift toward a quasi-territorial system of taxation.  The new rules feature a deemed repatriation, which treats “United States shareholders” (as defined in section 951) of specified foreign corporations as receiving a dividend (taxed at special effective rates) equal to their pro rata share of certain unrepatriated and untaxed existing earnings and profits of the foreign corporation, whether they actually receive such funds or not. The TCJA also provides domestic corporations with a new 100-percent deduction for the foreign-source portion of dividends received from specified 10-percent owned foreign corporations when the domestic corporation is a United States shareholder of such foreign corporation. The deemed repatriation and dividends received deduction are designed to remove the “lockout” effect that inhibits the investment of foreign subsidiary earnings back into the United States.

The new law retains the current subpart F regime with some tweaks.  It also provides for a new class of income known as global intangible low taxed income (“GILTI”), requiring United States shareholders of controlled foreign corporations (“CFCs”) to include their share of the CFC’s GILTI in current income in a manner similar to subpart F income. Corporate shareholders, however, are allowed to deduct 50 percent of such income (37.5 percent beginning in 2026). The new law also provides domestic corporations with a reduced effective tax rate (13.125 percent) on foreign derived intangible income (“FDII”), which is defined as a portion of the statutorily-defined “intangible” income earned directly by U.S. corporations from serving foreign markets.  In addition, the new law contains a number of base erosion and anti-hybrid measures.  As a result, taxpayers with international operations will be required to navigate a new and complex array of tax provisions and, for some, to rethink existing structures.

As published by Jason B. Freeman in Today’s CPA Magazine.

For other tax reform resources, try: Choice of Entity After Tax Reform, A Practical Roadmap Through Section 199A.

Business Tax Planning Lawyer

Need assistance in managing the business planning processes? Freeman Law advises clients with corporate and other entity formations and reorganizations. Restructuring entities—through conversions, mergers, and liquidations—can involve particularly complex tax and regulatory considerations. Freeman Law provides experienced tax and business counsel, helping our clients achieve their organizational goals in a tax-efficient manner. Schedule a consultation or call (214) 984-3000 to discuss your corporate structuring or business and tax planning concerns.

Why is the Concept of a Permanent Establishment Important?

Tax treaties typically provide that the business profits of a foreign business or taxpayer are taxable in the host state only to the extent that the enterprise/taxpayer has a permanent establishment in the host state to which the profits are attributable.

What is a Permanent Establishment?

In general, under a treaty, a permanent establishment is a fixed place of business through which the business of an enterprise is carried on in whole or in part. A permanent establishment generally includes a place of management, a branch, an office, a factory, a workshop, a mine, an oil or gas well, a quarry, or other places of extraction of natural resources.

Thus, if a person, other than an independent agent, is acting on behalf of an enterprise and has and habitually exercises the authority in a country to conclude contracts in the name of an enterprise of the other country, the enterprise generally will be deemed to have a permanent establishment in the first country in respect of any activities that person undertakes for the enterprise. Under the U.S. model and the OECD model, this rule does not apply where the contracting authority is limited to those activities described above, such as storage, display, or delivery of merchandise which are excluded from the definition of a permanent establishment.  A foreign enterprise will not be deemed to have a permanent establishment in the United States merely because it carries on business in the United States through a broker, general commission agent, or any other agent of an independent status, provided that such person is acting in the ordinary course of his business as an independent agent.

What about a subsidiary?

It is generally accepted that the existence of a subsidiary company does not, in and of itself, constitute a permanent establishment of its parent company.

However, any space or premises belonging to the subsidiary that is at the disposal of the parent company and that constitutes a fixed place of business through which the parent carries on its own business may constitute a permanent establishment of the parent.

An example is that of an employee of a company who, for a long period of time, is allowed to use an office in the headquarters of another company (e.g., a newly acquired subsidiary) in order to ensure that the latter company complies with its obligations under contracts concluded with the former company. In that case, the employee is carrying on activities related to the business of the former company and the office that is at his disposal at the headquarters of the other company may constitute a permanent establishment of his employer, provided that the office is at his disposal for a sufficiently long period of time so as to constitute a “fixed place of business.

Must the Place of Business be Fixed?

A place of business must be a “fixed” one.  That is, there must be a link between the place of business and a specific geographical point. (Geographically Fixed).

In addition, a permanent establishment will generally only be deemed to exist the place of business has a certain degree of permanency, i.e., if it is not of a purely temporary nature. (Temporally Fixed)

A place of business may, however, constitute a permanent establishment even though it exists, in practice, only for a very short period of time. Permanent establishments normally have not been considered to exist where a business had been carried on in a country through a place of business that was maintained for less than six months (conversely, there are a number of cases where a permanent establishment has been considered to exist where the place of business was maintained for a period longer than six months).

Temporary interruptions of activities do not cause a permanent establishment to cease to exist.

A nonresident alien individual or a foreign corporation is not considered to have an office or other fixed place of business merely because such alien individual or foreign corporation uses another person’s office or other fixed places of business, whether or not the office or place of business of a related person, through which to transact a trade or business, if the trade or business activities of the alien individual or foreign corporation in that office or other fixed place of business are relatively sporadic or infrequent, taking into account the overall needs and conduct of the trade or business.

See Commentary on Article 5(1) of the OECD Model; CIR v. Consolidated Premium Iron Ores, Limited, 265 F.2d 320 (6th Cir. 1959); Treas. Reg. Section 1.864-7(b)(2).

What are Recent Developments in the Concept of a Permanent Establishment?

The OECD’s Action Plan on Base Erosion and Profit Shifting (BEPS Action Plan) calls for a review of the PE definition to prevent the use of common tax avoidance strategies that are used to circumvent the existing PE definition.  Included among the targeted arrangements are arrangements through which taxpayers replace subsidiaries that traditionally acted as distributors by commissionaire arrangements.  The OECD believes that changes to the PE definition are necessary to prevent the exploitation of certain exceptions to the PE definition provided under Art. 5(4) of the OECD Model Tax Convention (2014), particularly in the digital economy.

Section 1202 offers a once little-known exclusion from income for gain on qualified small business stock (“QSB stock”).  The provision has undergone substantial revisions over the years and came back into vogue as a result of the Tax Cuts & Jobs Act.  Where applicable, section 1202’s exclusion offers a substantial and legitimate tax shelter: The exclusion of potentially all of the gain on QSB stock held for more than five years.

Section 1202 of the Internal Revenue Code allows a taxpayer (other than a corporation) to exclude a percentage of gain from the sale or exchange of qualified small business stock held for more than 5 years.  The exclusion is subject to a number of intricate requirements.  But where applicable, the exclusion provides one of the Code’s most significant tax breaks.

Section 1202

For taxpayers other than corporations, § 1202(a) provides that gross income does not include a percentage of the gain from the sale or exchange of qualified small business stock (QSB stock) that has been held for more than 5 years.  The percentage of the gain that is excludable varies, depending on the date of acquisition of the QSB stock:

• 100% of the gain is excluded for QSB stock acquired after September 27, 2010,[1]
• 75% for QSB stock acquired after February 17, 2009 and before September 28, 2010,[2] and
• 50% for QSB stock acquired on or before February 17, 2009.

Qualified Small Business Stock (“QSB” Stock)

Section 1202(c) provides that, in general, QSB stock includes any stock in a C corporation that was originally issued after the date of enactment of the Revenue Reconciliation Act of 1993 (Omnibus Budget Reconciliation Act of 1993, P.L. 103-66, § 13113(a)) if two conditions are met:

• on the date of the stock’s issuance the corporation is a qualified small business; and
• the stock was acquired by the taxpayer at its original issue in exchange for money or other property or as compensation for services.

Sec. 1202 is generally not available to exclude gain on the sale of S corporation stock or a partnership interest.

Section 1202 provides for a number of tacking rules, which may be applicable in situations where the QSB stock was gifted to a taxpayer or acquired as a result of a conversion of stock, for example.  Taxpayers should seek guidance from a tax attorney with respect to such circumstances, as other complexities may be involved.

What is a Qualified Small Business?

QSB stock is stock originally issued after August 9, 1993 by a domestic C corporation with total gross assets of $50 million or less.  The corporation must satisfy an active business requirement and must have been a C corporation during substantially all of the taxpayer’s holding period of the stock for which the taxpayer is claiming preferential treatment.  As such, the corporation must not be or have been a foreign corporation, DISC, former DISC, regulated investment company, real estate investment trust, REMIC, FASIT, cooperative, or a corporation that has made (or that has a subsidiary that has made) a section 936 election.

For these purposes, gross assets include those of any predecessor of the corporation. And all corporations that are members of the same parent-subsidiary controlled group are treated as one corporation.

The Active-Trade-or-Business Requirement

The code also imposes an active-trade-or-business requirement.  In order to be treated as QSB stock, the corporation issuing the stock must have satisfied the active-trade-or-business requirement during substantially all of the taxpayer’s holding period for the stock. This requires the corporation to use at least 80 percent of its assets (by value) in the active conduct of one or more qualified trades or businesses.

Generally, an active trade or business is defined as any trade or business other than trades or businesses expressly listed in § 1202(e)(3). Section 1202(e)(3) provides that a qualified trade or business means any trade or business other than a trade or business involving the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, athletics, financial services, brokerage services, consulting, or any other trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees.

Section 1202(e)(3) further provides that the term qualified trade or business does not include businesses in which the principal activity involves providing services in the fields of finance, insurance, banking, investing, leasing, farming, mining, or running a hotel, motel, restaurant or similar businesses.

Disqualifying Redemptions

The corporation must not have engaged in certain redemptions that would disqualify the stock as QSBS.  For example, stock is not qualified small business stock if it makes significant purchases of its own stock within a 2-year period beginning on the date 1 year before the issuance of the stock.  That is, if the issuing corporation purchases more than a de minimis amount of its stock and the purchased stock has an aggregate value exceeding 5 percent of the aggregate value of all of the issuing corporation’s stock as of the beginning of such 2-year period, the corporation’s stock will lose QSB status.

In addition, Stock acquired by a taxpayer is not qualified small business stock if, in one or more purchases during the 4-year period beginning on the date 2 years before the issuance of the stock, the issuing corporation purchases (directly or indirectly) more than a de minimis amount of its stock from the taxpayer or from a person related (within the meaning of section 267(b) or 707(b)) to the taxpayer.

For these purposes, any purchase of stock that is treated as a redemption distribution under §304 is treated as a purchase by the issuer of an amount of its own stock.

Claiming a Section 1202 Exclusion

Taxpayers seeking to invoke section 1202’s exclusion should generally seek advice from a tax attorney and, in many situations, should obtain a tax opinion regarding qualification under the provision, given the many intricate requirements under the Code, regulations, and case law.  But taxpayers who qualify to take advantage of section 1202’s exclusion for gain on the sale or exchange of qualified small business stock (“QSB stock”) may be entitled to one of the Code’s most significant tax breaks.

Business Tax Planning Lawyer

Need assistance in managing the business planning processes? Freeman Law advises clients with corporate and other entity formations and reorganizations. Restructuring entities—through conversions, mergers, and liquidations—can involve particularly complex tax and regulatory considerations. Freeman Law provides experienced tax and business counsel, helping our clients achieve their organizational goals in a tax-efficient manner. Schedule a consultation or call (214) 984-3000 to discuss your corporate structuring or business and tax planning concerns. 

[1] Section 1202(a)(4) provides that in the case of qualified small business stock acquired after the date of the enactment of the Creating Small Business Act of 2010, § 1202(a)(1) shall be applied by substituting “100 percent” for “50 percent” and § 1202(a)(2) shall not apply.

[2] Section 1202(a)(3) provides that in the case of qualified small business stock acquired after the date of enactment of § 1202(a)(3) and on or before the date of enactment of the Creating Small Business Jobs Act of 2010, § 1202(a)(1) shall be applied by substituting “75 percent” for “50 percent” and § 1202(a)(2) shall not apply.

Freeman Law advises domestic and international ventures with corporate and tax compliance.  Clients with flow-through entity structures may need to consider the impact of section 199A.  Planning for section 199A may significantly impact a client’s bottom line and investor returns.  For more on section 199A, see our other Insights, such as A Practical Roadmap Through Section 199A, Choice of Entity After Tax Reform, and Tax Reform is Here: A Brief Primer on the Key Business Provisions.

Section 199A was enacted as part of the Tax Cuts and Jobs Acts of 2017, P.L. 115-97 (the “TCJA”).  Its rules are currently effective for tax years beginning after 2017 and before 2026.

Section 199A provides a deduction of up to 20 percent of income from a domestic business that operates as a sole proprietorship or through a partnership, S corporation, trust, or estate.  The deduction is available to individuals and some estates and trusts.  It is not available for wage income or for business income earned through a C corporation.

For taxpayers with taxable income that exceeds a threshold amount,[1] their section 199A deduction may be limited based on (i) the type of trade or business that they are engaged in, (ii) the amount of W-2 wages paid with respect to the trade or business, and/or (iii) the unadjusted basis immediately after acquisition (“UBIA”) of qualified property held for use in the trade or business.[2]

Notably, the deduction under section 199A does not reduce net earnings from self-employment under section 1402 or net investment income under section 1411. Therefore, taxpayers should be aware that sections 1402 and 1411 continue to be calculated as though there is no section 199A deduction.

The Deduction

A qualifying taxpayer with income attributable to one or more qualifying domestic trades or businesses with taxable income equal to or less than the threshold amount may take a section 199A deduction equal to the lesser of: (i) 20 percent of the QBI from the individual’s trades or businesses plus 20 percent of the individual’s combined qualified REIT dividends and qualified PTP income or (ii) 20 percent of the excess (if any) of the individual’s taxable income over the individual’s net capital gain.

QBI is subject to limitations for taxpayers with taxable income exceeding the threshold amount. These limitations include the exclusion or reduction of items from a specified service trade or business (“SSTB”), as well as limitations based on the W-2 wages of the trade or business or a combination of the W-2 wages and the UBIA of qualified property.

The Limitations

Taxpayers must compare, on a trade-or-business by trade-or-business basis, 20% of each trade or business’ QBI against the alternative limitation that applies to that trade or business.  That limitation (again, for each trade or business) is the greater of (1) 50 percent of the W-2 wages attributable to the trade or business or (2) 25 percent of those W-2 wages plus 2.5 percent of the UBIA of qualified property for that trade or business. Thus, the QBI for each trade or business is equal to the lesser of 20% of the QBI for that trade or business or the applicable limitation. Special rules apply where the taxpayer’s taxable income is within the phase-in range.

Specified Service Trade or Business (“SSTB”)

Under the proposed regulations, if a trade or business is a SSTB, then no QBI, W-2 wages, or UBIA of qualified property from the SSTB may be taken into account by any taxpayer whose taxable income exceeds the phase-in range (defined in Proposed §1.199A- 1(b)(3)), even if the item is derived from an activity that is not itself a specified service activity. A phase-in rule, provided in Proposed §1.199A-1(d)(2), applies to individuals with taxable income within the phase-in range, allowing them to take into account a certain “applicable percentage” of QBI, W-2 wages, and UBIA of qualified property from an SSTB. If the taxpayer’s taxable income is above the phase-in range, then no amount of QBI, W-2 wages, or UBIA of qualified property from an SSTB can be used by the taxpayer in calculating their section 199A deduction.

A specified service trade or business includes any trade or business involving the performance of services in one or more of the following fields:

• (i) Health;
• (ii) Law;
• (iii) Accounting;
• (iv) Actuarial science;
• (v) Performing arts;
• (vi) Consulting;
• (vii) Athletics;
• (viii) Financial services;
• (ix) Brokerage services;
• (x) Investing and investment management;
• (xi) Trading;
• (xii) Dealing in securities (as defined in section 475(c)(2)), partnership interests, or commodities (as defined in section 475(e)(2)); or
• (xiii) Any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners.

Performing Services as an Employee:  Note that the trade or business of performing services as an employee is not a trade or business for purposes of section 199A. Therefore, no items of income, gain, loss, or deduction from the trade or business of performing services as an employee constitute QBI within the meaning of section 199A.

Trade or Business

Proposed Regulations at §1.199A-1(b) define the phrase trade or business for purposes of section 199A.  Under that proposed regulation, the IRS generally determined that the phrase trade or business should take on the meaning of that phrase that has been developed under section 162(a) of the Code.  Section 162(a) lends the benefits of a large body of existing case law and administrative guidance interpreting the phrase across a wide variety of industries.

Qualified Business Income (“QBI”)

Qualified Business Income (“QBI”) is defined as the net amount of qualified items of income, gain, deduction, and loss with respect to any trade or business of the taxpayer.  See our upcoming Insights on the topic for more on QBI.

[1]That threshold amount is equal to $157,500 (or $315,000 in the case of a taxpayer filing a joint return).

[2]Deductions related to combined qualified real estate investment trust (“REIT”) dividends and qualified publicly traded partnership (“PTP”) income are not subject to the W-2 wages or UZBIA of qualified property limitations.

Your Guide to Starting a Business in Mexico

Mexico is a great place to do business, and more and more US businesses realize this every day. If you’re thinking of expanding your business into Mexico or you’re just starting to explore the idea, this guide is for you. In it, we’ll discuss the basics of doing business in Mexico, from setting up a legal entity to hiring employees and paying taxes. We’ll also give you some tips on how to make the process smoother and less stressful.

Starting or Expanding a Business in Mexico

Opening or expanding a business in Mexico can be a great way for US business owners to improve both growth and profitability. However, doing business in Mexico requires a knowledge of not only the process, the laws, and the labor market but also the costs and legal basics as well.

All business owners must begin by registering their business in Mexico. On average, this process can be completed in just a few weeks.

How to Register a Business in Mexico

The first step in setting up a business in Mexico is to have your legal representative sign a Power of Attorney (POA), which will allow them to assist you in starting your business in Mexico.

Next, you’ll want to choose the legal structure for your business that best suits your needs. The most common structures for foreign-owned businesses are the maquiladora, the limited liability company (LLC), and the branch office.

After you have chosen your business structure, you will need to register it with the Mexican government. To begin, you should contact the Ministry of Economy and establish your business name as a trademark in Mexico. You will then need to register your business with the Public Registry of Property and Commerce by submitting a number of documents, including the following:

• A notarized copy of the articles of incorporation or partnership
• A notarized copy of the bylaws
• A notarized copy of the registration form
• A bank letter of good standing, showing that you have a business bank account in Mexico
• Proof of address

The registration fee is 16.3% of the estimated income of the business during its first year of operation. This is a separate, one-time fee, and it is not paid in subsequent years.

After your business has been registered, you will need to obtain both a business license and a Mexican tax identification number (NIF). You can submit an application for a business license to the local city or state government and an application for an NIF to the local Sistema de Administración Tributaria (SAT) office.

Hiring in Mexico

If you plan to hire a workforce in Mexico, as part of the registration process, you will need to register with the local tax administration to enroll employees in both income tax (handled by the Secretary of Financial Administration) and Social Security tax (overseen by the Mexican Social Security Institute).

Employment agreements are mandatory in Mexico, which means that you will need to have a signed contract with each employee. In general, an employment contract must not only contain the employee’s personal information but also clearly define the services to be provided; the work location and schedule; the form, amount, and payment date of wages; and other employment conditions, such as leave or vacation days.

In Mexico, the standard full-time work schedule is 8 hours a day, 6 days a week. Overtime is paid out at an additional 50% of hourly pay, and vacation days are typically awarded each year after the first full year of employment. The minimum wage is currently $140 US per month.

Mexican law allows either the employer or the employee to terminate an employment contract with cause. If an employee is fired, the company must provide a notice of the unsatisfactory conduct and the dates on which it occurred. Failing to give cause when terminating an employment contract may allow the employee to claim their dismissal was unjustified and sue for an additional 3 months’ salary, as well as any bonuses and accrued vacation or holiday pay.

Building Commercial Property in Mexico

Along with hiring employees, most businesses starting in or expanding into Mexico will need a physical facility in which to conduct operations. In most cases, you should plan to invest at least 10% of the commercial real estate value upfront. While the process of buying and building a warehouse, office, or factory in Mexico is similar to that in the US, there are also some differences you should be aware of.

For example, all new builds must be registered with the Mexican authorities. While the process is relatively simple, it can take several months to complete. The registration fee is 6.2% of the property’s value and does not include capital gains or other taxes. You will also need to connect your new building to the electrical grid, which can be another expensive and time-consuming process. Along with the required connection fees, you can also expect to pay a tariff on monthly electricity use of $0.793 MXN pesos per kilowatt hour.

It’s also important to note that the quality of land administration in Mexico can be unreliable and you may run into issues with property rights, infrastructure, and the transparency of information unless you have experienced legal counsel on hand to guide you through the process.

Taxes and Foreign Investor Protections

Most businesses in Mexico make as many as nine tax payments each year. These taxes are levied by various government offices and include everything from property to employment taxes. All businesses operating in Mexico must keep separate tax accounting books, complete and file tax returns with all appropriate agencies, and make arrangements to pay or have taxes withheld with each. The time investment in these activities is comparatively high, as is the tax rate. Altogether, tax contributions for most companies in Mexico equal about 55% of profits.

As a rule, foreign investors in Mexico have a number of protections under the United States-Mexico-Canada Agreement (USMCA), which replaced the North America Free Trade Agreement (NAFTA) in July 2020. It is also possible to enforce contracts and resolve disputes through the Mexican legal system. However, there are court costs and legal fees required, and the system can move slowly at times. Most lawsuits take about a year to obtain a judgment, and the reliability of the legal process can vary widely from place to place.

Grow Your Business in Mexico

As you can see, there are a number of hoops to jump through to start or expand a business in Mexico. However, as long as you understand the process and follow the regulations – and consult an experienced legal professional before you begin – starting a business in Mexico can be a rewarding option filled with possibilities.

Hobby Loss or Business Loss Tax Deduction 

It’s not every day that a case comes through the Tax Court centered on the taxation of miniature donkey breeding.  But the recent case of Huff v. Commissioner was focused on just that—specifically, whether the taxpayer (a breeder of miniature donkeys) could deduct expenses incurred in excess of income from the breeding activity.  The Tax Court’s decision focuses on section 183, the so-called “hobby loss” provision.  While taxpayers are generally entitled to deduct ordinary and necessary expenses necessary to conduct a trade or business or for the production of income, Section 183 of the Internal Revenue Code limits the ability to claim deductions arising from an activity that is not engaged in “for profit.”

Below is a summary of the recent decision.

William R. Huff and Cathy Markey Huff, v. Comm’r, T.C. Memorandum 2021-140| December 21, 2021 | Urda, J. | Dkt. No. 22604-17.

Short Summary:  The main issue in this case is whether the taxpayers’ miniature donkey breeding activity was operated with the intent to make a profit under section I.R.C. 183 during the 2013-2014 period (the tax years).

William R. Huff (the taxpayer), a wealthy financier, engaged in the miniature donkey breeding business with the intention of supplementing the income of her daughter. The venture was carried under Ecotone, an LLC solely owned by the taxpayer and his wife. To engage in the donkey breeding activity he conducted extensive research, and acquired multiple donkeys with the intention of breeding newer ones under 25 inches tall. His business was located in a specified area of his farmland and the business kept separate books and records detailing the donkey purchases and sales. The taxpayer did not obtain a personal pleasure of the business because according to his own words, having the donkeys “it’s a lot of work” and the donkeys are “quite ugly” and look  like a “gigantic hairball”.

The business reported losses since its inception and during the tax years, which were reported on the taxpayer’s personal income tax return. The taxpayer had gross income of approximately $21M and $29M during the tax years. The IRS disallowed the losses in the amount of approximately $87k and $47k for 2013 and 2014 on the ground that Ecotone was not a trade or business, and the Notice of Deficiency was issued.

Key Issues: Whether the taxpayers’ miniature donkey breeding activity constitutes a trade or business as provided by section 183 of the I.R.C.

Primary Holdings: The taxpayers’ miniature donkey breeding activity constitute a trade or business under section 183 I.R.C.

Key Points of Law:

The Court determined that the taxpayer was engaged in the business of breeding miniature donkeys, as provided by I.R.C. 183. Section 162 provides that all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business. I.R.C. § 183. An activity not engaged in for profit is defined under section 183(c) as “any activity other than one with respect to which deductions are allowable for the taxable year under section 162…”. I.R.C. § 183(c).

An activity is engaged in for profit “If the activity was entered into with the dominant hope and intent of realizing a profit”. Brannen v. Commissioner, 722 F.2d 695 , 704 (11th Cir. 1984), aff’g 78 T.C. 471 (1982); see, Helmick v. Commissioner, T.C. Memo. 2009-220 , 2009 WL 3012725 , at *7.

Breeding and raising equines may be an activity entered into for profit. For example, Engdahl v. Commissioner, 72 T.C. 659 , 665-666 (1979); Den Besten v. Commissioner, T.C. Memo. 2019-154, at *18. To determine the requisite profit objective, the Court attends to all the surrounding facts and circumstances. See Keanini v. Commissioner, 94 T.C. 41 , 46 (1990); sec. 1.183-2 (b), Income Tax Regs .

The Regulations provide with a list of factors that are relevant to ascertain the existence of the intent to earn a profit. Treas. Reg. § 1.1832(b). In this case, the Court discussed all these 9 factors as follows:

1. Manner in which the taxpayer conducts the activity. The activity must be carried in a businesslike manner which may indicate the activity is engaged in for profit. Treas. Reg. § 1.183-2(b)(1). “Businesslike manner” is suggested by the maintenance of books and records and a plausible business plan. Ibid. “Taxpayers operate in a businesslike manner when, among other things, they have a business plan, advertise goods or services, keep complete records, and respond to losses by changing what they do.” Metz v. Commissioner, T.C. Memo. 2015-54 , at *26; see also Helmick v. Commissioner, T.C. Memo 2009-220 , 2009 WL 3012725 , at *8.

In this case, the taxpayer had a business plan which was evidenced by its actions: assemble a team of miniature donkeys with certain attributes, breed them and sell the foal. Other circumstances such as consulting with experts, implementation of major changes to the area where the activities were carried, and purchases of breeding stock confirm the existence of the business plan. Moreover, Ecotone maintained a separate set of books and records different from the taxpayers. Finally, the taxpayers changed aspects of the breeding operation in response to the business’ needs such as feeding changes, alteration to breeding schedules, among others. Under these facts, the Court weighed this factor in favor of the taxpayers.

2. Expertise of the taxpayer or his advisers. If the taxpayer consults with industry experts and studies accepted business practices when preparing for an activity, that may suggest a profit motive. Treas. Reg. § 1.183-2(b)(2). In this case, the taxpayers did not have any previous experience in the miniature donkey breeding business. However, the taxpayers undertook deep research into all the factors of the activity and more relevantly, he hired an expert in the breeding activity. The Court found this factor in favor of the petitioners.
3. Time and effort spent by the taxpayer in carrying on the activity. Devotion of considerable time to an activity may indicate a profit motive, particularly if the activity does not have a substantial personal or recreational aspect. Treas. Reg. § 1.183-2(b)(3). In this case, the Court recognized the limited amount of time of the taxpayers to directly carry the activity. Thus, the Court focused its attention on whether the taxpayers employed competent and qualified people to carry on the activity. Here, the taxpayers hired various experts in the breeding activity and in the caretaking of the donkeys. This factor weighed in favor of the taxpayers.
4. Expectation that assets used in the activity may appreciate in value. Profit includes appreciation in the value of assets, such as land. Treas. Reg. § 1.183-2(b)(4). If the taxpayer engages in farming of the land, the farming and the holding of the land are considered as a single activity only if the farming activity reduces the net cost of carrying the land. Treas. Reg. § 1.183-1(d)(1). In this case, the Court found that although the taxpayers expected the donkeys to increase its value, no evidence was introduced to support this expectation. More relevantly, the fact that the donkeys were sold at a loss suggests that the appreciation of the donkeys was unlikely. Also, no evidence was introduced to support the appreciation in the value of the land. Accordingly, this factor was found in favor of the IRS.
5. Success of the taxpayer in carrying on other similar or dissimilar activities. The previous business activities of the taxpayers were not related to horse breeding. This factor was deemed neutral by the Court.
6. Taxpayer’s history of income or losses with respect to the activity. “The fact that the taxpayer has engaged in similar activities in the past and converted them from unprofitable to profitable enterprises [*14] may indicate that he is engaged in the present activity for profit, even though the activity is presently unprofitable.” Treas. Reg. 1.183-2 (b)(5). The fact that the taxpayer was an accomplished businessman engaged in turning around unsuccessful business to successful ones, was central for the Court to find that he intended to do the same with the donkey breeding activity. Blackwell v. Commissioner, T.C. Memo 2011-188 , [2011 BL 204853], 2011 WL 3444327 , at *7 (“[The taxpayer’s] obvious business acumen and success in business development and management with other companies, along with * * * [his] credible testimony, indicate, to us, an ability, determination, and savvy to make a profit and be successful in * * * [the] horse activity.”).This factor weighed in favor of the taxpayers.
7. History of income or losses with respect to the activity. “A series of losses during the initial or start-up stage of an activity may not necessarily be an indication that the activity is not engaged in for profit.” Treas. Reg. 1.183-2 (b)(6). Despite the losses sustained since its inception, the Court found that the donkey breeding business was within the startup phase and the exception applicable to losses derived of unforeseen circumstances beyond the taxpayer’s control does not preclude a profit motive. Ibid. This factor favored the taxpayers.
8. Amount of occasional profits, if any. An occasional small profit from an activity generating large losses, would not generally be determinative that the activity is engaged in for profit. Treas. Reg. § 1.183-2(b)(7). Here, Ecotone did not generate any profit. The factor favored the IRS.
9. Financial status of the taxpayer. If the taxpayer has substantial income or capital from sources other than the activity subject to inquiry, it may indicate lack of profit intent. Treas. Reg. § 1.183-2(b)(8). Here, the taxpayers had substantial capital from other sources. The Court considered the taxpayer’s testimony stating that his intend was to give her daughter a business that made money, not a losing one. Under such evidence, the Court found that this factor favored the taxpayers.
10. Elements of personal pleasure or recreation. If the taxpayer derives personal pleasure from an activity, or finds it recreational, it may suggest lack of intent of a profit. Treas. Reg. § 1.183-2(b)(9). However, “suffering has never been made a prerequisite to deductibility.” See Jackson v. Commissioner, 59 T.C. 312 , 317 (1972). In this case, the taxpayer did not derive any pleasure form this activity, in his own words, “there is no satisfaction of having these”, because the miniature donkeys are “quite ugly” and look like a “gigantic hairball”. This factor favored the taxpayers.

Based on the above analysis, the Court determined that the taxpayers’ activities were engaged in for profit.

Insight:  This case shows that to properly determine the existence of a trade or business, the facts and circumstances surrounding such activity are critical. In this case, the Court surprisingly found that even if the donkey breeding business was sustaining losses, this was not an impediment to determine the existence of a motive profit, because the breeding was characterized as “unforeseen”. In a similar case resolved just a week before this case, the Court did not rest its opinion on such characterization. See Mitchel Skolnick and Leslie Skolnick, et al., v. Comm’r, T.C. Memorandum 2021-139. This subject will still continue to raise questions, specifically in novel scenarios such as cryptocurrency.

Tax Court Litigation Attorneys

Need assistance litigating in the U.S. Tax Court? Freeman Law’s tax attorneys are experienced litigators with trial-tested litigation skills and in-depth substantive tax knowledge, having collectively litigated hundreds of cases before the U.S. Tax Court. Our tax controversy lawyers have extensive experience in Tax Court matters involving partnership audits and litigation under both the TEFRA and BBA regimes, international tax penalties, foreign trusts, valuation, reasonable compensation disputes, unreported income, fraud penalties, other tax penalties, and many other matters. We draw on our experience and wealth of tax knowledge to advise and guide clients through the entire tax controversy process, building the right strategy to resolve tax controversies from day one. Schedule a consultation or call (214) 984-3000 to discuss your Tax Court concerns or questions.