Court Strikes Down Micro-Captive Reporting Requirement

Date March 30, 2022
Categories

On March 21, the U.S. District Court for the Eastern District of Tennessee vacated Notice 2016-66 in its entirety, finding that the Internal Revenue Service failed to engage in required notice-and-comment procedures and that issuance of the Notice was arbitrary and capricious1. The Court declined the Service’s request to leave the Notice in place pending promulgation of a new or amended rule due to the Service’s poor history of complying with the applicable procedures.

Notice 2016-66 was promulgated to address concerns by the Service that so-called “micro-captive transactions” had the potential for tax avoidance or evasion. The Notice classified such transactions as “transactions of interest” for purposes of Treas. Reg. § 1.6011-4 and Code §§ 6011 and 6012 and directs that (1) persons engaging in such transactions must disclose the transaction on Form 8886 and (2) material advisors who make a tax statement with respect to the transaction have disclosure obligations.

A “micro-captive transaction” subject to the notice is structured as follows:

  1. Taxpayer owns an interest in an entity conducting a trade or business (the “Insured”);

  2. Taxpayer, Insured, or a related person owns another entity (“Captive”) that enters into an insurance contract with the Insured or reinsures a risk that an intermediary has previously insured;

  3. Captive elects under Code § 831(b) to be taxed only on taxable investment income;

  4. Taxpayer, Insured, or a related person own at least twenty percent of the voting power or value of the outstanding stock of Captive; and

  5. Either (A) the total of insured losses and administrative expenses during a computation period are less than seventy percent of the excess of premiums received by Captive over dividends returned to the policyholder, or (B) Captive has made insurance premiums available to Taxpayer, Insured, or a related party during a computation period in a transaction that did not result in taxable income.


Although the Court vacated the Notice in its entirety, the ruling only affects taxpayers within the jurisdiction of the Sixth Circuit, where the Eastern District of Tennessee sits (this comprises the states of Tennessee, Kentucky, Ohio, and Michigan). Taxpayers in this jurisdiction should consult their tax advisors to see how this particular decision may affect their tax reporting requirements. Taxpayers who are residents of other circuits should expect the Service to continue enforcing the requirements of the Notice.

It should be noted that the Service is likely to appeal this decision. Taxpayers under the reporting requirements of the Notice should be cautious and keep an eye out for new developments.

If your business is engaged in micro-captive transactions or other reportable transactions, please reach out to an HBK Tax Advisor.

1 CIC Services, LLC v. I.R.S., Case No. 3:17-cv-110 (E.D. Tenn. Mar. 21, 2022).

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IRS Expands Reporting for Venmo and PayPal Transactions

Date March 4, 2022
Categories

Following years of reported noncompliance by the gig economy, the government has crafted a new way to ensure it gets its pound of flesh from your side hustle. Beginning in 2022, third-party payment networks – like PayPal and Venmo – will be required to expand their reporting of business transactions to the IRS at a much lower threshold.

While third-party payment networks have always been required to report transactions to the IRS, the “American Rescue Plan” lowered the reporting threshold to $600. Previously, the threshold for reporting was $20,000 and 200 transactions. The reporting obligation only applies with respect to business transactions (the sale of goods or services); however, the taxpayer need not be a business to be subject to reporting. Taxpayers who have received payments for goods or services exceeding the annual threshold can expect to receive Form 1099-K from the third-party payment network. Form 1099-K reports transaction totals to both the taxpayer and the IRS.

Transactions that are marked as personal transactions (i.e., friends and family transfers) are not subject to reporting. Although gig workers could duck reporting by requesting that customers mark transactions as personal transfers, this comes at the cost of marketplace safety and purchase protection – a cost customers will not likely pay to help vendors evade their taxes. Additionally, PayPal (which also owns Venmo) says it will monitor accounts to ensure that personal payments are not being used for sales of goods and services. While some third-party payment networks have indicated that they will treat business and personal accounts differently, it is unclear whether they have the authority to do so.

While these reporting measures are likely to increase compliance in the gig economy, they are equally likely to incite panic among taxpayers who have had a garage sale during the year or sold used furniture on Facebook Marketplace. While these types of transactions are generally not taxable (when the items were purchased for more money than the sales price), the third-party payment network will still be required to report these transactions on Form 1099-K. To mitigate the risk of receiving a notice from the IRS, these taxpayers should report the nondeductible personal losses (as the case may be) on their tax returns so that the IRS can match the proceeds to the return.

There is also a risk that many taxpayers will overpay taxes with respect to proceeds reported on 1099-K. Taxpayers who self-prepare their returns using a commercial DIY tax software may simply key in the information reported on 1099-K and move on – paying tax on the entirety of the proceeds without an offset for the cost of the items. Oftentimes, taxpayers will not remember or have any record of the cost of items sold at a garage sale or on Facebook Marketplace, further complicating the issue.

If you receive a 1099-K and find yourself unsure about how to report it, please reach out to an HBK Tax Advisor.

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PA Dept of Revenue Releases Tax Bulletins Impacting Certain Deductions

Date May 6, 2019
Categories
Article Authors
HBK CPAs & Consultants

The Pennsylvania Department of Revenue (DOR) has issued tax bulletins that impact the way hedging transactions and those associate with certain intangible income are taxed. This article was compiled to give Pennsylvania business owners and operators important information on how these changes may impact the ways they deduct certain types of income and the ability to file for some types of tax deductions.

Background Information: Corporate Tax Bulletins #1 & #2
Corporation Tax Bulletin 2019-01 – Corporate Net Income Tax Hedging and Foreign Currency Transactions
This bulletin addresses the apportionment factor for PA Corporate Net Income Tax. It states that receipts from hedging transactions are to be excluded from the numerator and denominator when calculating the apportionment fraction.

Corporation Tax Bulletin 2019-02 – Pennsylvania Corporate Net Income Tax Treatment of Global Intangible Low-Taxed Income and Foreign-Derived Intangible Income This much awaited bulletin addresses how Global Intangible Low-Taxed Income (GILTI) and Foreign-Derived Intangible Income (FDII) is treated for PA Corporate Net Income (CNI) and Personal Income Tax (PIT) purposes.

What are the GILTI & FDII Deductions?
For federal tax purposes GILTI is treated in a manner similar to Subpart F income as it is deemed to be repatriated in the year it is earned. The GILTI and FDII deductions are considered special deductions for federal income tax purposes and are not allowed in the calculation of PA CNI tax. Pennsylvania treats Subpart F income as dividend income for CNI tax. Therefore, GILTI income will also be treated as dividend income. CNI taxpayers should include GILTI in their tax base in the year it is recognized.

A deduction is allowed for corporations receiving dividends from foreign corporations for CNI tax. The GILTI income will fall into this definition. However, the deduction may be less than 100% depending on the ownership interest in the entity generating the GILTI.

The bulletin also discussed the treatment of GILTI for PIT purposes. Because the GILTI is a “deemed dividend” and not an actual cash distribution, it is not a dividend subject to tax under PA PIT. When an actual distribution of cash out of the current or accumulated earnings and profits of the foreign entity is made to a PIT taxpayer, it will be subject to PIT as a dividend.

Restricted Tax Credit Bulletin 2019-01 – Claiming Donation-Based Tax Credits after the Tax Cuts and Jobs Act and Restricted Tax Credit Bulletin 2018-02 – Claiming Education tax Credits after the Tax Cuts and Jobs Act.

Pennsylvania is addressing chairity-related taxable deductions and credits. To be clear, the state has attempted to clarify the rules around the deductibility of charitable donations in exchange for PA tax credits. The federal Tax Cuts and Jobs Act limited the amount of state and local tax deduction to $10,000. As a result, some states discussed legislating a work around to allow taxpayers to get a charitable deduction in lieu of taxes. In response, the Internal Revenue Service issued a clarification limiting the amount of the charitable deduction to the amount donated in excess of the credits received. This created some confusion and uncertainty for taxpayers wanting to take advantage of the PA Educational Improvement Tax Credit, the Opportunity Scholarship Tax Credit, the Waterfront Development Tax Credit, and the Neighborhood Assistance Tax Credit.

The PA statute states that the donations to organizations in order to qualify for the credit cannot for activities that are a part of a business firm’s normal course of business. Pennsylvania has stated that if the payment is not made in the normal course of a commercial transaction, a taxpayer may claim the state credit for payments made to eligible organizations even if the taxpayer claimed a deduction for federal income tax purposes. However, for personal income tax purposes a pass-through entity must adjust its PA income by the amount claimed as a deduction on its federal income tax return. The Department still considers the contributions to be charitable in nature.

Sales and Use Tax Bulletin #1
Sales and Use Tax Bulletin 2019-01 – Maintaining a Place of Business in the Commonwealth
This bulletin is in response to the U.S. Supreme Court ruling in South Dakota v. Wayfair, Inc. This decision upheld South Dakota’s economic nexus statute that required out-of-state vendors who sold more than $100,000 worth of property or had more than 200 separate transactions into South Dakota to collect and remit sales tax. Pennsylvania joins nearly forty states by implementing the economic nexus standard for the collection of sales tax for out of state vendors. Effective July 1, 2019 out of state vendors selling more than $100,000 worth of property into Pennsylvania will be required to collect and remit Pennsylvania sales tax. PA does not have a transaction threshold. Vendors selling between $10,000 and $100,000 into Pennsylvania have the option to collect and remit or notice and report.

Philadelphia Responds to Wayfair
In response to the Wayfair decision, Philadelphia amended its regulations regarding the Philadelphia Business Income and Receipts Tax (“BIRT”). An economic nexus standard is added for tax years starting on or after January 1, 2019. If a business with no physical presence in Philadelphia has at least $100,000 in Philadelphia gross receipts during any 12-month period ending in the current year, it will be considered having nexus for the gross receipts portion of the BIRT. The “active presence standard” for nexus with Philadelphia is also amended to provide that an “active presence” will subject the taxpayer to at least the gross receipts portion of the BIRT. “Active presence” is defined as purposeful, regular and continuous efforts in Philadelphia in the pursuit of profit or gain and the performance in Philadelphia of activities essential to those pursuits.

In addition, activity rising to the level of “solicitation plus” will result in both the gross receipts and net income portions of the BIRT. “Solicitation plus” refers to cases in which the taxpayer’s business activities exceed solicitation.

For questions, please contact HBK State and Local Tax group leader and Tax Advisory Group member, Suzanne Leighton, MTA at SLeighton@hbkcpa.com.

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