At Around the Tax World, you can find out all about what’s going on in the wonderful, worldwide world of tax. Every month, we’ll feature a few mini-articles on what’s been going on in the world when it comes to tax, and fully available for viewing even if you don’t have a subscription.
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Check out what’s happening all around the world of tax!
In The Headlines
- Ryan Reynolds turns his entrepreneurial energy toward the world of sports. The actor recently purchased a minority interest in the Mexican football team Club Necaxa. Shortly after, Reynolds also led an investment round for the sports and licensed appeal company Homage through his investment advisory firm Maximum Effort Investments. With this funding, Homage intends to expand their production and operations, invest in new technology, and increase its business partnerships. The movie star’s $350 million net worth is largely a product of his business investments including gin brand Aviation American and telecommunications company Mint Mobile. Reynolds has also invested in football club Wrexham and the Renault-owned Alpine Formula One team.
- Tom Brady and Kevin O’Leary were among the casualties of the collapse of cryptocurrency exchange FTX—but will they receive a portion of the recovered funds? Sam Bankman-Fried, cofounder of FTX, was recently sentenced to 25 years in prison, charged with seven counts of fraud, embezzlement, and criminal conspiracy. The now-bankrupt company was discovered to have an $8 billion gap in its accounts. Typically, in bankruptcy cases, only bond-holders recapture their investment, but those with equity stakes simply eat the losses. The company had a number of celebrity stakeholders, including star quarterback Tom Brady and NBA player Stephen Curry, both of whom had appeared in FTX commercials. Shark Tank entrepreneur Kevin O’Leary owned about $1 million in shares and had also been paid to act as a spokesperson.
- The latest bankruptcy story is popular seafood chain Red Lobster. This comes after the restaurant announced it would close 99 locations around the U.S. Fortunately for patrons, the remaining locations will remain open as the company works on its reorganization and plans to sell the business to a new entity. Red Lobster’s assets are worth between $1 billion and $10 billion, and its estimated debts fall within the same range. The company lost about $76 million last year and saw an estimated 30% decrease in customer visits since before the COVID-19 pandemic. In 2024 alone, a number of well-known brands have filed for Chapter 11 bankruptcy, such as 99 Cents Only Stores, restaurant chain Boston Market, Hornblower Cruises, fabric and craft supplier Jo-Ann Stores, and clothing store rue21.
What's New In The Tax World?
The IRS is cracking down on large partnerships and companies are evaluating how to prepare
In September 2023, the IRS announced its intention to shift focus onto high-income earners, partnerships, and large corporations when it comes to tax audits. This effort would include an examination of the 75 largest partnerships in the U.S. Following this announcement, international law firm Baker McKenzie filed a lawsuit aimed at requiring the IRS to publicly disclose more information about their new tax compliance plans. The plaintiff states that they need to understand how the IRS might impose on their clients in order to effectively advise and protect them. However, Baker McKenzie recently voluntarily dismissed the lawsuit without explanation.
Back in 2021, the IRS launched the first phase of its new Large Corporate Compliance (LCC) program, shifting from its previous model of continuous audit toward risk-based audits for large and complex corporate taxpayers. The agency also began using artificial intelligence to help select partnerships for examination, especially companies whose tax returns show discrepancies of over $1 million between their end-of-year and beginning-of-year balances. At the end of 2023, the IRS identified about 500 partnerships with these discrepancies—and who will now be required to provide an explanation to avoid an official audit.
The agency also announced that it would use Inflation Reduction Act funding to prevent large partnerships from using pass-through businesses to avoid paying income taxes. These efforts have resulted in an almost ten-fold increase in audit rates of partnerships with over $10 million in assets, as of May 2024.
Experts advise that partnerships familiarize themselves with the red flags the IRS is looking for in these audits. For example, partnership tax returns must include a balance sheet. If any items on the balance sheet seem questionable, this may be enough for the IRS to flag the return for further scrutiny. If the partnership’s balance sheets do not reconcile from year to year, this could be a signal that the partnership has made mistakes in its books and records. On a slightly more complicated topic, the IRS may also look for partnerships that have neglected to pay their self-employment (SECA) taxes. The complication here is that partnerships may have previously made use of the “limited partner” exception, but in November 2023, the Tax Court ruled that this exception does not apply to partners who are limited in name only. Partnerships that erroneously continue to claim this benefit may find themselves facing a tax audit.
State-By-State Updates
- California is poised to become the first state to levy an excise tax on guns and ammunition. Firearms are already subject to an 10% or 11% federal tax, depending on the type, and California’s 6% sales tax. The new excise tax will add 11% to each purchase. In the debate over gun control, analysts have made comparisons between the U.S. approach to firearms versus cigarettes and alcohol—all products that are regulated by the Bureau of Alcohol, Tobacco, Firearms and Explosives. California currently levies a $2.87 excise tax on each pack of cigarettes and a 12.5% vaping excise tax as of 2021. After these changes kick in, guns and ammunition will be taxed at about the same level as alcohol in the state. Some economists estimate that the new tax may reduce gun sales by 30% to 44% in California.
- Ohio is withholding tax refunds from taxpayers who owe debt… that may be a result of fraud. This year, the Ohio Department of Taxation estimates that the agency withheld close to 250,000 tax refunds. However, some taxpayers have discovered that their refund was impacted by debt caused by a fraudulent unemployment claim. These issues fall under the jurisdiction of the Ohio Department of Job and Family Services (ODJFS). If the ODJFS discovers a claimant may not be eligible for benefits that were already paid out, they will contact the claimant and request supporting information. Claimants have five days to respond before the ODJFS issues a determination that requires the taxpayer to repay these funds. Taxpayers can appeal this determination if they believe it to be in error.
- Rhode Island is considering rewriting its tax code at the request of Citizens Bank. The bank was founded in Providence in 1828 and has helped fuel the local economy since then. Recently, Citizens Bank wrote a letter to lawmakers indicating that they may consider shifting their base outside of the state due to local tax treatment. Shortly after, Governor Daniel McKee proposed changes to how Rhode Island taxes banks. Currently, the state uses a “three-factor” tax calculation based on in-state sales, property, and payroll. The proposal would shift this to a “single-factor” formula based only on in-state sales. This switch would cost the state an estimated $15.6 million a year. However, proponents argue that losing Citizens Bank’s tax payments and overall economic contributions would be even more costly.
- Vermont moves forward on a bill that would more than double the tax on second homes. The state legislature recently passed a bill that includes an increase to the one-time tax a buyer pays on a home that is not their primary residence. Simultaneously, the bill would provide a tax break to those buying a primary residence. The state estimates that about 1,710 second homes were purchased last year, and if a similar tax had been in place, this would yield about $15.7 million in 2025 and as much as $18.6 million in 2026. These funds would go toward initiatives to affordable housing, ranging from first generation homeownership to rental assistance to one-time payments for manufactured home repair. If signed by the governor, the new tax will go into effect on August 1st of this year.
Tax Planning Tips
The list of vehicles that qualify for the EV tax credit is constantly shifting—which ones qualify now? As of May 2024, the IRS has eased up on certain requirements for this lucrative tax credit, such as the location where battery materials and components are sourced, until 2027 to give automakers time to make adjustments. The updated rules also allow buyers to “transfer” the tax credit to the car dealer so they can receive a discount on the total price of the car right away rather than wait until tax season. The caveat here is that the burden falls on the buyer to provide accurate tax information to the dealer to determine how much of the tax credit they qualify to receive.
Currently, the battery electric vehicles that likely qualify include the Acura ZDX, Cadillac Lyriq, Chevrolet Blazer, Chevrolet Bolt, Chevrolet Equinox, Ford F-150, Honda Prologue, Nissan Leaf, and Tesla Model 3, Model X, and Model Y. Plug-in hybrids that likely qualify include the Audi Q5, Chrysler Pacifica, Ford Escape, Jeep Grand Cherokee, Jeep Wrangler, and Lincoln Corsair Grand Touring. To confirm where a specific vehicle is assembled, you can use the U.S. Department of Energy’s VIN decoder tool.
Investors looking for tax-free income might like the perks of municipal bonds. Municipal bonds are not subject to federal income tax, and if the investor lives in the state where the bond was issued, the income is also exempt from state taxes. This is in part because a municipal bond is a state, municipality, or county’s way of financing its expenditures—the buyer is essentially lending money to the government in exchange for regular interest payments on top of the return of their original investment. Experts anticipate that bonds are likely to increase in value once the Federal Reserve begins to lower interest rates, which is a major incentive for investors to purchase bonds now.
Individual municipal bonds are typically sold in $5,000 increments. However, investors can also go the route of accessing bonds through open-ended mutual funds and exchange traded funds to lower that initial investment requirement. To take one example, Vanguard’s Intermediate-Term Tax-Exempt Fund includes over 13,000 municipal bonds and asks for a minimum investment of just $3,000. Timing is another factor. To get back their full investment, an investor with an individual bond must hold onto it to maturity. Maturities range from under a year to 30 years. Mutual funds and exchange traded funds differ in that their bonds do not have a defined maturity date, so prices can fluctuate while the investor is holding them.
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Intentionally Filing a Defective Tax Return
Creativity on a tax return is a natural tendency. Many strategies and behaviors we know are wrong, e.g. not reporting all income. However, is it ever okay to disregard some deductions and pay more tax? At first glance, it would seem that the IRS should like the idea of more reported income and a higher tax liability attached to the additional income. The IRS does not.
Side Hustles and Tax Tussles: Tax in the Gig and Share Economy Part Two
The gig economy involves more than one-off and part-time jobs. It also includes when you share your property in exchange for money. This can be a residential property, a vacation home, or even a vehicle. The gig economy has connected those who need rides and places to stay with owners via online platforms. We refer to this part of the gig economy as the share economy.
Accessing these accommodations is easy with the online platforms. But how the people participating should report their income isn’t quite as straightforward. Last time we looked at how your clients should report gig income, just like any other income made as a sole proprietor.
But making money from renting your property out is different, right? If you have clients with rental properties, you report their income on Schedule E (1040), Supplemental Income and Loss. We know from last time that we report gig economy income on Schedule C (1040), Profit or Loss from Business. So, how does rental income derived from the share economy get reported on a tax return? Every taxpayer’s favorite answer, it depends.
Loose Change in Your Couch and Maybe a Tax Break at Your Kitchen Table
A 2023 Tax Court decision upheld what many small business owners and tax practitioners have wondered about for some time. The court found that shareholders of an S corporation could exclude rental income paid to them by their S corporation for holding planning meetings in their homes. While the IRS and court found that the amounts charged by the shareholders were excessive, the court found the arrangement itself within the bounds of the law.
This article examines this case and underlying law and when and how this is a planning idea worth pursuing, the limitations and unknowns involved, and the policy implications of this long standing exclusion. The case is Sinopoli, TC Memo 2023-105 involving the exclusion at IRC Section 280A(g).