Monday, May 8, 2017

The Taxation of LLC Member Distributions for Broker Dealers | Bethesda Tax Lawyer

In today’s blog, I’d like to look at another case, Fleischer v. Commissioner (2016), that deals with the reporting of income.  In this case, Ryan Fleischer, a financial advisor with various securities-trading licenses, had left his prior employment with an investment firm to work on his own.  To this end, he secured a contract with Linsco Financial Services, which he signed in his personal capacity. Shortly thereafter, Fleischer incorporated his own business, Fleischer Wealth Plan (FWP), as an S corporation. He then entered into an employment agreement with this entity, entitling him to an annual salary in exchange for various services rendered.  Shortly thereafter, he personally entered into a broker agreement with Mass Mutual, but neglected to include Fleischer Wealth Plan in that agreement.

When he filed his taxes in 2009, Fleischer reported wages of $34,851 and nonpassive income of $11,924 from FWP (which, the company’s returns stated, had $147,617 against expenses of $135,693).  In 2010 and 2011, he reported a similar $34k salary, but the S-corp generated nonpassive income of $147,642 and $115,327, respectively.  The IRS later responded by issuing notices of deficiency for all three of these years, noting that the gross receipts or sales reported by FWP should have been classified as self-employment income by Fleischer.

Fleischer challenged this determination, requiring that the court sort out who earned the income:  the corporate entity or Fleischer himself.  In the case of sole proprietors or employees of companies who are paid salaries or commissions, this is easy enough--the individual earns the income.  But here, the presence of a corporation makes the analysis more challenging.  Fleischer, operating under the assumption that his S-corp had earned these large amounts of nonpassive income, had filed taxes related to FWP asserting that this was so.  

In order to ascertain who earned the income, the court evaluated “who controlled the earning of the income.”  This test, more complicated than a simple examination of “who earned the income,” necessitated that two elements be proven true for Fleischer’s earlier assessment of his S-corporation’s tax status to stand:  first, “the individual providing the services must be an employee of the corporation whom the corporation can direct and control in a meaningful sense”; and second, “there must exist between the corporation and the person or entity using the services a contract or similar indicium recognizing the corporation’s controlling position.”  

In this instance, the fact that Fleischer contracted without mentioning FWP in the documents, including his contract with Mass Mutual after FWP had been formed, indicated that Fleischer, not FWP, controlled the earning of the income (in fact, Fleischer specifically omitted mention of FWP in his contract with Mass Mutual because he hoped to enter another side of the insurance sales business in the future).   Fleischer contended that he had to assign the income to FWP while contracting in his personal capacity because the S-corp did not have the same securities-trading licenses he did, and acquiring them would be financially ruinous, but the court gave no weight to this argument.  

In short, Fleischer was assessed deficiencies because he structured his business contracts improperly and then assigned income to his S-corp that he should have paid taxes on himself.  Had Fleischer actually wished to avoid this situation, he likely could have done so with better advice about tax and contract law.

For a free phone consultation regarding assignment of income to a corporation, the self-employment tax, or other tax matters, please contact the Law Office of Aaron P Richter, a Bethesda-based tax law firm with expertise in Tax Controversy, Business Formation, Estate Planning, and Tax Preparation.

Sunday, April 9, 2017

FBARs are Due April 18th | Bethesda Tax Lawyer

Beginning this year, FBARs are due on tax day, April 15th, most years, and April 18th this year. If you cannot file by the deadline, for this year only, an automatic extension until October 18th will be provided. 

The FBAR is now filed electronically on the BSA website. You can find the form and filing instructions, here.

The penalties failing to file the FBAR are steep.  If you have any foreign accounts and do not think you are required to file; at least contact someone to verify that you are correct.

For a free phone consultation regarding the FBAR, or other tax matters, please contact the Law Office of Aaron P Richter,  a Bethesda-based law firm with expertise in Tax Controversy, Business Formation, Estate Planning, and Tax Preparation.

Sunday, March 12, 2017

The Taxation of LLC Member Distributions | Bethesda Tax Lawyer

With the deadline for filing income taxes approaching, I’d like to discuss a recent decision on whether an individual’s share of income earned through a Limited Liability Company (LLC) is subject to the self-employment tax.  Self-employed individuals generally must pay self-employment tax (SE tax, which consists of 12.4% Social Security tax plus a 2.9% Medicare tax ) as well as income tax, so it is crucially important to know whether money received in a given year counts for self-employment tax purposes.

An important prior case, Renkemeyer et al. LLP v. Commissioner (2011), addressed the question of earnings by partners in a law firm.  In that case, the Tax Court examined the operation of the partnership and determined that all of the earnings that passed through to the partners “arose from legal services they performed on behalf of the law firm” and thus were subject to the self-employment tax as surely as if each partner was doing business for himself. It was clear to the court that “the partners’ distributive shares of the law firm’s income did not arise as a return on the partners’ investment.”  Had some of the partners merely had their names on the masthead of the partnership, and drawn passive revenue from it after a substantial initial investment, the decision might have been different, but the facts as presented did not allow the court to make such a determination.  

However, in last month’s Hardy v. Commissioner (2017) decision, the Tax Court had the opportunity to distinguish Renkemeyer and clarify our understanding of when self-employment tax should apply.  Plastic surgeon Stephen Hardy had bought a $165,000 share, or 12.5%, of a surgery center organized as an LLC.  In exchange, Hardy received annual distributions from the center’s earnings and met quarterly with the other members of the LLC.  Unlike the Renkemeyer partners’ earnings, Hardy’s distributions from the surgical center were not premised on daily attendance at the center or even on the performance of a center number of surgeries on site.  He merely received the distributions, independent of any surgeries or other customer service duties he might undertake.  

After considering those facts, the Tax Court held that “Hardy’s distributive shares [were] not subject to self-employment tax because he received the income in his capacity as an investor.”  His distribution share was, of course, still subject to taxation per the rules governing LLCs, but he was not required to pay self-employment tax that can sometimes prove a significant added cost.  Obviously, some cases of earnings through LLCs will be less clear-cut than either Renkemeyer or Hardy, and the determination of whether the self-employment tax applies will depend on a careful analysis of the many factors that swayed the courts in those two cases, such as the income’s source (return on investment or services performed on behalf of the LLC) and the role of the individual within (daily management and oversight touching on all services that generate earnings, or merely receipt of passive distributions in accordance with their ownership stake in the LLC).  

For a free phone consultation regarding the self-employment tax or other tax matters, please contact the Law Office of Aaron P Richter, a Bethesda-based law firm with expertise in Tax Controversy, Business Formation, Estate Planning, and Tax Preparation.

Friday, January 20, 2017

Bitcoin Update | Bethesda Tax Lawyer

Back in June, I wrote this blog about the tax implications of using Bitcoins and other cryptocurrency.  I was also interviewed by VICE, where I discussed the possibility that the IRS might pursue the untaxed money kept in various cryptocurrency accounts (or “wallets,” as users call them).  Over the course of the past three months, the IRS, which has had success recovering revenue from offshore accounts, launched an investigation into the Coinbase “wallet” service to determine the correct amount of tax that people who use virtual currencies such as bitcoin are obligated to pay.  In November, the agency filed a petition to serve a “John Doe” summons, asking for the identities of any US Coinbase customer who transferred crypto-currency with the service between 2013 and 2015.

When signing up to Coinbase, users are sometimes required to provide identification documents. “There is a reasonable basis for believing these US taxpayers failed to comply with internal revenue laws,” the petition continued. In 2014, the IRS stated that virtual currencies which can be converted into fiat currency are property for tax purposes. As noted in an earlier blog, this means, among other things, that wages paid to employees using bitcoin are taxable to the employee, and are subject to federal income tax.

However, the petition acknowledged that not all Coinbase customers may have broken any internal revenue laws: “The taxpayers being investigated have not been or may not be complying with US internal revenue laws requiring the reporting of taxable income from virtual-currency transactions.”

After the petition was filed in November, several individual users rushed to intervene in the case, hoping to quash the “John Doe” summons on privacy grounds.  The IRS responded by arguing that these users, having revealed their identities in order to intervene, were publicly identified and thus unable to claim that the “John Doe” summons threatened their privacy.  The story took a further turn in mid-January, when Brian Armstrong, the CEO of Coinbase, wrote a blog post announcing that his company would fight the summons in court.

Armstrong made several notable points about tax policy, stating that Coinbase was, unlike other cryptocurrency wallets, “committed to compliance” and prepared to issue 1099-B forms at the end of the year to users.  He argued “asking for detailed transaction information on so many people, simply for using digital currency, is a violation of their privacy” and is not a safe and effective path toward tax compliance. He also criticized the current IRS treatment of cryptocurrency as property, noting that this treatment would occasion the distribution of 1099-B forms for even the smallest transactions, since gains on property do not have a de minimis exception.  This could be resolved, he explained, by treating “virtual currency as actual currency for tax purposes” since there is a de minimis exception for actual currency.

It is difficult, though by no means impossible, to contest actions taken by the IRS.  Nevertheless, individuals who have not reported cryptocurrency transactions would be well advised to take steps to voluntarily disclose this unpaid tax instead of awaiting the results of a decision on the “John Doe” summons.  I will cover voluntary disclosure in greater detail in a forthcoming blog, but the following example given by the IRS is worth noting:  a letter from an attorney which encloses amended returns from a client which are complete and accurate (reporting legal source income omitted from the original returns), which offers to pay the tax, interest, and any penalties determined by the IRS to be applicable in full and which meets the timeliness standard set forth above.  This meets the IRS standards for a voluntary disclosure, which consists of a) a taxpayer showing a willingness to cooperate and b) the taxpayer then making a good faith arrangement to pay the IRS in full, along with applicable interest and penalties.  

The IRS has made known its intentions to collect unpaid tax on income currently kept in cryptocurrency accounts.  With that in mind, taxpayers who have untaxed income in these accounts should take affirmative steps to remedy any delinquencies.  I will continue to monitor this litigation as the situation unfolds.

For a free phone consultation regarding Bitcoin, the FBAR, or other tax matters, please contact the Law Office of Aaron P Richter,  a Bethesda-based law firm with expertise in Tax Controversy, Business Formation, Estate Planning, and Tax Preparation.