The Pennsylvania Department of Revenue recently issued guidance in response to the Supreme Court opinion in South Dakota v. Wayfair, Inc., 138 S.Ct. 2080 (2018), clarifying when remote sellers are considered to maintain places of business in Pennsylvania and thus, required to collect and remit Pennsylvania sales taxes.  In Wayfair, the Supreme Court overruled previous precedent requiring a business to have a physical presence in a state before the state could require the business to collect its sales taxes.  See Quill Corp. v. North Dakota, 504 U.S. 298 (1992).  After Wayfair, economic nexus may be sufficient for a state to require an out-of-state business to collect and remit its sales tax.  The newly issued Pennsylvania guidance provides that any person who made more than $100,000 of gross sales in Pennsylvania in the past 12 months has sufficient economic nexus to be considered to maintain a place of business in Pennsylvania and thus, is required to collect and remit Pennsylvania sales tax.  This rule applies to transactions that occur on or after July 1, 2019.

Remote businesses must carefully determine whether they meet states’ economic nexus definitions and are required to collect and remit sales taxes.

The Internal Revenue Service announced today that it will waive the estimated tax penalty for many taxpayers whose 2018 federal income tax withholding and estimated tax payments fell short of their total tax liability for the year. The IRS is generally waiving the penalty for any taxpayer who paid at least 85 percent of their total tax liability during the year through federal income tax withholding, quarterly estimated tax payments, or a combination of the two. The usual percentage threshold is 90 percent to avoid a penalty.

The penalty relief announced today is designed to help taxpayers who were unable to properly adjust their withholding and estimated tax payments to reflect an array of changes under the Tax Cuts and Jobs Act (TCJA), the tax reform law enacted in December 2017. “We realize there were many changes that affected people last year, and this penalty waiver will help taxpayers who inadvertently didn’t have enough tax withheld,” said IRS Commissioner Chuck Rettig. “We urge people to check their withholding again this year to make sure they are having the right amount of tax withheld for 2019.”

The updated federal tax withholding tables, released in early 2018, largely reflected the lower tax rates and the increased standard deduction brought about by the new law. This generally meant taxpayers had less tax withheld in 2018 and saw more in their paychecks. However, the withholding tables could not fully factor in other changes, such as the suspension of dependency exemptions and reduced itemized deductions. As a result, some taxpayers could have paid too little tax during the year if they did not submit a revised Form W-4 withholding form to their employer or increase their estimated tax payments. The IRS and partner groups conducted an extensive outreach and education campaign throughout 2018 to encourage taxpayers to do a “Paycheck Checkup” to avoid a situation where they had too much or too little tax withheld when they file their tax returns.

An estimated tax penalty typically applies when the tax return is filed if too little is paid during the year. Normally, the penalty would not apply for 2018 if tax payments during the year met one of the following tests:

  • The person’s tax payments were at least 90 percent of the tax liability for 2018; or
  • The person’s tax payments were at least 100 percent of the prior year’s tax liability, in this case from 2017. However, the 100 percent threshold is increased to 110 percent if a taxpayer’s adjusted gross income is more than $150,000, or $75,000 if married and filing a separate return.

The penalty relief announced today lowers the 90 percent threshold to 85 percent. This means that a taxpayer will not owe a penalty if they paid at least 85 percent of their total 2018 tax liability. If the taxpayer paid less than 85 percent, then they are not eligible for the waiver and the penalty will be calculated as it normally would be, using the 90 percent threshold. For further details, see Notice 2019-11, posted today on IRS.gov.

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As the federal government shutdown approaches its fourth week, the Internal Revenue Service today unveiled its contingency plan for the upcoming tax filing season. Most IRS operations have been closed since funding for the agency ran out on December 22, 2018, and most IRS employees have been furloughed since that date.

Notwithstanding the shutdown, the IRS has announced that tax filing season will begin on January 28, 2019, for individual taxpayers. In today’s announcement, the IRS noted that taxpayers should be mindful of the following points during what it called “this challenging period”:

  • File electronically. The IRS will accept paper and electronic tax returns, but taxpayers are urged to file electronically to speed processing and refunds.
  • Tax refunds. Refunds will be paid, but the IRS cautions that returns will continue to be subject to refund fraud, identity theft and other internal reviews as in prior years.
  • Tax filing. Taxpayers can start working on their returns in advance of the January 28 opening. Both tax software and tax professionals will be available and working in advance of IRS systems opening. Software companies and tax professionals will then submit the returns when the IRS systems open. The IRS strongly encourages people to file their tax returns electronically to minimize errors and for faster refunds.

The IRS also warned taxpayers that the agency will continue to offer only limited operations during the shutdown, as follows:

  • Automated applications. IRS.gov and many automated applications remain available, including such things as Where’s My Refund, the IRS2go phone app and online payment agreements.
  • Telephones. No live telephone customer service assistance is currently available, although the IRS will be adding staff to answer some of the telephone lines in the coming days. Due to the heavier call volume, taxpayers should be prepared for longer wait times. Most automated toll-free telephone applications will remain operational. The IRS encourages people to use IRS.gov for information.
  • In-person service. IRS walk-in taxpayer assistance centers (TACs) are closed. That means those offices are unable to handle large cash payments or assist identity theft victims required to visit an IRS office to establish their identity. In-person assistance will not be available for taxpayers experiencing a hardship.
  • Taxpayer appointments. While the government is closed, people with appointments related to audits, collection, Appeals, or Taxpayer Advocate cases should assume their meetings are cancelled. IRS personnel will reschedule those meetings at a later date, when the IRS reopens.
  • Taxpayer correspondence. While able to receive mail, the IRS will be responding to paper correspondence to only a very limited degree during this lapse period. Taxpayers who mail in correspondence to the IRS during this period should expect a lengthy delay for a response after the IRS reopens due to a growing correspondence backlog.
  • Tax-exempt groups. The IRS will not be processing applications or determinations for tax-exempt status or pension plans.
  • Enforcement activity. During this period, the IRS will not be conducting audits, but automated initial contact letters will continue to be mailed. No collection activity will generally occur except for automated collection activity. For example, automated IRS collection notices will continue to be mailed. Criminal Investigation work, however, continues during this period.
  • Passports. The IRS will not be certifying for the State Department any individuals for passport eligibility.

For tax professionals and others interested in a more detailed view of IRS operations during the shutdown, there is an extensive listing available in the filing season lapse plan.

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Despite the government shutdown, the Internal Revenue Service has announced that it will process tax returns beginning January 28, 2019, and will provide refunds to taxpayers as scheduled.

“We are committed to ensuring that taxpayers receive their refunds notwithstanding the government shutdown. I appreciate the hard work of the employees and their commitment to the taxpayers during this period,” said IRS Commissioner Chuck Rettig.

Congress directed the payment of all tax refunds through a permanent, indefinite appropriation (codified at 31 U.S.C. § 1324), and the IRS takes the view that it has authority to pay refunds despite a lapse in annual appropriations. Although in 2011 the Office of Management and Budget (OMB) directed the IRS not to pay refunds during a lapse, according to the IRS, OMB has reviewed the relevant law and concluded that IRS may in fact pay tax refunds during a lapse.

The IRS will be recalling a significant portion of its workforce, currently furloughed as part of the government shutdown, back to work. Additional details for the IRS filing season will be included in an updated FY2019 Lapsed Appropriations Contingency Plan to be released publicly in the coming days.

The IRS will begin accepting and processing individual tax returns once the filing season begins. For taxpayers who usually file early in the year and have all of the needed documentation, there is no need to wait to file. They should file when they are ready to submit a complete and accurate tax return.

The filing deadline to submit 2018 tax returns is Monday, April 15, 2019, for most taxpayers. Because of the Patriots’ Day holiday on April 15 in Maine and Massachusetts and the Emancipation Day holiday on April 16 in the District of Columbia, taxpayers who live in Maine or Massachusetts have until April 17, 2019, to file their returns. The IRS strongly encourages people to file their tax returns electronically to minimize errors and for faster refunds.

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The IRS has been cracking down on conservation easement transactions for over ten years. Nevertheless, taxpayers have continued to claim charitable contribution deductions attributable to the donation of conservation easements and promoters have continued to assemble investments utilizing conservation easement charitable deductions. The IRS began focusing on syndicated conservation easement transactions when it issued Notice 2017-10, designating syndicated conservation easement transactions as listed transactions. These syndicated investments involve the use of partnerships to raise funds from investors, who are allocated a share of a charitable contribution deduction attributable to conservation easements donated on land owned by the partnership. In fall of 2018, the IRS doubled down on its attacks of these investments when syndicated conservation easements were added to the list of LB&I compliance campaigns. While the IRS continues to crack down on these arrangements, taxpayers have continued litigating the finer points of these transactions. On the flipside, DOJ has begun cracking down on promoters who market these transactions. Below are details on the most recent developments.

Pine Mountain Preserve v. Comm’r

This case involves three conservation easements covering various portions of an assemblage of over 2,000 acres of land. The land was located in what sounds like a beautiful location in Alabama for development of recreational and horse properties. Over three years, three different easements were granted on various portions of 1,300 of the 2,000 acres. The first two easements reserved the right to allow for small parcels of development, in a location to be agreed upon between the property owner and the charity holding the easement.

Relying on its prior rulings in Belk v. Comm’r, 140 T.C. 1 (2013), supplemented by T.C. Memo. 2013-154, aff’d 774 F.3d 221 (4th Cir. 2014) and Bosque Canyon Ranch v. Comm’r, T.C. Memo. 2015-130, vacated and remanded sub nom. 867 F.3d 547 (5th Cir. 2017), the court determined that the first two easements did not a qualified real property interest due to the uncertainty created by the reservation to create pockets of development on the property subject to the conservation easement. [We note that the Tax Court was not persuaded by the Fifth Circuit opinion in Bosque Canyon and declined to follow it since this case is not appealable to the Fifth Circuit.] However, while the third easement contained a reservation for installing a water tower, it did not allow for the parties to choose after the easement areas for development within the easement area. Thus, the third easement was determined to be a qualified real property interest.

Valuation of the third easement was discussed in a Memorandum opinion issued simultaneously with the full Tax Court opinion addressing the validity of the easement. The court found the taxpayer’s expert overvalued the potential development of the property in determining the value of the easement but that the IRS expert undervalued the easement by ignoring the development potential of the property. The court went to great lengths to discuss in detail the misgivings of both valuation expert’s opinions but the result for the taxpayer was not horrible. In the end, the court valued the easement based on 50% of the value determined by both experts. Considering this meant a $4.8 million charitable contribution deduction was allowed, this was not a total loss for the taxpayer.

Wendell Falls v. Comm’r

Sometimes developers want open space or a park included in a master plan for a residential community as a way to make the community more desirable. In that instance, because the developer expects to benefit as a result of the easement, the law does not allow a charitable contribution deduction, essentially because the contribution lacks donative intent or because the donation lacks value when weighed against the value of the expected benefit. This is exactly what happened in Wendell Falls. Here, a developer chose to place an easement on a parcel of land after it had already designed the parcel as a park in the master plan. In April of 2018, the court determined that because the highest and best use of the eased parcel was as a park, as outlined in the developer’s master plan, the easement requiring it to be preserved as a park did not diminish its value, therefore the easement had no value. However, the court did determine that the taxpayer was not subject to penalties.

The taxpayer asked the court to reconsider several of its findings, arguing that the court should have considered the value of the easement and separately considered the value of the enhancement to the donor’s property separately. The taxpayer also asserted that the receipt of a substantial benefits did not alone result in denial of a deduction and that the highest and best use of the parcel was for development rather than a park, attempting to get the court to reconsider values. On November 20, 2018, the court issued its opinion that the value of the substantial benefit expected was in excess of the value of the easement, and that parkland was the highest and best use of the property based on the proposed development. Unfortunately, the taxpayer lost all of its $1.8 million charitable contribution deduction.

Lawsuits against Promoters

The government had has enlisted another tactic for shutting down conservation easements by bringing actions against the organizers of conservation easement syndication schemes. On December 28, 2018, the Department of Justice filed a compliant in the Northern District of Georgia asserting that a group of defendants assembled partnership which were “nothing more than a thinly veiled sale of grossly overvalued federal tax deductions under the guise of investing in a partnership.” The complaint asserts that the defendants’ conservation easement syndicates have generated $2 billion in conservation easement charitable contribution deductions. The complaint seeks to enjoin the defendants from continuing to promote such schemes, and asks the court to order the defendants to disgorge all profits received as a result of the conservation easement syndicates.

The defendants include a conservation manager/broker dealer, an appraiser, and various professionals associated with EcoVest Capital, Inc., an entity that sponsors real estate investments focused on conservation. The promotional materials mentioned in the compliant set forth an example where in exchange for a $750,000 investment, an investor would receive $2 million of deductions, generating tax savings of $1 million. The syndicates were sold as securities exempt from registration through broker-dealers. The easement syndicates involved properties located in Alabama, Georgia, Indiana, Kentucky, North Carolina, South Caroline, Tennessee, and Texas.

Any taxpayer who may have invested in a syndicated conservation easement through Ecovest or any other investment advisor should carefully review Notice 2017-10 and related the disclosure requirements for listed transactions. Those taxpayers should also consult with a tax attorney to consider strategies for mitigating any damages.

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Yesterday the Tax Court issued two decisions discussing the impact of Section 280E on cannabis businesses.  One of these cases addresses the application of Section 280E to licensed and non-licensed entities.  Both cases address the application of penalties to cannabis businesses.

Alternative Health Care Advocates v. Comm’r

This case involves a California dispensary, Alternative Healthcare Advocates (“Alternative”), that operated similarly to the dispensary at issue in the Patients Mutual I case issued last month and discussed here.  Alternative was taxed as a C corporation.  Alternative sold marijuana and non-marijuana products.  Alternative claimed deductions other than cost of goods sold (“COGS”) on its tax returns.

In addition,  a management company, Wellness Management Group, Inc. (“Wellness”), was established for purposes of providing employees to dispensaries.  Wellness elected to be taxed as an S corporation.   Wellness’s deductions consisted of compensation, salaries and wages, rent, taxes and licenses, advertising, and other deductions.  Wellness’s only customer was Alternative.

The IRS allowed Alternative to deduction the total COGS claimed on its returns.  Applying Section 280E, the IRS disallowed all deductions claimed on Alternative’s return.  The IRS also disallowed all deduction claimed on Wellness’s returns, asserting that it also was subject to Section 280E.  This is the first case dealing with whether Section 280E applies to a non-licensed taxpayer.

Alternative argued that selling medical marijuana under state law did not fall within the Section 280E requirement that the taxpayer’s activities consist of drug trafficking and that it was permitted to allocate expenses between its trafficking and non-trafficking activities.  For the same reasons set forth in Patients Mutual, the court rejected these arguments and held that Alternative was not entitled to the deductions claimed on the returns.

Wellness argued that its activities did not consist of trafficking in a controlled substance.  The court concluded that “the only difference between what Alternative did and what Wellness did (since Alternative acted only through Wellness) is that Alternative had title to marijuana and Wellness did not.”  Slip Op. at 28.  The court held that Wellness employees were engaged in the purchase and sale of marijuana on behalf of Alternative and that Wellness did not need to obtain title to the marijuana in order to be involved in the trafficking of marijuana.

Given the harsh result, Wellness argued that applying Section 280E to both Alternative and Wellness was “inequitable because deductions for the same activities would be disallowed twice.”  As we have previously highlighted, the courts have not been sympathetic to the inequities of Section 280E.  Here, the court bluntly concluded that “[t]hese tax consequences are a direct result of the organizational structure petitioners employed.”

Other Observations

  • The Tax Court gave an detailed discussion of the definition of trafficking that should be reviewed by any business solely engaged in the cannabis industry, even if not a state-licensed entity.
  • The amount of cost of goods sold claimed on the return was sustained.  The importance of engaging good accountants to prepare returns and properly determine COGS cannot be underestimated.

The Applicability of Penalties to Cannabis Companies

The Tax Court held that Alternative was subject to penalties because in determining their liabilities they relied on the CHAMP case, which the court concluded was factually distinguishable from Alternative’s facts, and because they provided no evidence that it relied on their accountant for advice on whether Section 280E applied.  As we have seen in other cases, while the facts are not clear, this finding leads us to believe that no expenses were disallowed pursuant to Section 280E.

In contrast, the Tax Court ruled in the Patients Mutual II case that the taxpayer’s reporting positions were reasonable based on the timing of prior Section 280E litigation, such as CHAMP and Olive, in relation to when the tax returns were filed.  The court also noted that “[k]eeping good books and records was one of Harborside’s strengths.”  Slip. Op. at 6.

 

 

Our colleagues Melissa A. Terranova and Eric Sorkin have published a client alert about recently-issued Internal Revenue Service proposed regulations that would allow estates to leverage favorable gift exclusion amounts from the Tax Cuts and Jobs Act that are set to expire on December 31, 2025.  The proposed regulations create a special rule that allows an estate to apply the higher basic exclusion amount available at the time of the gift, rather than the exclusion amount that will be in effect after 2025 (at the time of the individual’s death).  You can read their alert here.

For more up-to-date coverage from Tax Controversy and Financial Crimes Report, please subscribe by clicking here.

Please join us for Fox Rothschild’s Second Annual Federal Tax Controversy Summit on December 12 in Philadelphia. We’ll be covering the latest developments in federal tax controversy and civil and criminal tax enforcement. CPE and CLE (PA) credits pending. Please click here to register.

Schedule:

8:00 a.m. – registration and breakfast
8:30 a.m. to 11:30 a.m. – program

Speakers:

Matthew D. Lee, Fox Rothschild LLP
Jennifer E. Benda, Fox Rothschild LLP
Ian M. Comisky, Fox Rothschild LLP

Topics:

  • The Internal Revenue Service’s focus on captive insurance arrangements
  • Tax audits and Section 280E litigation involving cannabis businesses
  • Offshore tax enforcement in a post-Offshore Voluntary Disclosure Program (OVDP) world
  • Updated IRS Voluntary Disclosure Practice (announced Nov. 29, 2018)
  • When tax engagements, client representation and advocacy become a crime
  • New initiatives at the IRS Criminal Investigation Division
  • Recent developments in federal taxation of cryptocurrency
  • When to call the Taxpayer Advocate

Location:

2000 Market Street, 20th Floor, Philadelphia, PA 19103