Members of an LLC and Partners of a Partnership Are Not Employees

In a recent treasury decision (TD 9766, NPRM REG-114307-15) the IRS has issued final, temporary and proposed regs that preserve a partner’s status as a partner, and not an employee. In this decision, the partner worked for a disregarded entity that was also owned by the partnership. The regulations settled herein are said to be consistent with Rev. Rul. 69-184, which concluded that members of a partnership are not employees of the partnership, even if they devote time to the partnership’s trade or business or provide services to the partnership as an independent contractor. 

The government, however, correctly noted in its discussions that it still needs a significant amount of outside assistance (particularly in the employee benefits area) to get comfortable with any such exception to the ‘partner-only’ treatment of persons who hold an equity interest (no matter how small) in a tax partnership and who also provide services to such partnership."  For example, it seems, certain members who hold say very small (incentive) amounts of an interest in the entity and who actually provides services to the entity might actually be considered as employees.  However, those situations are rare (see also Rev Ruling 69-184).

Treatment of Disregarded Entities (one-member LLCs) and Partners

An entity, such as a limited liability company, with a single owner is treated as a DE (assuming the entity did not elect to be treated as a corporation). Ordinarily, the DE is disregarded as an entity separate from its owner and is treated like a sole proprietorship, with the DE’s income and deductions attributed to the owner. However, for employment tax purposes, the IRS amended its regs previously so that a DE is treated as a corporation and is considered to be the employer of its employees. The owner of the DE is not treated as the employer.

At the same time, the owner of the DE is treated as self-employed and must pay self-employment tax on the DE’s earnings. Thus, for the owner’s self-employment purposes, the entity continues to be disregarded from the owner.

There is no distinction between a DE owned by an individual and a DE owned by a partnership. In fact, the current regulations do not discuss a DE that is owned by a partnership. Because a DE is treated as the employer of its employees, some partners have interpreted the current regs to permit individual partners to be treated as employees, if the partners provide services to a DE, even a DE owned by the partnership. Under this interpretation, partners have been treated as employees of the DE and have been allowed to participate in the partnership’s employee benefit plans.  This interpretation was not intended, the IRS indicated. There is no exception in the self-employment rules for a partnership that owns a DE. The IRS also affirmed that the regulations do not alter Revenue Ruling 69-184, which requires that partners providing services be treated as self-employed.

The New Regulations

The temporary regulations "clarify" that the rule treating a DE as a corporation for employment tax purposes does not apply to the employment tax treatment of individuals who are partners of a partnership that owns a DE. The entity continues to be disregarded from the partners for self-employment tax purposes, and the partners are still subject to self-employment tax as partners of a partnership. The partners are treated no differently from partners of a partnership that does not own a DE.

The regulations will not apply until the later of (1) August 1, 2016, or (2) or the first day of the latest-starting plan year after May 4, 2016, for an "affected" plan sponsored by a DE. Affected plans include qualified plans, health plans, and cafeteria plans. This effective date gives partnerships time to make payroll and benefit plan adjustments.

Finally Regarding Rev. Rul. 69-184

The regs do not address Rev. Rul. 69-184 and tiered partnerships. The IRS reported that stakeholders have requested guidance in this situation and, also, where employees of a partnership receive a small partnership interest as compensation. The IRS requested comments on the appropriate application of Rev. Rul. 69-184 in these situations, including when it would be appropriate to treat partners as employees, and the impact on employee benefit plans and on employment taxes.

 

References: CCH FED Paragraphs 47,024 and 49,696. 

Tax Gap Over Past Decade Has Increased

Tax Gap Estimates For Tax Years 2008-2010

The tax gap – the difference between what taxpayers owe and what they pay – widened over the past 10 years, the IRS has reported. At the same time, the voluntary compliance rate has declined slightly. However, and I'm not sure what this means: according to the IRS, the drop in the voluntary compliance rate was not attributable to changes in taxpayer behaviors.

Commerce Clearing House Take away. "The IRS makes inefficient use of what resources it does have," Contributing to the inefficiency, it's been observed, is a failure on the part of IRS supervisors. "They all read from the same script and give the agents free reign to waste whatever resources they feel like. "  All I can say is "wow".

The Tax Gap

The gross tax gap, the IRS explained, is the amount of true tax liability that is not paid voluntarily and timely. The IRS reported that the gross annual tax gap for TY 2008-2010 is estimated to be $458 billion. That's billion dollars. And I'm sure that's accurate given some of the statements I've heard from people about tax return preparation matters. 

Enforcement activities and late payments resulted in an additional $52 billion in tax paid, which resulted in a net tax gap for the 2008-2010 period of $406 billion per year. In comparison, the gross tax gap for TY 2006 was $450 billion and the net tax gap for TY 2006 was $385 billion.

The gross tax gap is composed of three components: (1) non-filers, (2) under-reporting, and (3) just not paying (underpayment). The IRS reported that the estimated gross tax gaps for these components are $32 billion, $387 billion, and $39 billion, respectively. Further, the gross tax gap estimates can be grouped by type of tax. The estimated gross tax gap for individual income tax is $319 billion, $91 billion for employment taxes, $44 billion for corporate income tax, and $4 billion for estate and excise taxes combined.

"It is not possible to eliminate the tax gap completely," IRS Commissioner said at a news conference in Washington, D.C. "Getting to 100 percent tax compliance would require a huge increase in audits, and significantly greater third-party reporting and withholding than we have now. Realistically, that wouldn’t work, because the burden on taxpayers and the strain on IRS resources would be too great."

And as one could imagine, the tax gap typically moves with changes in the economy. Gross collections were $2.52 trillion in FY 2006, $2.69 trillion in FY 2007 and $2.75 trillion in FY 2008. Reflecting the economic downturn, gross collections declined to $2.35 trillion in FY 2009 and remained at that level in FY 2010.

Voluntary compliance rate

The IRS reported that the voluntary compliance rate is estimated at approximately 81.7 percent. After accounting for enforcement and late payments, the net compliance rate is 83.7 percent. The prior estimated voluntary compliance rate, calculated in 2006, was 83.1 percent, the IRS reported.

Reference: taken from CCH (Commerce Clearing House) Tracker News letter, dated May 5, 2016. 

Business Licenses In Tennessee and the Gross Receipts Tax

Generally, if you conduct business within any county and/or incorporated municipality (city) in Tennessee, you are required to register it (each location) for a business license in both the county and in its municipality.  Each location's license is supported by a gross receipts tax assessed upon both the industry (classification) in which your business operates and the amount of revenue that location has received during each annual reporting period (calendar year).  

Under these circumstances, you must file two separate tax returns for each location; one for the city and one for the county. Click here for a comprehensive list of cities that have enacted the business (gross receipts) tax and that require a city license. In some cases, for example, construction contractors, may be required to have multiple city and county licenses.  

 

With a few exceptions, the requirement to have a business license extends to those businesses with a physical location in the state as well as out-of-state businesses that operate in the state.  If you are an out-of-state business, you must have a license and pay the tax if you:

• perform a service in Tennessee that is received by a Tennessee customer,
• lease tangible personal property in Tennessee,
• deliver items to a customer in Tennessee in your own vehicle, or
• purchase an item in Tennessee and then sell the same item in Tennessee, using someone located in Tennessee acting on your behalf.

Finally, if you decide to close your business or close a particular location, you must file a final business tax return for that location with the Department of Revenue within 15 days of its closing.  (a minimum tax of $22 will be due).  Businesses holding minimum activity licenses that do not file tax returns should notify local city and county officials or the Department of Revenue that the business or location is closed.

Most licenses and renewals are due on or before April 15th (unless the business closed mid year). And these returns and/or the renewals for licenses are now filed online.  

If you have any questions, contact me.  

Generally, if you conduct business within any county and/or incorporated municipality in Tennessee, then you should register for and remit business tax.  Business tax consists of two separate taxes: the state business tax and the city business tax.
With a few exceptions, all businesses that sell goods or services must pay the state business tax.  This includes businesses with a physical location in the state as well as out-of-state businesses performing certain activities in the state.  If you are an out-of-state business, you must pay the state business tax if you:

• perform a service in Tennessee that is received by a Tennessee customer,
• lease items in Tennessee,
• deliver items to a customer in Tennessee in your own vehicle, or
• purchase an item in Tennessee and then sell the same item in Tennessee, using someone located in Tennessee acting on your behalf.

Additionally, if you have a business location in a city that has enacted the business tax, then you are required to pay the city business tax as well.  Under these circumstances, you must file two separate tax returns. Click here for a comprehensive list of cities that have enacted business tax.
If you decide to close your business, you must file a final business tax return with the Department of Revenue within 15 days of closing and pay any tax that is due (minimum of $22). Businesses holding minimum activity licenses that do not file tax returns should notify local city and county officials or the Department of Revenue that the business is closed.
- See more at: https://www.tn.gov/revenue/topic/business-tax#sthash.t2JT7mJq.dpuf

Generally, if you conduct business within any county and/or incorporated municipality in Tennessee, then you should register for and remit business tax.  Business tax consists of two separate taxes: the state business tax and the city business tax.
With a few exceptions, all businesses that sell goods or services must pay the state business tax.  This includes businesses with a physical location in the state as well as out-of-state businesses performing certain activities in the state.  If you are an out-of-state business, you must pay the state business tax if you:

• perform a service in Tennessee that is received by a Tennessee customer,
• lease items in Tennessee,
• deliver items to a customer in Tennessee in your own vehicle, or
• purchase an item in Tennessee and then sell the same item in Tennessee, using someone located in Tennessee acting on your behalf.

Additionally, if you have a business location in a city that has enacted the business tax, then you are required to pay the city business tax as well.  Under these circumstances, you must file two separate tax returns. Click here for a comprehensive list of cities that have enacted business tax.
If you decide to close your business, you must file a final business tax return with the Department of Revenue within 15 days of closing and pay any tax that is due (minimum of $22). Businesses holding minimum activity licenses that do not file tax returns should notify local city and county officials or the Department of Revenue that the business is closed.
- See more at: https://www.tn.gov/revenue/topic/business-tax#sthash.t2JT7mJq.dpuf

Generally, if you conduct business within any county and/or incorporated municipality in Tennessee, then you should register for and remit business tax.  Business tax consists of two separate taxes: the state business tax and the city business tax.
With a few exceptions, all businesses that sell goods or services must pay the state business tax.  This includes businesses with a physical location in the state as well as out-of-state businesses performing certain activities in the state.  If you are an out-of-state business, you must pay the state business tax if you:

• perform a service in Tennessee that is received by a Tennessee customer,
• lease items in Tennessee,
• deliver items to a customer in Tennessee in your own vehicle, or
• purchase an item in Tennessee and then sell the same item in Tennessee, using someone located in Tennessee acting on your behalf.

Additionally, if you have a business location in a city that has enacted the business tax, then you are required to pay the city business tax as well.  Under these circumstances, you must file two separate tax returns. Click here for a comprehensive list of cities that have enacted business tax.
If you decide to close your business, you must file a final business tax return with the Department of Revenue within 15 days of closing and pay any tax that is due (minimum of $22). Businesses holding minimum activity licenses that do not file tax returns should notify local city and county officials or the Department of Revenue that the business is closed.
- See more at: https://www.tn.gov/revenue/topic/business-tax#sthash.t2JT7mJq.dpuf

Due Date for Calendar Year 2015 Tax Returns

The due date for calendar year 2015 federal individual income tax returns is Monday, April 18, 2016, this tax season rather than April 15, 2016.  The due dates for certain Tennessee franchise and excise tax returns, business tax returns and Hall income tax returns will be Monday, April 18, 2016, rather than Friday, April 15, 2016, consistent with the Internal Revenue Service (“IRS”) federal income tax filing deadline change for most of the country.

This change in the due dates is due to our Nation's Emancipation Day which will be celebrated on Friday, April 15, 2016, in Washington, D.C., making it a legal IRS holiday.  Emancipation Day is a local public holiday in Washington, D.C., that commemorates the day in history when President Abraham Lincoln signed a declaration freeing slaves living in the city.

In accordance with Tennessee law, whenever the due date for filing the return occurs on a legal holiday for IRS purposes, the Commissioner of Revenue is allowed to extend the due date of state returns to the next workday, in this case, Monday, April 18, 2016.

Accordingly, Tennessee franchise and excise tax returns, Hall income tax returns and business tax returns with a tax period ending on December 31, 2015 will be considered timely if they are filed (and any tax due is paid) on or before April 18, 2016.

States New Market-Based Appoach

One of the current shifts in state and local income taxation has been recent adoption of market-based sourcing for assigning service-based revenue and its related income from the use of intangibles to a particular state. Many states have enacted new legislation to adopt market-based sourcing for state franchise and excise (income), creating additional tax revenue from out-of-state service providers servicing in-state customers.
 
Old Cost of Performance vs. the new Market-Based Approach

Frankly, this makes sense. Most states have historically utilized a cost of performance method for purposes of apportioning service revenue to a particular state. The cost of performance method is defined in the Uniform Division of Income for Tax Purposes Act (UDITPA). The rule states service revenue is apportioned to the state where the income-producing activity is performed. It is important to note that it must be the taxpayer’s income-producing activity and not someone else, such as an independent contractor, acting on behalf of the taxpayer. If the income-producing activity is performed across multiple states, the revenue is apportioned entirely to the state in which the greatest proportion of the revenue was earned.

The greatest proportion is determined by the cost incurred to generate the revenue. Often, cost of performance is looked at as an all or nothing type sourcing rule because the majority state gets assigned all of the revenue whereas the   minority state receives no allocation. Generally, the cost of performance method was not difficult to follow as it only focused on the efforts and locations of the taxpayer’s own employees. The location of the recipient client is not a factor in apportioning service revenue. 

Market-based sourcing, on the other hand, brings about a complete shift in methodology and allocates the service revenue to the state in which the benefit of the service is received and will subsequently be used. Service revenue is defined as any revenue other than sales of tangible personal property and does include revenue from and sales of intangible assets in some states. Under this method, the destination of the service revenue is the driving factor rather than the location where the revenue was actually earned. Market-based sourcing allows states to tax out-of-state service providers. 
 
It is important to note the statutory language used in determining and assignment of the service revenue for each state. States access service revenue in various ways. Samples of the criteria can be the state where the “benefit of the service” is received; the state where “the service is received”; the state “where the customer is located”; or the state where the “service is delivered.”

The income-producing activity of a particular company can also impact the tax implications that market-based sourcing covers.  Service companies generally must look at the criteria cited above. Holding companies often hold intangible assets, which can be treated differently across various states.  For example, royalty receipts are traced to where the IP is used. Software, which often is categorized as a type of service, does not follow the same cost of performance and market-based sourcing rules and are often treated differently. 

Many of the states that have adopted market-based sourcing regulations have also adopted a single factor sales apportionment method now rather than the old two-factor and three-factor appointment methodologies (ie. sales assigned to the state and divided by total sales in all states). Single factor apportionment can create a loophole (or a headache – see later) in which a taxpayer pays no tax on a portion of their service revenue.  This scenario can occur when the home state uses the market-based sourcing approach with single sales factor and the destination state uses the cost of performance approach with single sales factor apportionment.  In this case, the revenue would not be assigned to the home state since the service was delivered to an out-of-state customer.  Additionally, the revenue would not be sourced to the destination state since the company's income-producing activity was performed outside of that state.  Effectively, this is a tax-free transaction.

The aforementioned headache could occur producing double taxation across various states. For example, a taxpayer located in a cost-of-performance state could provide a service for a customer located in a market-based sourcing state where both states happen to use a single sales facto apportionment methodology. If the majority of the income-producing activity is performed in the home state, the taxpayer would be forced to source the entire service revenue from that transaction to its home state, while also being forced to source the same transaction to the state of the customer.

Performance of Services and Nexus

Market-based sourcing obviously has a direct impact on the allocation of tangible personal property sales.  Long-established Public Law 86-272 governs sales of tangible personal property and the assessment of sale taxes throughout the United States. Generally, P.L. 86-272 says that no state has the power to impose its income (excise) tax on an out of state seller of tangible personal property, if the only activity that the seller has in the respective state is sales to customers located in that state and that the company’s activities do not exceed “mere solicitation”.  

If the company has no other activity in the state, it is said to not have “nexus.” States have battled as to what types of activities may exceed the protection afforded under P.L. 86-272 but that is beyond the scope of this article. Under P.L.  86-272, a merchant located in Illinois, for example, would not be subject to income tax on a sale of tangible property to a customer in Indiana as long as it has no connection to or presence in Indiana other than this sale.

The impact of the market-based sourcing is twofold. For states that have adopted market-based sourcing, they are now able to tax out-of-state service providers, as mentioned previously.  In essence, states are eliminating the loophole of the all or nothing scenario that occurs with cost of performance and ensuring themselves a portion of any service revenue generated from customers within their state.  In addition, since the sales factor within the home state drops as a result of market-based sourcing methods, in-state companies enjoy smaller tax burdens within their home state by higher overall bills when taxed by other states.  States lose out on income tax revenue from in-state companies due to the lower apportionment factors, but the states generate more income tax revenue from out-of-state companies performing services within their boundaries. 

When coupled with the continued presence of cost of performance regulations, the new market-based approach has made tax treatment of service revenue more much complex. It is important to note nexus must be established first before market-based sourcing rules may be applied.

Automobiles and Trucks Provided to Shareholder-Employees by Wholely-Owned Companies

Internal Revenue Code Section 61 provides that an employee (even an employee shareholder) whose employer (or wholely-owned company) has provided a vehicle for both business and personal use must include the value of that personal use in his or her income and wages as a fringe benefit. Yeah, you heard that right..."in their wages".  Technically, the employer is supposed to make a calculation (see below) under one or two authorized methods and adjust the employee's year-to-date wages for the value of the personal use of a company-provided vehicle. 

Employers and taxpayers may calculate the value of their personal use using several valuation methods, including the cents-per-mile valuation rule outlined in Reg. §1.61-21(e) or the fleet average valuation rule under Reg. §1.61-21(d).

Cents-per-mile valuation rule

Employers and employees arrive at the value of the fringe benefit provided in a particular calendar year by multiplying the standard mileage rate for the year by the total number of miles the vehicle is driven by the employee for personal purposes.

The standard business mileage allowance rate for 2016 is 54 cents-per-mile. Employers and employees may not use the cents-per-mile rule, however, if the fair market value of the vehicle exceeds the sum of the maximum recovery deductions under Code Sec. 280F(a) for the first five years of service. 

The maximum 2016 FMV amounts for use under this cents-per-mile valuation rule are:

• $15,900 for a passenger automobile (down from $16,000 for 2015); and
• $17,700 for a truck or van, including passenger automobiles such as minivans and sport utility vehicles, which are built on a truck chassis (up from $17,500 for 2015).

Fleet average valuation

For employers maintaining a fleet of at least 20 automobiles can value the FMV of each automobile as equal to the average value of the entire fleet. The fleet average value is the average of the FMV of all automobiles used in the fleet.

The maximum FMV amounts for use under this fleet-average valuation rule in 2016 are $21,300 for a passenger automobile (the same as for 2015) and $23,100 for a truck or van (up from $22,900 for 2015).

Taken from CCH Reference.