Tuesday, May 19, 2015

Supreme Court Mandates State Income Tax Credits, Pretty Much

Maryland imposes income taxes on its residents. There is a state level income tax, and a county level tax. If a Maryland resident incurs income in other states and pays state income tax to those other states, there is a mechanism for the resident to receive a credit against the Maryland state level taxes for the non-Maryland taxes paid. This avoids double taxation of that income. However, there is no such credit mechanism for non-Maryland taxes paid in regard to the county level tax, so double taxes can result for those taxes.

The U.S. Supreme Court has ruled that the failure to provide such a credit for the county income taxes violates the Commerce Clause of the U.S. Constitution. Normally, the Commerce Clause only restricts federal laws that impede interstate commerce. Here, however, the violation was of what is known as the “dormant Commerce Clause” which is read to prohibit discriminatory state taxation even if Congress has not legislated on the subject.

The Court determined that the lack of a credit penalizes interstate commerce, as compared to intrastate commerce. It concluded this by testing whether interstate commerce produces more taxes than intrastate commerce, using the fiction that all states adopt the Maryland tax scheme at issue. Since interstate commerce generates double tax – a tax in each of the state where the activity occurs and the tax of residence, and since intrastate commerce (commerce conducting in the state of residence of the taxpayer) would only be taxed in the state of residence, interstate commerce is thus burdened with more taxes.

The Court notes that not all double tax consequences violate the dormant Commerce Clause. For example, if the nature of the double taxation arises from each state asserting different taxing systems (e.g., one taxes by source and one by residence), that might not violate the above test.

Thus, the Court appears to be requiring that a state taxing its residents on income must provide a credit for taxes imposed on the same income in other states. The majority opinion does say that there may be other constitutional means to avoiding double taxation other than a credit for taxes, but declines to name them or discuss them. So while it does not mandate a credit for taxes, that is the only route as of now that the Court acknowledges avoids constitutional infirmities.

The opinion should apply to similar arrangements in other states that do not offer the credit – not good news for those states.

Comptroller of the Treasury of Maryland v. Wynne, U.S. Supreme Court, Case No. 13-485 (2015)

Sunday, May 17, 2015

Seniors Need to Use Care in Deferring Income Into 2016

Tax Planning 101 says to defer income into the next year if you can, since it is better to pay a tax later than sooner. You get to keep the money in your account and can earn interest (good luck with that with today’s nonexistent interest rates – thank you Federal Reserve) or invest it for other gains and appreciation. An exception to that rule is if tax rates are going up – in that case, you might be better paying the tax in an earlier year at a lower rate.

Medicare surcharges are going up in 2018. Those surcharges are based on income earned in 2016. The higher rates will impact single seniors with incomes between $133,500 to $214,000, and married couples between $267,000 to $428,000. The rate increases will likely be as high as $1,000 for singles or $2,000 for joint filers.

Thus, senior taxpayers who are in or around those brackets should use care at the end of 2015 in trying to defer tax into 2016 – e.g., deciding whether to sell shares for a gain.To decide what works best, they will need to put pencil to paper to see what year yields the best overall result.

Monday, May 11, 2015

Triple Drop and Check

Sounds like an ice hockey term, but this is a tax blog so don’t get your hopes up.

Parent corporation owns all the stock of subsidiary 1, which owns all the stock of subsidiary 2, which owns all the stock of subsidiary 3. Parent corporation also owns 100% of an LLC that had elected to be taxed as a corporation.

Parent corporation will transfer all of its interests in the LLC to subsidiary 1, which will transfer it to subsidiary 2, which will transfer it to subsidiary 3 (with stock issued to the transferor by the transferee at each step). After it is in subsidiary 3 a check-the-box election will be filed to treat the LLC as a disregarded entity. Hence the name – triple drop and check [the box].

How should this be taxed – as 3 successive Section 351 transfers, followed by a Section 332 deemed liquidation of the corporate LLC in subsidiary 3 upon the check-the-box election? No, says the IRS, in Rev.Rul. 2015-10. Instead, this is two Section 351 transfers. Then, the transfer from subsidiary 2 to subsidiary 3 is not a third Section 351 transfer, but is a ‘D’ reorganization. Does it matter? In many circumstances, the same tax results may apply. But Section 351 and the reorganization provisions can yield different results as to income and basis, so proper characterization may be important.

The IRS relied on Rev. Rul. 67-274. In that ruling, the IRS ruled that an acquisition by a corporation of stock of another corporation with its own stock followed by a liquidation of the acquired corporation should be treated as a ‘C’ reorganization. Because the stock of the new subsidiary was not acquired from a third party, a ‘D’ reorganization instead of a ‘C’ reorganization fits the bill in Rev.Rul. 2015-10, but the same general reorganization characterization from Rev. Rul. 67-274 applies here by analogy.

It is not material that there were three drops here. If there had only been one transfer of the LLC to subsidiary 1 followed by a check-the-box of the LLC to become a disregarded entity, the same ‘D’ reorganization treatment should again apply (this time at the subsidiary 1 level).

Rev.Rul. 2015-10