Author: Arthur Lander

Can a 1041 tax return fiscal year filing end on any day of the year?

Can an Estate choose any day of the year to end its fiscal year  in filing the 1041 tax return?

An Estate can choose a fiscal year for a year end.  But can an Estate choose any day of the year for a year end  What if you are trying to close the estate in one year and not have to incur the cost of preparing a second 1041 tax return?

For example, the death occurs on February 22, 2015, and the client is on February 15th  of 2016 just finishing selling stock, collecting dividends, and making the final distributions. Can I elect a February 21, 2016 year end?  If not, I would have to choose January 31, 2016, and then a second 1041 would have to be filed.

IRS Publication 559 states, “The estate’s
first tax year can be any period that ends on the
last day of a month and does not exceed 12
months.”

So unfortunately, the estate will have to have a January 31st year end, and a second 1041 tax return will have to be filed for the activity in February.

Also 26 USC §441(e) also answers this same question,

“For purposes of this subtitle, the term “fiscal year” means a period of 12 months ending on the last day of any month other than December.”

When is a debt discharged in bankruptcy?

When is a debt discharged in bankruptcy?

108(1)(1) talks about the exclusion from gross income by reason of discharge of indebtedness of the taxpayer.

The issue is what is the date of the discharge of the indebtedness in a Chapter 7 liquidation. For a large corporate bankruptcy the litigation of whether there is a legitimate debt may go on over a number of years while the corporation is in bankruptcy. Even though the corporation filed in year 1, the ultimate determination of whether the debt is legitimate, and what amount will actually be collected may be many years later. The Trustee may have preference action and fraudulent transfer litigation that goes on for years in trying to collect moneys for the creditors.

Even with a secured debt, the amount of COD may not be known until the Trustee’s final report is approved. For example, a secured creditor, ABC Mortgagee, has a Deed of Trust on a hotel worth 100,000,000. The property is foreclosed on in year 2 at a FMV of 80,000,000. Is the COD 20,000,000? The ABC Mortgagee is unsecured in the amount of 20,000,000. What if there are other assets in the corporation that are being liquidated by the Trustee and in year 4 the Trustee is able out of the remaining liquidated assets to pay the ABC Mortgagee 15,000,000 as an unsecured creditor. Now the COD is only 5,000,000. So what is the date of the discharge of the indebtedness. Year 4? Yes if Year 4 is the final year of the Corporation administration and all the assets have been abandoned, foreclosed, sold, collected, adjudicated, and admin expenses paid. The determination of what moneys are available for all claims is determined only upon the approval of the Trustees final report in year 4 of this example. There is no way of knowing what the final payouts will be until year 4.

In general, a debt is considered discharged at the point when it becomes clear that the debt will never have to be paid. Cozzi v. Commissioner, 88 T.C. 435, 445 (1987). The test for determining that point requires a practical assessment of all the facts and circumstances surrounding the likelihood of repayment of the debt. Id. Any “identifiable event” which fixes the loss with certainty may be taken into consideration. Id. (citing United States v. S.S. White Dental Mfg. Co., 274 U.S. 398 (1927)). The commencement of a bankruptcy proceeding is not an identifiable event. See Friedman v. Commissioner, 216 F.3d 537 (6th Cir. 2000), aff’g T.C. Memo. 1998-196; Alpert v. United States, 481 F.3d 404 (6th Cir. 2007), aff’g 430 F. Supp. 2d 682 (N.D. Ohio 2006). Private Letter Ruling 144654-10.
This issue is critical because under 108(b)(4) the attribute reduction Ordering Rules are made AFTER the year of the taxable year of the discharge. (108(b)(4) uses the word “discharge”, which I believe means “discharge of the indebtedness”, which is a separate issue from the discharge of a debtor and of course corporations never obtain a discharge 11 USC 727(a)(1).)

Reg Sec. 1.6050P-1(b)(2)(i) clarifies the date of discharge and the identifiable event under (b)(2)(i)(A), see below. This section again returns back to the issue of the actual date that it become clear that the debt will not be paid.
b) Date of discharge –

(1) In general. Solely for purposes of this section, except as provided in paragraph (b)(3) of this section, indebtedness is discharged on the date of the occurrence of an identifiable event specified in paragraph (b)(2) of this section.

(2) Identifiable events –

(i) In general. An identifiable event is –

(A) A discharge of indebtedness under title 11 of the United States Code (bankruptcy);

(B) A cancellation or extinguishment of an indebtedness that renders a debt unenforceable in a receivership, foreclosure, or similar proceeding in a federal or State court, as described in section 368(a)(3)(A)(ii) (other than a discharge described in paragraph (b)(2)(i)(A) of this section);

(C) A cancellation or extinguishment of an indebtedness upon the expiration of the statute of limitations for collection of an indebtedness, subject to the limitations described in paragraph (b)(2)(ii) of this section, or upon the expiration of a statutory period for filing a claim or commencing a deficiency judgment proceeding;

(D) A cancellation or extinguishment of an indebtedness pursuant to an election of foreclosure remedies by a creditor that statutorily extinguishes or bars the creditor’s right to pursue collection of the indebtedness;

(E) A cancellation or extinguishment of an indebtedness that renders a debt unenforceable pursuant to a probate or similar proceeding;

(F) A discharge of indebtedness pursuant to an agreement between an applicable entity and a debtor to discharge indebtedness at less than full consideration;

(G) A discharge of indebtedness pursuant to a decision by the creditor, or the application of a defined policy of the creditor, to discontinue collection activity and discharge debt; or

(H) In the case of an entity described in section 6050P(c)(2)(A) through (C), the expiration of the non-payment testing period, as described in § 1.6050P-1(b)(2)(iv).

When is a debt discharged in bankruptcy for a plan of reorganization?

For entities with an approved Chapter 11 plan of reorganization where for example a certain class will not be paid at all, then it is clear the debt will not be paid and the tax attributes will be reduced in the following year. If the approved Chapter 11 plan of reorganization is based on a percentage, then there is still a question on what that exact amount will be. Further, even if the plan allows for a fixed percentage or an amount certain, approximately 90% of all chapter 11 plans are eventually converted to a chapter 7 plan. And of course with the conversion to a chapter 7 plan the amount a creditor may receive can be reduced. Also the amount received can be reduced by the chapter 7 administrative expenses. For a secured creditor the issue would be whether they will have to wait under the chapter 11 plan until all the payments are made, or alternatively whether the plan will default and the secured creditor will be able to obtain a relief from stay and foreclose, and then at what price and when.

So when is a debt discharged in bankruptcy? Certainty in bankruptcy is elusive.

Please see your attorney or tax advisor for your specific legal issues and situation. The above should not be consider legal advice.

Can a “responsible person” take a deduction for trust fund liabilities paid?

When a company is not doing well, the withholding taxes are often not paid. The IRS in such cases can assess the “responsible person” for personal liability. The question becomes whether upon payment by the individual held responsible if that individual can take a deduction on their 1040 for trust fund liabilities.

So, an IRS agent will interview the people at the company who could have paid the withholding tax ( and instead paid suppliers, etc.) and make a determination of who is going to be held personally responsible for not having made the IRS payroll withholding deposits.

That “responsible person” is personally liable for the employee withholding taxes that were not paid. Collection action is then taken by the IRS against that individual.

And assuming the “responsible person” actually makes the payment, the question arises: can the responsible person take a tax deduction on their 1040?

Or, in the alternative, if not allowed an immediate tax deduction, can the responsible person, who is also a shareholder or partner, increase their basis in their stock or partnership interest by the amount of the payment?

A couple of practical points:

1. Most likely the corporation has already taken this same deduction and thus the “responsible person” is attempting taking the same deduction again.

How so? When the business made the entry for payroll it most likely looked like this example:

 

example

A. Even a cash basis taxpayer will be on an modified accrual method for payroll and thus accruing the payroll withholding taxes.

B. So in our example, the 20,000 is never paid by the business, and assuming all of the 20,000 is trust fund liability, then the responsible person would be liable.

So, when the “responsible person” tries to deduct the 20,000, the problem is the 20,000 was already included as part of the 100,000 salary deduction taken by the business.

C. The other point is that if the “responsible person”, who is a shareholder or partner, contributed the cash to pay the withholding tax liability of 20,000 before it got to the point of the IRS assessing the individual with the trust fund liability, then the shareholder/partner basis would be increased.

2. The IRC 162(f) specifically denies certain deductions:

(f) Fines and penalties

No deduction shall be allowed under subsection (a) for any fine or similar penalty paid to a government for the violation of any law.

3. Here is a case below where the responsible person argued that he could take a deduction personally as a business bad debt (this would be limited to 3,000 a year or offsetting capital gains) because the corporation agreed to indemnify him.

The Tax Court in Elliott V. Commissioner, 73 T.C.M. 3197 (1997), T.C. Memo 1997-294 states,

Petitioner is not entitled to deduct any portion of this amount. Even if we were to assume that EPC was required to indemnify petitioner for this payment, an assumption which we do not find as a fact, petitioner would be unable to deduct this amount because he paid it in settlement of amounts assessed against him under section 6672. Amounts paid for section 6672 assessments are nondeductible. See sec. 162(f); sec 1.162-21(b), Income Tax Regs; see also Arrigoni v. Commissioner , 73 T.C. 792 (1980); Patton v. Commissioner , 71 T.C. 389 (1978); Smith v. Commissioner , 34 T.C. 1100 (1960), affd. per curiam 294 F.2d 957 (5th Cir. 1961); Duncan v. Commissioner , T.C. Memo. 1993-370, affd. 68 F.3d 315 (9th Cir. 1995).

The answer is “No”, a “responsible person” cannot take a deduction on their 1040. The answer can be “Yes” if a “responsible person” makes the capital contribution to the cash account and pays the taxes before the trust fund liability penalty is assessed.

Please see your attorney or CPA for answers to your particular situation.

Have you changed your name? This will affect the processing of your tax return.

Did you know that a name change could impact your taxes? Here’s what you need to know:

1. Report Name Changes. Did you get married and are now using your new spouse’s last name or hyphenate your last name? Did you divorce and go back to using your former last name? In either case, you should notify the SSA of your name change. That way, your new name on your IRS records will match up with your SSA records. A mismatch could unexpectedly increase a tax bill or reduce the size of any refund.

2. Make Dependent’s Name Change. Notify the SSA if your dependent had a name change. For example, this could apply if you adopted a child and the child’s last name changed. If you adopted a child who does not have a Social Security number, you may use an Adoption Taxpayer Identification Number on your tax return. An ATIN is a temporary number. You can apply for an ATIN by filing Form W-7A, Application for Taxpayer Identification Number for Pending U.S. Adoptions, with the IRS.

3. Get a New Card. File Form SS-5, Application for a Social Security Card, to notify SSA of your name change. You can get the form on SSA.gov or call 800-772-1213 to order it. Your new card will show your new name with the same SSN you had before.