Taxation Law Blog | State Bar of Wisconsin

Direct Pay: How Local Governments Can Leverage Tax Credits

Nicholas Jerschefske — 2024-12-13 00:00:00

As local governments face growing pressure to combat climate change and promote sustainable energy, funding innovative projects remains a challenge. The Inflation Reduction Act of 2022 (IRA) includes an elective pay option (direct pay) that presents an opportunity for municipalities and other governmental entities to directly benefit from new and existing clean energy tax credits.

Although the continued federal commitment to the IRA is uncertain, a full repeal of the IRA may prove difficult. While certain parts of the IRA may be repealed or amended in the 119th Congress, local governments should be aware of the benefits of direct pay to take advantage of any available energy-related tax credits and position themselves for potential future benefits.

What is Direct Pay?

Through direct pay, local governments can receive cash payments equivalent to the value of specific clean energy tax credits. Historically, these tax credits could only reduce federal tax liabilities – a benefit inaccessible to nontaxable entities. Direct pay bridges this gap by turning tax credits into cash payments by treating local governments and other nontaxable entities as having overpaid their taxes. Direct pay effectively enables cash payments that help offset expenditures by the local government related to clean energy generation, energy storage, and electric vehicles.

The Tax Credits Most Relevant to Local Governments

While there are 12 IRA tax credits that are available under direct pay, some are less relevant to local governments. The four that are most relevant to local governments include the credits for alternative fuel vehicle refueling property, qualified commercial vehicles, renewable electricity production, and renewable energy investment.

Nicholas Jerschefske is a 2L at Marquette University Law School and a student liaison for the State Bar Taxation Law Section.

Alternative fuel vehicle refueling property (IRA section 30C). Section 30C applies to vehicle refueling properties for various alternative fuel sources, but the most common application of section 30C is likely electric vehicle charging stations. The credit applies to costs incurred for purchasing and installing alternative fuel vehicle refueling equipment, as well as upgrading or retrofitting existing equipment to support qualifying fuels. Costs related to general site preparation (e.g., paving or unrelated construction) are typically excluded.

Local governments within Wisconsin that are planning to invest in electric vehicle charging stations should be aware that the Wisconsin Legislature recently implemented a new regulatory scheme related to public EV charging and implemented a new tax on electricity supplied at public electric vehicle charging stations. Electric vehicle charging stations will be exempt from sales tax but will be subject to an excise tax at a rate of three cents per kilowatt-hour (kWh). The tax applies even if the charging station is free for public use. The two exemptions are charging stations at residences and any “Level 1” or “Level 2” charger installed prior to March 22, 2024.

Qualified commercial clean vehicles (IRA section 45W). Local governments can receive a tax credit for up to 30% of their cost basis in fully electric or fuel cell vehicles under Section 45W (plug-in hybrids can receive up to 15%) provided that the vehicles battery meets specific size requirements. This credit could be used for electric garbage trucks, public transit, and other governmental uses like school buses. The credit has a maximum limit of $7,500 for vehicles less than 14,000 pounds, and otherwise, the limit is $40,000. The credit is also limited by the incremental cost, the price difference between the clean vehicle and a similar conventionally fueled vehicle. The credit will be equal to the percentage of basis, the maximum limit, or the incremental cost, whatever figure is lowest.

Renewable electricity production tax credit (IRA section 45). Section 45 provides for a production tax credit for projects employing the “qualified energy resources” listed in the IRA, including wind, solar, and geothermal energy projects. The tax credit ranges from 0.3 cents to 2.75 cents per kWh depending on the size, type, date of construction, and the in-service date of the particular project. For projects that will be in service starting in 2025 or later, the clean electricity production credit (section 45Y), will apply. Section 45Y is a “technology neutral” credit that makes qualified zero-emission energy technologies eligible. Section 45Y ranges from 0.3 cents to 1.5 cents per kWh depending on whether certain requirements are met. Both the 45 and 45Y tax credit also have numerous bonus credit incentives available.

Energy investment tax credit (IRA section 48). Section 48, commonly referred to as the Energy Investment Tax Credit, is a federal tax incentive that supports the development and installation of renewable energy projects by providing a credit based on the upfront costs of eligible energy property. Eligible projects include wind and solar farms as well as battery energy storage. The credit ranges from 6% to 30% of cost basis depending on whether certain requirements are met. Numerous bonus credits are also available that can potentially increase the available credit up to 70%. Relevant costs include equipment and materials directly related to energy production, installation and labor costs, and some related soft costs, such as permitting and site preparation. Similar to section 45, section 48 will be replaced by section 48E, the clean electricity investment credit. Section 48E, like section 45Y, applies to projects placed in service in 2025 or later, and applies to any clean electricity generation technology that achieves zero emissions or energy storage.

Important note on section 179D deductions. Tax deductions for energy efficiency upgrades under section 179D are not eligible for direct pay. However, the IRA did allow governmental entities to allocate section 179D deductions to architects, engineers, and contractors that install qualifying systems in government buildings. Local governments could consider this when planning energy efficiency projects in order to secure reduced pricing.

Bonus credits and additional requirements. Local governments can take advantage of bonus incentives to maximize their credits and ultimate direct payment. There are also additional requirements that must be met to avoid a reduction in the available tax credit. The relevant bonuses and requirements include domestic content, prevailing wage and apprenticeship (PWA), energy communities, and low-income communities bonus (LICB).

Domestic content.The domestic content bonus credit is available when a qualified facility, energy project, or energy storage technology has been certifiably built with certain percentages of steel, iron, or manufactured products that were mined, produced, or manufactured in the United States. The domestic content bonus applies to both the production and investment credits. For projects put in service in 2024 or later, the domestic content bonus requirements must be met to avoid a reduction in the total available tax credit. The domestic content bonus and requirements only apply to projects greater than 1.0 megawatt (MW).

Prevailing wage and apprenticeship (PWA). The PWA requirements impose a floor on the wages of workers employed in the construction, alteration, or repair of green energy projects. They also set a minimum standard for apprenticeship hours spent on the construction. The PWA requirements apply to any investment and production credits on projects greater than 1.0 MW. The requirements also apply to refueling properties constructed in 2024 or later.

Energy communities. Both investment and production tax credits are eligible for a 10% bonus when the energy project is located in:

a “brownfield” site;
an area employed by coal, oil, or natural gas with an unemployment rate above national average; or
a census tract in which coal mine closed after 1999 or coal-fired power plant has been retired after 2009.

The IRA Bonus Mapper will provide eligibility information by zip code. Additional information on energy communities can be found atenergycommunities.gov.

Low-Income Communities Bonus Credit (LICB). The LICB only applies to investment tax credit projects with a max net output under 5 MW. The credit adds 10% if the project is located in a low-income community or on Tribal land. The credit adds 20% if the project qualifies as a low-income residential building project (affordable housing programs) or a low-income benefit project (financial benefits to low-income/affordable housing). The LICB has a separate application process that can take a considerable amount of time, so local governments should apply before the relevant project is completed.

The Direct Pay Process

Local governments should identify qualifying projects for the current taxable year and begin planning for future years by working with key stakeholders. Once projects are identified, they will need to be registered with the IRS after gathering the appropriate documentation to prove their qualification, such as, ownership documentation, domestic content, and compliance with prevailing wage laws. Registration with the IRS is required prior to filing a return claiming these credits.

Conclusion

By offering refundable tax credits, direct pay empowers municipalities, school districts, and other nontaxable entities to significantly reduce project costs while advancing sustainability goals. However, the complexity of direct pay – including its eligibility criteria, compliance requirements, and interaction with various financing mechanisms – necessitates careful planning and collaboration.

By embracing a proactive and multidisciplinary approach, local governments can position themselves to effectively leverage direct pay to update and improve local infrastructure. However, because of the complex regulatory regime proposed by the IRA, and the rapidly evolving governmental support for the IRA, it is critical that local governments engage with legal counsel and tax and finance professionals who are experienced in federal energy tax credits.

This article was originally published on the State Bar of Wisconsin’s Taxation Law Section Blog. Visit the State Bar sections or the Taxation Law Section webpages to learn more about the benefits of section membership.

Life Insurance Planning to Fund Buy-Sell Obligations

Curtis C. Walther, Thomas W. Moniz — 2023-07-20 00:00:00

Business owners often dread the concept of “succession planning.” Succession planning requires owners to confront their own mortality and the transition of control over their cherished businesses.

The process can, simply, seem daunting. While succession planning is perhaps considered as much of a necessary evil as visiting a dentist while expecting a cavity, proper planning can help alleviate the transition and facilitate the continuity of the business for the next generation in particularly challenging times.

Where to Begin

Many business owners may struggle with where to begin. One of the most essential legal documents to include with proper planning is a well-drafted buy-sell or shareholder agreement, and it is a good place to start the succession-planning process.

These agreements customarily include stock purchase or redemption options in the event of a shareholder’s death. The decision of how to structure such a transaction is frequently overlooked, but there are various options that can impact funding, asset protection and present drastic tax differences determined by its basic structure.

Curtis C. Walther, Marquette 2019, is with von Briesen & Roper, s.c. in Milwaukee, where he practices in the firm’s Business Practice Group.

Thomas W. Moniz, Marquette 2009, is a shareholder with von Briesen & Roper, s.c. in the Business Practice and Nonprofit and Tax Exemption groups.

Taxation of Redemption versus Cross-purchase

Many buy-sell agreements require the corporation to redeem all of a deceased shareholder’s stock upon their death. This basic structure can often present a missed opportunity to provide a tax benefit to the remaining shareholders.

In a redemption structure, the corporation will reserve the purchased stock as treasury stock, but it will not provide any meaningful benefit to the remaining shareholders from a tax perspective.

In comparison, a cross-purchase structure provides the remaining shareholders with a cost basis in the purchased shares. This difference can result in substantial tax differences when the remaining shareholders in turn sell their stock due to this cost basis.

Often, the redemption is the default structure, because the corporation typically will have better access to credit and liquidity to fund the purchase compared to the individual shareholders. Additionally, the corporation enjoys limited liability and asset protection that the individual shareholders do not.

However, these downsides to the cross-purchase can be mitigated to achieve the tax benefits with proper planning.

Funding with Life Insurance

To alleviate concerns on liquidity and access to credit, it is common for businesses to fund the redemption structure with life insurance proceeds.

The preferred structure (redemption versus cross-purchase) should be coordinated with the underlying policy provide the purchaser with the proceeds from such policies. It may also provide a particularly beneficial source of liquidity for single-owner businesses who designate a key employee as a beneficiary to purchase the owner’s equity upon their death.

If the corporation is the beneficiary of such life insurance policies on an employee-shareholder, Internal Revenue Code (I.R.C.) section 101(j) would apply and needs appropriate planning. The section 101(j) requirements include notice and consent requirements for the employee and annual Form 8925 filing requirements for the corporation.

Unless these requirements are satisfied, the life insurance proceeds are includible in gross income to the beneficiary. The proceeds, provided that these requirements are satisfied, are generally not taxable. Assuming proper planning, this source of funds provides an effective means of funding buy-sell obligations upon the death of a shareholder.

Exposure to Creditors and Third Parties

From an asset-protection standpoint, it typically is the best option to have the life insurance proceeds payable to the corporation to fund a stock redemption transaction to enjoy limited liability benefits.

While it may present a less favorable tax outcome as to the purchaser, the risk of an individual shareholder exposing the life insurance proceeds to individual creditors is often an unacceptable level of risk. Indeed, with buy-sell obligations and insurance proceeds that may reach several million dollars, there may be a very low tolerance for susceptibility to a shareholder’s personal creditors.

However, there may be an approach that could provide the benefits of a cost basis from a cross-purchase and also the limited liability protection of the redemption.

Separate Limited Liability Company for Asset Protection

Instead of corporate or shareholder ownership, there is another hybrid approach that involves the formation of a separate limited liability company. The LLC would be formed solely for the purposes of holding the life insurance policies and would be the beneficiary of all life insurance policies that are used to fund the individual shareholders’ buy-sell obligations. The equity ownership of the LLC would mirror that of the operating corporation and each shareholder would be required to contribute capital from time to time to fund the life insurance premiums.

This structure provides a better alternative to both the corporate and individual ownership of the life insurance from an asset protection standpoint since it is isolated from both the corporation’s operating liabilities and also the individual shareholders’ personal liabilities.

Taxation of Life Insurance Partnership

The key to the effectiveness in this life insurance LLC structure is I.R.C. section 704(b).

Instead of allocating the life insurance proceeds to each partner’s capital account on a pro rata basis, the LLC’s operating agreement would include a special allocation provision. Capital contributions from each partner would be required in proportion to their equity ownership to fund the life insurance premiums, but only for life insurance policies that do not insure their life. The life insurance proceeds, when received, would be specially allocated to the surviving partners in proportion to their relative (i.e., excluding the deceased member) equity ownership.

The LLC would then be required to distribute the insurance policies consistent with the partner’s positive capital account balances, and first to the partners to whom the life insurance proceeds had been specially allocated.

Once distributed, the partners would use the proceeds to fund the mandatory cross-purchase obligation under the buy-sell agreement of the operating corporation. In this manner, the surviving shareholders would obtain a cost basis in the purchased stock, while having a controlled and limited exposure to personal creditors or the corporation’s operating liabilities.

Finally, the LLC would redeem the deceased partner for the amount of their positive capital account balance. To the extent that amount exceeds the LLC’s remaining cash, it would trigger a mandatory capital contribution by the surviving partners.

Despite being held in a relatively inactive LLC with which the partners are not employed, the employer-owned life insurance provisions in section 101(j) would still apply under the common control rules in I.R.C. section 101(j)(3)(B)(ii), and should be complied with.

Understanding Common Notices from the IRS

Britany Morrison — 2022-12-22 00:00:00

This article was originally published in O'Neil, Cannon, Hollman, DeJong & Laing s.c's Tax and Wealth Advisor Blog and is published here with the author’s permission. Blog has been edited for publication on WisBar, with author approval.

Although tax season may end for many individuals after returns are filed on April 15, for others it may be just the beginning. Many people receive a notice from the IRS as they process returns. These communications from the IRS are common and aren’t necessarily a sign of trouble. If you receive a notice, read it carefully, address it promptly, and consider whether you should contact a lawyer.

Most notices from the IRS are regarding incomplete or incorrect information on taxpayer’s tax forms, but there are plenty of other reasons the agency might be contacting you. The IRS website notes that the IRS sends notices and letters to individuals because:

they are due money;
they owe money;
they need to provide additional information or clarify part of their tax return;
they need to verify their identity; or
their tax return has a processing delay.

Each notice or letter contains a lot of valuable information, so it is particularly important to read it carefully. Any communication you receive from the IRS will have a code on the right side at either the top or the bottom. The codes on notices begin with CP. The codes on letters begin with LTR. Here are some common notices the IRS sends out, identified by code.

Britany Morrison, Marquette 2014, is an attorney with O’Neil, Cannon, Hollman, DeJong & Laing s.c. in Milwaukee, where she practices in business and tax law.

CP2000 Notice

The IRS sends taxpayers a CP2000 Notice when the information they have on file does not match the information provided on the tax return. There might need to be an adjustment to your tax forms.

For example, your employer originally sent you a W-2 with incorrect information. They later sent an amended W-2, but you used the incorrect W-2 when completing your taxes.

If the notice alerts you to a discrepancy in your tax filing, it will explain how the IRS determined the error. You can either agree and sign off on the proposed changes or explain why you disagree, including providing relevant documents. You typically will be given 30 days to respond.

CP3219A Notice

If you fail to resolve the issue highlighted by a CP2000 Notice, the IRS sends a CP3219A Notice. Known as the Statutory Notice of Deficiency, this form gives you 90 days to reply. Like a CP2000 Notice, you can either agree or disagree with the changes when you respond.

Failure to reply to this notification can bar your ability to appeal and contest the issue in Tax Court.

CP3219N Notice

When the IRS has not received your tax return, they will send a CP3219N Notice. You have 90 days to reply. If you believe you did not have to file a return but receive this notice, you should contact the IRS.

CP501 Notice

The IRS sends a CP501 Notice to remind taxpayers that they have 21 days to pay any outstanding tax. If you cannot pay what you still owe, you can see if you qualify for a payment plan.

CP501 notices are generally the first notice sent. If you do not reply within 15 days, the IRS will then send a CP503 notice. If you receive a CP503 notice but believe you have resolved the issue, you should contact the IRS for confirmation.

If you fail to respond to this notice, the IRS can levy interest and penalties as well as file a Notice of a Federal Tax Lien. Like other notices, you can disagree with the IRS’s calculations. You should be prepared to offer documentation to show their error.

CP14 Notice

A CP14 Notice closely relates to CP501. It lets you know that the IRS believes you underpaid the amount due on your taxes.

Similar to a CP501 Notice, failure to respond in the required time period can result in additional penalties and accruing interest.

Timely Action

If you have received communication from the IRS, you should act promptly.

Failure to act in a timely manner can cause serious problems. Additional fees and interest can accrue on unpaid tax. If you disagree with the IRS’s determinations, failure to reply may bar you from appealing the decision.

It is especially critical to respond to an IRS notice if you’re unable to pay the full amount you owe on your taxes, because the agency may allow you to arrange a payment plan.

Beware of Scams

There are scammers out there who will send fake IRS letters and notices in an effort to obtain your personal information or even a check. Whenever you get a communication from the IRS, examine it carefully to make sure it is legitimate. If you are unsure, contact the IRS directly or reach out to a tax professional or attorney for guidance.

The SECURE Act’s Impact on Retirement and Tax Planning

Britany Morrison — 2020-03-13 00:00:00

The Setting Every Community Up for Retirement Enhancement Act (SECURE Act), signed into law by President Trump on Dec. 20, 2019, pointedly changes many requirements for employer-provided retirement plans, IRAs, and other tax-favored savings accounts.

While some of the provisions of the SECURE Act may provide taxpayers with great tax savings opportunities, not all the changes are helpful, and there may be steps taxpayers can take to minimize its impact.

Below is a summary of the key provisions of the SECURE Act that taxpayers should be aware of now, especially since many of the provisions go into effect in 2020.

Britany Morrison, Marquette 2014, is an attorney with O’Neil, Cannon, Hollman, DeJong & Laing s.c. in Milwaukee, where she practices in business and tax law.

Repeal of the Maximum Age for Traditional IRA Contributions

Before 2020, individuals were prohibited from making traditional IRA contributions upon reaching the age of 70 ½. However, starting in 2020, the SECURE Act allows an individual of any age to make contributions to a traditional IRA if the individual has compensation, such as earned income from wages or self-employment.

This SECURE Act provision eliminates the age limitation, which previously prevented taxpayers older than 72 ½ from contributing to their IRAs. This will allow individuals working into their later years to increase, or catch up with, their retirement savings goals.

Required Minimum Distribution Age Raised from 70½ to 72

Pre-2020 retirement plan participants and IRA owners were typically forced to begin taking required minimum distributions (RMDs) from their plan when they reached age 70½. The age 70½ requirement was first established in the early 1960s and, until the SECURE Act, had not been adjusted to account for increases in life expectancy.

Under the SECURE Act, the age at which individuals must begin taking distributions from their retirement plan or IRA is increased from 70½ to 72. Notably, RMDs for individuals who turned 70½ in 2019 are not delayed, and instead, such individuals must continue to take their RMDs under the same rules prior to passage of the SECURE Act.

Increasing the age at which distributions are required allows additional time for the IRA to grow untouched. With many taxpayers remaining in the workforce longer, this provision might prove especially beneficial.

Partial Elimination of Stretch IRAs

If plan participants or IRA owners died before 2020, beneficiaries (both spousal and nonspousal) were generally allowed to draw from the account and pay taxes on their withdrawals over the beneficiary’s life or life expectancy (in the IRA context, this is sometimes referred to as a “stretch IRA”).

For example, if a 25-year old inherited a $1 million IRA from his grandmother, he would take distributions over his life expectancy of 57.2 years (as provided by the IRS table). His required minimum distributions would be about $17,482 ($1,000,000/57.2), which he would need to withdraw yearly over a 57.2-year period. Each year, this would result in a federal tax bill anywhere between $548 (if he were in the lowest tax bracket) to $6,468 (if he were in the highest tax bracket).

The stretch IRA is a beneficial tax strategy, especially for younger beneficiaries, because they have smaller required minimum distributions stretched out through their life expectancy and thus, incur smaller tax bills. Additionally, the stretch allows for tax-deferred growth over longer accumulation periods, which means a larger amount of money may reach the pockets of the beneficiaries.

However, under the SECURE Act, if a plan participant or IRA owner dies in 2020 or after, distributions to most nonspouse beneficiaries are generally required to be distributed within 10 years after the plan participant’s or IRA owner’s death. So, for those beneficiaries, the “stretching” strategy is no longer allowed.

To illustrate, using the previously mentioned example of the 25-year old beneficiary of a $1 million IRA, if he were to take equal distributions of $100,000 over the 10-year period, in the first year alone, his income would be bumped up by $82,517 ($100,000 versus $17,482 in the life-expectancy stretch), which could easily land him in a higher tax bracket. He would then have a yearly tax bill between $24,000 (if the distributions were his only income) to $37,000 (if he were in the highest tax bracket). That is an incredible difference in tax bills, not to mention the loss of tax-free compounding that was allowed for longer periods of time under the life-expectancy stretch.

There are exceptions to the 10-year rule for distributions to beneficiaries who are:

the surviving spouse of the plan participant or IRA owner;
a child of the plan participant or IRA owner who has not reached the age of majority;
a chronically ill individual; or
any other individual who is not more than 10 years younger than the plan participant or IRA owner.

Beneficiaries who qualify under these exceptions may generally still take their distributions over their life expectancy (as allowed under the rules in effect for deaths occurring before 2020).

Overall, this change will cause much larger distributions during peak earning years, which will have a significant impact on the tax obligation of nonspouse beneficiaries.

Many retirement and estate plans were created to benefit from the pre-SECURE Act “stretch” tax deferral, so the SECURE Act’s elimination of the “stretch IRA” might change plans to pass on accumulated accounts, or influence how to handle accounts that are passed down.

Conclusion: Many Other Provisions

Aside from the key provisions of the SECURE Act mentioned above, there are many other provisions in the SECURE Act as well – such as an expansion of Section 529 education savings plans, kiddie tax changes for gold star children and others, and sweeping changes for employers with employer-sponsored retirement plans.

However, the individual retirement plan changes under the SECURE Act could have the biggest direct impact upon taxpayers, and the time to act is now.

Taxpayers should review their tax situation along with their wealth-planning documents to understand the implications of the SECURE Act. Many estate plans, trusts, and beneficiary designations will require rethinking and revision. With careful attention and planning, every taxpayer can begin to feel secure about their wealth planning goals under the SECURE Act.

Interested in learning more? Attend the upcoming online CLE webcast, SECURE Act: What Every Trusts & Estates Lawyer Needs to Know, from State Bar of Wisconsin PINNACLE®. The 1.0 CLE session reviews what has changed, who it affects, and what actions your clients may want to take in light of the changes. For more information, visit WisBar.org’s Marketplace.

IRS Initiates Enforcement of Taxes on Virtual Currency Transactions

Kelly S. Kuglitsch, Britany Morrison — 2019-08-23 00:00:00

The Internal Revenue Service (IRS) recently announced that, by the end of August 2019, more than 10,000 taxpayers will receive mailed letters relating to virtual currency.

The IRS is sending the letters to taxpayers who may have failed to report income, pay taxes, or properly report virtual currency transactions. For this purpose, virtual currency includes cryptocurrency and non-crypto virtual currency, including Bitcoin, Ether, and JPM Coin.

Kelly Kuglitsch, DePaul 2002, is an attorney with O’Neil, Cannon, Hollman, DeJong and Laing in Milwaukee, where she practices in employee benefits and compensation.

Britany Morrison, Marquette 2014, is an attorney with O’Neil, Cannon, Hollman, DeJong and Laing in Milwaukee, where she practices in business and tax law.

There are three different types of letters being sent to taxpayers. Each of the three versions are intended to provide information to help taxpayers understand their tax and filing obligations and how to correct previous errors. However, the letters differ from one another in tone and in the response required by the recipient taxpayer.

Two of the letters invite taxpayers to voluntarily report and pay previously unreported virtual currency income, penalties, and interest. The other letter alleges likely noncompliance in stronger terms and requires specific action by a stated deadline. The text of this final letter indicates that the recipient should expect significant IRS scrutiny, as well as potential examination or enforcement action.

The Three Letters

Letter 6174 notifies a taxpayer that the IRS has information regarding a potential failure to report income from a virtual currency transaction. The letter provides information regarding the taxation and reporting rules which apply regardless of whether the taxpayer received a payee statement (such as a Form W-2 or Form 1999) for a virtual currency transaction. Taxpayers need not respond to the letter but are advised to file amended tax returns or delinquent tax returns if a virtual currency transaction was not previously accurately reported on a federal income tax return.

Letter 6174-A is worded nearly identically to Letter 6174, but in addition informs the recipient taxpayer that the IRS is likely to send additional correspondence about potential virtual currency tax enforcement in the future.

Letter 6173 asserts that federal tax filing and reporting requirements appear to have been unmet by the recipient taxpayer for one or more of the tax years 2013 through 2017. The letter then directs the taxpayer to file amended tax returns. If the taxpayer believes that all tax reporting requirements have already been properly met, the taxpayer must formally respond to the IRS to attest to that position. Supporting detail and documentation must also be submitted. The taxpayer is required to sign the attestation under penalties of perjury that the submission, including all attachments, are true, correct, and complete. Any taxpayer-submitted information will be checked for accuracy against information received by the IRS from banks, financial advisors, and other sources. If a taxpayer does not respond to this letter within 30 days of the date on which the letter was mailed, the IRS will refer the account for audit.

A Second Round of Letters

In addition to the more than 10,000-letter initiative that the IRS publicly announced, as described above, a second, unannounced initiative also appears to be underway.

Some taxpayers are reporting receipt of IRS letters related to virtual currency in the form of a CP2000 Notice. The CP2000 Notice states that the IRS has received information from a third party that doesn’t match information on the taxpayer’s submitted tax return. The notices acknowledge that a virtual currency trading exchange, rather than the taxpayer, may have made the error. In any event, receipt of a CP2000 Notice indicates that the IRS is aware of a reporting discrepancy. A response to the letter is imperative and additional detail on responding is available on the irs.gov website.

IRS Regards Virtual Currency as Property

The current IRS Virtual Currency enforcement initiatives conform to IRS guidance previously published in Notice 2014-21, which provides that virtual currency is treated as property for federal tax purposes.

As is the case with any property, tax law requires reporting and taxation of amounts that are transferred for services or sold. Among other things, this means that:

A payment made (or received) in virtual currency is subject to information reporting to the same extent as any other payment made (or received) in property.

Payments using virtual currency made to independent contractors and other service providers are taxable, and self-employment tax rules generally apply. Typically, payers must issue Form 1099-MISC.

Wages paid to employees using virtual currency are taxable to the employee, must be reported by an employer on a Form W-2 and are subject to federal income tax withholding and payroll taxes.

Certain third parties who settle payments made in virtual currency on behalf of merchants that accept virtual currency from their customers are required to report payments to those merchants on Form 1099-K, Payment Card, and Third-Party Network Transactions.

A taxpayer who successfully “mines” virtual currency (for example, uses computer resources to validate bitcoin transactions and maintain the public bitcoin transaction ledger) realizes gross income upon receipt of the virtual currency resulting from those activities.

The character of gain or loss from the sale or exchange of virtual currency depends on whether the virtual currency is a capital asset in the hands of the taxpayer.

Expect Additional IRS Enforcement Efforts

The IRS has stated its awareness that, because transactions conducted using the more than 1,500 known virtual currencies can be difficult to trace and have an inherently pseudo-anonymous aspect, some taxpayers may be tempted not to report virtual currency-related income to the IRS.

The mailing of these 10,000 letters and CP2000 Notices is therefore likely to be only the first of many virtual currency enforcement actions. Additional IRS guidance is expected to be published on virtual currency reporting and taxation rules soon, updating the last official guidance issued in 2014.

In the meantime, even taxpayers who do not receive a letter or notice should be aware that a failure to properly report the income tax consequences of virtual currency transactions could result in liability for tax, penalties, interest, and in some cases, exposure to criminal prosecution. Criminal charges could include tax evasion and filing a false tax return.

Anyone convicted of tax evasion is subject to a prison term of up to five years and a fine of up to $250,000. Anyone convicted of filing a false return is subject to a prison term of up to three years and a fine of up to $250,000.

Investing in Communities: A Brief Primer on Qualified Opportunity Zones and Funds

Peter J. White — 2019-07-12 00:00:00

Under the Tax Cuts and Jobs Act of 2017, new rules were established that allow taxpayers to defer capital gain from the sale of assets to unrelated persons by investing in a Qualified Opportunity Zone.

Qualified Opportunity Zones

Qualified Opportunity Zones are mostly high-poverty, low-income census tracts in which the federal and state governments wish to encourage investments. The aim is to spur economic development and job creation in distressed areas of the country.

In early 2018, governors of each state and U.S. territory nominated candidate zones, which were subsequently certified as Qualified Opportunity Zones by the U.S. Treasury Department as of July 1, 2018.

In Wisconsin, there are 120 Qualified Opportunity Zones involving areas in each of Wisconsin’s eight Congressional districts, reaching every part of the state.

Investing in a Quality Opportunity Fund

Taxpayers can defer the gain portion of the amount realized on a sale, and take back the basis portion as tax-free cash by investing the gain through a Qualified Opportunity Fund, which makes an investment in a Qualified Opportunity Zone.

The deferral includes both long-term and short-term capital gains from the sale of any property (not just sales of real estate), including marketable securities and closely held business interests.

A Qualified Opportunity Fund is any tax corporation or tax partnership that self certifies with the Internal Revenue Service. The investments can be in the form of either cash or property; however, property investments only get capital gain deferral to the extent of basis rather than fair market value.

Peter J. White , U.W. 2009, is an attorney with von Briesen & Roper SC in Milwaukee, where he practices in business and tax law.

Taxpayers have a 180-day time limit to reinvest into a Qualified Opportunity Fund. For individual and C-corporation taxpayers, the 180-day time limit starts on the date the capital gain is recognized. For taxpayers receiving capital gains from pass through entities (e.g., tax partnerships, S corporations, trusts, etc.), the taxpayers may elect to start the 180-day time limit on either the date the capital gain is recognized or the last day of the taxable year. For instances in which a taxpayer has a net section 1231 gain, the 180-day time limit starts on the last day of the taxable year.

The deferred capital gain that is the initial investment in a Qualified Opportunity Fund is taxable to the taxpayer upon the earlier of either the sale of the Qualified Opportunity Fund interest or Dec. 31, 2026. Additionally, the deferred capital gain that represents the initial investment in a Qualified Opportunity Fund is taxable upon a pre-2027 inclusion event, which generally includes any disposition that results in a reduction of the taxpayer’s beneficial interest in a Qualified Opportunity Fund.

Benefits and Time Periods

The beneficial tax treatment for the deferred capital gain depends on the holding period.

If the taxpayer holds the Qualified Opportunity Fund interest for less than five years, then 100% of the deferred capital is taxed as a long-term capital gain (including any portion of the deferred capital gain that was initial short-term capital gain).
If the taxpayer holds the Qualified Opportunity Fund interest for five years or more but less than seven years, then 10% of the deferred capital gain is forgiven and the remainder of the deferred capital is taxed as a long-term capital gain (including any portion of the deferred capital gain that was initial short-term capital gain). In order to receive this treatment, a taxpayer needs to make an investment in a Qualified Opportunity Fund prior to Dec. 31, 2021.
If the taxpayer holds the Qualified Opportunity Fund interest for seven years or more but less than 10 years, then 15% of the deferred capital gain is forgiven and the remainder of the deferred capital is taxed as a long-term capital gain (including any portion of the deferred capital gain that was initial short-term capital gain). In order to receive this treatment, a taxpayer needs to make an investment in a Qualified Opportunity Fund prior to Dec. 31, 2019.
If the taxpayer holds the Qualified Opportunity Fund interest for 10 years or more, then 15% of the deferred capital gain and all capital appreciation is forgiven and the remainder of the deferred capital is taxed as a long-term capital gain (including any portion of the deferred capital gain that was initial short-term capital gain).

Permissible Fund Investments

There are restrictions on the permissible investments that a Qualified Opportunity Fund can make. Every six months (typically on June 30 and Dec. 31), the fund must be 90% invested in Qualified Opportunity Zone Property. The fund can meet this requirement in one of two ways: by owning a Qualified Opportunity Zone Business Property or the equity interests of a Qualified Opportunity Zone Business.

In order to be considered Qualified Opportunity Zone Business Property, property must:

be acquired by purchase or lease after Dec. 31, 2017, from an unrelated party;
be originally used or substantially improved by the Qualified Opportunity Fund; and
be located substantially (defined as 70%) within the Qualified Opportunity Zone.

Note that:

The original use requirement applies to the use by the Qualified Opportunity Fund and not the property’s original use as a whole. Thus, a fund could acquire an existing business and relocate it in a Qualified Opportunity Zone, and that business’s assets would be considered originally used by the fund.
Substantial improvement requires the Qualified Opportunity Fund to spend more on improvement of the property than the original acquisition cost over a 30-month period after the property is acquired. The basis in any land does not count when determining whether the substantial improvement test has been met.
For real estate assets specifically, land and existing structures cannot be originally used in the Qualified Opportunity Zone, so substantial improvement is the only method by which a Qualified Opportunity Fund can have the property meet the second test for qualifying as Qualified Opportunity Zone Business Property. Further, substantial improvement can only be achieved through either a full renovation or demolition with ground-up development. If there is unimproved land in a Qualified Opportunity Zone, any structure that is built upon it and used by the Qualified Opportunity Fund will be considered originally used by the fund.
Qualified Opportunity Zone Business Property only refers to tangible property; intangible property does not qualify as Qualified Opportunity Zone Business Property. The tangible property needs to be leased or purchased by the Qualified Opportunity Fund or the Qualified Opportunity Zone Business and have substantially all of its use (70%) in the Qualified Opportunity Zone.

Qualified Opportunity Zone Businesses

A Qualified Opportunity Zone Business must be either a tax corporation or a tax partnership, and it must qualify as a trade or business by reference to Section 162 of the Internal Revenue Code, except that ownership and operation of real estate qualifies for purposes of a Qualified Opportunity Zone Business (other than triple net leases). However, certain sin businesses are excluded from qualifying as a Qualified Opportunity Zone Business (e.g., golf courses, gambling parlors, liquor stores, etc.).

Substantially all (70%) of the tangible property owned or leased by a Qualified Opportunity Zone Business must be Qualified Opportunity Zone Business Property. Additionally, the Qualified Opportunity Zone Business must meet these criteria:

50% of the entity’s gross income is derived from the active conduct of a trade or business in the Qualified Opportunity Zone;
a substantial portion (40%) of intangible property of the Qualified Opportunity Zone Business are used in the trade or business; and
less than 5% of the average aggregate unadjusted basis of the entity property is non-qualified financial property (e.g., debt, stock, partnership interests, or other financial products).

Investments Worth Investigating

The Tax Cuts and Jobs Act of 2017 gives taxpayers an opportunity to defer capital gain from the sale of assets. To achieve the best results, taxpayers should be aware of the nuts-and-bolts of the program, which also allows investors to help turn around the most high-poverty, low-income areas in the U.S.

For more information, visit the FAQs on the IRS’ website.

Supreme Court Divided on Nexus for Internet Sellers

Luona Hao — 2018-05-01 00:00:00

The U.S. Supreme Court heard oral arguments in the case of South Dakota v. Wayfair, Inc. et al. on Tuesday, April 17. South Dakota asked the Court to revisit Quill Corp. v. North Dakota’s physical-presence rule and uphold the constitutionality of South Dakota’s sales tax nexus law.

In 1992, the Court ruled in Quill that the Constitution's dormant Commerce Clause prohibits the states from imposing a sales tax collection obligation on out-of-state retailers that do not have a physical presence in the state, reaffirming the physical-presence rule it established in the 1967 National Bellas Hess Inc. v. Illinois Department of Revenue decision. Both Quill and Bellas Hess involved mail-order businesses.

Justice Kennedy’s 2015 criticism of Quill (in Direct Marketing Association v. Brohl) encouraged South Dakota to enact a law that challenges Quill. That law looks to a retailer's economic presence rather than its physical presence in the state. It provides that retailers with annual sales of more than $100,000 or 200 separate transactions in South Dakota must collect and remit South Dakota sales tax. The law also protects retailers from retroactive liability.

Luona Hao, U.W. LLM/SJD candidate, is a member of the New York Bar and currently a law clerk at the Wisconsin Department of Revenue.

At the oral argument, South Dakota argued that the physical-presence rule under Quill is causing states to "lose massive sales tax revenue," and creating an "unlevel playing field … where out-of-state remote sellers are given a price advantage." It suggested that Quill's physical-presence rule was obsolete in the digital era. Fifteen briefs were filed in support of South Dakota, including one from the United States government.

Respondents (Wayfair Inc., Overstock.com, Inc. and Newegg, Inc.) argued that Quill was correctly decided and should be upheld under stare decisis based on reliance interests of retailers, and to avoid anticipated high compliance burdens. They contended that "Congress remains the proper body" to address this issue. Twenty-three briefs have been filed in support of this position.

Wayfair highlights a trend among states to use economic presence as the threshold standard for finding sales and use tax nexus. If the physical-presence rule of Quill is overturned, the sales and use tax nexus landscape will change significantly.

Possible Outcomes

A justice's questions at oral argument do not always reflect the final decision of the Court, so one cannot be sure what the ultimate decision will be. However, the concerns expressed may telegraph some possible outcomes.

Deferring to Congressional Action. Three justices (Kagan, Breyer, and Alito) seem to lean toward leaving the issue to Congress.

Justice Kagan suggested during the oral arguments that Congress is in a better position to strike a balance. She explained that "the [Court’s] choice is just binary … you either have the Quill rule or you don't," but “[Congress] can craft a compromise in ways that we cannot.”

South Dakota Attorney General Marty Jackley said that Congress’s 26 years of inaction demonstrated that it is unlikely to act now, and thus urged the Court to act. However, Justice Kagan interpreted this inaction differently, saying “[I]t gives us reason to pause. … This is a very prominent issue which Congress has been aware of for a very long time and has chosen not to do something about that."

Justice Breyer suggested that the lack of empirical data has hindered the Court from reaching an answer, and that these questions might be better settled by a hearing in Congress. Justice Breyer pointed out that the reason the Court is "more willing to overturn a constitutional case is because Congress can’t act." He noted that briefs from three Senators and Representative asserted that Congress had paused action when the Court took this case.

Justice Alito suggested congressional action was a better option because it could address potential retroactivity and nexus threshold concerns. “[I]f Quill is overruled, what incentives do the states have to ask for any kind of congressional legislation?” he said. However, Justice Alito cautioned that South Dakota law is a “test case … devised to present the most reasonable incarnation of this scheme,” and other states and municipalities tottering on the edge of insolvency have a strong incentive to “grab everything they possibly can.” This means that Justice Alito might be willing to join a narrow ruling upholding South Dakota's law.

Overturning Quill. Based on oral argument and history, Justices Kennedy, Gorsuch, Ginsburg, and Thomas are the four justices most likely to uphold the stated law and overturn Quill.

Justice Kennedy has directly criticized Quill in the 2015 DMA decision. “A case questionable even when decided, Quill now harms states to a degree far greater than could have been anticipated earlier.”

Justice Gorsuch’s opinions in the oral argument were, as anticipated, also in line with his known skepticism about Quill. He suggested that upholding Quill would be favoring internet retailers over brick-and-mortar retailers. He also voiced his concern that if Quill is upheld, internet retailers will have to deal with Colorado-type statutes requiring internet retailers to report sales to customers, and that such reporting statutes may be even more burdensome than just requiring collection and remittance.

Justice Ginsburg questioned why the Supreme Court should not take its responsibility to overturn its own doctrine created in Quill. “Quill, right or wrong, was this Court's decision. And if time has, and changing conditions have, rendered it obsolete, why should the Court … say we'll let Congress fix up what turns out to be our obsolete precedent?” Ginsberg suggested that subjecting everyone that sells in-state with the same sales tax collection obligation would be “equalizing rather than discriminating." If Quill is upheld, then “the state has the burden of going after consumers,” which is less efficient than going after the seller.

Justice Thomas remained silent during the oral argument, but has criticized constitutional basis of the dormant Commerce Clause in his 2015 dissenting opinion in Comptroller of the Treasury of Maryland v. Wynne, which could mean he is more likely to vote to overturn Quill.

Upholding Quill. Justice Sotomayor was the most vocal justice in favor of upholding Quill. She noted overturning Quill may “create a massive amount of lawsuits” and bring potential retroactivity concerns in many states who have already made this collection retroactive. She also noted the burdens on small business to implement sales tax programs.

It is not yet clear what the position of Chief Justice Roberts would be. He questioned whether there would be a “constitutional minimum” regarding whether out-of-state business would be protected from the obligation and burdens of sales tax collection. South Dakota responded that the substantial nexus test in the 1977 Complete Auto Transit, Inc. v. Brady and balancing test in the 1979 Pike v. Bruce Church, Inc. decisions would provide the protection. Chief Justice Roberts seems to read the voluntary collection by big e-commerce companies as signs that the economic impact of sales tax noncollection by remote sellers is getting better, and therefore the Court may not need to act.

Given the divided opinions of the justices, as well as the uncertainty of the positions of Chief Justice Roberts and Justice Breyer, the outcome of Wayfair remains unpredictable.

Implications for Business

While the outcome of Wayfair cannot be certain until the final decision comes out, businesses should begin to consider compliance issues in anticipation of future sales tax collection requirements.

Regardless of whether Quill stands or is overturned, retailers may want to consider:

Whether current internal systems and processes reflect recent changes in state sales tax laws and regulations, such as click-through nexus, economic nexus, or notification and information reporting requirements.
In states adopting Colorado-type notification requirements, whether voluntary registration or compliance with the notice requirements is more appropriate.
Whether the increased compliance burdens change the decision to enter a market.
If Quill is modified or overturned:
- Whether state statutes clearly impose sales and use tax under a new nexus standard, or require amendment.
- How much retroactive liability, if any, may exist for consumers and retailers.
- Whether the required customer data are available to determine how to source sales if sales and use tax obligations are imposed.
- Whether appropriate systems and processes are in place to collect applicable sales taxes.

Disclaimer

The views and opinions expressed in this article are those of the author's and do not reflect the position of the Wisconsin Department of Revenue.

This article was originally published on the State Bar of Wisconsin’s Taxation Law Blog. Visit the State Bar sections or the Taxation Law Section web pages to learn more about the benefits of section membership.

Wisconsin Legislature Eases Sales Tax Burden on Nonprofits

Atty. Robert A. Mathers — 2016-06-28 00:00:00

As the summer breezes begin to bring tourists into Wisconsin, various nonprofit enterprises, like churches and chambers of commerce, are holding their events and enjoying the great Wisconsin outdoors.

Robert A. Mathers (William Mitchell 1990) is a 20-year veteran of the accounting industry. He practices business and tax law as a shareholder at Von Briesen & Roper, S.C., Oshkosh.

While sales tax could not be further from most people’s mind, Wisconsin’s taxation of occasional sales by these entities can be an expensive and unforeseen misfortune. On April 15, Governor Scott Walker signed into law Assembly Bill 553, which increases the threshold for sales tax exemptions for occasional sales by nonprofit organizations.

This means that fewer nonprofits will owe sales tax when they sell goods or services across Wisconsin. Here is a summary of the changes:

Under current law, if a nonprofit sells an aggregate of more than $25,000 and those sales occur more than 20 days during the year, it is liable for sales tax. The new bill increases these measurements to 75 days and $50,000 in sales.
Also under current law, if a nonprofit sells admission to an event where the entertainment cost is more than $500, the admissions are taxable. The new law increases the eligible entertainment expense to $10,000.

For example, a Wisconsin tax exempt entity that charged admission to attend a golf outing where a jazz band was playing during the reception would be subject to the tax for the admissions to the event if the band was paid $600. Under the new law, the admissions would no longer be subject to a sales tax.

As another example, a church that arranged for volunteers to donate time to provide $35,000 of fundraising for 18 pie sales during the year, and then also sold T-shirts three times a year to its members’ affinity groups, would have to pay sales tax on the amount over $25,000 – in this case, $10,000. Under the new law, these sales would be exempt from the sales tax.

Wisconsin legislators addressed an increasingly burdensome requirement for many tax-exempt entities. Under the old law the definition of “entertainment” was being expanded by the Wisconsin Department of Revenue to include not only musicians and artists, but also to include the presence of doughnuts and coffee at an event. This created a trap for nonprofits seeking to carry-out their tax exempt mission in that they faced an unforeseen expense, resulting in not only a tax, but also penalties and interest being assessed on these “sales.”

Under the new law, nonprofit Wisconsin entities will be able to reduce not only the cost of providing these services to our residents and guests, but they will also enjoy lower compliance and administrative costs associated with an outdated statute.

Unfortunately, the increased limits apply to sales beginning Jan. 1, 2017, so affected nonprofit organizations should plan accordingly for any events in 2016.

The Taxation Section Blog: Welcome!

2016-06-22 00:00:00

Dear Taxation Section Members,

We’re excited to announce the launch of a new blog for the State Bar of Wisconsin Taxation Section!

This blog is designed to deliver the latest news, practical advice, and valuable resources that focus on tax matters.

Why a Blog?

We chose to create a blog because it combines the benefits of a newsletter with the timeliness and immediacy of online communication.

Blogs bring many advantages:

Easy to read
Can be updated frequently with the latest news and developments
Link to additional information and related blogs, including those written by our members
Posts can be shared on social media

We Need Bloggers!

Have an idea for a blog post? Know information that would be helpful to your fellow Section members? Send us a post! You’ll get the chance to share your experience with others and link your post to your State Bar web profile and your personal or corporate blog. Contact Robert Mathers for our blog post template and guidelines, as well as tips for creating an attention-getting post.

If you have suggestions for how we can make the blog even better, we want to hear your ideas. Just contact one of the section board members with your thoughts.

Happy Blogging!

Taxation Section Board