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Why It’s Been 31 Years Since the Last Tax ReformSources: Inside.gov & Internal Revenue Service

President Donald Trump has promised the most comprehensive overhaul of the tax system since 1986. That was when a Republican president joined forces with a Democratic House of Representatives and a Republican Senate to lower personal income-tax rates and simplify a messy and outdated tax system.

Today, Republicans control both houses of Congress as well as the White House. Democrats agree with them that the system has once again become messy and outdated. So in theory it should be easier to reach agreement now than it was then.

Forget that theory. Passing tax reform this year will be a much tougher slog than it was 30 years ago, or than Republicans expect it to be today.

Republican opposition would have doomed President Ronald Reagan’s plans without Democratic support, and the bipartisanship and skilled political leadership needed to push them through don’t exist today.

Thus while a sweeping tax-reform bill is a top priority of both Trump and House Speaker Paul Ryan, with a goal of passing it by July, the odds are that it won’t happen. A look at what took place in 1986 helps explain why.

The architect of the 1986 tax bill was a Democratic senator, Bill Bradley, who was a relentless and effective advocate. The concept was embraced and proposed by Reagan, who delegated the responsibility for getting it through to Jim Baker, the most politically skillful Treasury secretary of modern times, and his brilliant deputy, Richard Darman, a genius at navigating the intersection of policy and politics.

On Capitol Hill, the chairmen of the two tax-writing committees surprisingly rose to the occasion. The Democratic Ways and Means Chairman Dan Rostenkowski transcended his roots as a Chicago machine politician to become a national legislator. Senate Finance Committee Chairman Bob Packwood stopped defending tax benefits tailored for some of the business interests he and other Republicans had faithfully championed.

The result was a comprehensive bill that slashed individual and corporate rates while compensating for the lost revenue by closing loopholes. That meant eliminating tax advantages enjoyed by powerful interest groups like the oil and real-estate industries and overcoming their formidable allies in Congress.

On the way, the 1986 tax bill nearly died on multiple occasions as lobbyists pressed their cases. Throughout almost two years of debate and negotiation, the conventional wisdom was that the proposal would not survive. It was defeated once in the House. The Senate, with Democrats and Republicans equally beholden to special interests, appeared to be a certain graveyard.

Then, as the bill reached final passage, Senate Republican Leader Bob Dole marveled that in a matter of days, it went from “immovable to unstoppable.” It cleared the Senate by 97 votes to 3. A combination of will, skill and ideological flexibility made it possible.

For example, conservatives got the lower individual rates they favored by giving liberals something they wanted: stiff increases in corporate taxes (something Reagan chose not to talk about in public). Liberals suppressed their horror at the idea of a 28-percent rate for wealthy people (down from 70 percent just six years earlier) because conservatives overcame their fears about constraining economic growth.

Today, that spirit of horse-trading is gone. Many Republicans are dead-set against raising any taxes, even if needed to offset cuts elsewhere. Some Democrats are unbending on reducing high U.S. corporate tax rates despite widespread agreement that they are counterproductive. It’s hard to see why either side would give ground.

The Trump administration’s tax-reform effort, for now, is being guided by a top White House economic adviser, Gary Cohn. Until a month ago he was president of Goldman Sachs Group Inc., and undoubtedly is knowledgeable about taxes. When it comes to Washington politics, though, he’s no Jim Baker.

In Congress, Paul Ryan is a committed tax-policy wonk, as are a number of other Republican leaders. At this stage there is no Democrat who might be a Bradley or Rostenkowksi. In the Senate, Finance Committee chairman Orrin Hatch, who once worked across the political aisle, has become an aging partisan, lacking the dexterity Packwood displayed.

The reason personal heft matters so much is that tax reform is so hard. It directly affects as many, if not more people, than a health-care overhaul. By definition, there are winners and losers — somebody gets something at somebody else’s expense. The losers always feel more passionate and make more noise.

“Doing major tax reform with familiar income or consumption taxes has proved remarkably difficult — even when everyone agrees that reform is necessary,” notes Michael Graetz, a Columbia Law School professor and former Treasury Department tax official who has written extensively on the issue.

The machinations Republicans are starting to go through attests to that wisdom. Ryan says the final product won’t reduce government revenue and Treasury Secretary Steven Mnuchin says the wealthy won’t get a net tax cut. Those claims are overtures to moderates. But given Republican fondness for lowering rates, especially for the wealthiest taxpayers, neither result is likely.

Republicans envision a new sales tax on domestic and imported goods and services dubbed a “border adjustment tax,” a variation of a European-style value-added levy that would favor exporters like Boeing and Caterpillar over equally powerful consumer-product companies like Wal-Mart and Target, not to mention consumers themselves. There’s economic merit to the idea since it would raise money to enable rate cuts and avoids the crude protectionism that Trump has championed.

But it would create a big new tax, and already some House conservatives are objecting. So has the right-wing advocacy group Americans for Prosperity, which was founded by the Republican mega-donors Charles and David Koch.

Politics aside, Graetz, who’s supported a form of a value-added levy, warns that the border-tax idea proposes “a unique tax used nowhere in the world with big but uncertain economic effects, which certainly will produce major legal challenges both here and from our trading partners.”

Thus, concludes Len Berman of the Tax Policy Center, “The theory of this tax looks good but the politics may prove impossible.” U.S. retailers already are rallying in opposition.

Another source of revenue could be a special lower rate on corporate income from foreign sources intended to allow companies to invest that money in the U.S. instead of banking it abroad to avoid high corporate taxes. Perhaps Democrats could be brought on board by a promise to use some of the resulting revenue to finance infrastructure improvements, as Trump has promised to do.

But those revenues would be temporary while the tax cuts, Ryan insists, would be permanent. Democrats, skeptical of cutting any deal, sense a trap where Republicans subsequently would come back with big spending cutbacks to make up for the deficits.

It may not be that tough for Republicans to cut taxes, mainly on a party-line vote. But as they struggle to pass comprehensive tax reform by this summer, expect sometime this spring for them to start wondering: Where are Bill Bradley and Jim Baker?

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STATEMENTS TO IRS & BENEFICIARIES REGARDING BASIS REPORTING POSTPONED UNTIL JUNE 30, 2016

 

IRS has again delayed the initial due date for providing statements to IRS and

to beneficiaries, under the rules requiring consistent basis reporting for estate

tax and income tax purposes, this time until June 30, 2016. (Notice 201627,

201615 IRB 1)
Background. The executor or administrator of a decedent’s estate must file

the estate tax return. (Code Sec. 6018(a))

 

If the executor or administrator is unable to make a complete return with

respect to any part of the gross estate, he must include in his return all the

information he has, including a description of such part and the name and

address of every person holding a legal or beneficial interest in such part. If

they are notified by IRS, such legal or beneficial owners must then file returns

as to their parts of the estate. (Code Sec. 6018(b))

 

On July 31, 2015, President Obama signed into law the Surface

Transportation and Veterans Health Care Choice Improvement Act of 2015

(P.L. 11441;the Act). Section 2004 of the Act enacted Code Sec. 1014(f) and

Code Sec. 6035).

 

Under the Act, effective for property with respect to which an estate tax return

is filed after July 31, 2015, the basis of any property to which Code Sec.

1014(a) (i.e., the rules for determining basis of property acquired from a

decedent) applies can’t exceed:

 

(A) In the case of property, the final value of which has been determined

for purposes of the estate tax on the estate of the decedent, such value.

(B) In the case of property not described in (A), above, and with respect

to which a statement has been furnished under new Code Sec. 6035(a)

(see below) identifying the value of such property, such value. (Code Sec. 1014(f)(1))

 

Code Sec. 6035 imposes new reporting requirements with regard to the value

of property included in a decedent’s gross estate for federal estate tax

purposes.

 

Code Sec. 6035(a)(1) provides that the executor of any estate required to file

an estate tax return under Code Sec. 6018(a) must furnish, both to IRS and

the person acquiring any interest in property included in the decedent’s gross

estate for federal estate tax purposes, a statement identifying the value of

each interest in such property as reported on such return and such other

information with respect to that interest as IRS may prescribe.

 

Under Code Sec. 6035(a)(2), each person required to file a return under

Code Sec. 6018(b) must furnish, both to IRS and each other person who

holds a legal or beneficial interest in the property to which such return relates,

a statement identifying the information described in Code Sec. 6035(a)(1).

Code Sec. 6035(a)(3)(A) provides that each statement required to be

furnished under Code Sec. 6035(a)(1) or Code Sec. 6035(a)(2) must be

furnished at such time as IRS may prescribe, but in no case at a time later

than the earlier of: (i) the date which is 30 days after the date on which the

return under Code Sec. 6018 was required to be filed (including extensions, if

any); or (ii) the date which is 30 days after the date such return is filed.

Previous delays. Notice 201557, 201536 IRB 294, provided that, for

statements required under Code Sec. 6035(a)(1) and Code Sec. 6035(a)(2)

to be filed with IRS or furnished to a beneficiary before February 29, 2016,

the due date under Code Sec. 6035(a)(3) was delayed to February 29, 2016.

Notice 201619, 20169 IRB 362, provided the same rule, except with

March 31, 2016 substituted for February 29, 2016.

 

And, in temporary regulations issued earlier this month,

IRS reiterated the March 31, 2016 date by saying

that executors and other persons required to file or furnish a statement under

Code Sec. 6035(a)(1) or Code Sec. 6035(a)(2) before March 31, 2016, need

not do so until March 31, 2016.

 

IRS announces second delay.

 

IRS has now announced that statements

required under Code Sec. 6035(a)(1) and Code Sec. 6035(a)(2) to be filed

with IRS or furnished to a beneficiary before June 30, 2016 need not be filed

with IRS and furnished to a beneficiary until June 30, 2016.

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Have Recent Court Decisions Sounded The Death Knell For Single Member LLCs In An Asset Protection Plan?

As LLCs are creatures of state law, any analysis of an LLC’s role in an asset protection strategy must consider the relevant state’s LLC act as well as case law that interprets it. The Revised Uniform Limited Liability Company Act, on which most state LLC legislation, including Wyoming’s, is based, provides in Section 304(b):

“The failure of a limited liability company to observe any particular formalities relating to the exercise of its powers or management of its activities is not ground for imposing liability on the members or managers for the debts, obligations or other liabilities of the company.”

In other words, failure to observe corporate formalities is not a reason to pierce an LLC’s veil.

Or is it?

A recent case out of the Supreme Court of Wyoming, Greenhunter Energy, Inc. v. Western Ecosystems Technology, Inc. (2014 WY 144), left many wondering (1) if the death knell had sounded on the use of Wyoming single-member LLCs in an asset protection strategy, and (2) if other states like New Mexico would follow suit in liberally piercing the veil of a single-member LLC. The case serves as a sobering reminder of the vulnerability of single-member LLCs even in a traditionally LLC-favorable jurisdiction such as Wyoming.

Greenhunter Energy involved a contract for consulting services between GreenHunter Wind Energy, LLC (the “Debtor LLC”) and Western Ecosystems Technology, Inc. (the “Consultant”). The Consultant provided services to the Debtor over the course of a year and never received payment. The Consultant sought to obtain judgment against the Debtor LLC only to learn that the Debtor LLC had no assets. The Consultant then sought judgment against the Debtor LLC’s sole member, GreenHunter Energy, Inc. (the “Sole Member”).

The primary issue before the Court was whether the Debtor LLC’s veil of limited liability should be pierced, subjecting the Sole Member to liability. In analyzing this issue, the Court outlined a new test:

The veil of a limited liability company may be pierced under exceptional circumstances when:

(1) the limited liability company is not only owned, influenced and governed by its members, but the required separateness has ceased to exist due to misuse of the limited liability company; and

(2) the facts are such that an adherence to the fiction of its separate existence would, under the particular circumstances, lead to injustice, fundamental unfairness, or inequity.

In considering whether both prongs of its “fact-driven and flexible” test had been met, the Court applied the following non-exhaustive factors:

(1) presence of fraud,

(2) inadequate capitalization,

(3) the degree to which the business and finances of the LLC and its member are intermingled, and

(4) manipulation of assets and liabilities between the LLC and its member to concentrate the assets in the member and the liabilities in the LLC.

The Court repeated that the analysis is fact-driven and clarified that no one factor, except fraud, alone justifies piercing an LLC’s veil of limited liability.

Additionally, to pierce the veil, “an injustice or unfairness must always be proven.”

Despite reiterating that “limited liability is the rule, and piercing is the rare exception to be applied only in cases involving exceptional circumstances,” the Court affirmed the district court’s judgment piercing the LLC’s veil and holding the Sole Member liable for the debt to the Consultant. The Court cited the following facts to support its holding:

(1) Undercapitalization: During the period that the Consultant provided services to the Debtor LLC, the Debtor LLC often had $0 in its operating account and received periodic transfers from the Sole Member who had sole discretion in how the money was used. The Consultant submitted seven invoices to the Debtor LLC over time, yet never received payment. The Court held that these facts indicated that the Debtor LLC was inadequately capitalized due to manipulation by the Sole Member.

(2) Inter-mingling: Although the Sole Member and Debtor LLC had separate bank accounts and business records, the Court nonetheless found evidence of improper intermingling. The Sole Member and the Debtor LLC had: (a) overlapping ownership, membership and management; (b) the same business address; and (c) the same accountants, who consolidated the entities’ tax returns. Funds were passed through the Debtor LLC by periodic transfers from the Sole Member to pay selected expenses.

(3) Misuse of the Debtor LLC: The Court pointed out that the Sole Member “enjoyed significant tax breaks attributable to the LLC’s losses, without bearing any responsibility for the LLC’s debt and obligations that contributed to such losses” and held that the “disparity in the risks and rewards resulting from this manipulation would lead to injustice.” The Court recognized that filing a consolidated tax return was permitted by federal tax law, and concluded that the tax filings were only one of many relevant pieces of evidence that the Sole Member had improperly directed benefits from the Debtor LLC to itself.

As the Sole Member argued in Greenhunter Energy, the holding is troubling from a policy perspective.

Federal tax law permits the consolidated tax filing. To identify this fact as supporting veil piercing puts single-member LLCs in the position of having to choose between the tax and asset protection benefits of an LLC. Furthermore, LLCs are defined by their flexibility and lack of corporate formalities. The minimal requirements of forming and operating a single-member LLC are part of the entity’s attractiveness, and it is not inconceivable that such informality and flexibility would lead to some degree of overlap between the business and its owner. No fraud was proven, yet the veil was still pierced, leading many to question whether LLC veil piercing, particularly in the case of single-member LLCs, truly is reserved for exceptional circumstances.

As case law continues to develop around this issue, business owners and their advisors should be cautious about the potential dangers of using a single-member LLC where asset protection is a primary objective.

After Greenhunter Energy, it would be prudent to (1) keep adequate funds in the LLC’s operating account, allowing it to pay all debts as they come due, (2) consider using a separate accountant for the LLC’s bookkeeping, (3) establish separate mailing addresses for the entities, (4) acknowledge and prioritize ongoing LLC compliance responsibilities, and (5) ensure that all liabilities associated with any tax benefits derived from an LLC are satisfied in full in a timely manner.

For more information on this issue and other matters related to the proper formation and administration of limited liability companies, please contact THOMAS LAW FIRM, Chartered, PO Box 21580, Albuquerque, NM 87154-1580 Telephone: 505-837-2344 Email: Attorneys@ThomasLaw.US.