r Volume XXII, Issue 4 Fourth Quarter 1996

TABLE OF CONTENTS

CHAIRPERSON'S LETTER TO TAXATION SECTION MEMBERS 2

REPORTS FROM THE COMMITTEES Corporation Committee 5 Employee Benefits Committee 6 Estates & Trusts Committee 6 International Tax Law Committee 7 Partnership Committee 7 Practice & Procedure Committee 8 State & Local Committee 9 FEATURE ARTICLES Pension Simplification - Really! A Summary of Selected Pension Related Provisions in the Small Business Job Protection Act of 1996 By: David B. Walters 11 1996 Legislative Improvements for S Corporations By: Dean A. Rocheleau, J.D., C.P.A. 17 STATE AND LOCAL TAX UPDATE Recent Cases 22 SHORT SUBJECTS Taypayer Bill of Rights 2 24 By: James H. Novis MICHIGAN TAX LAWYER

~' ( I The Michigan Tax Lawyer is a quarterly publication of the Taxation Section of the State Bar of Michigan that is designed to be a practical and useful resource for the tax practitioner. Features include concise reports in a uniform format from the Section's committees, practitioner articles with the ''how to" approach, news of events and of other Section members, and "Short Subjects" providing helpful practice information.

Input from members of the Taxation Section is most welcome. Our publication is aimed toward involving you in Section activities and assisting you in your practice. If you have suggestions or an article you wish to have considered for publication, please contact Eric T. Weiss, Esq., 27777 Franklin Road, Suite 1400, Southfield, Michigan 48034 (810) 355-5000.

ERIC T. WEISS Editor Publication Committee EDWARD M. DERON ::;I State Bar of Michigan Taxation Section Council

STEPHEN M. FELDMAN GEORGE W. GREGORY ROBERT R. STEAD Chairperson Vice Chairperson Secretary-Treasurer CAROL J. KARR Ex-Officio Joseph A. Bonventre Mark C. Larson James H. Novis William E. Sider Eric T. Weiss Gary Schwarcz Gregory A. Nowak Edward M. Deron Edward D. MacDonald Editor's Assistant Sue A. Woodcock Subscription Information The Michigan Tax Lawyer (ISSN 0899-2460), (USPS 093930) is published quarterly by the Taxa­ tion Section, State Bar of Michigan, 817 N. Gainsborough, Royal Oak, Michigan 48067. Subscrip­ I ! tion fee of $5.00 is included in the $30.00 annual Taxation Section membership fee. Periodicals •I· postage paid at Royal Oak, Michigan. POSTMASTER: Send address changes to Michigan Tax Lawyer, Membership Records, Taxation Section, State Bar of Michigan, 306 Townsend, Lansing, Michigan 48904. Change of Address Individual subscribers should send notification in writing to: Michigan Tax Lawyer, Membership Records, Taxation Section, State Bar of Michigan, 306 Townsend, Lansing, Michigan 48904. Citation Form The Michigan Tax Lawyer may be cited as follows: (Vol.) (Issue) MI Tax L. (Page) (Qtr. and Yr.). Disclaimer The opinions expressed herein are those of the authors exclusively and do not necessarily reflect those of the Publication Committee, the Taxation Section Council or the Taxation Section. It is the responsibility of the individual lawyer to determine if advice or comments in an article are appro­ '( priate or relevant in a given situation. The Publication Committee, the Taxation Section Council ( and the Taxation Section disclaim all liability resulting from statements and opinions contained in the Michigan Tax Lawyer. TAXATION SECTION

CHAIRPERSON STEPHEN M. FELDMAN SUITE 200 32300 NORTHWESTERN HWY. FARMINGTON HILLS 48334·1567 (810) 855-6500

VICE-CHAIRPERSON GEORGE W. GREGORY 300 WABEEK BLDG. 280 W. MAPLE RD. BIRMINGHAM 48009·3344 (810) 646-4200

SECRETARY-TREASURER ROBERT R. STEAD SUITE 200 2851 CHARLEVOIX DR.. S.E. GRAND RAPIDS 49546-7048 November 14, 1996 (616) 949·2300

COUNCIL JOSEPH A. BONVENTRE (313) 965-8293

EDWARD M. DERON (313) 963-9625 Dear Taxation Section Members: MARK C. LARSON (313) 568-5790

EDWARD D. MacDONALD As my term as Chairperson starts I look foriNard to an exciting year (810) 512-3064 of innovations and exciting new projects being undertaken by the Taxation JAMES H. NOVIS (313) 256-7940 Section. GREGORY A. NOWAK (313) 259·0500 GARY SCHWARCZ Before I share with all of you our plans for the upcoming year, I (810) 855·8808

WILLIAM E. SIDER would like to take this opportunity to thank my predecessors, in particular (313) 961·8380 Carol Karr, for all of their hard work and leadership. Carol's devotion and ERIC T. WEISS (810) 355·5000 dedication to the Taxation Section was reflected in the successful

EX-OFFICIO programs carried out during her term as Chairperson. ~, CAROL J. KARR (616) 459·8311 With the new year comes new faces. Bob Stead was elected COMMISSIONER LIAISON ROLAND HWANG Secretary/Treasurer of the Section at the annual meeting held in Grand (517) 373·1476 Rapids. Edward Deron, Edward MacDonald and Gregory Nowack were COMMITTEE CHAIRPERSONS all elected to council. I look forward to working with all of these individuals CORPORATION JAY A. KENNEDY this year in bringing to you, the members of the Section, the benefits this (313) 963-2500 group has to offer its members. EMPLOYEE BENEFITS SHERILL A. SIEBERT (313) 256-7502 Four new Committee Chairpersons have also joined our ra.nks ..J~y ESTATES AND TRUSTS GREGORY V. Dl CENSO Kennedy is now Chairperson of the Corporation Committee; Gregory (810) 258·3049

INTERNATIONAL DiCenso is Chairperson of the Estates and Trusts Committee; David DAVID WUNDER (313) 446-7249 Wunder is Chairperson of the International Committee and Michele PARTNERSHIP Halloran is Chairperson of the State and Local Committee. The ANTHONY ILARDI, JR. (810) 362·8212 Committees and Committee Chairs form the backbone of our Section PRACfiCE AND PROCEDURE since most officers ·~rise through the ranks" by working within a ERIC M. NEMETH (810) 357-3010 Committee. The future of our section is dependent upon you, our STATE AND LOCAL MICHELE L. HALLORAN members, becoming actively involved in Committee activities as well as (517) 485-1483 supporting Section activities. PROGRAM FACILITAlOR KAREN A. NIZOL 16411 NOLA DR. LIVONIA 48154-1206 (313) 953-0088

PAST COUNCIL CHAIRPERSONS ALLAN J. CLAYPOOL OSCAR H. FELDMAN JOHN L. KING JACK E. MITCHELL B. COURTNEY RANKIN JOHN N. SEAMAN STEPHEN H. CLINK EUGENE A. GARGARO, JR. DONALD M. LANSKY DENNIS M. MITZEL JOHN J. RAYMOND, SR. PETER S. SHELDON JOHN J. COLLINS, JR. ERNEST GETZ JEFFREY A. LEVINE J. LEE MURPHY DAVID M. ROSENBERGER WILLIAM J. SIKKENGA ROGER COOK JOSEPH D. HARTWIG ARNOLD W. WNGERSHAUSEN LAWRENCE J. MURPHY ANDREW M. SAVEL I. JOHN SNIDER, II CLIFFORD H. DOMKE STEPHEN I. JURMU JERRY D. WPTAK REGINALD J. NIZOL BENJAMIN 0. SCHWENDENER, JR. LAWRENCE R. VAN TIL J. BRUCE DONALDSON LOUIS W. KASISCHKE JOHN W. McNEIL ROBERT B. PIERCE F I

CT

Our 1997 Summer Tax Conference is well into the planning stages with Joe Bonventre at the helm. The conference is scheduled for June 20th and 21st at the Grand Traverse Resort in Traverse City, Michigan. joe has aiready arranged for national speakers to make presentations during the conference on subjects ranging from planning for qualified plan distributions, maximizing the benefits .of S Corporations and L.L.C.'s and wealth transfer planning tips and techniques. This looks to be one of the best conferences we had so far and certainly would be worth while attending.

A new project which should be on-line by the time you are reading this is our internet involvement. Both ICLE and The State Bar Of Michigan will be interfacing with the Taxation Section in connection with the internet (I for purposes of both dissemination of technical information, as well as membership information. If any of you have any interests in becoming involved on this internet committee, please contact me.

The year ahead looks to be interesting in light of the implementation of some of the new tax laws enacted this past summer. I urge all of you to get involved, get on a committee and experience the Taxation Section.

Cordially,

STATE BAR OF MICHIGAN TAXATION SECTION

By: zJt;4. --;;-~ Stephen M. Feldman, Chairperson Reports from the Michigan Tax Lawyer-4th Quarter 1996 Committees

Report of the - For tax years beginning after December 31, 1996, an S Corpo­ Corporation Committee ration will be permitted to own Jay A Kennedy, Chairperson 80% or more of a C Corporation Abbott, Nicholson, Quilter, without disqualifying its election Esshaki & Youngblood, P.C. since S Corporations are no One Woodward Avenue, 19th Floor Detroit, Michigan 4843 longer prevented from being a member of an affiliated group. 1. Recent Activities. - For tax years beginning after ~ecember 31, 1996, S Corpora­ I The Corporation Committee held a ~· joint program with the Partnership tions may own a "qualified Committee at this year's animal Subchapter S subsidiary" if the meeting of the State Bar of Michigan subsidiary is 100% owned by the regarding valuation issues with S Corporation parent and the transfers of family limited partner­ appropriate election is made. Under these new provisions ~hip and limited liability company mterests. The informative, and income and losses of both compa­ sometimes lively, discussion was led nies are combined on one tax by business appraiser Tim Dankoff of return and passed through to Beginning after Plante & Moran, LLP and Brian shareholders of the parent com­ pany. December 31, Trindell, manager of the IRS Estate 1996, an S and Gift Tax Audit Group in Detroit. - For tax years beginning after Another joint program was held December 31, 1996, a new rule Corporation will with the Partnership Committee on permits certain multiple benefi­ be permitted to (I October 30, 1996 concerning the new ciary trusts to qualify as S Cor­ ownBO% or S Corporation provisions contained in poration shareholders if the trust moreofaC the Small Business Job Protection elects to be treated as an "elect­ ing small business trust." A Corporation Act of 1996. This in-depth discussion without was led by Dean Rocheleau of Plante trust that makes an election & Moran, LLP, who has also contrib­ under these rules will pay tax on disqualifying uted an article on this subject con­ all S Corporation income at the its election tained in this publication. Highlights highest tax rate applicable to of the new legislation include the trusts (currently 39.6% for following: ordinary income and 28% for - For tax years beginning after long term capital gains), even if December 31, 1996, S Corpora­ the income is distributed to trust tions will be permitted to have 75 beneficiaries. Also, each poten­ shareholders (35 under old law). tial income beneficiary of the - For tax years beginning after trust is counted when applying r' December 31, 1997, qualified the 75 shareholder limitation. retirement plans and tax-exempt I would be happy to send copies of organizations will be permitted Dean's outline, which includes sev­ to hold S Corporation stock. eral Planning Considerations, to These organizations will be members of the Tax Section. Please treated as one shareholder for call my office at (313) 963-2500 if you purposes of the 75 shareholder are interested. limitation. S Corporation income allocated to these organizations 2. Other Developments. will be subject to the tax on ~he new ~'Check-the-Box" regula­ unrelated business income as tions, whiCh generally permit non­ will gain on the sale of the S corporate entities to elect to be taxed either as a corporation or as a Corporation stock. 5 Reports from the Committees Michigan Tax Lawyer-4th Quarter 1996

~ partnership was adopted in Decem- and accepted questions from the iJI ber 1996. attendees. The Pension Liaison In Rev. Proc. 96-30, I.R.B. 1996-19, Group is an on-going group with April 22, 1996, the IRS updated Rev. whom the Chairperson of the Em- Proc. 86-41, which set forth in a ployee Benefits Committee will have checklist questionnaire the informa- a continuing presence. Please give tion that must be included in a tax- me a call if you desire a copy of the free spin-off ruling pursuant to Code minutes of this meeting. Sec. 355. Included in this new Rev. Our most recent meeting was held Proc. is an appendix which provides on November 21, 1996 at the offices guidelines for determining whether of Honigman Miller Schwartz and the IRS will rule that the Sec. 355 Cohn. The meeting featured a panel "business purpose" requirements are discussion of the employee benefit met under certain circumstances. provisions of the Small Business Job Tax counsel for companies consider- Protection Act of 1996. The panelists ing the tax-free spin-off of a subsid- included Nancy Keppelman, Mary Jo iary should carefully review this Rev. Larson and David Walters who gave Proc. excellent presentations. David Walters has also contributed an 3. Future Schedule. article on new legislation effecting The Committee is planning a joint pension plans which can be found program with the Partnership Com- in this issue of the Michigan Tax mittee for early next year which Lawyer. focuses on the newly adopted "Check- the-Box" regulations and other current issues. I would also welcome Report of Estates suggestions for future programs. and Trusts Committee • Gregory V. Di Censo, Chairperson Miller Canfield, Paddock & Stone Report of the Employee 1400 N. Woodward, Ste. 100 Benefits Committee P.O. Box 2014 Sherill Siebert, Chairperson Bloomfield Hills, Ml 48303-2014 Honigman Miller Schwartz and Cohn (81 0} 258-3049 2290 First National Building Detroit, MI 48226 1. Chairperson's Message. (313} 256-7502 I am honored to be the current Chair- person of this Committee. Ifi can do 1. Recent Activities. even half the job that Ed Deron did in On October 16, 1996, I represented this capacity, I will be happy. I am the Employee Benefits Committee at grateful for his assistance in the the Pension Liaison Group Meeting transition. sponsored by the Internal Revenue I will appreciate hearing from you Service in Brooklyn, New Y

Renaissance Center 18, 1996, the Partnership Committee Detroit, Michigan 48243 held a joint meeting with the Corpo­ (313) 446-71 00 ration Committee. Tim Dankoff, a 1. Chairperson's Message. business appraiser with Plante & I would like to thank my predeces­ Moran, and Brian Trindell, Manager sor, Ed MacDonald for his fine work of the Estate and Gift Tax Group in in serving as Chairperson ofthe the Detroit District Director's Office,

7 Reports from the Committees Michigan Tax Lawyer-4th Quarter 1996

were on a panel to discuss valuation partnership distributions should be issues affecting family limited part­ reconsidered; and what is the proper nerships and other closely held self-employment tax treatment of entities. Ken Kingma, Chair of the individual LLC members. The final Corporation Committee, and Tony regulations were adopted despite JCT Ilardi, Chair of the Partnership staff concerns. Additional Congres­ Committee, moderated. sional action may be taken, possibly Mr. Dankoff explained the proce­ to confirm the regulations. dures an appraiser used to arrive at appropriate discounts. Mr. Trindell 3. Future Schedule. discussed the concerns the IRS has The Committee is planning a joint with valuation discounts that may program with the Corporation Com­ not be well supported. All agreed mittee in January or February to that no one discount is correct in all consider regulations. The time and circumstances. place will be announced.

2. Important Developments. On May 9, 1996, the Department of Report of the Practice Treasury proposed what may be the most significant partnership regula­ and Procedure tions in many years: the long Committee awaited "check-the-box" regulations. Eric M. Nemeth, Chairperson The proposed regulations became Raymond & Prokop, P.C. final in December, 1996. The old 2000 Town Center, Suite 2400 Kintner four corporate characteristic Southfield, Michigan 48075 classification tests -limited liabil­ (81 0) 357-301 0 ity, continuity of life, centralization of management and free transferability 1. Recent Developments. of interests - will no longer be The IRS has issued proposed regula­ relevant. tions (I -42-95) providing guidance on On November 7, 1996, Kenneth the "reasonable basis" standard Kies, Chief of Staff of the Joint under which taxpayers would not be Committee on Taxation, announced subject to the accuracy related penal­ that the JCT Staff is undertaking a ties. The regulations were published review of the proposed entity classifi­ on November 12th in the Federal cation and partnership income taxa­ Register. Written comments are to tion rules. The entity classification be received by February 10, 1997 are issues being reviewed include: the to be submitted to effects on the corporate tax base; CCDON:CORP:R(I-482-95), Room whether the S corporation rules 5226, Internal Revenue Service, POB should be modified if the "check-the­ 7604, Ben Franklin Station, Wash­ box" rules are adopted; whether the ington, D.C. 20044. changes may be made by regulations On November 1, 1996, the First or whether legislation may be Circuit Court of Appeals in United needed; implications for U.S. interna­ States v. Olbres ruled that while a tional competitiveness; and implica­ sentence in tax evasion cases is tions for fundamental tax reform. predicated on the finding as to the Other partnership issues being amount the government has proven considered include: minimization of to be evaded, the court in sentencing basis shifting on partnership distri­ is not precluded from considering a butions; whether nonrecognition on possible dower departure because of 8 --- Reports from the Michigan Tax Lawyer-4th Quarter 1996 Committees

the job loss to employees of a defen­ from 3:00 p.m. until 5:00 p.m. A dant. special announcement to committee The California Court of Appeals in members will be sent, however, all Talley v. Henriksen et al. has held members of the Taxation Section are that a cause of action for account cordially invited to attend. Reserva­ malpractice based on negligent tions can be made by contacting . preparation of income tax returns Tracy Lawyer, Raymond & Prokop, commences on the date of the issu­ P.C., (810) 357-3010. The cost is ance of the Notice of Deficiency from $20.00. the IRS. The Annual IRS/State Bar Liaison The United States District Court Meeting will be held on March 19, for the District of Southern New York 1997. As has been the tradition, in United States v. Tenzer, on Sep­ senior representatives from the IRS tember 10, 1996, dealt an unexpected Michigan District will be in atten­ blow to the IRS' voluntary disclosure dance. It is anticipated that the policy when it held that a tax attor­ Assistant District Director and ney/accountant who had a long various IRS division chiefs will history of delinquent filing was speak. In addition, we are expecting protected under the IRS' voluntary Mr. Stanley Krysa from the Depart­ disclosure policy as he filed his ment of Justice Criminal Tax Divi­ delinquent tax returns prior to being sion. A separate announcement to all notified of a pending criminal investi­ committee members will be sent out gation. after the first of the year with more specific information. 2. Future Activities. The next scheduled Practice and Procedure Committee Meeting will be Report of the State held on January 29, 1997 in Room 115 of the United States Courthouse, and Local Committee 211 W. Fort Street, Detroit, Michi­ Michele L. Halloran gan. The meeting will be a combined Howard & Howard, P.C. meeting with the Taxation Section of Phoenix Building, Ste. 500 the Federal Bar Association and the 222 Washington Square North Lansing, Ml 48933 Bankruptcy Section of the Federal (517) 485-1483 Bar Association. The meeting will feature a panel discussion with 1. Upcoming Activities. respect to the procedural and tax We are in the process of scheduling a effects of bankruptcy on delinquent meeting with Cheryl Ruppel of the tax returns and the tax ramifications Michigan Department of Treasury's of bankruptcy. The scheduled panel hearings and tax research section participants are Jackie Hotz of the and the new member of the United States Attorney's Office, Lynn Department's Hearing Referee staff Brimer, Special Assistant United to discuss rulemaking, to entertain States Attorney, and Senior Attorney any questions Committee members IRS District Counsel, Joan Fahlgren, may have about current or proposed Special Assistant United States departmental rules, and to introduce Attorney, a representative from the the new Hearing Referee. Look for IRS Special Procedures Section, and details concerning this meeting and Eric Nemeth of Raymond & Prokop, please plan to attend. P.C. The meeting is scheduled to last

9 Reports from the Committees Michigan Tax Lawyer-4th Quarter 1996

2. Recent State and Local Tax like to receive a copy of the Developments. Taxpayer Bill of Rights rules. • Property tax practitioners A. Legislative Developments: may be interested in rules Among bills currently before the recently published by the Legislature: Department of Consumer and • HB 5757 and 5758 - Industry Services for real Privatization of state income estate appraiser licensure, see tax returns R 339.23101 et seq. • HB 5760 and 5761 - Direct deposit of 1997 income tax C. MTT/Court of Claims/ and SBT refunds to financial Appellate Developments: institutions • Please refer to the State and • HB 5761- Implementation Local Tax Update Column in of a telephone filing (telefile) this publication for a summary program under the income of recent Michigan Tax Tribunal tax act and court decisions. • HB 5759- Elimination of • Cases to Watch: exemptions, deductions and credits for taxpayers who derive - Thiokol and Akzo -As of the date of this report was income from illegal activities prepared, no action yet by • HB 5778- Increase income the United States Supreme tax credit for community Court on the petition for foundation/homeless shelter/food writ of certiorari. kitchens/food banks - MagnoTek -The Michi­ • HB 6101 -Amend Tax gan Court of Appeals heard Tribunal Act to eliminate re­ oral argument in early quirement that motion to amend October, 1996; no decision as be filed to include subsequent of the date this report was tax year in exemption cases prepared. • HB 52254 - Amend General - Realtron -Both parties Property Tax Act to exempt have filed applications for personal property that is rented leave to appeal in the Michi­ to consumers gan Supreme Court. • SB 699-676; HB 5190-5198 - - (Send me information Various components of the about your case so that it renaissance zone legislation can be added to the "Cases to Watch" list.) B. Administrative • To foster a greater aware­ Developments: ness among Committee members • The department's Taxpayer about cases that have been Bill of Rights rules have been decided by the Court of Claims officially promulgated. Among or unpublished orders or deci­ other things, these rules set sions of the Michigan Tax Tribu­ forth the Department's interpre­ nal or Court of Appeals, please tation of the bases for waiver of forward copies of such cases to both the negligence and failure my attention so that they may to file/failure to pay penalties. be disseminated periodically to the Committee. 10 Please contact me if you would Feature Michigan Tax Lawyer-4th Quarter 1996 Article

Pension Simplification - Really! A Summary of Selected Pension Related Provisions in the Small Business Job Protection Act of 1996 By: David B. Walters pants beginning no later than the April 1st of the calendar year follow­ ,,.i This article presents a summary of ing the calendar year in which the selected provisions contained in the participant attained age 701/z. The Small Business Job Protection Act of same rule applied to IRA owners. 19961 (96 Act) that affect qualified Beginning in 1997, required distribu­ retirement plans. The 96 Act contains tions from qualified retirement plans many of the pension reform proposals need not commence to participants, that had been under consideration by other than 5% owners of the em­ Congress and represents the most ployer, until the Aprillst of the significant piece of pension legisla­ calendar year following the later of 1) tion since the Tax Reform Act of the calendar year in which the em­ 1986.2 The 96 Act also contains a ployee attains age 701/2 or 2) the The excise tax number of provisions which affect tax calendar year in which the employee will apply once exempt and governmental employers, retires. In the case of an IRA owner again to and other employee fringe benefits. or, in the case of a qualified retire­ distributions However, these provisions are beyond ment plan, a 5% owner of the em­ received after the scope of this article. This sum­ ployer, the pre-96 Act required mary highlights some of the most distribution rule described above will December31, significant changes. continue to apply. The 96 Act also 1999. allows employees who are currently Distribution of Benefits receiving required distributions but Recovery of Basis. who would otherwise be eligible for Amounts received as an annuity the relief provided under the new under a qualified retirement plan provisions, to suspend their required were subject to a complex set of rules distributions until they would have to for determining the portion of the commence distributions under the annuity payment which represented new rules. the taxpayer's investment, or basis, in the annuity.3 Generally, these Holiday from Excise Tax rules relied on a determination of the on Excess Distribution. life expectancy of the individual Individuals who received, in the receiving the annuity payments.4 aggregate, distributions from quali­ Effective for annuity contract pay­ fied retirement plans, tax sheltered ments commencing after November annuities and IRAs in excess of 30, 1996, the rules for making this certain threshold amounts6 were determination have been simplified. subject to a 15% excise tax on the Under the new method, the determi­ excess distribution. Commencing on nation of life expectancy is replaced January 1, 1997 and running through with a fixed period dependent on the December 31, 1999, the 15% excise annuitant's age when the annuity tax on excess distributions takes a payments commence. 5 holiday. The excise tax does not apply to distributions made during those Required Distributions. years. The excise tax will apply once Under pre-96 Act law, qualified again to distributions received after retirement plans were required to December 31, 1999. The corollary commence distributions to all partici- 15% excise tax on decedent's excess 11 Feature Articles Michigan Tax Lawyer-4th Quarter 1996

retirement accumulations will con­ interim testing. If the projections tinue to apply throughout the holiday indicated that the test was likely to period. Those individuals who had fail, the highly compensated employ­ made the excise tax grandfather ees having the highest deferral rates election are permitted to treat the could voluntarily reduce their defer­ distributions as coming from the rals. in an attempt to avoid the refund non-grandfathered portion first. of monies at a later date. The prob­ lem common to this method, and all Repeal of 5 Year of the other methods intended to Averaging Treatment. predict the outcome of the ADP\ACP Five year income averaging treat­ test, was the fact that the test results ment is repealed for distributions were not final until the year had occurring after December 31, 1999. ended. Therefore, there remained a Employers, Congress preserved the special 10 degree of uncertainty related to unless they year income averaging and capital passage of the test. elect otherwise, gains treatment for pre-1974 portion Beginning with the 1997 plan year, will have to use of the distribution for individuals employers, unless they elect other­ who reached age 50 before 1986. The wise, will have to use the prior year's the prior year's 96 Act provides that individuals who non-highly compensated employees' non-highly elect to be taxed under the special10 percentages in performing the compensated year income averaging and capital ADP\ACP test. This should make the employees' gains rule will not be eligible for 5 calculations involved in applying the percentages in year averaging in the interim. How­ test much easier. Additionally, the performing the ever, the Committee Reports indicate new rule should reduce 401(k) record that individuals who are eligible for keeping necessary to monitor em­ ADPIACP test. the special10 year income averaging ployee elections. The election to use and capital gains rule would not be the non-highly compensated employ­ able to elect 5 year averaging in the ees' current year percentages as the interim. benchmark against which the highly compensated employees' current Plan Administration and Testing deferrals are measured, once made, Simplification in can only be changed in accordance Contribution Testing. with as yet unissued, guidance by the Most 401(k) plans are subject to Internal Revenue Service. Therefore, ADP\ACP7 testing. These tests care must be taken in making the measure the permissible differences election. Additionally, given the between what highly compensated change in definition of highly com­ employees can defer based on what pensated employee and the repeal of the non-highly compensated individu­ family aggregation, as discussed als actually deferred in a given year. below, employers will want to ana­ If the differences are too great, then lyze their particular facts and cir­ certain steps must be taken to correct cumstances to determine which the disparity. Often the correction method of determining the non­ takes the form of returning some highly compensated employee's portion of amounts that the highly percentage best suits their situation. compensated employees had previ­ The 96 Act also made certain ously elected to defer into the plan. changes in the method of returning Employers seeking to avoid returning excess contributions made by the previously deferred amounts em­ highly compensated employees. ployed a number of different methods Under prior law, excess deferrals to predict the outcome of this test. were returned to the highly compen­ One common method was to do sated employees in the order of the 12 Feature Michigan Tax Lawyer-4th Quarter 1996 Articles their deferral percentages, beginning provide adequate retirement benefits with those with the highest deferral for all members of the family group percentages. This rule had the ten­ working in the business. Effective for dency of returning deferrals to the years beginning after December 31, "lower paid" highly compensated 1996, the family aggregation rules employees (e.g., employees making were repealed. between $70,000 and $90,000) while leaving deferrals of the "higher paid" Limitations on the Minimum highly compensated employees with Participation Requirements. maximum deferrals untouched. Under pre-96 Act law, plans had to Beginning in years after December meet a minimum participation re­ 31, 1996, the correction of the excess quirement in order to be considered The rule could deferrals will be made by returning tax qualified.11 This rule required be applied deferrals first to those highly compen­ that plans benefit the lesser of: separately to sated employees with the greatest 1) 50 employees of the employer, or different lines of dollar amount of elective deferrals. 2) 40% of all of employees of the employer. Comparable plans could business of the New Definition of Highly not be combined to satisfy this rule. employer, Compensated Employee. However, the rule could be applied provided that Another simplification enacted as separately to different lines of busi­ each line of part of the 96 Act is a new definition ness of the employer, provided that business had at of highly compensated employee. each line of business had at least 50 least 50 Under pre-96 Act law, in order to employees. After enactment, the determine whether an employee was scope of the minimum participation employees. "highly compensated" the employer rule has been greatly reduced. The would have to run the particular minimum participation rule now employee through a maze of four applies only to defined benefit plans. different tests, applying a series of Defined benefit plans will now fail special definitions and rules. Under the new minimum participation rule the new definition of highly compen­ only if the plan benefits fewer than sated employee, an individual will be the lesser of 1) 50 employees of the considered highly compensated if the employer, or 2) the greater of a) 40% individual: 1) was a 5% owner of the of all of employees of the employer, or employer during the current year or b) 2 employees (1 employee if there is immediately preceding year, or 2) for only 1 employee). Additionally, the the preceding year had compensation requirement that a line of business in excess of $80,000 (which will be have at least 50 employees does not indexed for inflation).8 The new law apply in determining whether a plan preserves the old "top paid group satisfies the minimum participation test"9, however, the "top paid group rule on a separate line of business test" now only applies if the employer basis.12 elects to have it apply. Effective Increase in 25% Repeal of Family Aggregation. of Compensation Limitation. Prior to the enactment of the 96 Act, The Internal Revenue Code places an certain members of the same family overall cap on the amount ofbenefits group were aggregated together and that can be credited to any employee treated as if they were a single em­ for a given year.13 For defined contri­ ployee. 1° Congress found that the bution plans, this "annual addition" family aggregation rules imposed limitation caps the allocation of undue restrictions on the ability of a contributions and forfeitures for family owned small business to employees making less than $120,000 13 Feature Articles Michigan Tax Lawyer-4th Quarter 1996 tl\ at 25% of their pay.14 For individuals designs which have the effect of making more than $120,000 the limit replacing the Salary Reduction is $30,000. For purposes of the 25% Simplified Employee Pension of pay limitation, salary reduction (SARSEP). These new plans will be contributions made by employees to available commencing January 1, 40 l(k) plans, cafeteria plans and 1997. The new Savings Incentive other similar arrangements were Match Plan for Employees (SIMPLE) disregarded. 15 Therefore, when can be adopted by employers who applying the 25% of pay test, employ- employ less than 100 employees This has the ees who had made significant salary earning at least $5,000 in compensa- reductions may have been limited in tion for the preceding year. The effect of an the amount of company contributions employer can not maintain any other increase in this allocated to them. For years begin- retirement plan. Employees will be limitation since ning after December 31, 1997, the 96 eligible to participate in the SIMPLE the test will be Act modifies this limitation by adding if they have received compensation calculated using back the salary reduction amounts during any two prior years in excess a larger base. made by a participant to the of $5,000 from the employer and are participant's pay. This has the effect reasonably expected to receive simi- of an increase in this limitation since lar compensation during the year.17 the test will be calculated using a The SIMPLE savings arrangement larger base. allows the employees to direct salary reductions to an individual retire- Repeal of Combined ment account (IRA). The salary Annual Addition Limit. reduction elections are limited to In addition to the annual addition $6,000 per year and are made in the limit for defined contribution plans; 60 day enrollment period before the there are separate limits for defined beginning of the year. The SIMPLE benefit plans. When an employer must allow employees to suspend • maintains both types of plans there is their elections during the year. The an overall combined limitation on the SIMPLE may, but is not required to, amount of contribution, forfeitures allow for other changes during the and benefits that are allocated or year. accrue on behalf of an employee The employer is required to satisfy covered under both plans.16 The test one of two contribution formulas. and record keeping requirements Under the matching contribution associated with this combined plan approach, the employer is required to limit was found by Congress to match the employee elective deferrals discourage the formation of defined on a dollar-for-dollar basis up to 3% benefit arrangements. The 96 Act of the employees compensation. repeals the combined plan limit for Special rules would allow the em- limitation years beginning after ployer to lower the match to 1% December 31, 1999. Repeal of the provided that certain notice require- combined plan limit should make ments are satisfied and that the defined benefit plans more attractive lower percentage was not elected to smaller service type organizations more frequently than 2 out of any 5 looking to maximize benefits and years. As an alternative to the increase deductions. matching contribution approach, the employer may elect to make a 2% of New Plan Designs compensation contribution on behalf SIMPLE Saving Arrangements of each eligible employee. 18 The and "Simple" 401(k) Plans. employer is required to notify the The 96 Act has created two new plan employee of its election prior to the 14 'i Feature Michigan Tax Lawyer-4th Quarter 1996 Articles

enrollment period described above. elective deferrals from 3% to 5% of All contributions to the SIMPLE IRA compensation.20 Additionally, the must be fully vested. matching contribution rate for any If a SIMPLE is adopted, the tax elective deferrals of the highly com­ rules related to IRAs are generally pensated employees cannot be applicable. The exception is an in­ greater than that for any non-highly creased additional tax on early compensated employee.21 Under an ,' ~ distributions from a SIMPLE. If a alternative matching contribution withdrawal occurs within the test, if the rate of matching contribu­ two year period beginning when the tions with respect to any rate of employee first participates in the elective deferrals is not equal to the SIMPLE, the employee will be sub­ percentages described above, the ject to a 25% additional tax on early matching contribution requirement withdrawals rather than the usual will be deemed to be satisfied if, first, If a SIMPLE is 10%. The employer maintaining a the rate of matching contributions SIMPLE will enjoy simplified report­ will not increase as deferrals increase adopted, the tax ing requirements and reduced fidu­ and, second, the aggregate amount of rules related to ciary liability exposure. matching contributions at such rate IRAsare "Simple" 401(k) plans follow the of elective deferrals at least equals generally same rules for SIMPLE Saving the aggregate amount of matching . applicable. Arrangements. The principal differ­ contributions the would be made if ence is that the "Simple" 401(k) plan matching contributions had satisfied will be deemed to have satisfied the the percentages described above. 22 ADP \ACP test and will not be sub­ Under the alternative to the ject to the top heavy rules. However, matching contribution test, the these plans will remain subject to the employer can make a fully vested 3% other qualified plan rules. of compensation contribution on behalf of each non-highly compen­ Design Based Safe Harbor sated employee eligible to participate 401 (k) Plans. in the plan (regardless of whether the Beginning on January 1, 1999, a employee makes elective deferrals).23 401 (k) plan will be able to be de­ Special safe harbors are available signed to take advantage of a safe for the ACP test as well. Generally, harbor so as to avoid testing for the design based safe harbor for the ADP\ACP. In order to take advan­ ADP test will have to apply and the tage of the safe harbor the employer plan must satisfy a special limitation will have to meet one of two contribu­ on matching contributions. Under the tion tests and provide eligible em­ special limitation on matching contri­ ployees with a notice advising the butions, the matching contribution participant of his rights and obliga­ cannot be made in excess of 6% of tions under the plan. 19 The notice compensation, second, the rate of must be given prior to the beginning matching contributions cannot in­ oftheyear. crease as the rate of employee contri­ Under the safe harbor matching butions and elective deferrals in­ contribution design, the employer creases, and, third, the matching will have to make fully vested match­ contribution with respect to any ing contributions on behalf of each highly compensated employee at any non-highly compensated employee rate of employee contribution or equal to 1) 100% of the employee's elective deferral is not greater than elective deferrals up to 3% of compen­ that of any non-highly compensated sation, and 2) 50% of the employee's employee. 24 15 Feature Articles Michigan Tax Lawyer-4th Quarter 1996

Summary The 96 Act simplifies a number of DAVID B. WALTERS is the head of the the rules affecting qualified retire­ Employee Benefits practice group at Cox, ment arrangements and creates Hodgman & Giarmarco and specializes in employee benefits and related tax issues. planning opportunities to take ad­ He is an active member of the American vantage of these new rules. If Con­ and Michigan Bar Associations' Employee gress was correct in its assessment of Benefit Committees. Mr. Walters received the changes, plan sponsors can his Bachelors of Science degree from expect to experience a significant Central Michigan University and his law reduction in the burdens in maintain­ degree from the University of Detroit. ing these arrangements.

ENDNOTES ------1. P.L. 104-188. 2. P.L. 99-514. 3. Code Section 72(d). 4. Publication 939 which is published by the Internal Revenue Service to aid taxpayers in making the calculation contains over 60 pages of tables used to determine the amount. 5. Code Section 72(d)(1)(8). 6. For 1996, $155,000 in annual distributions or $775,000 for lump-sum distributions. 7. The Average Deferral Percentage (ADP) measures pre-tax contributions and the Average Contribution Percentage (ACP) measures after tax and matching contributions. 8. The new definition is generally effective for years beginning after December 31, 1996. However, in determining the group of employees who are considered highly compensated employees for 1997, the 96 Act is treated as being in effect for 1996. P.L. 104-188 §1431 (b). 9. The top paid group test treated as highly compensated employees individuals whose compensation was in excess of $66,000 for 1996 and was within the top 20% of the active employees based on compensation paid during the plan year. 10. The family aggregation rule required the compensation and any contribution or benefit of a family member of a 5% owner of the employer or of 1 of the top 10 highly compensated employees by compensation to be aggregated with that of the 5% owner or the highly compensated employee in the top 10 employees by compensation. An individual was considered a family member if he or she was the individual's spouse, lineal ascendant or descendant, or spouses of a lineal ascendant or descendent of the employee. I.R.C. §414(q)(6). A similar rule existed for purposes of determining the compensation limit for benefit and deduction purposes. I.R.C. §§401 (a)(17)and 404(1). 11. I.R.C. §401 (a)(26). 12. I.R.C. §401 (a)(26)(G). 13. I.R.C. §415. 14. I.R.C. §415(c)(1)(B). 15. SeeTreas. Reg. §§1.415-2(d)(3) and 1.415-2(d)(10). 16. I.R.C. §415(e). 17. Certain employees may be excluded from the SIMPLE IRA. Those employee who are those described in I.R.C. §410(b)(3): employees covered under a collective bargaining agreement, certain airline pilots and nonresident aliens who earned no income form the employer form sources within the US. The term employee does include self-employed individuals. 18. If the employer elects the 2% contribution approach, the contribution is required for all eligible employees, including employees who do not elect to make contributions to the SIMPLE. I.A. C. §408(p)(2)(B)(i). 19. I.R.C. §401 (k)(12)(D). 20. I.R.C. §401 (k)(12)(B)(i). 21. I.R.C. §401 (k)(12)(B)(ii). 22. I.R.C. §401 (k)(12)(B)(iii). See the Committee Reports with respect to P.L. 104-288 for an example of the alternative matching contribution test. 23. I.R.C. §401 (k)(12)(C). 24. I.A. C. §§401 (m)(11)(A) and (B). 16 Feature Michigan Tax Lawyer-4th Quarter 1996 Articles

1996 Legislative Improvements for S Corporations

By: Dean A. Rocheleau share of the S corporation's income will be subject to the tax on unrelated During the 1990's, there have been business income as will any gain on several legislative attempts to liber­ the sale of the S corporation stock. alize restrictions on the use of S Any dividends received by these corporations. With the proliferation shareholders (from C corporation of limited liability companies on the E& P) will reduce the basis of their national scene, modifications to the 3 S corporation stock. The legislation S corporation laws became even more Third, the restrictions on trust essential to assure the continued ownership of stock are relaxed. contains viability of this passthrough taxation Under prior rules, only grantor numerous entity. trusts, voting trusts, certain testa­ revisions that Important changes to the laws mentary trusts, and qualified simplify and governing S corporations arrived as Subchapter S trusts (which must liberalize the part of the Small Business Job Pro­ generally have only a single benefi­ taxation of S tection Act of 1996 that was enacted ciary) may be S corporation share­ on August 20, 1996. The legislation holders. The new law permits certain corporations. contains numerous revisions that multiple beneficiary trusts to be S simplify and liberalize the taxation of corporation shareholders if the trust S corporations. The majority of these opts to be treated as an "electing amendments are effective for tax small business trust."4 years beginning after December 31, An electing small business trust 1996; changes that have different pays tax on S corporation income at . effective dates are noted below. the highest tax rate applicable to Although S corporations retain some trusts (currently 39.6% on ordinary significant tax and structuring differ­ income and 28% on long-term capital ences when compared with other pass gains), even if the income is distrib­ through entities, the changes do uted to trust beneficiaries.5 The trust make S corporations a more attrac­ is not required to distribute all tive business entity. income currently. All of the benefi­ ciaries of the trust must be eligible Eligible Shareholders S corporation shareholders, or tax­ To make S corporations more usable, exempt charities that hold only there are several liberalizations to contingent future interests (e.g., the shareholder eligibility rules. charitable remainder trusts).6 Each First, the number of permissible potential income beneficiary is S corporation shareholders has counted when applying the 75 share­ increased from 35 shareholders to holder limitation. 7 Interests in the 75 shareholders.1 trust may only be acquired by gift or Second, the new legislation allows bequest, n·ot by purchase. 8 qualified retirement plans and IRC Planning consideration: The Section 501(c)(3) tax-exempt organi­ electing small business trust can zations to be S corporation sharehold­ provide a convenient mechanism to ers for tax years beginning after retain S corporation distributions or December 31, 1997.2 These organiza­ to discretionarily spread S corpora­ tions will be treated as one share­ tion income among family members. holder for the purpose of applying the This benefit, however, may be offset 75 shareholder limitation. Their by the fact that all income attribut- 17 Feature Articles Michigan Tax Lawyer-4th Quarter 1996

''' able to the trust is taxed at the and passed through to the sharehold- ~ highest tax rate that applies to ers of the parent company.12 Any trusts. QSSS's debt that is issued to the Finally, a grantor trust that holds parent corporation's shareholders can S corporation stock will be permitted be utilized when determining the to hold the stock for a two year period amount of loss that can be deducted following the death of the grantor, by the parent corporation's share- S corporations regardless of whether the trust holders. 13 The amount of loss that are now corpus is includible in the decedent's can be deducted, however, may be gross estate. 9 The post-death owner- limited by the at-risk or passive permitted to ship period was previously limited to activity loss rules. own SO% or 60 days unless the entire trust's An existing corporation that makes more of a C corpus was included in the decedent's a QSSS election is deemed to have corporation ... gross estate. liquidated under Sections 332 and 337 immediately before the election Member of Affiliated Group is effective. If the subsidiary corpora- S corporations are now permitted to tion was ever a C corporation, the own 80% or more of a C corporation built-in gains tax and the LIFO without disqualifying its S election recapture tax may apply.14 If a because it is no longer prevented subsidiary ceases to be a QSSS, it from being a member of an affiliated must wait 5 years before reelecting group. 1° C corporations are allowed QSSS status. 15 to file consolidated returns with Planning consideration: De- affiliated C corporations, but are still pending on the liability protection not allowed to file consolidated required, it may be better to convert returns with S corporations. Divi- identically owned brother-sister S dends received from an 80% or corporations to parent-subsidiary greater owned subsidiary that are corporations to eliminate any inter- • attributable· to the active trade or company transactions and to reduce business of the subsidiary are not the number of annual income tax considered passive investment in- returns required. come to the S corporation parent. 11 Planning consideration: The S Corporation Elections tax imposed for excess passive invest- Effective for tax years beginning ment income and the rule that termi- after December 31, 1982, the Internal nates an S election when passive Revenue Service ("IRS") is given the investment income exceeds 25% of authority to treat invalid S elections gross receipts for three consecutive as valid and to treat late S elections years can be avoided by increasing as timely filed. 16 The IRS previously ownership in an active C corporation only had the authority to waive subsidiary to at least 80% if the inadvertent terminations. The IRS is subsidiary pays dividends. directed to apply the same reasonable An S corporation is now allowed to cause standards that it has applied in own a "qualified Subchapter S sub- the past to inadvertent terminations sidiary" ("QSSS") if the corporation when dealing with invalid or un- is 100% owned by the S corporation timely elections. 17 parent and the appropriate election Planning consideration: Since is made. The subsidiary also must the new provision is retroactive, satisfy the general S corporation corporations that have previously eligibility requirements. In this case, made invalid or late elections may be the income and losses of both compa- able to utilize this provision to get nies are combined in one tax return relief from the double taxation im- 18 • Feature Michigan Tax Lawyer-4th Quarter 1996 Articles

posed on C corporations if the years an IRS audit of a terminated S are not closed by the statute of limi­ corporation's tax returns.20 tations. Planning consideration: This As was permitted in other tax acts period is important because during that substantially revised the S this period distributions are treated corporation rules, corporations that as made by an S corporation. If the terminated S elections before August shareholder has sufficient basis in 20, 1996, do not have to wait the the stock, these distributions are normal5-year period before re­ nontaxable. electing S corporation status. 18 S corporation losses suspended under the at-risk rules are now Terminations carried forward to the post-termina­ The election to allocate S corporation tion transition period. This rule income or loss between shareholders previously existed only for losses who buy and sell their stock during a suspended by the tax basis rule. 21 /fanS tax year using the "cut-off' basis will Planning consideration: A corporation shareholder may contribute addi­ only have to be approved by the redeems stock, shareholders who are affected by the tional capital during the post-termi­ transaction. Previously, all of the nation transition period in order to all shareholders shareholders of the corporation at claim losses that will otherwise be are affected by any time during the year had to unavailable to the shareholder of the ·this transaction consent to the use of this method or former S corporation. and are required the per share, per day rule was In a technical clarification, the new to consent to applied. If an S corporation redeems law provides that in the year that a the cut-off stock, all shareholders are affected by trust or estate that owns S corpora­ this transaction and are required to tion stock terminates, a pro-rata method. consent to the cut-off method.19 share of the S corporation income or Planning consideration: This loss items will be allocated to the provision makes it easier to allocate trust or estate for its final year.22 income or loss among parties who exchange stock. If more income was Distributions earned during a particular period of The order in which loss items and the year, tax savings may be obtained distributions reduce an S corporation by using the method that assigns the shareholder's basis in the S corpora­ I most income to the taxpayer in the tion stock determines whether the q) lowest individual tax bracket. current year loss is deductible or the I Planning consideration: It is distribution is taxable in a year in still advisable to negotiate which which there is insufficient basis to method should be used to allocate absorb both of these items. Under income or loss when the stock trans­ the new law, the stock basis reduc­ action is being negotiated. If the cut­ tion rules are revised to provide that off method is decided upon, obtaining a shareholder's basis is reduced for all necessary shareholder consents distributions prior to losses incurred when the sales documents are being in the same year. 23 signed will avoid trying to obtain This ordering rule allows taxpay­ these consents later when the income ers to receive more nontaxable distri­ tax return of the S corporation is butions but to deduct a lesser amount being prepared. oflosses currently. The unallowable The post-termination transition losses, however, can be carried for­ period is expanded to include the ward to future years when there 120-day period that begins on the would be sufficient basis to deduct date of a determination pursuant to these losses. In addition, the accu- 19 Feature Articles Michigan Tax Lawyer-4th Quarter 1996

mulated adjustments account election under IRC Section 338 to (".AAA:') will not be adjusted for "net obtain a step-up in basis in the negative adjustments" from opera­ subsidiary's assets.29 However, if this tions before testing whether distribu­ election is made, gain must be recog­ tions are being made tax-free from nized on the deemed sale of the theAAA.24 subsidiary's assets. Planning consideration: This change converts capital gain distribu­ Miscellaneous Modifications tions under the prior law to sus­ There are several other modifications pended losses due to basis limitations to the taxation of S corporations Certain financial under the new law for S corporations made by this Act. The rule in IRC institutions that without C corporation earnings and Section 1237 that generally permits do not use the profits ("E&P"). For S corporations a noncorporate taxpayer to claim bad debt reserve with C corporation E&P, a greater capital gain treatment in connection method of portion of distributions will be tax with the subdivision and sale of free coming from the AAA before unimproved real estate that has been accounting are such distributions will come from C owned for at least 5 years is now now eligible to corporation E&P which are taxable extended to S corporations. 30 makeanS as dividends. The tax basis of S corporation corporation Earnings and profits from S corpo­ shares owned by an individual who election. ration years prior to 1983 are elimi­ dies after August 20, 1996, may no nated. Thus, only E&P from C longer be stepped-up to reflect the corporation years will constitute E&P value of unrecognized income and in an S corporation.25 gain attributable to items classified as "income in respect of a decedent" S Corporations as Shareholders ("IRD"). The shareholder is treated An S corporation, in its capacity as a as directly owning a pro-rata share shareholder of another corporation, of each IRD item.31 This provision will be treated as a corporation, equalizes how owners of S corpora­ rather than as an individual. 26 The tions and partnerships treat this new rule regarding the treatment of issue. S corporations as shareholders does Certain financial institutions that not change the current method for do not use the bad debt reserve determining the taxable income and method of accounting are now eligible separately stated items of the S to make an S corporation election. 32 corporation. For example, the S Also, financial institutions are per­ corporation cannot take advantage mitted to hold "straight debt" for the of the dividends received deduction purpose of satisfying the one class for distributions received from sub­ of stock safe harbor rule. 33 sidiaries.27 The TEFRA consolidated audit Planning consideration: This procedures for S corporations and provision allows an S corporation their shareholders, that required that that owns another corporation to all audit items of an S corporation be make a tax-free liquidation of the determined at the corporate level, are subsidiary under IRC Section 332.28 repealed. However, modified consis­ The taxpayer should be aware that tency rules were enacted that require a subsequent disposition of the shareholders to treat Subchapter S subsidiary's assets may result in the items consistently with the S imposition of the built-in gains tax. corporation's treatment, unless the Planning consideration: The S inconsistency is noted in a statement corporation is allowed to make an to the IRS.3434 20 Feature Michigan Tax Lawyer-4th Quarter 1996 Articles (( Conclusion tions in a manner to minimize their The Small Business Job Protection overall income tax burden. Act of 1996 did liberalize the rules concerning the taxation of S corpora­ Dean A. Rocheleau is a tax partner with tions. The amendments make S the largest Michigan-based certified public corporations a bit more flexible and accounting and management consulting usable for business transactions. In firm of Plante & Moran, LLP. Mr. addition, several aggravating restric­ Rocheleau is a 1980 graduate of The tions and technical glitches were University of Michigan Law School and is a Certified Public Accountant. He is a eliminated. member of the firm's Real Estate Special­ Hopefully, the revised S corpora­ ization Group and frequently consults with tion rules will make these pass clients regarding the most advantageous through taxation entities more useful form of business entity. He is an active when dealing with your clients and in member of the State Bar of Michigan structuring their business transac- Taxation and Real Property Law Sections.

------ENDNOTES

1. Internal Revenue Code of 1986 ("IRC") Section 1361 (b)(1)(A) 2. IRC Section 1361 (c)(7) 3. IRC Section 512(e) 4. IRC Section 1361 (e) 5. IRC Section 641 (d) 6. IRC Section 1361(e)(1)(A)(i) 7. IRC Section1361 (c)(2)(B)(v) 8. IRC Section 1361 (e)(1)(A)(ii) 9. IRC Sections 1361 (c)(2)(A)(ii) and (iii) 10. Small Business Job Protection Act of 1996 ("Acf') Section 1308(a) 11. IRC Section 1362(d)(3)(E) 12.1RC Section 1361(b){3) 13. Act Section 1308 House Committee Report 14. ld 15. IRC Section 1361 (b)(3)(D) 16. IRC Section 1362(b)(5) 17. Act Section 1305 House Committee Report 18. Act Section 1317(b) and related House Committee Reports 19. IRC Section 1377(a)(2) 20. IRC Section 1377(b) 21. IRC Section 1366(d)(3)(D) 22. IRC Section 1366(a)(1) 23. IRC Section 1368(d) 24. IRC Section 1368(e)(1)(C) 25. Act Section 1311 (a) 26. Act Section 1310 27. Act Section 1310 House Committee Report 28. ld 29. ld 30. IRC Section 1237(a) 31. IRC Section 1367(b)(4) 32. IRC Section 1361 (b)(2)(A) 33. IRC Section 1361 (c)(5)(B)(iii) 34. IRC Section 6037(c) 21 State and Local Tax Update Michigan Tax Lawyer-4th Quarter 1996

Tax: Single Business Tax Tax: Single Business Tax Recent Case: Zenith Data Systems v Dep't of Case: Syntex Laboratories v Michi­ Cases Treasury, 218 Mich App 742; 555 gan Dep't of Treasury, MTT Docket NW2d 264 (1996) No. 97852 (9/9/96) Court/Tribunal: Michigan Court Court/Tribunal: Michigan Tax of Appeals Tribunal Judge: Hoekstra/Kelly/Graves Judge: Shinkle Issue: Whether payments plaintiffs Issue: Whether the Michigan De­ received for software modified and partment of Treasury could, conso­ distributed pursuant to licensing nant with the equal protection agreements constitute royalties provisions of the United States and subject to subtraction in ascertaining Michigan Constitutions, as well as plaintiffs' single business tax base? the uniformity clause of the Michigan Outcome: The payments qualify as Constitution, subject the petitioner to royalties under expansive definitions SBT for tax years 1982 and 1983 addressed by governing case law, as using the jurisdictional standard the transactions in issue were in the announced in Gillette on March 1, nature of licensing agreements giving 1993? rise to royalty payments. A different Outcome: The Department did not result is not dictated by the fact that purposefully discriminate against the payors were the end users of the Syntex; no equal protection violation software. arises despite the inequities disclosed by this situation. Tax: Procedural Issues/MTT Jurisdiction Tax: Single Business Tax Case: Cracchiolo v Dep't of Treasury, Case: Dearborn Financial Services, Unpublished opinion per curiam of Inc v Michigan Dep't of Treasury, the Court of Appeals; Docket No. MTT Docket No. 221510 (5/16/96) 183955 (8/30/96) Court/Tribunal: Michigan Tax Court/Tribunal: Michigan Court Tribunal of Appeals Judge: Dean Judge: Kelly/Reilly/Martlew Issue: Whether officer compensation Issue: Did the taxpayer's ongoing of a for-profit subsidiary must be settlement negotiations with the aggregated with that of its tax ex­ Department of Treasury toll the empt credit union parent for pur­ running of the statutory thirty-five poses of determining eligibility for an day period for filing an appeal of SBT small business credit? (what appears to have been) a final Outcome: The compensation of the assessment? for-profit subsidiary need not be Outcome: The thirty-five day period aggregated with its exempt parent in provided for under MCL 205.22; MSA computing the small business credit. 7 .657(22) for appeals to the Michigan Tax Tribunal was tolled under cir­ Tax: Property Tax cumstances in which the taxpayer Case: Holland Home v City of Grand demonstrated that the Department of Rapids, Mich ; NW2d Treasury had requested additional (1996) -- information in response to the Court/Tribunal: Michigan Court of taxpayer's communications, thus Appeals holding out the possibility that it Judge: Doctoroff/Hood/N eff would be willing to reconsider its Issue: Are certain independent care original position. apartments for the aged owned and operated by a nonprofit association 22 State and Local f Michigan Tax Lawyer-4th Quarter 1996 Tax Update entitled to a charitable exemption and did the MTT premise its decision under the General Property Tax Act? on competent, material and substan­ Outcome: The Court of Appeals tial evidence? held, inter alia, that petitioner was Outcome: The MTT's factual find­ not a charitable institution insofar as ings were sufficiently detailed, and the independent care apartments its legal conclusions adequately were concerned because the contract presented; assertions relative to the it entered into with the residents did weight to be accorded evidence pre­ not constitute a gift for purposes of sented by the parties are outside the the charitable exemption. scope of the Court of Appeals' review.

Tax: Property Tax Case: Comfort Inn v City of Sault PATRICK R. VAN TIFLIN, MICHELE L. Sainte Marie, Unpublished opinion HALLORAN and KIM D. CROOKS, per curiam of the Court of Appeals; members of the law firm of Howard & Howard Attorneys, P.C. in Lansing, Docket No. 181297 (10/15/96) prepared the state tax case summaries Court/Tribunal: Michigan Court in this issue. of Appeals Judge: Kelly/Hoekstra/O'Connell Issue: Did the MTT erroneously rely on evidence submitted in violation of the so-called "ten day rule," and did it make adequate findings of fact? Outcome: The MTT's reliance upon written evidentiary materials fur­ nished in a post-hearing brief submit­ ted by a party to a small claims proceeding violated the "ten day rule" set forth in 1981 AACS, R 205.1642(2); the MTT's decision was reversed as not based on competent, material, and substantial evidence on the whole record. Moreover, the findings of fact and conclusions of law outlined in the judgment issued by l the small claims hearing referee "are l so nonspecific and lacking in detail" that the Court could not verify what reasoning the MTT relied on in achieving its cash value determina­ tion.

Tax: Property Tax ( Case: Karmanos v City of Orchard Village, Unpublished opinion per curiam of the Court of Appeals; Docket Nos. 180417 et al (8/2/96) I Court/Tribunal: Michigan Court of Appeals Judge: White/Smolenski/Lamb Issue: Were the MTT's findings of fact and conclusions of law adequate, 23 Short Subjects Michigan Tax Lawyer-4th Quarter 1996

I Taxpayer Bill of Rights 2 By: James H. Navis Ombudsman. The TA is appointed by the Commissioner of IRS and is ' On July 30, 1996, the Taxpayer Bill compensated as a position reporting of Rights 2 ('TBR2'~, which had directly to the Deputy Commissioner. been unanimously passed by both Houses of Congress, was signed by 0 TheTA's functions include (i) the President. Generally, taxpayers resolving problems within the IRS, gained expanded legal and proce- (ii) identifying areas in which taxpay- dural rights in dealing with the ers have problems dealing with the Internal Revenue Service ("IRS'~. IRS, (iii) proposing changes to admin- Under revenue offset provisions, tax istrative practices to mitigate such exempt organizations become subject problems, and (iv) identifying legisla- to some new or expanded penalties tive changes appropriate to mitigate and legal obligations. A summary of such problems. the more important provisions of TBR2 follows. 0 TheTA is granted authority to issue a Taxpayer Assistance Order Offers-in-Compromise on an expanded basis to take any 0 If the cumulative amount of tax, action permitted by law if a taxpayer interest and penalty compromised is is suffering or about to suffer a less than $50,000, an offer-in-compro- significant hardship. mise can be accepted at the local level without approval by IRS Chief Coun- 0 TheTA reports to Congress twice sel. Prior to TBR2, the local level annually concerning activities in the approval ceiling was only $500. prior year and objectives for the subsequent year. Installment Agreements 0 In most cases, the IRS must give a Collection Issues taxpayer 30-days notice before termi- 0 A public notice of tax lien can be nating, modifying or altering an withdrawn and property taken under installment agreement (a procedure levy can be returned prior to full already adopted in late 1994 by Reg. payment of the liability for various §301.6159-1). reasons including the making of an installment agreement by the tax- 0 The IRS is required to establish payer. procedures allowing taxpayers to request an independent administra- 0 Levy exemptions for personal tive review of the termination of an property and tools of the trade are installment agreement. increased to $2,500 and $1,650 respectively. 0 The IRS can now release tax liens based on a taxpayer's promise to pay 0 The 10-day interest-free period through an installment agreement. allowed in demand notices is ex- tended to 21 calendar days if the Taxpayer Advocate/Taxpayer amount in demand is less ,that Assistance Order $100,000, and 10 business days if the 0 The office of the Taxpayer amount is $100,000 or more. Advocate ('TA'~ has been created to replace the office of Taxpayer 24 • Short Michigan Tax Lawyer-4th Quarter 1996 Subjects

Abatement of Interest Trust Fund Recovery Penalty and Penalties 0 A person is subject to assessment 0 Interest may now be abated due to of the trust fund recovery penalty managerial acts resulting in unrea- (Code §6672) only if a written notice sonable error or delay. Prior law is mailed at least 60 days before a addressed only ministerial acts. notice and demand is made.

0 Tax Court has been granted juris- 0 A person determined to be a re- diction to review the IRS's failure to sponsible person may make a written abate interest. request to the IRS and receive disclo- sure of the names of all other persons 0 The IRS may waive penalties for that the IRS has determined to be failure to deposit payroll taxes for responsible persons with respect to smaller taxpayers if the failure the same liability. occurred in the employer's first quarter of liability and the employ- 0 Each person paying a trust fund ment tax return was filed on time. recovery penalty may recover a proportionate amount from other Litigation Costs and Issues responsible persons. 0 A taxpayers opportunity to collect attorney fees· is improved by (i) 0 The trust fund recovery penalty putting the burden of proof on the will no longer be imposed on volun- IRS to prove it was substantially teer, unpaid members of a board of justified in its position after a tax- trustees or directors of a tax-exempt ,'(~ I payer substantially prevails; (ii) organizations if specified limits exist \... raising the statutory attorney fee with respect to the member's respon- reimbursement rate to $110/hour sibilities. from $75/hour (iii) allowing the award of attorney fees generally in Joint Returns declaratory judgement actions 0 Taxpayers who file a separate I against the IRS, and (iv) deeming return may now change to a joint I irrelevant whether a taxpayer re- return without contemporaneously I fused to extend the statute oflimita- paying the full joint tax liability. I tions on assessment in determining if I the taxpayer has exhausted all 0 If taxpayers filing a joint return I ~~ administrative remedies, a prerequi- are no longer married or sharing the I site to a claim for attorney fees. same household, the IRS must dis- close, to a requesting taxpayer, 0 The damages ceiling has been collection activities against the other raised from $100,000 to $1 million for taxpayer. an Internal Revenue Code ("Code'~ l §7 433 cause of action which is Miscellaneous Other "! granted to taxpayers damaged by the Pro-Taxpayer Provisions reckless or intentional disregard of 0 Private delivery services may be provisions of the Code or regulations designated by the IRS as qualifying in the collection of federal taxes. for the timely-mailed-is-timely-filed l Such an award can be reduced at the rule. I court's discretion if all administrative I remedies are not exhausted. The 0 An annual notice of tax delin- exhaustion of all administrative quency must be issued to taxpayers ( \ remedies had previously been a subject to a collectible tax liability. I ' mandatory prerequisite. ·'* 25 Short Subjects Michigan Tax Lawyer-4th Quarter 1996

0 Payee statements (certain informa­ of $10,000 or 5 percent of gross tion returns) must include the tele­ receipts. phone number of the payee. For more information on TBR2, 0 The IRS must make reasonable contact James H. Novis at efforts to notify a taxpayer if a tax (313) 256-7940. payment cannot be associated with a balance owed by the taxpayer. James H. Novis practices generally in the 0 Retroactive regulations are greatly area of federal, state and local taxation. restricted unless authorized by He has extensive experience in corporate tax planning, mergers and federal tax audit statute. representation. In addition, Mr. Novis works extensively on state and local tax 0 Third-party summons are re­ representation of corporations and stricted and safeguarded. individuals with an emphasis on Michigan single business tax and sales/use tax planning and litigation. He is a past Offsetting Revenue Provisions chairperson of the State and Local Tax 0 Intermediate Sanctions - An excise Committee of the Michigan Bar Associa­ tax penalty may now be imposed as tion Taxation Section, and currently is a an intermediate sanction (i.e., sanc­ member of the Taxation Section Council. tion short of revocation of exemption) when certain exempt (Code §501(c)(3) Mr. Novis received a Bachelor of Arts and 501(c)(4)) organizations engage degree in Accounting from Michigan State in an "excess benefit transaction." University in 1976 and a Juris Doctor degree from the University of Michigan in An excess benefit transaction gener­ 1979. He is certified as a Public Accoun­ ally is one in which a "disqualified tant in Michigan. Mr. Novis is a member of person" (insider) receives a benefit the Michigan Association of Certified from a non-fair-market transaction. Public Accountants and the Tax Sections The excise tax is generally imposed of the American Institute of Certified Public Accounts and the State Bar of Michigan. on the insiders benefiting from the transaction.

0 The private inurement prohibition in Code §501(c) is extended to organi­ zations described in Code §501(c)(4) (civic leagues, social welfare organi­ zations and certain employee chari­ table trusts).

0 The Form 990 filed by Code §501(c)(3) organizations is expanded to disclose additional information including lobbying payments, politi­ cal expenditures and excess benefit transactions.

0 The public's right to inspect an exempt organization's Form 990 is expanded, and the penalty for failure to include the required information is increased to $20 per day for each failure, with a maximum of the lesser 26