Bankruptcy filings, both personal and business, increased by 16.2% in the twelve-month period ending June 30, 2024. Business bankruptcies saw a significant rise of 40.3%, increasing from 15,724 to 22,060 cases. Non-business bankruptcies also grew, reaching 464,553, up from 403,000 the previous year.

One of the most common tax issues faced by debtors during bankruptcy is the recognition of cancellation-of-debt (COD) income. This occurs when a debt is discharged for less than the amount owed, requiring the debtor to recognize the difference as taxable income. While this concept is straightforward in theory, its application can be complex, especially in bankruptcy scenarios. The tax consequences vary significantly depending on factors such as whether the debt is recourse or nonrecourse.

The general rule is that COD income is taxable, but several exceptions and exclusions exist under the tax law. The most relevant for debtors in bankruptcy are the exclusions provided under Section 108(a)(1)(A) for bankrupt taxpayers and Section 108(a)(1)(B) for insolvent taxpayers. These provisions allow debtors to exclude COD income from their gross income under certain conditions.

Insolvency is determined by comparing the fair market value of the debtor's assets to their liabilities immediately before the debt discharge. If a debtor is insolvent, they may exclude COD income, but only to the extent of their insolvency. For bankrupt taxpayers, all COD income can be excluded if the discharge occurs under a Title 11 bankruptcy proceeding. However, these exclusions come with the requirement to reduce certain tax attributes, such as net operating losses and property basis, as a form of deferred tax recognition.

Taxpayers have the option to elect a different order in reducing their tax attributes, which requires careful planning to optimize the tax benefits. Understanding the implications of these exclusions and the associated attribute reductions is crucial for effective tax planning, particularly in times of economic uncertainty when debt restructurings are common.

Overall, the rules surrounding COD income and its exclusions are intricate, requiring a deep understanding of tax law to navigate effectively. Affected taxpayers must be vigilant in learning and understanding these tax rules, as the proper application of exclusions can significantly influence their financial outcomes during bankruptcy. Careful attention to the details of these complex rules is essential during debt workouts and restructurings to ensure that the financial benefits are maximized and potential tax liabilities are minimized.

The political landscape in the United States has recently witnessed significant developments, including President Biden's abrupt withdrawal from the presidential race, the Democratic leaders' selection of Kamala Harris as his replacement, and an assassination attempt on former President Trump. As Harris emerges as the most likely Democratic nominee, it is crucial to understand her stance on key issues, particularly taxation. While we await her official campaign promises, analyzing her past proposals and comments provides valuable insights into her potential tax policies. Here’s a summary of what we know so far and the key questions surrounding her tax stance.

Corporate Tax Rate

The Tax Cuts and Jobs Act of 2017 reduced the corporate tax rate from 35% to 21%. Harris has previously suggested returning the rate to 35%. The direction she chooses could significantly impact the business community and economic landscape.

Introduction of Financial Transaction Tax

During her 2020 presidential campaign, Harris proposed a financial transaction tax (FTT) to fund healthcare coverage. This included taxes on stock, bond, and derivative trades. Although it is uncertain if she will reintroduce this idea, it highlights her approach to leveraging taxes for broad social programs.

Harris’ Other Historical Tax Proposals

Harris has proposed various tax measures in the past, which provide a glimpse into her potential policy directions:

• Top Marginal Income Tax Rate: Increase top marginal tax rate for individuals to 39.6% from 34%.
• Income-Based Premium: A 4% tax on households making over $100,000 for Medicare for All (including all undocumented migrants).
• Repeal of Long Term Capital Gains Tax Rate: Raise rates to align with ordinary income tax rates. Appeal the current preferred long term capital gains tax rate of 20%.
• Estate Tax: Expansion of the current estate tax.
• Financial Transaction Tax: 0.2% on stock trades, 0.1% on bond trades, and 0.002% on derivative transactions.

Kamala Harris’s tax policy platform is anticipated to largely reflect her past proposals.  As more details emerge, it will be essential to monitor how her policies evolve and their implications for businesses and individuals.

Stay informed and prepared as the political landscape shifts.

California Senate Bill 167, signed into law on June 27, 2024, introduces tax changes aimed at addressing the 2024-2025 budget shortfall of $27.6 billion and the projected $28.4 billion deficit for 2025-2026. This budget shortfall is largely due to two significant measures: Starting January 1, 2024, California became the first state to offer health insurance to all undocumented immigrants through Medi-Cal, California’s version of the federal Medicaid program for low-income individuals, regardless of age. Additionally, Governor Gavin Newsom signed a suite of bills to address the homelessness crisis and enhance California’s response to people suffering from mental health issues on the streets, as part of his $22 billion housing affordability and homelessness package.

Senate Bill 167 suspends net operating losses (NOLs) from January 1, 2024, to January 1, 2027, for both corporate and personal income taxes, with exemptions for taxpayers with net business income or modified adjusted income below $1 million. The existing 20-year carryforward period for NOLs is extended by up to three years if the losses cannot be used due to the suspension.

Additionally, Senate Bill 167 limits the use of business credits to $5 million annually from January 1, 2024, to January 1, 2027. This limit applies to both the Corporation and Personal Income Tax laws, though certain personal income tax credits and the low-income housing credit are excluded. The carryover periods for these credits are extended by the number of years they are disallowed.

Senate Bill 175, pending signature, provides relief for businesses affected by the measures in Senate Bill 167. It offers the potential for an early sunset of the NOL suspension and credit limitation if the Director of Finance determines by May 14, 2025, or 2026, that the General Fund money is sufficient without these revenue measures.

서비스 산업에서 팁은 종사자들의 소득의 상당 부분을 차지한다. 레스토랑과 바에서 일하는 서버와 바텐더는 소득의 50-70%를 팁에서 얻으며, 호텔 직원인 벨보이와 하우스키퍼는 약 10-20%를, 발레 파킹 직원과 스파 직원 등은 20-40%의 수입을 팁으로 받는다.

2024년 기준으로 서비스 산업에는 약 1,680만 명의 사람들이 고용되어 있으며, 수백만 명이 팁에 의존하고 있다. 여기에는 250만 명의 웨이터와 웨이트리스, 거의 50만 명의 바텐더가 포함된다. 1965년부터 IRS는 팁을 과세 대상으로 삼아, 직원들이 이를 소득으로 보고하고 고용주가 세금을 원천 징수하도록 요구해 왔다.

최근 공화당의 유력 대선 후보인 도널드 트럼프 전 대통령은 2024년 6월 8일 네바다에서 열린 집회에서, 당선될 경우 서비스 산업 종사자들의 팁 소득을 비과세로 전환하는 연방 법률 변경을 약속했다. 이러한 변화는 서비스 업에 종사하는 많은 사람들에게 세금 부담에서 벗어나도록 도와줄 수 있으며, 물가 상승으로 인한 경제적 어려움을 완화시킬 수 있을 것으로 예상된다. 트럼프가 다시 백악관에 입성할지 여부는 아직 알 수 없지만, 만약 그렇게 된다면 2017년 세금 감면에 포함된 많은 세금 규정들이 연장될 것으로 예상된다. 또한, 경제를 활성화하기 위해 많은 다른 세금 인센티브들이 도입될 것으로 보인다.

하지만·위 공약은 트럼프의 백악관 입성과 공화당의 상·하원석 다수 확보가 필요하기에 일각에서는 위 공약의 이행 가능성 여부에 대한 의구심이 일고 있다. 게다가, 세금 법률에 대한 유일한 권한은 의회가 가지고 있기 때문에 트럼프는 줄어든 세수의 균형을 맞추기 위한 보완 조항을 도입해야 할 것이다.

In the hospitality industry, tips form a significant part of workers' income, with servers and bartenders in restaurants and bars earning 50-70% of their income from tips. Hotel staff, such as bellhops and housekeepers, receive a smaller portion, around 10-20%, while other roles like valet attendants and spa staff see tips contributing 20-40%.

As of 2024, the hospitality sector employs about 16.8 million people in the U.S., with millions relying on tips, including 2.5 million waiters and waitresses and nearly half a million bartenders. Since 1965, the IRS has taxed tips, requiring employees to report them as income and employers to withhold taxes.

Recently, former President Donald Trump, a presumptive presidential candidate of the Republican Party, promised during a rally in Nevada on June 8, 2024, to change federal laws to exempt tip income from taxes for hospitality workers if elected. This potential change could relieve many in the sector from tax burdens and mitigate economic hardships from rising prices. While it is too soon to assume that Trump will reclaim the White House, if he does, taxpayers can expect to see many of the tax provisions included in the 2017 tax cuts extended. Additionally, many other tax incentives would likely be introduced to revitalize the economy.

However, some are skeptical that such a promise would be fulfilled unless Trump reclaims the White House and the Republicans secure a majority in both the Senate and the House.  Additionally, Trump would need to introduce offsetting provisions to balance the budget, as Congress holds the sole authority over tax legislation.

A recent Tax Court ruling in Soroban Capital Partners Op, et al v. Commissioner, 161 T.C. No. 12, Nov. 28, 2023 examined if a limited partner's share of partnership profits is exempt from self-employment tax under Sec. 1402(a)(13). This provision generally excludes limited partners' distributive shares from self-employment income, except for guaranteed payments for services rendered.

The court emphasized the need to analyze the partner’s role and function within the partnership to determine eligibility for this tax exclusion. Historically, under state law, limited partners lose their limited liability if they control the partnership's business. The Revised Uniform Limited Partnership Act (RULPA) of 1976 outlined activities that do not constitute control, suggesting that limited partners who avoid managerial roles should qualify for the tax exemption.

Past cases involving LLPs and PLLCs have influenced the interpretation, often focusing on partners' activities rather than their control over the business. The Tax Court's decisions in Renkemeyer, Campbell & Weaver, LLP v Commissioner, 136 T.C. 137, 2011 and Castigliola v. Commissioner (T.C. Memo. 2017-62) show a preference for examining the extent of partners' participation in business operations to determine tax liability.

The IRS issued a proposed regulation in 1997 outlining conditions under which an individual would not be treated as a limited partner, including personal liability, authority to contract, or participation in business for more than 500 hours annually. Though not finalized, these guidelines suggest avoiding excessive control or contractual authority to maintain limited partner status.

In summary, limited partners must avoid significant control or excessive participation in the partnership's daily operations to qualify for the self-employment tax exclusion under Sec. 1402(a)(13). This ongoing legal interpretation necessitates careful review and potential adjustments to partnership agreements to ensure compliance and tax benefits.

The economic downturn has resulted in a significant decrease in profits for many businesses. This sudden financial strain has made it increasingly difficult for businesses to deduct interest expenses due to the limitations imposed by Section 163(j) of the Internal Revenue Code. In this challenging environment, businesses must explore strategic measures to optimize their tax positions and maintain financial stability. One such measure is adopting an accounting method change to capitalize interest expenditures into inventory costs. This approach can effectively convert interest expenses, which are subject to Section 163(j) limitations, into costs of goods sold (COGS), which are not subject to these limitations.

Section 163(j) limits the deduction of business interest expenses to the sum of business interest income, 30% of adjusted taxable income (ATI), and floor plan financing interest. Due to the economic downturn, many businesses are experiencing lower ATI, which in turn reduces the allowable interest deduction. Consequently, a significant portion of interest expenses may become disallowed, further exacerbating financial challenges.

Capitalizing interest expenditures involves adding the interest costs incurred during the production of inventory to the cost basis of that inventory. This process aligns with the Uniform Capitalization (UNICAP) rules under Section 263A of the Internal Revenue Code, read in combination with Sections 263(a) and 266. By capitalizing interest costs, businesses can transform interest expenses subject to Section 163(j) limitations into COGS, which are deductible when the inventory is sold and are not subject to the same limitations.

Capitalized interest is not considered interest for Section 163(j) purposes and thus avoids disallowance. This enables businesses to fully utilize their interest expenses as part of COGS. Aligning interest costs with the period in which inventory is sold can smooth taxable income, potentially lowering tax liabilities during periods of reduced profitability. Furthermore, capitalizing interest can help increase the foreign-derived intangible income (FDII) deduction.

Businesses should evaluate their eligibility to capitalize interest under Section 263A. Conducting financial modeling to assess the impact of capitalizing interest on taxable income and overall tax position is essential. Consulting with tax advisors to understand the regulatory requirements and implications of changing the accounting method is crucial. The formal change can be implemented by filing Form 3115 (Application for Change in Accounting Method) with the IRS and obtaining their approval.

In the face of an economic downturn, businesses must proactively explore strategies to navigate the challenges posed by Section 163(j) limitations. Capitalizing interest expenditures into inventory costs offers a viable solution to convert interest expenses subject to disallowance into deductible COGS. By adopting this accounting method change, businesses can optimize their tax positions and improve cash flow. Given the complexities involved, it is crucial to conduct thorough financial modeling and consult with tax advisors to ensure a smooth and compliant transition. Businesses interested in exploring this strategy should consult with their tax advisors.

The U.S. Treasury Department on May 11, 2024, released the “Green Book,” which is the Treasury’s “General Explanations of the Administration’s Fiscal Year 2025 Revenue Proposals.” This 256-page document details the tax proposals in the Biden Administration’s FY 2025 budget, also released and transmitted to Congress.

These proposals, as explained in the Green Book, aim to increase and reform corporate taxation and raise individual taxes to “reduce the deficit by cracking down on fraud, cutting wasteful spending, and making the wealthy and corporations pay their fair share.” Here are some key proposals included in the Green Book:

• Increase the corporate rate to 28% from the current 21%
• Increase the CAMT rate to 21% from the current 15%
• Increase the global intangible low-taxed income (GILTI) rate to 21% from the current 10.5%
• Repeal the foreign-derived intangible income (FDII) deduction, which was enacted by Trump to provide a tax break for businesses in export and effectively reduced the corporate tax rate to 13.125% for qualifying taxpayers
• Quadruple the stock buyback tax from the current 1%
• Deny the deduction for all compensation over $1 million for all C corporations
• Eliminate tax-free treatment of like-kind exchanges
• Strengthen the limitation on losses for noncorporate taxpayers
• Increase the top individual income tax rate from the current 37% to 39.6%
• Increase the Medicare rate and net investment income tax rate to 5% from the current 3.8%
• Apply the net investment income tax to pass-through business income
• Impose a 25% minimum tax on those with wealth exceeding $100 million
• Tax capital gains at ordinary rates for households with over $1 million in earnings
• Tax unrealized gains at death

The Biden administration proposes these tax hikes to control the current inflation crisis and promote “equality” and “equity.” In theory, raising taxes can potentially ease inflation and reallocate wealth to those in need, but it can also slow down the economy, resulting in higher unemployment and reduced economic growth, and decrease everyday people’s buying power—a situation known as “stagflation.”

We expect strong pushback from Republicans on the proposal, and it is likely that the proposal will face significant challenges in Congress. Therefore, enactment of these proposals is unlikely. However, taxpayers should keep an eye on developments.

임금의 일부를 스톡 옵션으로 지급 받는 개인들은 소득세가 없는 주로 이주할 경우의 관련 세금 영향을 고민한다. 이는 캘리포니아 주민에게 특히 중요한데, 이 뉴스레터는 캘리포니아 주민이 다른 주로 이주하였을 때 스톡 옵션에 대한 소득세를 피할 수 있는지에 대해 탐구한다.

핵심은 캘리포니아 주민이었을 때 받은 스톡 옵션을 소득세가 없는 주로 이주한 후 행사하였을 때에 소득세 회피 가능 여부이다.

캘리포니아 세무 규정은 거주자에겐 전 세계 소득에 대해 과세하는 반면 비거주자에겐 캘리포니아에서 발생한 소득에만 과세를 한다. 스톡 옵션에 경우, 캘리포니아는 스톡 옵션을 얻기 위한 서비스 또는 노동을 행한 장소를 기준으로 소득을 배분하는 “source rule”을 사용한다.

Gene and Joann Clark 의 항소 사례(2001-SBE-006)에서 the California State Board of Equalization (이하 캘리포니아 주세위원회) 는 조세를 위한 스톡 옵션 소득 분배를 다루었다. Gene Clark 은 캘리포니아에서 고용 되었을 때 스톡 옵션을 받았고, 다른 주로 이주한 후 해당 옵션을 행사하였다.

위원회는 스톡 옵션의 귀속 기간 동안 캘리포니아에서 근무한 시간의 비율에 따라 관련 소득을 과세키로 결정하였다. 판결은 구체적으로 스톡 옵션 부여일부터 귀속 또는 행사일까지의 기간 중 근무한 시간을 기준으로 소득이 배분되어야 함을 확정하였다. 이는 캘리포니아에서 근무한 시간에 해당하는 스톡 옵션 소득에 대해서만 과세함을 의미한다.

캘리포니아 주민이었을 때 받은 스톡 옵션은 해당 주에서 행한 서비스에 대한 보상으로 간주한다. 즉, 소득세가 없는 주로 이주하여 캘리포니아 비거주자로 변경이 되더라도 해당 스톡 옵션 행사에 대한 소득은 캘리포니아 소득세에 대상이 되며, 이는 부여일부터 귀속 또는 행사일까지의 기간 중 캘리포니아에서 근무한 시간의 비율을 기준으로 계산된다.

소득세가 없는 주로 이주하는 것은 캘리포니아 주민이었을 때 부여받은 스톡 옵션에 대한 캘리포니아 소득세를 면제시키지 못한다. 캘리포니아는 주에서 행한 서비스에 따라 소득을 과세한다. 핵심 결정 요인은 행사 시점의 거주지가 아닌 소득의 출처지이다.

Many individuals who receive stock options as part of their compensation package ponder the tax implications if they relocate to a state with no income tax. This issue is particularly relevant for those who were California residents when they received their stock options. This newsletter explores whether moving out of California can help you avoid California income tax on these stock options.

The core question is: Can a former California resident avoid California state income tax on stock options received while a resident but exercised after moving to a state with no income tax? 

California's tax regulations stipulate that residents are taxed on worldwide income, while non-residents are taxed on income derived from California sources. For stock options, California uses a source rule, which allocates income based on where the services that earned the options were performed.

In the case of the Appeal of Gene and Joann Clark (2001-SBE-006), the California State Board of Equalization addressed the issue of how to apportion income from stock options for tax purposes. Gene Clark received stock options while he was employed in California. He later exercised these options after moving out of state.

The Board determined that the income from the stock options was subject to California tax based on the proportion of time Clark had worked in California during the vesting period of the options. Specifically, the ruling confirmed that the income should be apportioned according to the period of service performed in California relative to the total period from the grant date to the vesting or exercise date. This meant that only the portion of the stock option income attributable to the time he worked in California would be subject to California income tax.

If you received stock options while a resident of California, these options are considered compensation for services rendered during your employment in the state. Upon moving to a no-income-tax state, you change your residency status to non-resident. However, the income from exercising these stock options will still be subject to California tax based on the proportion of time you were employed in California relative to the total time from the grant date to the vesting or exercise date.

Relocating to a no-income-tax state does not exempt you from California income tax on stock options received while you were a California resident. California will tax the portion of the stock option income that corresponds to services performed in the state. The key determinant is the source of the income, not your residency at the time of exercise.