AICPA Workload Compression Relief Bill Introduced
(AICPA Workload Compression Relief Bill Introduced
On May 17, 1995, Congressman Clay Shaw (R-Fla) introduced the Small Business Tax Flexibility Act of 1995, H.R. 1661. The bill, designed by the AICPA Tax Division Task Force on Workload Compression, was briefly outlined in the May/June issue of the Tax and Regulatory Bulletin and is covered here more specifically. The proposal allows any S corporation or partnership to elect any fiscal year, and is a significant improvement over the current fiscal year approach, which itself is a morass of complexity. The bill is not a model of simplicity. But any complexities (and there are a number), arise from two significant considerations: (1) the need for revenue neutrality, and (2) anti-abuse provisions to prevent taxpayers from "gaming the system."
The bill would create a new IRC sec. 444 (redesignating the current section as section 445). The new section 444 would permit any S corporation or partnership to elect any fiscal year. Personal service corporations, or PSCs, whose fiscal years are also restricted under a different part of the current statutory framework (section 280H), will require a different approach to their issues and are not covered under H.R. 1661.
A business entity that elects under the proposed new section 444 would no longer be required to make a deposit with the government to reimburse it for lost revenue from the tax deferral occasioned by the fiscal year election. Instead, the electing entity would make quarterly estimated tax payments on behalf of its owners. The rate used to determine the tax estimates is normally 34%, but if the entity is a "high average income entity" (HAIE), the rate is 39.6%. An HAIE is an entity that flows through to its two-percent owners an average of $250,000 of "applicable income" during the immediately preceding 12-month taxable year (base year). Also, any partnership with $10,000,000 of applicable income during the base year is an HAIE. An entity with no base year uses the 34% rate.
Applicable income would be determined using the normal rules pertaining to S corporations and partnerships with some exceptions. For instance, entity-level charitable deductions reduce applicable income but partnership guaranteed payments do not.
Entity-level Estimated Tax Rules
An entity electing under proposed section 444 generally would need to make quarterly estimated tax payments. However, if those payments do not exceed $5,000 during the year, no estimates are required. Commonly controlled entities are treated as a single entity for purposes of determining whether the $5,000 de minimis rule applies.
Common control would occur when the same person or persons actually or constructively own 50% or more of the entities. The section 267(c) rules are used to determine constructive ownership for both S corporations and partnerships. Unlike the IRC sec. 1563 definition of controlled group (used for purposes of allocating corporate tax brackets and other corporate tax features), the proposed section 444 leaves open the issue of determining common ownership when the common owners have varying interests.
The estimated tax payments would be determined using one of three methods: the 110% method, the 100% method, and the annualized income method. The 110% method is the default method. A quarterly payment under the 110% method equals one-quarter of 110% of the entity's base year "applicable income" times 34% (39.6% for HAIEs). Quarterly payments under the 100% method equal one-quarter of 100% of the entity's current year applicable income times 34% or 39.6%. This method only applies if elected by the time the first installment for the year is made. Finally, quarterly payments under the annualized income method equal one-quarter of the tax at the appropriate rate times the annualized income for the entity reduced by any installments made previously during the year. The annualized income method may be elected at any quarter, but the election continues through the end of the year.
If the proposal becomes law, estimated tax payments would be due on the fifteenth day of the 3rd, 5th, 8th and 12th months of the taxable year. Note that these estimates follow the corporate rather than the personal estimated tax due dates. The discrepancy was dictated by the cash-flow needs of revenue neutrality.
Special Short-year Rules
An additional estimated tax payment would be required for the short-year created by the election. This extra estimate is computed using the applicable income for the short period or the 110% method applied to the base year. Also, unless the entity is new, if there is a net operating loss for the short-year, it must be spread over the short-year and the two succeeding taxable years.
A new section 35 would be added to the tax code to handle the flow through of estimated taxes paid by the entity under section 444. At the end of the year, the estimated taxes paid by the entity would be passed through to the owners based on their allocable share of "applicable income."
Other issues addressed in the proposal include:
oHow to determine estimates if an electing S corporation was a C corporation during the base year.
oEntities in tiered structures are not permitted to elect fiscal years under the proposal unless all the tiered entities elect the same fiscal year.
oIn the event the entity fails to pay the estimated taxes, there is a penalty under a newly proposed section 6654A.
