Company’s Tuition Payment Was Not Deductible

 

Let me give you a fact pattern and you tell me whether there is a tax deduction.

·      You own a company.

·      A young man is dating your daughter.

·      The young man wants to take a computer course at Northwestern University. If it turns out he has both aptitude and interest, perhaps he can maintain the company’s website, at least for a while.

·      The company pays for the course.

Let me up the ante: is there a tax deduction to you and tax-free income to the young man?

You are thinking: maybe.

For example, my firm pays for my expenses when I attend professional seminars or conferences. Then again, my CPA license carries a continuing education requirement, so the seminars and conferences are necessary for me keep my gig as a practicing CPA.

Sounds like a working condition fringe benefit. The “working condition” qualifier means that the employer is paying for something that the employee could deduct (at least before the tax Code nixed miscellaneous itemized deductions) had the employee paid for it.

Alternatively, there are companies who pay (or help pay) tuition for employees who go to college. There are hitches to this educational assistance arrangement, though: it has to be available to everybody, cannot discriminate in favor of highly-compensated employees, and so on.

I am not seeing a tax deduction down either path. Why? Notice that a fringe benefit or assistance program requires an employer:employee relationship. You have no such relationship with the young man.

I suppose you could make him an employee.

No, you say.  Dating your daughter does not put him on the payroll.

You circle back to the possibility that he could take care of your website, at least for a while. That costs money to do. If he did so for free, or at a substantially reduced rate, the cost of that course could be a drop in the bucket compared to what you would have paid a webmaster.

OK. I am certain that the tuition is more than $600, so you pay for the course, send him a 1099 and he will have to settle-up while he files his tax return. On the upside, he should get a tax credit for taking that course.

Nope, you say. You want to deduct it as a business expense but not issue a W-2 or a 1099. None of that.

And that is how Robert and Swanette Ward appeared before the Tax Court. Clearly the IRS disagreed with the tax outcome they wanted.

Here is the Court:

While [] has provided services to Sherwin [CTG: Mrs Ward’s company] free of charge that would likely have cost Sherwin more than the amount of the tuition, we nonetheless find that the petitioners have not established that Sherwin is entitled to deduct the tuition.”

Why not?

Mr [] was not an employee of Sherwin.”

Yes, but what of the possibility that he would help with the website?

The Wards did not have an agreement with Mr [] that he would perform any services in exchange for the tuition payment.”

What, do you want a written contract or something?

Sherwin paid the tuition without any expectation of a return and thus did not have a business purpose for the payment. The tuition was a personal expense, and Sherwin is not entitled to deduct it.”

Why is the Court is circling the wagons on this one?

Folks, sometimes tax law occurs in the folds and the corners. There is something I have not yet told you that might explain the Court’s obstinacy.

That young man eventually married your daughter.

The Court saw a personal expense all the way.

I get it.

There is a distinction in the Code between deductible business expenses and nondeductible personal expenses. One could reason that showing some business angle or benefit – however abstract or hypothetical – can make the expense deductible, even if the primary factor for incurring the expense was personal. One would be wrong, but one could reason.

Our case this time was Sherwin Community Painters Inc v Commissioner, T.C. Memo 2022-19.

New Tax On Colleges

I read that Harvard estimates that a change from the Tax Cut and Jobs Act will cost approximately $38 million.

Harvard is referring to the “endowment tax” on colleges and universities.

Have you heard about this?

Let us set up the issue by discussing the taxation of private foundations.

The “best” type of charity (at least tax-wise) is the 501(c)(3). These are the March of Dimes and United Ways, and they are publicly-supported by a broad group of interested donors. In general, this means a large number of individually modest donations. Mind you, there can be an outsized donation (or several), but there are mathematical tests to restrict a limited number of donors from providing a disproportionate amount of the charity’s support.

Then we get to private foundations. In general, this means that a limited number of donors provide a disproportionate amount of support. Say that CTG comes into big bucks and sets up the CTG Family Foundation. There is little question that one donor provided a lopsided amount of donations: that donor would be me. In its classic version, I would be the only one funding the CTG Family Foundation.

There can be issues when a foundation and a person are essentially alter egos, and the Code provides serious penalties should that someone forget the difference. Foundations have enhanced information reporting requirements, and they also pay a 2% income tax on their net investment income. The 2% tax is supposedly to pay for the increased IRS attention given foundations compared to publicly-supported charities.

The Tax Cut and Jobs Act created a new tax – the 1.4% tax on endowment income – and it targets an unexpected group: colleges and universities that enroll at least 500 tuition-paying students and have endowment assets of at least $500,000 per student.

Let me think this through. I went to graduate school at the University of Missouri at Columbia. Its student body is approximately 30,000. UMC would need an endowment of at least $15 billion to come within reach of this tax.

I have two immediate thoughts:

(1)  Tax practitioners commonly refer to the 2% tax on foundations as inconsequential, because … well, it is. My fee might be more than the tax; and

(2)  I am having a difficult time getting worked up over somebody who has $15 billion in the bank.

The endowment tax is designed to hit a minimal number of colleges and universities – probably less than 50 in total. It is expected to provide approximately $200 million in new taxes annually, not an insignificant sum but not budget-balancing either. As a consequence, there has been speculation as to its provenance and purpose.

With this Congress has again introduced brain-numbing complexity to the tax Code. For example, the tax is supposed to exclude endowment funds used to carry-on the school’s tax-exempt purpose.  Folks, it does not take 30-plus years of tax practice to argue that everything a school does furthers its tax-exempt purpose, meaning there is nothing left to tax. Clearly that is not the intent of the law, and tax practitioners are breathlessly awaiting the IRS to provide near-Torahic definitions of terms in this area.  

The criticism of the tax has already begun. Here is Harvard referring to its $40 billion endowment:

“We remain opposed to this damaging and unprecedented tax that will not only reduce resources available to colleges and universities to promote excellence in teaching and to sustain innovative research…”

Breathe deeply there, Winchester. Explain again why any school with $40 billion in investments even charges tuition.

Which brings us to Berea College in central Kentucky, south of Lexington. The school has an endowment of approximately $700,000 per student, so it meets the first requirement of the tax. The initial draft of the tax bill would have pulled Berea into its dragnet, but there was bipartisan agreement that the second requirement refer to “tuition-paying” students.

So what?

Berea College does not charge tuition.

Memphian Appeals An Offer In Compromise

I am looking at a case dealing with an offer in compromise.

You know these from the late-night television and radio advertisements to “settle your IRS debts for pennies on the dollar.”

Yeah, right.

If it were so easy, I would use it myself.

Don’t get me wrong, there are fact patterns where you probably could settle for pennies on the dollar. Unfortunately, these fact patterns tend to involve permanent injury, loss of earning power, a debilitating illness or something similar.

I will just pay my dollar on the dollar, thank you.

What caught my attention is that the case involves a Memphian and was tried in Memphis, Tennessee. I have an interest in Memphis these days.

Let’s set it up.

Taxpayer filed tax returns for 2012 through 2014 but did not pay the full amount of tax due, which was about $40 grand. A big chunk of tax was for 2014, when he withdrew almost $90,000 from his retirement account.

Why did he do this?

He was sending his kids to a private high school.

I get it. I cannot tell you how many times I have heard from Memphians that one simply cannot send their kids to a public school, unless one lives in the suburbs.

In December, 2016 he received a letter from the IRS that they were going to lien.

He put the brakes on that by requesting a Collection Due Process (CDP) hearing.

Well done.

In January he sent an installment agreement to the IRS requesting payments of $300 per month until both sides could arrive at a settlement.

The following month (February) he submitted an Offer in Compromise (OIC) for $1,500.

That went to a hearing in April. The IRS transferred the OIC request to the appropriate unit.

In late August the IRS denied the OIC.

Let’s talk about an OIC for a moment. I am thinking about a full post (or two) about OICs in the future, but let’s hit a couple of high spots right now.

The IRS takes a look at a couple of things when reviewing an OIC:

(1)  Your net worth, defined as the value of assets less any liabilities thereon.

There are certain arcane rules. For example, the IRS will probably allow you to use 80% of an asset’s otherwise fair market value. The reason is that it is considered a forced sale, meaning that you might accept a lower price than otherwise.

(2) Your earning power

This is where those late-night IRS settlement mills dwell. Have no earning power and near-zero net worth and you get pennies on the dollar.

There are twists here. For example, the IRS is probably not going to spot you a monthly Lexus payment. That is not how it works. The IRS provides tables for certain categories of living expenses, and that is the number you use when calculating how much you have “left over” to pay the IRS.

Let’s elaborate what the above means. If the IRS spots you a lower amount than you are actually spending, then the IRS sees an ability to pay that you do not have in real life.

You can ask for more than the table amount, but you have to document and advocate your cause. It is far from automatic, and, in fact, I would say that the IRS is more inclined to turn you down than to approve any increase from the table amount. I had a client several years ago who was denied veterinary bills and prescriptions for his dog, for example.

The IRS workup showed that the taxpayer had monthly income of approximately $12,700 and allowable monthly expenses of approximately $11,000. That left approximately $1,700 monthly, and the IRS wanted to get paid.

But there was one expense that made up the largest share of the IRS difference. Can you guess what it was?

It was the private school.

The IRS will not spot you private school tuition, unless there is something about your child’s needs that requires that private school. A special school for the deaf, for example, would likely qualify.

That is not what we have here.

The IRS saw an ability to pay that the taxpayer did not have in real life.

Taxpayer proposed a one-time OIC of $5,000.

The IRS said No.

They went back and forth and agreed to $200 per month, eventually increasing to $700 per month.

COMMENT: This is not uncommon for OICs. The IRS will often give you a year to rework your finances, with the expectation that you will then be able to pay more.

The taxpayer then requested abatement of interest and penalties, which was denied. Generally, those requests require the taxpayer to have a clean filing history, and that was not the case here.

The mess ended up in Tax Court.

Being a court, there are rules. The rule at play here is that the Court was limited to reviewing whether the IRS exercised abuse of discretion.

Folks, that is a nearly impossible standard to meet.

Let me give you one fact: he had net assets worth approximately $43 thousand.

His tax was approximately $40 thousand.

Let’s set aside the 80% thing. It would not take a lot of earning power for the IRS to expect him to be able to repay the full $40 grand.

He lost. There really was no surprise, as least to me.

I do have a question, though.

His monthly income was closer to $13 grand than to $12 grand.

It fair to say that is well above the average American monthly household income.

Private school is expensive, granted.

But where was the money going?

Our case this time was Love v Commissioner, T.C. Memo 2019-92.

Tax Provisions Expiring on December 31, 2013

We have been reviewing tax provisions scheduled to expire at the end of this year, December 31, 2013. This is an unhappy, contemporary development in federal taxation. Taxpayers in recent years have waited on Congress to come to the rescue, even if that rescue was in January and retroactive.  I am not optimistic for any breakthrough this year. The Senate nuclear-option fiasco last week tells you that the parties will not be sending Christmas cards across the aisle this year.

 (1)  Mortgage debt relief

The tax code considers the forgiveness of debt to be similar to you receiving a paycheck. Your wealth has gone up (in this case, because your debts have gone down), so the IRS considers this income to you. There has been an exception for debt discharged on your principal residence.

 (2)  Deduction for mortgage insurance premiums

You buy this insurance when you put down less than 20% on the purchase of a house.

 (3)  Teachers classroom expenses

This is the $250 deduction for unreimbursed teacher school supplies.

(4) IRA distributions to Charity

 If you are age 70 ½, the IRS requires you to take “minimum required distributions” from your IRA (but not from your Roth IRA). This provision lets you donate that distribution to charity without counting it as income. You don’t get the charitable deduction, of course, but it can stop you from being pushed into tax phase-outs because of the increase to your gross income.

(5)  State sales taxes

If you live in a state without income taxes (Florida and Texas, for example), this provision allows you to deduct sales taxes in lieu of income taxes.

 (6)  Research & development tax credit  

 It seems that this credit has been “extended” as long as I have been in practice. It will again, if only because some very powerful interests (think Apple and Intel) will make it so.

 (7)  Credit for construction of new energy efficient homes

This $2,000 credit goes to the contractor for building your energy-efficient new home. Granted, it has not meant as much in recent years, except perhaps to the cash-strapped contractor.

(8)  Credit for energy efficient home improvements

This is the $500 credit for doors, windows, insulation and exterior doors. There are other, less recognizable, categories, such as a biomass stove.

 (9) Expensing of depreciable assets

Also referred to as the Section 179 deduction, it is scheduled to drop to $25,000 next year from $500,000 this year.

 (10)     50 percent depreciation

You are allowed (for a brief remaining time) to immediately deduct 50% of a wide range of business assets, other than real estate.

 (11)     Work opportunity tax credit

Many people associate this credit with hiring welfare recipients, but it also covers military veterans. The credit can be as much as $9,600 per employee.

 (12)     Depreciation for certain leasehold, restaurant and retail  improvements

 Depreciation on real estate is brutal: the tax Code requires one to depreciate over 39 years. This break allows a business or restaurant (think Applebee’s or Kroger) to depreciate their build-out over 15 rather than 39 years.

(13)     Deduction for qualified tuition and related expenses

This is the deduction of up to $4,000 (not to be confused with the tax credit!) for you or your child attending college.

 (14)     Child tax credit

This is the credit for a child under age 17. It is worth $1,000 this year. It drops to $500 in 2014.

This is just stuff that is going away. We haven’t talked about new tax stuff, such as the increase in the maximum individual tax rate, the new capital gains rate, the 3.8% Obama tax on investments, the 0.9% Obama tax on your W-2, the disallowance of your itemized deductions, the disallowance of your personal exemptions, the ObamaCare individual mandate penalty for 2014, the new dollar limits on your FSA, and so on and so on.