Countdown to tax season 2009: the landscape has changed since the terrain of tax season was last travelled. Here are nine of the most important changes Ohio CPAs need to know before navigating this year's tax season.

• Author: Kadish, Matthew F.
• Position: Cover story

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This article highlights the federal tax changes for 2008. I presented a more in-depth look at the changes during the Federal Tax Update presented at the OSCPA's Ohio Accounting Show in Cleveland. A video of the presentation is available in the OSCPA Online Library at www.ohioscpa.com. For $35, you can also take an exam for one hour of tax CPE credit. A complete outline is also available at http://khwlaw.com/speeches.htm.

1. S CORPORATIONS

   1. NEW PENALTY FOR FAILURE TO FILE S CORPORATION RETURN

      Until recently, there was no penalty for failure to file an S corporation return (Form 1120-S), which is strange compared with the long-standing penalty for failure to file a partnership return (Form 1065). The Mortgage Relief Act of 2007 includes a penalty, effective for returns required to be filed after Dec. 20, 2007. The new law imposes a monthly penalty for failure to file an S corporation return, or failure to provide information required to be shown on such a return. The amount of penalty is $85 times the number of shareholders in the corporation during any time in the month, times the number of months the failure continues (to a maximum of 12). Example: Scorp Inc. has 50 shareholders, and files its 2007 Form 1120-S more than a year late. The penalty would be $4,250 ($85 x 50) times 12 (maximum countable months) = $51,000. Note: There does not appear to be any exception for inactive corporations.

   2. PREVIOUSLY C SUBCHAPTER S CORPORATION AND KEY-MAN INSURANCE

      Where an S corporation was previously a C corporation and still has subchapter C earnings and profits (E&P), distributions from the corporation first draw out the E&P as a taxable dividend. Care should be taken before allowing such a corporation to own life insurance, such as key-man insurance. As illustrated in Rev. Rul. 2008-42, although the corporation would generally receive the insurance proceeds income-tax free, absent special planning, getting those proceeds out of the corporation may draw out the E&P, essentially converting tax-free money into a taxable dividend. In such a case, consider holding the insurance outside the corporation.

   3. CORRECTING NON-PRO RATA DISTRIBUTIONS FROM S CORPORATION

      In PLR 200802002, an S corporation made disproportionate distributions, but corrected them by the end of the taxable year. The concern was whether the failure to distribute to all shareholders pro-rata at the same time caused the corporation to lose its S status, by creating a second class of stock. The IRS ruled that the disproportionate distributions did not create a second class of stock, and the corporation's S status was therefore not terminated. Note: private letter rulings cannot be relied on by taxpayers other than the ones to whom they were issued. However, they indicate the IRS' current thinking, though that can change from time to time. Taxpayers needing to rely on the reasoning of a PLR should consider whether to apply to the IRS for their own ruling.

2. TRUSTS

   1. TRUSTS' INCOME TAX DEDUCTION FOR INVESTMENT FEES

      In Knight v. Commissioner,--U.S.--, 128 S.Ct. 782 (2008) the Supreme Court held that trust administration expenses are exempted from the 2% floor only if those expenses would be "uncommon" for a hypothetical individual to occur. That leaves the determination as a case-by-case factual issue, and the current Prop. Regs. will probably have to be re-proposed.

   2. TRUSTS AND PASSIVE ACTIVITY LOSSES

      The IRS now says a trust materially participates in an activity only if its fiduciaries (e.g., trustees) participate in the activity on a regular, continuous and substantial basis. See TAM 200733023. The IRS says the activities of employees are not enough. However, at least one court case holds to the contrary--see Mattie K. Carter Trust v. United States, 256 F. Supp 2d 536 (N.D. Tex. 2003). In that case, the employees' activities were held sufficient to qualify as material participation by the trust.

3. ESTATE PLANNING

   1. CURING FLP ASSETS; SUB-MARKET BUY-SELL RESTRICTIONS

      In Holman v. Commissioner, 130 T.C.--(No. 12) (2008), an FLP was funded with publicly traded (Dell) stock. Six days later, the parent made gifts of partnership interests. The Tax Court held that the six days were long enough for there to be a meaningful chance for a change in the value of the underlying assets--therefore, giving the LP interests was not the same as giving the underlying stock. Also, in the Holman case, the partnership agreement contained a harsh buy-sell provision. The court held that under Code [section]2703, the restriction was disregarded because of arm's length terms. Note: that creates a whip-saw: the buy-sell still applies, but the heirs pay tax as if it didn't.

   2. CHARITABLE FORMULA PLANNING

      In Estate of Christiansen v. Commissioner, 130 T.C. 1 (2008) (court-reviewed), the Tax Court for the first time...