Over the past few weeks there have been some new rulings on topics we have discussed previously. Given that Congress is on recess this week – observing Memorial Day and otherwise presumably spending time with constituents – we thought it was a good time for an update.
Qualified Small Business Stock
Last year we covered an IRS Private Letter Ruling (“PLR”) that ruled an insurance brokerage business qualified for preferential tax treatment under Section 1202 as Qualified Small Business Stock (“QSBS”). You can now add a pharmaceutical business to the list of active trades or businesses that qualify. It is important to remember that the Internal Revenue Code defines Qualified Trade or Business by exclusion. In other words, it lists the activities that don’t qualify including, among others, health and brokerage services.
The taxpayer in question does not manufacture drugs but does have exclusive distribution arrangements with manufacturers. It employs pharmacists to fill prescriptions written by physicians and non-pharmacists to coordinate with patients and handle insurance issues. The employees do not diagnose, recommend specific treatments, or manage any aspect of patient care. All revenues are strictly from drug sales.
Based on those facts, the PLR concluded that the taxpayer’s employees are not engaged in the provision of medical services and so the taxpayer’s trade or business does not involve “the performance of services in the field of health.” Moreover, the taxpayer’s principal asset is its exclusive pharmaceutical distribution rights and not the reputation or skill of one or more employees. Therefore, it isn’t disqualified from being a qualified trade or business based on that criterion.
Contrary to the maxim that it is easier to ask for forgiveness that it is to get permission, when it comes to QSBS it seems the IRS is quite willing to rule on what does and does not qualify. So, given the magnitude of the potential tax savings, taxpayers are well advised to request PLRs.
Prior to the Tax Cuts and Jobs Act of 2017(“TCJA”), alimony or separate maintenance payments were deductible by the payor subject to certain conditions:
- The payment must be specified in a divorce or separation agreement
- The divorce or separation agreement can’t designate the payment as one that is NOT includible in the recipient’s gross income or deductible by the payor
- The payor and recipient cannot be living together when the payment is made; and
- The payments must end with the death of the payee spouse without any liability for substitute payments after death
Even though the provision was repealed by TCJA, payments made pursuant to a divorce or separation agreement in effect prior to January 1, 2019 (and not modified to have TCJA apply after that date) are still deductible. Which leads us to the case of Dr. Ibrahim.
He and his wife, each previously married, decided to try again. This marriage also ended. The Marital Separation Agreement stated that “[t]he parties agree that neither shall pay maintenance, each will be forever precluded from requesting maintenance as part of their decree of dissolution.” Nevertheless, for reasons undisclosed, Dr. Ibrahim agreed to pay his wife $10,000 (later increased to $50,000) to assist with relocation costs and legal fees. He claimed these payments as alimony or separate maintenance on his 2017 tax return and the IRS disallowed the deduction.
In court, Dr. Ibrahim contended that notwithstanding the express language of the Agreement, the payments should be considered alimony under Missouri state law. The Tax Court was not persuaded relying on the fact that the language in the Agreement was clear and explicit. Because no maintenance was to be paid by either party, Dr. Ibrahim’s payments failed #2 in the list of requirements. The fact that the Missouri state court in the divorce proceedings didn’t find his wife eligible for maintenance didn’t help his argument. And, since he couldn’t demonstrate a reasonable cause or that he acted in good faith, he was hit with an accuracy related penalty as well.
Count on Friedman
Like many Tax Court Summary opinions, this one starts by saying, “this opinion shall not be treated as precedent for any other case.” That doesn’t mean the lesson of the case isn’t applicable. Tax deductions exist by legislative grace. They aren’t an entitlement. So, to benefit from them, follow the rules. Your Friedman LLP advisor can help you stay within the guardrails.