The most recent on alimony funds and tax therapy of qualifying small firm shares

In the last few weeks there have been some new decisions on issues that we have previously discussed. With Congress on recess this week to mark Memorial Day and otherwise presumably spend time with voters, we thought it was a good time for an update.

Qualifying inventory for small businesses

Last year we covered an IRS Private Letter Ruling (“PLR”) that qualified an insurance brokerage firm for preferential tax treatment under Section 1202 as a Qualified Small Business Stock (“QSBS”). You can now add a pharmaceutical company to the list of active trades or companies that qualify. It is important to remember that the Internal Revenue Code defines qualifying trade or business by exclusion. In other words, it lists the activities that do not qualify, including health and referral services, among others.

The taxpayer in question does not manufacture medicines but has exclusive distribution agreements with manufacturers. It employs pharmacists to fill prescriptions written by physicians and non-pharmacists, coordinate with patients, and handle insurance issues. Staff do not diagnose, recommend specific treatments, or manage any aspect of patient care. All income comes exclusively from the sale of medicines.

Based on these facts, the PLR ​​concluded that the taxpayer’s employees are not engaged in the provision of medical services and therefore the taxpayer’s trade or business does not include “the provision of health services”. Furthermore, the taxpayer’s most important asset is its exclusive pharmaceutical distribution rights and not the reputation or skills of one or more employees. Therefore, this criterion does not preclude it from being a qualifying trade or business.

Contrary to the maxim that it’s easier to ask for a forgiveness than to get a permit, when it comes to QSBS, the IRS seems perfectly willing to decide what qualifies and what doesn’t. Therefore, given the magnitude of the potential tax savings, taxpayers would be wise to apply for PLRs.

alimony

Prior to the Tax Cuts and Jobs Act 2017 (“TCJA”), alimony or separate alimony payments were deductible by the payer under certain conditions:

1. Payment must be specified in a divorce or separation agreement
2. The divorce or separation agreement must not designate the payment as one that CANNOT be included in the gross income of the recipient or deducted from the payer
3. Payer and recipient must not live together at the time of payment; and
4. The benefits must end upon the death of the spouse entitled to pay, without there being any obligation to pay compensation after death

Even if the provision has been superseded by TCJA, payments made pursuant to a divorce or separation agreement in effect prior to January 1, 2019 (and not amended to make TCJA effective after that date) will continue to be deductible. What about the case of Dr. Abraham leads.

He and his wife, both previously married, decided to try again. This marriage also ended. The divorce agreement states: “[t]The parties agree that neither will pay alimony, each will be forever barred from claiming alimony as part of their dissolution resolution. Ibrahim, for reasons unknown, agreed to pay his wife $10,000 (later increased to $50,000) to help her with relocation expenses and legal fees. He claimed those payments as alimony or separate alimony on his 2017 tax return, and the IRS denied the deduction.

In court, Dr. Ibrahim contends that regardless of the express wording of the agreement, the payments should be considered alimony under Missouri state law. The Finance Court could not be persuaded that the wording of the agreement was clear and unambiguous. With no alimony to be paid by either party, Dr. Ibrahim at #2 on the requirement list. The fact that the Missouri state court did not find his wife dependent in the divorce proceedings did not help his argument. And since he couldn’t show a good reason or acted in good faith, he was also hit with an accuracy penalty.

Count on Friedman

Like many summary opinions from the Tax Court, this one begins with the words: “This opinion must not be treated as a precedent for any other case.” That does not mean that the lesson of the case is not applicable. Tax deductions exist by statutory grace. You are not entitled. So, to benefit from them, follow the rules. Your Friedman LLP advisor can help you stay within the guard rails.