TAXFAX

Employee Retention Credit

By Tara Guler The CARES (“Coronavirus Aid, Relief, and Economic Security”) Act enacted in March of 2020 provided various benefits for employers to retain their current employees amid the economic downturn of the pandemic. The Employee Retention Credit (“ERC”) was first introduced in this Act. In December of 2020, the ERC was modified under the Consolidated Appropriations Act (“CAA”), which made significant taxpayer friendly changes. Specifically, the CAA provided retroactive changes to the ERC (allowing Payroll Protection Program (“PPP”) recipients to also claim the ERC) and extended the ERC into the first two quarters of 2021. Not long after, Congress extended and expanded the ERC a second time with the passage of the American Rescue Plan Act (“ARPA”), extending the ERC through December 31, 2021. Outside of the legislative language, guidance on the ERC can be found in IRS Notices 2021-20, 2021-23 and 2021-24.

The ERC is a refundable payroll tax credit claimed on Form 941 and is calculated as a percentage of qualified wages. In order to be eligible for the ERC, an employer must have been subject to a full or partial closure due to a government order or experienced a significant decline in gross receipts. Exactly what can be treated as qualified wages hinges on whether the employer is a large or a small employer. Determination of eligibility and qualified wages can appear to be a simple on its face, but the rules are often vague, complex, and heavily facts and circumstances based, requiring employers to dig into the details to determine if they are truly entitled to a credit.

Aggregated group

The existence of an aggregated group can have a considerable impact on an employer’s entitlement to the ERC. As such, before testing the employer’s eligibility and size, the employer must first determine if they are part of an aggregated group. For purposes of the ERC, employers are generally aggregated

TAXFAX EDITOR George W. Benson Counsel McDermott Will & Emery LLP 444 West Lake Street Suite 4000 Chicago, IL 60606 (312) 984-7529 fax: (312) 984-7700 gbenson@mwe.com

GUEST WRITER Tara Guler Senior Manager Baker Tilly Virchow Krause, LLP Ten Terrace Court Madison, WI 53718 Tel: (608) 240-6714 Fax: (608) 249-8532 e-mail: tara.guler@bakertilly.com

under the controlled group and affiliated service group rules (different tests may apply to tax-exempt entities). These rules can be quite complex, and it is strongly encouraged employers consult their tax advisors. As an overview, the rules typically break out as follows:

• Controlled Group o Parent-subsidiary with more than 50% ownership, vote or value o Brother-sister with five or fewer common owners which have both:  Controlling interest (80% or more, vote or value), and  Effective control (more than 50%, vote or value)

• Affiliated service group o A-Type Group o B-Type Group o Management Group

Full or partial government shutdown

A business is considered to be fully or partially suspended if, due to COVID-19, the government fully or partially suspended business operations (this can include a reduction to business hours or even modifications to operations as required by local social distancing mandates). For those employers eligible under this provision, the credit is calculated only on wages during the suspension period, not the entire quarter of the suspension.

Significant decline in gross receipts

For the 2020 calendar year, a significant decline in gross receipts is a greater than 50% decline compared to the same quarter in 2019. For 2021, a business must see a decline of greater than 20% in gross receipts when comparing corresponding quarters in 2021 and 2019. Employers should be aware that the mechanics for testing a significant decline in gross receipts in 2021 is different than 2020. Additionally, employers need to ensure they have taken into account all revenue sources (e.g., forgiven PPP loans, grants, etc.).

Small and large employer definitions

The determination of whether an employer is large or small is based on a count of its 2019 full time employees, defined to mean employees who worked at least 30 hours of service a week or 130 hours of service a month. For 2020, a small employer is one which had 100 or less full-time employees in 2019. For 2021, the small employee limit increased from 100 to 500.

Qualified wages

For large employers, wages paid only to employees who are not performing services qualify for the ERC. In addition, paid time off or sick time paid in accordance with a pre-existing policy is not eligible. For small employers, all wages paid are eligible whether or not services were performed, including payments under a pre-existing leave policy.

Wages eligible for the ERC include FICA wages and qualified health plan expenses (employer provided coverage plus pre-tax employee contributions). Wages do not include:

• Wages used in the calculation of PPP forgiveness • Wages used to claim credits under the

Families First Coronavirus Relief Act or the

Family Medical Leave Act • Wages used for the Work Opportunity

Credit • Wages used to calculate the research and development credit • Wages paid to Internal Revenue Code

Section 51(i)(1) related employees (50% or more owners) including a child, grandchild,

brother, sister, father, mother, ancestor, stepfather, stepmother, niece, nephew, aunt, uncle

Credit Calculation

For 2020, the credit is equal to 50% of qualifying wages up to $10,000 per employee per calendar year. For 2021, the credit is equal to 70% of qualifying wages up to $10,000 per employee per calendar quarter. The credit may be claimed on a timely filed Form 941 or Form 941-X (amended Form 941). A taxpayer has three years from the original filing deadline to file Form 941-X and claim the credit for that quarter.

For federal income tax purposes, the employer is allowed to deduct the payroll taxes, but is not allowed to deduct the qualifying wages to the extent of ERC. States have taken various approaches to the deductibility of the wages so please consult your tax advisor for various state tax laws.

Conclusion

The retrospective changes and the extension of the ERC period and dollar value can potentially provide a great deal of value to taxpayers. It would be beneficial to talk through the eligibility requirements with your tax advisor to make sure all credit options have been exhausted related to pandemic relief.

Are Bins at a Feed Mill Subject to Property Tax? – The Iowa Supreme Court Weighs In

By George W. Benson In the Spring 2021 TAXFAX Column, we described the decision on an Iowa Court of Appeals decision in a case involving Stateline Cooperative. That decision recently was affirmed in part and reversed in part by the Iowa Supreme Court. Stateline Cooperative v. Iowa Property Assessment Appeal Board, Case No. 19-0674 (Iowa Supreme Court, April 30, 2021).

The controversy involved whether certain bins at a feed mill qualified for an exemption from property tax as “machinery used in manufacturing establishments.” The feed mill had (i) two large stand-alone silos for corn used in the manufacture of feed, (ii) twenty-four overhead bins holding milled corn and other components used in the feed manufacturing process, and (iii) eighteen load-out bins holding finished products until shipped to customers. The parties agreed that the load-out bins were not exempt, but disagreed as to the status of the corn silos and overhead bins.

As described in the prior article, the Court of Appeals concluded the corn silos and overhead bins qualified, but the loadout bins did not, observing that the storage feature of the silos and overhead bins “is only temporary and incidental, and their primary purpose is to serve directly in the manufacturing process.”

The Supreme Court disagreed with the treatment of the corn silos. It observed that they were separate buildings, similar to other grain storage facilities. In fact, the smaller of the two had served that purpose for thirty-five years prior to the construction of the feed mill. The Court observed that “no processing or manufacturing occurs at the silos themselves.” It concluded:

“They should thus be viewed as storage buildings. Just as the load-out bins are the epilogue to the manufacturing process, and thus not a part of the process itself, the corn silos are the prologue.”

However, it agreed with the Court of Appeals that the overhead bins qualified:

“They are part of the sequential manufacturing process at the feed mill building. They discharge directly into the scale and then the mixer. They do

not appear to have any independent value as storage apart from this particular manufacturing process. Nor does the fact that they are structurally part of the building alter the situation.”

But it did not stop there. The parties also disagreed as to the value of the overhead bins. The Property Assessment Appeal Board concluded that Stateline’s evidence as was not reliable and thus assigned no value to the bins. The Court of Appeals found that to be unreasonable and arbitrary. The Supreme Court agreed. However, the Court of Appeals had then taken the evidence in the record and determined a value. The Supreme Court concluded that it should not have done so given the conflicting evidence in the record. It remanded the case to the Property Assessment Appeal Board for further proceedings to determine the appropriate value of the overhead bins for exemption purposes.

IRS 2020 Data Book – Cooperative Statistics

The IRS recently released the 2020 IRS Data Book, Publication 55-B (June 2021) describing IRS activities during its fiscal year 2020 (beginning October 1, 2019 and ending September 30, 2020).

In recent years, the IRS Data Books have included line item information regarding cooperative tax returns (Form 1120-C). The information historically has been hard to interpret because of the reporting format. However, four things are clear:

1. There are not many Subchapter T

cooperatives. This year’s Data Book reports receipt of 7,524 cooperative tax returns (Form 1120-C) for tax year 2018. In prior years, the number of reported returns was consistently approximately 9,000. The drop is unexplained (1,500 cooperatives did not go out of business during the past year). Perhaps it is attributable to reporting anomalies arising from the coronavirus situation. It will be interesting to see what is reported next year.

2. Not many cooperative tax returns are

audited. The 2020 Data Book reports that only 13 of the 7,524 returns for 2018 have so far been examined (or 0.2%). This low audit rate is consistent with the reported rates for 2017 (0.2%), 2016 (0.2%) and 2015 (0.3%).

3. Audits of cooperative returns have not been very productive for the IRS (which may explain why there are so few

audits). The IRS reported that it closed 28 examinations during its fiscal year 2020. Most were closed on an agreed basis with a total of $228,000 of proposed deficiencies. Five were unagreed. They involved a total of $166,000 of proposed deficiencies.

4. Refund claims attract examinations.

The IRS reported that it completed examinations of 16 amended returns involving refund claims during its fiscal year 2020. It reported denying 7 claims totaling $4,168,000 and allowing 9 claims totaling $2,464,000.

In addition, the Data Book reported that the IRS received 4 applications for Section 521 status during its 2020 fiscal year, a low, but not surprising, number.

The figures reported over the years in the Data Books for cooperative audits have seemed to understate audit activity. However, even if the actual number of audits is a multiple of those reported, the overall level of audit activity would still be very low. In the years to come, this could change. The Biden administration has proposed significant increases in IRS funding over the next few years focused on enforcement and

compliance and there have been reports that some parts of the IRS have already begun hiring agents in anticipation of that funding.

Section 481(a) Adjustments and Section 163(j)

The limitation on the deduction of interest expense contained in Section 163(j) might have seemed simple to its Congressional architects, but it has proved very complicated to implement. Most areas of tax law are directly or indirectly affected. The IRS and taxpayers who are affected by the limitation will likely be wrestling with its intricacies for years to come.

A recent IRS Chief Counsel memorandum is a case in point. See, CCA 202123007 (May 10, 2021). Generally, for most taxpayers, the Section 163(j) limitation is equal to business interest income plus 30% (50% for taxable years beginning in 2019 and 2020) of “adjusted taxable income.” Cooperatives are permitted to add back patronage dividends in determining adjusted taxable income.

For years beginning before January 1, 2022, all taxpayers are permitted to add back depreciation in figuring adjusted taxable income. CCA 202123007 involves a taxpayer who had originally put a 7-year life on an asset acquired in 2017 (and who did not claim additional first-year depreciation). The taxpayer later determined that the asset should have had a 5-year life. In 2020, the taxpayer sought permission to change its method of accounting for the asset, changing its life from 7 to 5 years (and not claiming additional first-year depreciation).

Permission was granted.

The change resulted in a negative Section 481(a) adjustment, which the taxpayer was entitled to deduct in 2020. The question posed was whether the Section 481(a) deduction retained its character as depreciation, which, although deducted in determining the corporation’s tentative taxable income, could be added back in determining adjusted taxable income for Section 163(j) purposes. The CCA concluded that it did.

That conclusion is reasonable and taxpayer favorable for taxpayers running into a Section 163(j) limitation. However, the CCA suggests that if the taxpayer’s year of change was a taxable year beginning after January 1, 2022, when depreciation can no longer be added back, the Section 481(a) adjustment would reduce tentative taxable income and not be added back in determining adjusted taxable income (an unfavorable result).

The CCA also observes that if the Section 481(a) adjustment had been positive (as it would have been if an asset’s life had been changed from 5 years to 7 years), and if the change was taken into account in a taxable year beginning before January 1, 2022, then the Section 481(a) change would increase tentative taxable income, but be offset by a negative depreciation add-back in determining adjusted taxable income. The CCA suggests that if the positive Section 481(a) adjustment was taken into account over four years and those years included years beginning both before and after January 1, 2022, the negative addback would apply only to the taxable years beginning before January 1, 2022.

Accruing Sales Incentives

Many group purchasing cooperatives enter into contracts with suppliers that include incentives tied to achieving specified targets. In negotiating those contracts, it is useful to understand how suppliers are taxed on the incentives they pay.

Virtually all suppliers are accrual basis taxpayers. Accrual basis suppliers are entitled to accrue a deduction for incentive payments in the taxable year in which (i) all events have occurred that establish the

fact of the liability, (ii) the amount of the liability can be determined with reasonable accuracy, and (iii) economic performance has occurred. For payments in the nature of rebates, economic performance occurs as payment is made. See. Treas. Reg. § 1.4614(g)(3). However, under the recurring item exception, a liability is treated as incurred for a taxable year if (i) at the end of the taxable year, all events have occurred that establish the fact of the liability and the amount of the liability can be determined with reasonable accuracy, (ii) the liability is recurring in nature, (iii) payment is made before the earlier of the date the taxpayer files its return or the 15th day of the ninth month after the close of the taxable year, and (iv) either the amount of the liability is not material or the accrual for the taxable year results in a better matching of income and expense. An example in the regulations illustrates the application of these rules to rebates. See, Treas. Reg. § 1.4614(g)(8), example 2.

These rules can delay accrual for a supplier if the supplier’s fiscal year is different than the measuring period used to determine the incentive. For instance, if a supplier is on a fiscal year ended September 30 and its contract with a cooperative calls for an incentive payment based on sales occurring during a calendar year, under these rules the supplier cannot accrue an estimate of the amount to be paid for the calendar year ending the next December 31. That is the case even if the amount is paid within eight and one-half months after September 30. All events have not occurred to establish the fact of the liability.

TAM 202121010 (released May 21, 2021) analyzes an attempt by a supplier to structure an incentive arrangement to allow it to accelerate its deduction.

This technical advice memorandum addresses the tax consequences of a sales incentive program offered by a manufacturer of a product (“product A” in the ruling) to its customers, independently owned and operated stores, to encourage them to make sales of product A to their customers. The incentive was keyed to sales of product A by the stores to their retail customers. It applied to sales of product A which was in the stores’ ending inventories on a specified date and that was sold by the stores to customers by another specified date.

Normally such an incentive could not be accrued until the end of the measuring period because that is when all events would occur to establish the liability to make the payment. However, there was a twist in the design of the program.

The manufacturer guaranteed that it would pay a specified aggregate minimum amount (the “guaranteed payment”) to stores, to be allocated among the stores based on a method that apparently was never determined (because the amount was never paid). This, the manufacturer argued, established the fact of the liability before the measuring period began to run. However, the program provided that the guaranteed amount would be paid only if it was less than the aggregate amount of the sales incentives earned under the program by the stores. Moreover, to be eligible to share in the sales incentive (or in the guaranteed payment) the stores had to sell product A to customers during the qualifying period which fell in manufacturer’s next fiscal year.

It seems apparent from the TAM that the IRS believed that the only reason for the guaranteed payment was to provide the manufacturer with a colorable argument for accruing a deduction earlier than it normally would. The IRS expressed skepticism as to whether stores even knew about the program and whether, as a practical matter, it was designed so that it would never be paid.

“For every taxable year of the [guaranteed

incentive program], Taxpayer [the

By Barbara A. Wechmanufacturer] set the guaranteed minimum payment amount to be ‘somewhat below’ the total incentive payments Taxpayer expected to pay [stores] pursuant to the [sales incentive program] for the qualifying period. In effect,

Taxpayer did not develop a mechanism to allocate the guaranteed minimum payment among the [stores] for any of the taxable years at issue because participating [stores] always qualified to receive sales incentive payments in excess of the guaranteed amount promised under the [guaranteed incentive program].

Also, for the taxable years at issue for the [guaranteed incentive program], there is no evidence indicating that participating [stores] relied upon the announcement letters to purchase any additional [product A] prior to the fiscal year-end announcement period.

Taxpayer was unable to confirm or track whether any participating [stores] opened or viewed the [guaranteed incentive program] announcement letters.”

In any event, on technical grounds, the TAM concluded that the manufacturer was not entitled to accrue a deduction for the guaranteed payment because all events had not occurred at the end of the manufacturer’s tax year to establish the fact of the manufacturer’s liability under the program. The IRS pointed to two conditions precedent to establishing the manufacturer’s liability that occurred after the manufacturer’s year end.

First and probably most important, stores had to sell product A to earn the incentive, and the sales did not occur until after the manufacturer’s year end.

“In conclusion, assuming that the [guaranteed incentive program] creates an unconditional obligation of [the manufacturer] to pay the guaranteed minimum amount stated to qualifying [stores], to be a qualifying [store] requires sales during the qualifying period during the next year. These facts are distinguishable from the bonus cases and Mass. Mutual [cited by the manufacturer] because at the end of Year 1, the class of eligible recipients does not yet have any members, no [stores] have earned sales incentives during the qualifying period.” One wonders what the IRS would have said if the measuring period had begun prior to the end of the manufacturer’s fiscal year end. Second, liability to make the minimum payment depended upon stores in the aggregate not earning incentives in excess of the minimum payment amount. The IRS viewed the liability to make the minimum payment to be in the nature of a guarantee, not a primary liability. “Also, we conclude that the guarantee is secondary to the liability to pay incentives under the [sales incentive program], so that the [guaranteed payment] liability could only arise if [the stores], in the aggregate failed to attain the minimum incentive payment offered in the [guaranteed minimum payment program], under the [sales incentive program] during the qualifying period.” Thus, in the IRS view, the liability was contingent at the end of the manufacturer’s fiscal year.

Will the Biodiesel Mixture Tax Credit Be Extended Again?

Producers of biodiesel mixtures are entitled to claim a tax credit equal to $1.00 per gallon of biodiesel used in the mixture. Section 6426(c). This credit was originally enacted in 2005. It has always been temporary, but has repeatedly been extended, sometimes retroactively. The most recent extension occurred in 2019. Currently the credit is scheduled to expire on December 31, 2022. On May 25, 2021, a bipartisan group of

Senators and Congressmen introduced a bill in the House and Senate to extend the current biodiesel tax credit through 2025. The bill is entitled the Biodiesel Tax Credit Extension Act of 2021.

Given the discussions going on in Washington regarding the Biden administration’s spending and taxing plans, the sponsors of the legislation undoubtedly wanted to make sure that biodiesel was at the table. While it is not at all clear what may be enacted later by Congress this year, it seems likely that any legislative package will revisit credits related to energy production, repealing those related to fossil fuels, and rewriting those related to the production and use of green energy. The farming community wants to make certain that renewable biofuels remain part of the picture.

When the bill was introduced, one of the co-sponsors, Representative Cindy Axne (Iowa), stated:

“Backing clean biodiesel means supporting and expanding an American industry that fuels our society while reducing carbon emissions. As Congress is engaged in discussions about how to invest in clean energy infrastructure while growing our economy, continued support for biodiesel will keep us on a pathway that has kept millions of tons of carbon out of our air and put 65,000 Americans to work.”

Obtaining Costs When a Taxpayer Prevails in a Case and the Government’s Position Was Not Substantially Justified

Under certain narrowly-defined circumstances, some taxpayers who prevail in an administrative or court proceeding with the IRS may be entitled to reasonable administrative or litigation costs incurred in connection with the proceeding. See, Section 7430, which is patterned on the Equal Access to Justice Act, 28 U.S.C. § 2412.

Section 7430 is targeted to small taxpayers. It incorporates the requirements of the Equal Access to Justice Act. See, Section 7430(c)(4)(A)(ii). In the case of individuals, the relief is available only for those whose net worth did not exceed $2 million at the time the case was commenced. For corporations, the relief is generally available only if, at the time the case was commenced, the corporation had a net worth which did not exceed $7 million and did not have more than 500 employees.

However, there is a special rule for cooperatives which was added to the law in 1980 by P.L. 96-481 (October 21, 1980).1 The net worth test does not apply to farmer cooperatives “defined in section 15(a) of the Agricultural Marketing Act (12 U.S.C. 1141j(a)).” See 28 U.S.C. § 2412(d)(2) (B). Cooperatives described in that section are eligible for relief under Section 7430 (assuming all of its other requirements are met) if they do not have more than 500 employees at the time the case was commenced.

The Agricultural Marketing Act definition is identical to the definition contained in the Capper-Volstead Act. To qualify, an association must be “operated for the mutual benefit of the members thereof as … producers or purchasers,” it must either be organized on a one-member, one-vote basis or must not pay dividends on stock or membership capital in excess of 8 per centum per year, and the value of the business it conducts with members must equal or exceed the value of business conducted with nonmembers.

Over the years, there have been many cases dealing with claims for costs under Section 7430. Only one of the cases has involved a cooperative. See, Columbus Fruit & Vegetable Cooperative Association v. United States, 8 Cl. Ct. 525 (U.S. Claims Court 1985), which awarded legal fees after Columbus Fruit prevailed in an IRS challenge

to its cooperative status because it did not do more than 50% of its business on a patronage basis.

Generally, to be eligible to claim such costs, the taxpayer must be the “prevailing party” and the position of the Government must not be “substantially justified.” There are other requirements as well. A complete description of this provision is beyond the scope of this article, which is intended principally to highlight the existence of the special cooperative rule.

This provision can be a tool for reaching a reasonable settlement of a case. Where a taxpayer makes made a “qualified offer” during the “qualified offer period” which the Government does not accept, the taxpayer will be treated as the prevailing party in litigation if the result is more favorable than the offer even though it would not otherwise be regarded as having prevailed.

It should be noted that most of the hundreds of reported cases under Section 7430 involve taxpayer losses. Even when taxpayers win, they rarely recover more than a fraction of their litigation costs. By statute, there is a cap set on attorney’s fees of $125 per hour, adjusted by inflation, “unless the court determines than an increase in the cost of living or a special factor, such as the limited availability of qualified attorneys for such proceeding, the difficulty of the issues presented in the case, or the local availability of tax expertise, justifies a higher rate.” Section 7430(c)(1)(B)(iii). For 2021, the inflation adjusted rate is $210 per hour.

Courts have been stingy in awarding costs. For instance, in Columbus Fruit, the Court refused to award more than the then statutory rate of $75 per hour, “if for no other reason that plaintiff was retreading ground argued before other courts.” More recently, in Charles P. Adkins v. United States, Docket No. 10-851T (U.S. Court of Federal Claims 2021), the Court refused to award more than the inflation adjusted statutory rate (observing, “the fact their attorneys are experienced tax litigators is not a special factor justifying an increase in the cap…”) and reduced the reimbursed hours. The net effect was to award $60,800.60 (instead of the requested $185,330.40). In Jesse C. Morreale v. Commissioner, T.C. Memo 202190 (July 15, 2021), the Tax Court awarded the taxpayer only a fraction of the legal fees requested. The taxpayer requested $411,000, but was awarded only $15,034. A large portion of the claimed costs related to a bankruptcy proceeding (where the tax issue surfaced), not to the Tax Court proceeding, and the Tax Court held those not covered by Section 7430. In addition, the Tax Court allowed all the hours related to the case itself, but disallowed some of the claimed hours related to the fee petition (since they related to correcting a procedural fault) and limited the award to the statutory rate.

The taxpayer argued that he could not have hired qualified counsel at the statutory rate.

But the Tax Court was not impressed.

“While petitioner may or may not have been able to retain counsel at the statutory rate, he cannot show that his market lacked competent counsel overall. Even assuming that petitioner’s claims are accurate, he has shown only that he could not retain those counsel at the statutory rate – and that is not enough to establish a special a special factor permitting an upward departure. … Moreover, while this case has a long knotted procedural background, the issues involved are ordinary questions of proper accounting methods and substantiation. These are not the types of egregiously complex legal or factual matters that justify an upward departure from the statutory rate.” (emphasis in original).