April 1999 Issue



By Randy A. Schwartzman, CPA

The IRS recently issued Notice 99-6, soliciting comments from and providing guidance to taxpayers and practitioners regarding issues related to employment tax reporting and payment by qualified subchapter S subsidiaries (QSSS) and other entities that are disregarded as separate from their owners, i.e., single member limited liability companies (SMLLC). The notice essentially provides taxpayers with two methods of employment tax compliance that will be accepted by the IRS until such time as formal reporting procedures are provided in other guidance.

The Two Methods

The notice stated that the IRS would generally accept two alternative methods for reporting and payment of employment taxes with respect to the employees of a QSSS or any other disregarded entity. The allowable methods are as follows:

  • Calculation, reporting, and payment of all employment tax obligations with respect to employees of a disregarded entity by its owner (as though the employees of the disregarded entity are employed directly by the QSSS's parent or the SMLLC). The tax compliance would therefore be reported and the payments would be made under the owner's name and taxpayer identification number; or

  • Separate calculation, reporting, and payment of all employment tax obligations by each state law entity with respect to its employees under its own name and taxpayer identification number.

    An owner of multiple disregarded entities may choose the first method with respect to some disregarded entities and the second method with respect to the others. The fact that an owner of a disregarded entity chooses the second method with respect to a given disregarded entity for one taxable year will not preclude the owner from switching to the first method in a subsequent taxable year. However, if the owner uses the first method with respect to a given disregarded entity for a return period that begins on or after April 20, 1999, the taxpayer must continue to use the first method unless, and until, otherwise permitted by the commissioner.

    If the first method (reporting by the owner) is chosen, a final employment tax return should be filed with respect to a disregarded entity that formerly calculated, reported, and paid its employment tax obligations on a separate basis. Although not specifically stated, it would be advisable to attach a statement to the final return indicating the taxpayer's intention to report under the owner's name and taxpayer identification number in the future.

    If the second method (reporting by the disregarded entity) is chosen, the owner retains ultimate responsibility for the employment tax obligations incurred with respect to employees of the disregarded entity. This method merely permits the employment tax obligations of the owner incurred with respect to the disregarded entity to be fulfilled through the separate calculation, reporting, and payment of employment taxes by the disregarded entity. Accordingly, the IRS will not proceed against the owner for employment tax obligations relating to employees of a disregarded entity if those obligations are fulfilled by the disregarded entity using its own name and taxpayer identification number. This should hold true even if differences exist in the timing or amount of payments or deposits as calculated under the second method.

    Although at first it would appear that the separate reporting under the second method would result in an increase in total tax compliance, this method offers certain advantages that may negate the burden associated with additional entity-level filings. The second method could result in less frequent deposits by the owner and the separate entity. For example, the owner and the disregarded entity may qualify as monthly depositors under the second method whereas under the first method the owner might be a more frequent filer, i.e., a semi-weekly depositor, taking into account the total salaries of the employees of the disregarded entity.

    Moreover, the separate reporting under the second method may permit the owner or the disregarded entity to take advantage of de minimis exceptions that allow payment of payroll taxes with the quarterly Form 941 rather than through deposits. On the other hand, if an individual is employed by both the owner and the disregarded entity, the second method may cause additional employer social security tax to be paid. Query: Would the common paymaster rules apply for these disregarded entities?

    Other Considerations

    It should be noted that the choice of the two methods permitted under the notice does not apply to qualified real estate investment trust (REIT) subsidiaries. However, in the notice the IRS solicited comments from taxpayers and practitioners as to whether the forthcoming guidance should also apply to these qualified REIT subsidiaries.

    The IRS also solicited comments from both practitioners and taxpayers with respect to more obscure payroll tax matters affecting disregarded entities, such as--

  • whether different rules should apply to newly formed disregarded entities with no previous employment tax history (as opposed to entities in existence before the time they became disregarded);

  • appropriate methods for notifying the service center about changes in employment tax obligations when an entity's status as a disregarded entity changes (e.g., sale, or certain nonrelated party transfers, of any portion of QSSS stock or an interest in an SMLLC);

  • possible issues arising in situations where the owner or the disregarded entity is formed or domiciled in a country other than the United States;

  • whether the administrative burden placed on taxpayers filing employment tax returns under the owner's name would actually increase or decrease where employees are actually employed by a separate and distinct state law entity that is disregarded for federal income tax purposes; and

  • whether reporting by the owner would result in confusion to employees, employers, and state and federal agencies.

    For now, the IRS has addressed the concerns of the broadest group of taxpayers by providing an option for reporting and paying employment taxes with respect to the employees of a QSSS or any other disregarded entity. Upon the issuance of the final guidance, taxpayers can be hopeful that both methods of tax compliance will remain available. However, uncertainty exists as to how the IRS will address the other issues for which it encouraged public comment. Uncertainty also exists as to acceptable compliance methods that are currently permitted (and will be permitted upon the issuance of final Federal guidance) by most states for these disregarded entities and the effect of these separate tax entities on pension plan qualification and discrimination rules. *


    By Anthony P. Viola, CPA,
    Paneth, Haber & Zimmerman, LLP

    By now, every accountant knows that the Taxpayer Relief Act of 1997 (TRA '97) changed the rules with regard to sales of residences. IRC section 121 now allows a taxpayer to exclude up to $250,000 ($500,000 for couples filing jointly) of gain on the sale or exchange of a principal residence.

    To qualify, IRC section 121(a) requires a taxpayer to have owned and used the residence as a principal residence for periods aggregating two years or more during the five-year period preceding the date of sale or exchange of the residence. IRC section 121(b)(3)(A) restricts a taxpayer's exclusion to one every two years.

    Under IRC section 121(c), as amended by the IRS Restructuring and Reform Act of 1998, the aforementioned two-out-of-five­year ownership and use requirement is softened when a taxpayer sells or exchanges a principal residence because of unforeseen circumstances such as a change in health or place of employment. Under one of these conditions, the exclusion is prorated based upon a percentage calculated by using a fraction. The numerator of the fraction is the smaller of 1) the portion of the five-year period preceding the sale or exchange of the residence during which the taxpayer owned or used the residence as her principal residence or 2) the period since the last sale or exchange by the taxpayer. The denominator of the fraction is two years.

    Nevertheless, TRA '97 sections 312(d)[(e)]j(2)­(4) provide special rules regarding IRC section 121. In particular, TRA '97 section 312(d)[(e)](3) provides a special rule for sales within two years after the date of enactment. This section states that IRC section 121 will be applied without regard to subsection (c)(2)(B) in any sale or exchange of property during the two-year period, beginning on the date of enactment, if the taxpayer held the property at that time and fails to meet the ownership and use requirements of subsection (a).

    IRC section 121(c)(2)(B) is the requirement of a change of employment, health, or unforeseen circumstance, and the ownership and use requirement of subsection (a) contains the two-out-of-five year rule. Therefore, a taxpayer who owns more than one residence as of August 5, 1997, can establish consecutively each property as a principal residence, sell each property up until August 4, 1999, and exclude a prorated portion of the total exclusion ($250,000 for singles or $500,000 for married filing jointly) for each property. The exclusion would be without regard to the two-out-of-five­year use requirement of IRC section 121(a) and the special circumstance requirement of IRC section 121(c)(2)(B).

    Whether the taxpayer in the above example must occupy the residence as a principal residence is unresolved. It seems that the intent of Congress was such, but the wording of TRA '97
    section 312(d)[(e)](3) obscures
    its meaning. *

    Edwin B. Morris, CPA
    Rosenberg, Neuwirth & Kuchner

    Contributing Editors:
    Alan Ted Frankel, CPA
    Frankel Loughran Starr &
    Vallone LLP

    Richard M. Barth, CPA

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