There are numerous different situations where taxpayers may face tax penalties. IRS audits may determine that a taxpayer failed to file tax returns or other required forms or failed to pay taxes as required. In some cases, relief may be available that will allow taxpayers to avoid or reduce penalties, and in some cases, a taxpayer may be able to show that they were unable to comply with their requirements due to "reasonable cause." However, a recent court ruling shows that the standards used by the government to assess reasonable cause can be anything but reasonable.

Operating Engineers Local Union No. 3 v. United States

Operating Engineers Local Union No. 3 is the largest construction union in the United States, and prior to 2018, it had a record of over 100 years of full compliance with federal tax laws. However, in the third and fourth quarters of 2018 and the first quarter of 2019, the union failed to deposit payroll taxes as required. The IRS assessed a penalty of over $580,000, and the union paid this penalty. The union later sought a refund of the penalty, claiming that it had reasonable cause for its failure to meet its obligations.

The union's claims were based on its reliance on an employee to handle payroll tax issues and make timely payroll tax deposits. These matters were typically handled by the union's Accounting Manager. In 2015, a woman who had previously served as Accounting Manager was promoted to Finance Director, and a new Accounting Manager was hired. After that person resigned in June 2018, the Finance Director became responsible for handling the payroll tax duties. Due to confusion about whether a replacement had been trained to take over these duties, payroll taxes were not deposited as required during this time, and the problem was not discovered until December 2018. These issues were not fully corrected until audits were performed in the first quarter of 2019.

Closing a business can be a difficult decision. Despite a business owner's best efforts, a company may be unsuccessful, and it may be necessary to terminate operations and dissolve the business entity. However, wrapping up business operations can be a daunting task that will require careful planning and execution. Tax issues can be some of the most crucial aspects of closing a business, and business owners will need to understand the tax implications that may affect them in these situations.

Filing Final Tax Returns and Other Forms

Business owners or partners will need to make sure all delinquent tax returns for a business have been filed, and they will also need to file a tax return for the year in which the business ceased operations. Any taxes that are owed must be paid. Depending on the way the business was structured, different types of forms may need to be filed with the IRS. In addition to income tax return forms, a business owner may need to report sales of business property, and asset acquisition statements may be required if the business was sold to a new owner. For corporations, a Corporate Dissolution or Liquidation form must be filed with the IRS. When filing a state tax return with the California Franchise Tax Board, it must be marked as a final return, and the business must cease all business operations before the end of that tax year.

Employee Payroll Tax Obligations

Final wages that are owed must be paid to all employees. An employer must also withhold and pay all required payroll taxes, Social Security taxes, and Medicare taxes. Failure to withhold and pay these taxes will result in penalties. Employment taxes can be reported by filing either a quarterly or annual employer's tax return, and a federal unemployment tax return must also be filed. Any payments of over $600 made to contractors during the final year of business must also be reported to the IRS. An employer will be required to provide employees with W-2 forms for the final year in which wages were paid. They may also need to take steps to terminate health plans and retirement plans for employees.

The IRS regularly reviews the documentation filed by individual taxpayers, businesses, and organizations, and it has identified numerous ways that taxpayers may engage in tax avoidance or tax evasion. The "abusive tax schemes" that are recognized by the IRS may lead to tax audits, and a taxpayer that has failed to pay taxes as required or meet other requirements for reporting information to the IRS may be subject to penalties. One abusive tax scheme recently highlighted by the IRS involves micro-captive transactions, and companies that engage in these types of transactions will need to be aware of what requirements may apply to them and how they can avoid potential penalties.

What Are Micro-Captive Transactions?

In some cases, businesses may establish "captive" insurance companies that are owned and operated by the parties who are insured by these companies. This can be an effective way to ensure that a company has appropriate insurance coverage to address unique issues, and it can provide other benefits as well. However, the IRS has identified certain types of captive insurance companies as "micro-captives" that may be used to reduce the amount of taxes a business may be required to pay.

In general, insurance companies are taxed based on their taxable income under Section 831(a) of the Internal Revenue Code. However, some companies may be eligible for an alternative tax under Section 831(b), and this tax is calculated based on a company's investment income in a given tax year. Because the income generated through premiums is not included in an insurance company's investment income, this may allow for a reduction in the taxes a company is required to pay.

There are numerous different types of tax credits and deductions that may be available to small business owners, and these can be essential methods of minimizing a business's tax burden and ensuring that a company can continue operating successfully. Business owners should be aware of the types of employment tax credits they may be able to use, as well as the potential penalties they could face if they do not claim these credits correctly. One concern that has risen recently is related to the Employee Retention Credit (ERC), which has been highlighted by the IRS as a potential avenue for tax scams.

What Is the Employee Retention Credit?

During the COVID-19 pandemic, a variety of measures was put in place to provide assistance for businesses that were forced to shut down or experienced other issues that led to losses of revenue. One of these was the Employee Retention Credit, which was a payroll tax credit that was available in the tax years of 2020 and 2021. It allowed employers to receive a credit for a percentage of qualified wages paid to employees, with a maximum credit of $5,000 per employee in 2020 and $7,000 per employee per quarter in 2021.

The ERC was limited to specific businesses that were affected by the pandemic. These included businesses that were required to fully or partially suspend operations due to government orders, businesses that experienced declines in gross receipts in 2020 or during the first three quarters of 2021, and businesses that met the qualifications to be considered recovery startup businesses in the third and fourth quarters of 2021.

As part of the ongoing efforts to address global climate change, the U.S. government has taken steps to promote the use of clean energy in a number of ways. This includes offering tax credits and deductions for small businesses that take steps to cut energy costs and reduce reliance on fossil fuels. By investing in energy efficiency, small business owners may be able to realize significant savings by reducing their expenses and lowering their tax bills.

Types of Clean Energy Credits and Deductions

There are several options that may be available for small businesses that make the shift toward clean energy, including:

• Solar energy tax credits - Businesses that purchase new solar energy systems have two options for receiving tax credits. The investment tax credit (ITC) will reduce a business's federal tax liability in the year in which a new solar power system is installed, while the production tax credit (PTC) will provide ongoing credits based on the electricity generated by a solar power system within the first 10 years of operation. The ITC provides a credit of 30 percent of the amount spent on systems such as solar panels, inverters, transformers, circuit breaks, and energy storage devices, and it may be the preferred option for smaller-scale solar power projects. The PTC provides a tax credit of 2.75 cents per kilowatt-hour of electricity generated in a tax year, and it may provide more tax savings in situations involving large-scale projects that will generate a significant amount of electricity over several years. Both the ITC and PTC will be available for systems that began operating in 2022 or later, as long as construction begins prior to 2033.

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