This year, Americans will file an estimated 140 million federal tax returns.  Dreading the process, many of us wait until the very last day – April 15^th – to file.  But could there be cause to celebrate on tax day?

In fact, there is.  That’s because with each passing due date the window of opportunity closes for the IRS to assess new taxes against you from years you’ve probably long since forgotten.

Here’s how it works.  If the IRS looks at your tax return and decides you owe more taxes than you reported owing, they’ll come after you to collect the unpaid tax.  To do this, the IRS mails you a “Notice of Deficiency” – also called a “90-day letter” – which tells you how much the IRS plans to assess against you.  Until the IRS sends this letter, it can’t assess the additional tax, nor can it take any steps to collect the tax it claims you owe.

But here’s the important point.  Generally, to assess a tax against you for any given tax year, the IRS must mail its 90-day letter within three years of either the date that you filed the return for that year or the return’s due date, whichever is later.

Since your 2009 tax return was due in April of 2010, this year’s tax due date probably means an end to the IRS’ ability to assess new taxes against you for the year 2009.  This is true even if you later amended your original 2009 return.

Thus, with each passing April you can smile, armed with the knowledge that the mathematical or other innocent error you made three years ago is now all in the past.

There are, of course, a few exceptions.   If, in your return, you omit more than 25% of your gross income, the IRS has six years to assess the tax instead of three.  In addition, if the IRS can prove that you filed a false or fraudulent return with the intent of evading taxes, or if you fail to file any return at all, then there’s no limit on when they can assess the tax.

Finally, the three year deadline only applies if you and the IRS reach different conclusions on the amount owed.  If you reported the correct amount on your return but simply didn’t pay up, the IRS can move forward with collection efforts without issuing a 90-day letter.  Generally, they’ll have ten years to collect what you owe.

So, there is cause to celebrate this April 15^th after all.  But get your 2012 return filed first.

Tomorrow, the United States Supreme Court hears oral arguments in United States v. Windsor, a case challenging the constitutionality of the Defense of Marriage Act (or “DOMA”).

Although the Court’s decision in Windsor could affect many areas of federal law, it should be remembered that the case is – first and foremost – a tax case.  The Plaintiff, Edie Windsor, was the lawfully married spouse of her long-time domestic partner, Thea Spyer.  Ordinarily, when someone dies, his or her estate passes tax-free to his or her spouse.  But because of DOMA, same-sex marriages that are lawful under state law are not recognized for purposes of federal law, including federal tax law.  As a result, Mrs. Spyer’s estate was required to pay an additional $353,053 in federal estate taxes.

Most observers believe that there is a significant chance that the Supreme Court will hold that DOMA is unconstitutional.  But because it will be months before any decision will be handed down, same-sex couples who were lawfully married in or before 2009 should act now to protect their right to a tax refund.

There’s a lot of talk in the news about the so-called “marriage penalty.”  The idea is that the tax code penalizes married couples by imposing a higher rate on the couple’s aggregated income than would be due had they been single.  In truth, while some married couples are penalized, others enjoy tax advantages.  As a general rule, spouses with roughly comparable incomes will be penalized; spouses with significantly unequal incomes will benefit.

Because of DOMA, the IRS has rejected joint tax returns filed by lawfully married same-sex couples.  But married same-sex couples who could benefit from a joint return can still file a protective refund claim.  This is an amended return, filed on Form 1040X, which seeks a refund contingent upon the outcome of litigation.  The claim should specify that it is a “Protective Claim for Refund” and that it is filed in anticipation that litigation will result in a holding that DOMA is unconstitutional.

Generally, taxpayers have three years from the due date of a tax return to file an amended return, including a protective refund claim.  (There is an exception which permits a taxpayer to file an amended return within two years of any payment made for a tax year; but the refund is limited to the amount of the payment).  As a result, same-sex couples married on or before December 31, 2009 generally have until April 15 of this year to file a claim.  If they fail to do so, they likely will lose out on the chance to claim a refund for 2009 if DOMA is later declared unconstitutional.

If you’ve decided not to establish a C-corporation, chances are you are considering either an S-corporation or a Limited Liability Company (or LLC) as the alternative.  Technically, S-corporation status is a federal tax status, while an LLC is a type of legal entity created under state corporate law.  But, as a practical matter, LLCs almost always stick with the default tax rules, under which they are treated either as a sole proprietorship or a partnership, depending upon the number of owners.  (In the discussion that follows, I assume that these default rules apply.)

In addition to the advantages of limited liability, both S-corporations and LLCs offer the benefits of pass-through taxation.  In other words, unlike the C-corporation, no tax is paid by the entity itself.  All of the business income passes through to the owners of the business, who report it on their own tax returns.

Although similar, there are important differences between the S-corporation and the LLC that ought to be considered when deciding which path to take.  Here are a few of the larger questions to ask.

How will the business be financed?

With both an S-corporation and an LLC, business losses flow-through to the owners and potentially can be used to offset the owners’ other income.  But there are limitations, the most significant of which is the rule that an owner cannot deduct a loss in excess of “basis.”  A complicated calculation, basis is intended to reflect the owner’s capital investment in the business.  With both an S-corporation and an LLC, basis is adjusted upward whenever the owner makes a loan directly to the business.  But, if the owner only guarantees a loan from a third-party instead of making a direct loan, there is an upward adjustment to basis for an LLC but not for an S-corporation.  As a result, if a significant source of financing will be third-party loans guaranteed by the owner(s), this favors the creation of an LLC.

In addition, an S-corporation is only allowed to issue one class of common stock.  While there can be both voting and non-voting common stock, no group of shareholders can have special preference to receive distributions (that is, there can be no preferred stock).  If you need flexibility in securing equity financing, this restriction may limit your options.

Can you save on self-employment taxes? 

Income from an LLC is subject to self-employment taxes in addition to income taxes.  That means that all of the income you receive from an LLC, up to (currently) $113,700, will be subject to a tax rate of 15.3%.  In addition, all of your LLC income will be subject to a Medicare tax of 2.9% (or more for upper income taxpayers).  These taxes are intended to mirror the FICA and Medicare taxes paid by employees and their employers.  While half of each tax is deductible, this is still a hefty tax bite.

S-corporation owners who also work for the corporation receive compensation in their role as an employee.  Only this portion is subject to FICA and Medicare taxes.  Any remaining income to the owner in the owner’s capacity as a shareholder is treated as a dividend and taxed as ordinary income, but not subject to payroll taxes.  This can result in tremendous savings on self-employment taxes.

Obviously, this creates an incentive for owners who work for an S-corporation to pay themselves less than they deserve.  The IRS is aware of this incentive.  It can – and does – recharacterize dividends as salary when it determines that an owner has not been paid reasonable compensation for his or her work.

Who will be the owners?

There are generally no limitations on who can be an owner of an LLC or on how many owners there can be.  But that’s not true of an S-corporation.  An S-corporation must have 100 or fewer shareholders.  In addition, with a few exceptions (like estates or certain trusts), each shareholder must be an individual, none of whom is a nonresident alien.  When it comes time to find new equity investors, these rules could prove limiting.

Do you need flexibility in allocating income and losses? 

As pass-through entities, an S-corporation or LLC’s items of income, gain, loss, or deductions flow through to the entity’s owners.  In an S-corporation, these items pass-through only in direct proportion to each owner’s percentage of stock ownership.  There is no opportunity to allocate some items to some shareholders and other items to other shareholders.

Sometimes you want the flexibility to make special allocations of this sort.  An LLC taxed as a partnership allows you to do that, by putting those allocations in the LLC’s operating agreement.  Of course, this could lead to abuse, with taxpayers using the LLC as a vehicle to gratuitously transfer assets without paying gift taxes.  Consequently, there is a complex set of rules that establish when the IRS will and will not respect such allocations.

What’s your end game?

Whether it’s selling the business and retiring to the Caribbean or passing it along to your children, you probably have an idea of what the end game should be.

Under certain circumstances, a corporation can merge with, or by acquired by, another company in a tax-free reorganization.  Generally for a reorganization to be tax-free, you must receive stock of the acquiring company in exchange for your interest in the business.

These tax-free reorganization provisions apply to S-corporations, but not to multi-owner LLCs.  So, if you hope to one day be gobbled up by a large, publicly traded corporation in exchange for the latter’s stock, you’ll want to be an S-corporation. Of course, there are ways (if carefully planned) to convert an LLC into a C-corporation or an S-corporation in order to later achieve a tax-free reorganization.  But, if not done carefully, the IRS may treat the conversion and subsequent merger or acquisition as a single transaction, forcing you to pay unexpected taxes.

Can you follow corporate formalities?

One of the main reasons for incorporating a business is to achieve limited liability – limiting your exposure on debts or other obligations (including obligations arising out of tort claims) to the amount you have invested in the business.

In very unusual circumstances, a court may strip a corporation of this limited liability by “piercing the corporate veil.”  Usually this happens when a corporation’s owner uses the entity as a personal piggy bank, undercapitalizing it and treating it as a mere extension of the owner, instead of separate and distinct.

To avoid piercing the corporate veil, corporations are generally expected to follow certain corporate formalities – things like holding annual meetings of the shareholders and directors, electing officers, and preparing written minutes and corporate resolutions.  The required corporate formalities are prescribed both in the corporate bylaws or operating agreement and in any governing state statute.

Generally, LLCs are expected to follow fewer corporate formalities than S-corporations.  None of these formalities, mind you, are overwhelming.  But if you prefer to conduct the business less formally and without attention to all those procedural niceties, the LLC may better suit your style.

What are you now?

If you’ve already got a C-corporation up and running but you’d like to move towards a pass-through entity, your decision is likely easy.  Converting from a C-corporation to an S-corporation – though not without difficulties – is far easier than converting from a C-corporation to an LLC taxed as a partnership.

Under the tax code, a conversion from C-corporation to LLC is treated as a deemed liquidation of the C-corporation.  What does that mean?  It means that the C-corporation is deemed to have distributed all of its property to its shareholders in exchange for their stock and the shareholders, in turn, are deemed to have contributed this property to a new LLC.  The tax consequences can be extraordinary.  The C-corporation is deemed to have sold the property at fair market value, recognizing any gain – including any gain resulting from years of depreciation – in the process.  The shareholder, in turn, usually recognizes gain too, since the shareholder is deemed to have sold shares in exchange for property.

While a conversion from a C-corporation to an S-corporation is not without its hurdles and may come at a price, it is far easier than a conversion to an LLC.

Employees are typically reimbursed when they pay or incur expenses on behalf of their employer.  But, unless those reimbursements are made in compliance with federal regulations, they are treated as wages to the employee.  The consequences for both employer and employee can be crushing:  the employer may owe payroll taxes on the amount reimbursed; the employee may be forced to treat the funds as taxable income.

That’s why every business should have a written reimbursement policy that complies with prescribed Treasury regulations.  (You can find a sample policy here.)  When an employer adopts – and follows – an “accountable plan” for reimbursement, reimbursements are excluded from the employee’s income and exempt from payroll taxes.

To qualify as an “accountable plan” the policy must, at a minimum:

1.  Provide that employees will only be reimbursed for ordinary and necessary business expenses paid or incurred by the employee in connection with the performance of services as an employee.

2.  Require that all expenses be substantiated within a reasonable period of time.  Substantiation within 60 days of the expense is always deemed reasonable.  Generally, substantiation requires documentation of the amount of the expense, the date and time of the expense, the place of any travel (if applicable), and the business purpose of the expense.

3.  Require employees to return to the employer, within a reasonable period of time, any amount advanced to the employee for expenses which are not later substantiated.  For this purpose, 120 days is always deemed reasonable.

Having a proper, written reimbursement policy is especially important when an owner-employee incurs expenses on behalf of a business that doesn’t have the money to make a prompt reimbursement.  Such situations frequently give rise to thorny issues about whether the owner-employee has made a loan to the business or a capital contribution, with all of the resulting tax and other legal implications.  By substantiating the expenses in accordance with a proper reimbursement policy, you can eliminate questions about how these expenses should be characterized.

Of course, it is not enough to simply have a written policy.  The policy must also be followed and enforced.  The IRS decides how to treat reimbursements on an employee-by-employee basis.  In addition, if an employer’s actual reimbursement practices reflect a pattern of abusing the provisions relating to employee reimbursement, the IRS can treat all of the reimbursements as having been made under a nonaccountable plan, even when there’s a compliant plan in place.

Elsewhere, I’ve written about the power of the implied covenant of good faith and fair dealing as a litigation tool.  Last week, a New York appellate court proved the point, holding that claims by two auto dealers, based both on the express language of the Dealer Agreements and the implied covenant of good faith and fair dealing, could move forward.

In Legend Autorama, Ltd. v. Audi of America, Inc., 2012 WL 5503626 (N.Y.A.D.2 Dept.), Audi appealed the lower court’s decision denying Audi’s motion for summary judgment.  The plaintiffs in the case were two franchised Audi dealers, operating pursuant to identical Dealer Agreements with Audi.  They filed suit after Audi appointed a new dealer to operate at a location within 13 miles of the plaintiffs’ location.

The plaintiff dealers asserted three claims against Audi.  First, they argued that Audi was in breach of the express terms of the Dealer Agreement.  Second, they argued that Audi’s conduct constituted a breach of the implied covenant of good faith and fair dealing implied in that agreement.  Third, they argued that Audi had breached fiduciary duties they owed to the dealers.

The appellate court rejected the plaintiffs’ breach of fiduciary duty claims, noting that “a conventional business relationship, without more, is insufficient to create a fiduciary relationship.”  But the court allowed the plaintiffs’ breach of contract claims – based both upon the express provisions and the implied covenant – to go forward.

Echoing other courts, the New York Court observed that “implicit in every contract is a covenant of good faith and fair dealing, which encompasses any promise that a reasonable promisee would understand to be included.”  Audi argued that, since the Dealer Agreement specifically provided that the plaintiffs would be nonexclusive distributors, Audi had discretion to add new dealers even within existing dealers’ territories.  The Court rejected the argument, noting that “even an explicitly discretionary contract right may not be exercised in bad faith so as to frustrate the other party’s right to the benefit under the agreement.”

The plaintiffs also argued that Audi’s conduct breached an express provision of the Dealer Agreement, under which Audi agreed to “actively assist Dealer in all aspects of Dealer’s Operations through such means as Audi considers appropriate.”  There was evidence that, when other dealers were underperforming, Audi would permit them to implement action plans prior to opening new dealers in the area.  This they did not do in the case of the plaintiff dealers.  This evidence, according to the Court, was sufficient to allow the express breach of contract claim to move forward.

In the end, the Court’s decision to deny summary judgment on the implied covenant claim reflects the fact specific inquiry that any such claim requires.  Ordinarily, questions of good faith are to be decided by the jury and thus are inappropriate issues for summary judgment.  Here, the dealer plaintiffs got a bonus – even their express breach of contract claim survived.

The United States Tax Court is a nationwide court, created by Congress pursuant to its powers under Article I of the U.S. Constitution.  The Court is composed of 19 Judges appointed by the President, former Judges serving on recall (known as “Senior Judges”), and Special Trial Judges appointed by the Court’s Chief Judge.  The Court’s Judges hold session in 74 designated cities across the country, permitting matters to be litigated in locations convenient to taxpayers.

The Court’s jurisdiction is defined by statute.  The four powers most commonly exercised by the Court are:

1. The power to redetermine tax deficiencies (I.R.C. § 6211 et. seq.).  When the IRS sends a statutory notice of deficiency to a taxpayer, informing the taxpayer that the taxpayer’s return understates the tax owed, the taxpayer has the right to appeal the IRS’s determination to the Tax Court.  The Tax Court is the only court empowered to adjudicate tax disputes before the taxpayer pays the tax demanded.  The U.S. district courts and the U.S. Court of Federal Claims, in contrast, exercise “refund jurisdiction,” deciding tax disputes only after the tax has been paid and a refund demanded.

2. The power to review claims for relief from joint and several liability (I.R.C. § 6015(e)).  When married taxpayers file joint returns, each spouse becomes jointly and severally liable for the entire amount owed.  This means that the IRS can pursue either spouse for the full amount, regardless of which spouse is to blame for the unpaid tax.  Taxpayers can ask the IRS for relief from joint and several liability.  If the request is denied, taxpayers can appeal to the Tax Court.

3. The power to review IRS decisions on liens and levies (I.R.C. §6320 and § 6330).  It may not seem like it, but there are significant procedural limitations on the IRS’s ability to collect the tax it says is due.  If the IRS files a Notice of Federal Tax Lien, for example, it must give the taxpayer an opportunity for an administrative hearing.  Similarly if the IRS intends to seize (or “levy” upon) the taxpayer’s property, it generally must first provide the taxpayer with an opportunity for a hearing.  The IRS’ decisions at such hearings – known as “collection due process hearings” – can be overturned by the Tax Court.

4. The power to review IRS decisions on installment agreements and offers in compromise  (I.R.C. § 6330).  If a taxpayer cannot pay an undisputed tax, the IRS has the power to enter into “installment agreements” or “offers in compromise.”  Under an installment agreement, the IRS agrees to accept payments over a period of time, suspending other collection efforts in the process.  Under an offer in compromise, the IRS agrees to accept less than the full amount owed.  IRS guidelines determine whether the IRS will enter into such agreements, and on what terms.  If a taxpayer disagrees with the IRS’s decision on a taxpayer’s request to enter into an agreement, and the proper procedural steps are followed, the Tax Court has the power to review the decision.

Except in certain cases designated as small cases (or “S Cases”), a decision of the Tax Court can be appealed to the U.S. Circuit Court for the State in which the taxpayer is domiciled.  As a result, under the “Golsen rule,” the Tax Court must apply the law in each case as that law has been interpreted by the Circuit Court of the taxpayer’s domicile.  See Golsen v. Commissioner, 54 T.C. 742 (1970).  Thus, in rare cases, the Tax Court will reach different rulings for different taxpayers, even on the same facts.

Claims for trademark or service mark infringement are usually brought pursuant to the Lanham Act, 15 U.S.C. § 1051 et. seq.  But that Act contains no statute of limitations.  So when infringement occurs, how long do you have to seek redress?

Some Courts – including the Fourth Circuit – draw on the statute of limitations of analogous state laws to determine the applicable statute of limitations.  See PBM Products, LLC v. Mead Johnson & Co., 639 F.3d 111 (4th Cir. 2011).   As a result, claims based upon infringing activity that occurred outside of the State’s analogous statute of limitations will be barred.  This means that, for statute of limitations purposes, the time limit will often vary based upon state law.

But, as illustrated in a recent First Circuit decision, other Courts determine the applicable time limit by applying the equitable doctrine of laches, either in lieu of the State’s analogous statute of limitations or to supplement that statute of limitations.  In Oriental Financial Group, Inc. v. Cooperativa de Ahorro y Crédito Oriental, 11-1473, 11-1476 (1st Cir. Oct. 18, 2012), the plaintiff and defendant were competing financial institutions, providing services in Puerto Rico.  The plaintiff began using the mark “ORIENTAL” in connection with its services in 1964.  The defendant first began using the term “oriental” as part of its corporate name in 1966 and adopted the mark “COOP ORIENTAL” (or some variation thereof) in 1995.

In 2009, the plaintiff sent a cease and desist letter to the defendant, demanding that it cease the use of the ORIENTAL mark.  When litigation ensued, the defendant argued – in part – that the injunction sought by the plaintiff against the defendant’s use of the ORIENTAL mark was barred by the doctrine of laches.

As the Court noted, “[l]aches . . . is an equitable doctrine which penalizes a litigant for negligent or willful failure to assert his rights. . . .”  Id.  It requires proof of:  “(1) lack of diligence by the party against whom the defense is asserted, and (2) prejudice to the party asserting the defense.”  Id.  Laches only applies, however, “where the plaintiff knew or should have known of the infringing conduct.”  Id.

The First Circuit held that, regardless of whether these elements of a laches defense can be shown, the defense itself is barred by the doctrine of progressive encroachment.  The “progressive encroachment doctrine requires proof that (1) during the period of the delay the plaintiff could reasonably conclude that it should not bring suit to challenge the allegedly infringing activity; (2) the defendant materially altered its infringing activities; and (3) suit was not unreasonably delayed after the alteration in infringing activity.”

As to the second element, the Court found that between 2008 and 2010 (when the plaintiff filed suit), the defendant “materially altered the reach of both its operations and its allegedly infringing advertising. “  Specifically, the defendant’s activities expanded geographically to encompass more regions in Puerto Rico.  The defendant also expanded its advertising efforts in 2009, reaching far more consumers.  As a result, the defendant grew from a “regional to an island-wide business” more “squarely in competition with the plaintiff.”  As to the third element, the Court noted that the plaintiff filed suit “shortly after these changes occurred.”

Finally, the Court considered the first element – whether the plaintiff could have reasonably concluded that it should not bring suit.  Obviously, the plaintiff could not have been expected to file suit until it had a claim.  The test, therefore, is “whether and when any likelihood of confusion may have ripened into a claim.”  The Court found that any pre-2009 infringement was de minimis and thus “it was reasonable as a matter of law for [the plaintiff] to delay bringing suit.”

The doctrine of laches is premised on the idea that it would be inequitable for a party to simply sleep on its rights.  That is, in the context of trademark or service mark infringement, a senior user should not be allowed to wait, while a junior user spends money and time developing a mark and expanding its business based on that mark, only to later act to prevent the mark’s use.  In addition, since infringement actions are designed to protect consumers by eliminating confusion in the marketplace, allowing infringement to unnecessarily persist undermines free market mechanisms.

But, as the doctrine of progressive encroachment suggests, the policy rationale underlying the doctrine of laches can sometimes be trumped by the need to protect senior users who, through no fault of their own, were caught off-guard by a junior user’s expanded use of the mark.

I’m not a big music fan, but a decision last week by the U.S. District Court for the Southern District of New York caught my eye.

It seems that Ryan Leslie – described in his Wikipedia page as an “American record producer, singer-songwriter, multi-instrumentalist and occasional rapper – lost his laptop and external hard drive while on tour in Germany.  Lost too was apparently some of Leslie’s intellectual property, including music and videos relating to his records and performances.

So Leslie posted a YouTube video, offering a $20,000 reward for the equipment’s return.  Eleven days later, he posted a second video, vowing to continue his “Euro tour” and increasing the reward to $1 million.

After Armin Augstein found and returned the laptop and hard drive, Augstein naturally wanted his reward.  When Leslie refused to pay up, Augstein sued.  Leslie argued that the offer for a reward wasn’t really an offer at all – instead, it was an “advertisement” or mere “invitation to negotiate.”  The offer was made on “YouTube,” he added, suggesting that no one could have taken it seriously.  Besides, he argued, he tried to access the intellectual property after the equipment was returned and couldn’t.  The reward had been offered, he contended, not for the equipment itself, but for the intellectual property the equipment held.

But, as the Court noted in Augstein v. Leslie, 11 Civ. 7512 (S.D.N.Y. Oct. 17, 2012), there was no dispute that – even after receiving notice of a potential lawsuit against him – Leslie allowed the equipment’s manufacturer to delete everything and send Leslie a replacement.  So, we’ll never know what was on the equipment.

According to the Court, the key question in resolving whether this was an “offer” or a mere “advertisement” is whether a “reasonable person” would have believed that this was an offer.  Here, Leslie’s offer was for someone to perform a specific action – finding the property.  As a result “a reasonable person viewing the video would understand that Leslie was seeking the return of his property and that by returning it, the bargain would be concluded.”

In addition, given that litigation was all but certain at the time that Leslie authorized the manufacturer to destroy the equipment, “Leslie and his team were at least negligent in their handling of the hard drive.”  The Court therefore sanctioned Leslie with an adverse inference – in other words, the Court ordered that it will be “assumed that the desired intellectual property was present on the hard drive” when Augstein returned it.

Augstein doesn’t have his reward yet.  But it looks like he’s well on his way.

In 2007, Edie Windsor married her long-time domestic partner, Thea Spyer.   Two years later Spyer died, leaving a substantial estate.

Large estates can be subject to the federal estate tax, which currently imposes a top tax rate of 35%.  But under I.R.C. § 2056(a), any portion of your estate which passes to your spouse qualifies for an unlimited marital deduction.  As a result, this portion goes untaxed – until that is, your spouse dies.

Unfortunately for Mrs. Windsor, the Defense of Marriage Act (or DOMA) provides that – regardless of whether you are lawfully married under state law – the marriage will not be recognized for purposes of federal tax law.  As a result, the money left to Mrs. Windsor by her spouse did not qualify for the marital deduction and the estate had to pay $353,053 in additional federal estate taxes.

After paying the tax, Mrs. Windsor, in her capacity as Executor of the Estate, filed suit, seeking a refund.  She argued that Section 3 of DOMA – which defines marriage as between a man and a woman – is unconstitutional under the Fifth Amendment’s Equal Protection Clause.  In June, she won in U.S. district court, which ordered the IRS to pay back the taxes.

Now she’s won again.  In Windsor v. United States, 12-2335-cv (2nd Cir. October 18, 2012), the Second Circuit held that Section 3 of DOMA is unconstitutional.  Noting that “homosexuals as a group have historically endured persecution and discrimination,” the Court determined that “homosexuals compose a class that is subject to heightened scrutiny.”

What difference does it make what level of scrutiny applies?  A lot, in the world of equal protection analysis.  When the government treats people differently based on race or ethnicity, the government must prove that the different treatment is “necessary” to achieve a “compelling” state interest.  This “strict scrutiny” test is almost never met.  When government treats people differently based on gender, it must pass “intermediate scrutiny” – that is, the different treatment must be “substantially related” to an “important” government interest.  Virtually all other classifications need only meet “rational basis review,” under which the different treatment must be “rationally related” to a “legitimate” government interest.  Virtually every law passes this test.

The Supreme Court has yet to say what level of scrutiny should be applied to laws that treat people differently based on sexual orientation.  In Windsor, the district court applied rational basis review and still concluded that DOMA was unconstitutional.  In Massachusetts v. DHHS, 682 F.2d 1 (1st Cir. 2012), the First Circuit also held that DOMA was unconstitutional, although it applied an arguably novel form of “heightened scrutiny,” after concluding that there was no precedent for applying intermediate scrutiny.  But the Second Circuit took yet a different approach, applying intermediate scrutiny, which it found DOMA did not pass.

Ultimately the issue will be decided by the Supreme Court.  For some time now, tax advisers have encouraged married, same-sex couples to file protective refund claims, protecting their right to a refund in the event that DOMA is ultimately declared unconstitutional.  Usually such claims are filed by couples who overpay their taxes because DOMA prevents them from filing joint returns.  Today’s decision will surely add new urgency to this advice.

If you run a business, there are a few things you should know about politics and taxes.

1. There’s no bad debt deduction for debts owed by political organizations.  Accrual method taxpayers are accustomed to reporting income when earned, regardless of when they actually get paid.  If, in a later tax year, they don’t get paid, they are generally allowed a bad debt deduction.  But, under I.R.C. § 271, if you provide goods or services to a political organization (including a political party or any committee which attempts to influence an election) and the organization doesn’t pay up, a bad debt deduction is disallowed.  There is an exception if more than 30% of your receivables come from such organizations and you make continuing efforts to collect on the debt.  And, obviously, cash method taxpayers need not be concerned, since they report income only when the bill is paid.  The obvious policy rationale behind this rule is to prevent people from converting otherwise non-deductible political contributions into tax deductions.  But the unaware can get hit twice – once when the customer fails to pay up and again when the IRS disallows a deduction on the bad debt.

2. Political expenses are not deductible.  Almost every business owner knows that “ordinary and necessary” business expenses are deductible.  What if your business buys an ad in a political program or a ticket to a political event?  Is this deductible if the expense is incurred to promote your business?  Under a special provision of Internal Revenue Code, it is not.  I.R.C. § 276 disallows a deduction for such “indirect contributions,” including expenses for:  (1) advertising in a publication if part of the proceeds supports a party or candidate; (2) admission to any dinner or program if part of the proceeds support a party or candidate; or (3) admission to a gala, parade, concert, or “similar event” if “identified with” a party or candidate.

3. Most – but not all – lobbying expenses are not deductible.  Let’s say that whether your business thrives or struggles depends on what happens with a particular bill in Congress or the State Legislature.  Can you deduct any expenses incurred in lobbying for or against the bill?   No you can’t.  Under I.R.C. § 162(e), no business deduction is allowed for expenses incurred in connection with influencing legislation, attempting to influence the public on legislative matters, or directly communicating with certain executive branch officials in an attempt to influence official actions.  There are three important exceptions to the rule.  First, the rule doesn’t apply to “local legislation.”  So, for example, if you spend money trying to lobby the City Council on a zoning issue, this is fully deductible (provided it meets the other requirements for a business deduction).  Second, if someone in-house does the lobbying, you can continue to deduct that person’s full salary, provided that the amount attributable to lobbying does not exceed $2000 in any taxable year.  Finally, if you are in the business of lobbying, the rule obviously doesn’t apply.

4. Illegal bribes or kickbacks to government employees are not deductible.  There are a lot of reasons why you shouldn’t pay bribes or kickbacks to government employees.  There are criminal sanctions for doing that, regardless of whether the official or employee is here in United States or in a foreign nation.  But if that’s not a sufficient deterrent, I.R.C. § 162(c) disallows a deduction for any such payments made.  The regulations provide one example:  a company in the business of selling hospital equipment hires a moonlighting employee whose full time job is Superintendent of Hospitals.  If done to procure an improper advantage in violation of state law, the employee’s salary is not deductible.