Category: Tax Law

Wade owns 40 percent of an oilfield-services LLC in Artesia. He schedules the crews every morning and signs the equipment leases himself. The LLC files a partnership return, and for years its preparer has put a zero on the self-employment line of Wade’s K-1, reasoning that a member with limited liability is close enough to a limited partner to skip Social Security and Medicare tax on his profit share.

That reasoning had a bad September. The Second Circuit ruled for the IRS on September 17, 2026, adopting the Tax Court’s view of the limited partner exclusion, five weeks after the Fifth Circuit rewrote its own test. Both cases involved investment firms, and neither court hears New Mexico appeals. The rule lands harder on operating LLCs here, where owners do the work.

Does a New Mexico LLC member owe self-employment tax on K-1 income?

Usually, yes. Self-employment tax is 12.4 percent for Social Security and 2.9 percent for Medicare (26 U.S.C. § 1401). Net earnings from self-employment include the slice of partnership business income allocated to each partner, “whether or not distributed” (26 U.S.C. § 1402(a)). Section 1402(a)(13) carves out “the distributive share of any item of income or loss of a limited partner, as such,” though guaranteed payments for services stay taxable.

An LLC member is not a limited partner under New Mexico law at all. The Limited Liability Company Act, NMSA 1978, § 53-19-1 et seq., shields members from company debts (NMSA 1978, § 53-19-13), while limited partners exist under a separate statute, NMSA 1978, ch. 54, art. 2A. The question becomes whether he functions like a limited partner, as such. Congress never defined the term.

What does “limited partner” mean in section 1402(a)(13) after Soroban and K Alain?

Congress wrote the exclusion in 1977 with passive investors in mind. Treasury’s January 1997 proposal, 62 Fed. Reg. 1702 (Prop. Treas. Reg. § 1.1402(a)-2(h)), would have denied limited partner treatment to anyone personally liable for partnership debts, holding authority to contract for the entity, or working more than 500 hours a year. Congress responded in § 935 of the Taxpayer Relief Act of 1997, barring final or temporary regulations before July 1, 1998. Nothing was finalized, and the 2026-2027 Priority Guidance Plan (September 29, 2026) lists no project on it.

In Renkemeyer, Campbell & Weaver, LLP v. Commissioner, 136 T.C. 137 (2011), law partners who paid $110 each for their interests owed the tax on shares earned by legal work. Soroban Capital Partners LP v. Commissioner, 161 T.C. 310 (2023), read “as such” to reach only a limited partner “who is functioning as a limited partner,” and T.C. Memo. 2025-52 applied that functional analysis test. The Second Circuit affirmed (Nos. 25-2079, 25-2250), defining the term as a partner who, “in addition to having limited liability, does not run, manage, or control the partnership’s business.”

On August 12, 2026, granting panel rehearing in No. 24-60240, the Fifth Circuit withdrew Sirius Solutions, L.L.L.P. v. Commissioner, 165 F.4th 374 (5th Cir. 2026), and substituted K Alain, L.L.L.P. v. Commissioner; Sirius had changed its name. A limited partner is now one “who plays no significant role in managing or running a business,” and the case went back for the facts over a dissent. The taxpayer reportedly sought en banc review in late September. Denham Capital Management LP v. Commissioner, T.C. Memo. 2024-114, argued in the First Circuit (No. 25-1349) in February 2026, was undecided when I checked.

Which rule applies to a New Mexico LLC, and what has the Tenth Circuit said?

Nothing yet. I found no Tenth Circuit or Tenth Circuit BAP opinion construing § 1402(a)(13). An individual’s Tax Court case is appealable to the circuit of his legal residence under 26 U.S.C. § 7482(b)(1)(A), which for Wade is the Tenth Circuit.

Under Golsen v. Commissioner, 54 T.C. 742 (1970), aff’d, 445 F.2d 985 (10th Cir. 1971), the Tax Court follows an appellate decision “squarely in point” only from the circuit that will hear the appeal. With no Tenth Circuit ruling, a New Mexico member in Tax Court (see the firm’s post on New Mexico Tax Court trial locations) should expect Soroban and Denham to govern. K Alain becomes an argument for the Tenth Circuit, not a rule the trial judge must apply.

How would the functional analysis test treat an Artesia oilfield-services LLC?

Denham asks where the partnership’s income comes from, what the partner does to generate it, and how his share relates to the capital he put in, and the taxpayer carries the burden. An oilfield-services company earns its money from crews and equipment, and Wade runs it full time. Unless his capital is large next to what labor earns, his position is weak.

Castigliola v. Commissioner, T.C. Memo. 2017-62, involved a member-managed Mississippi PLLC. Management was vested in each member, all of them made the borrowing and hiring decisions, and the court held none could be a limited partner; with equal rights, each stood where a general partner would. New Mexico’s default points the same way: unless the articles name managers, management “shall be vested in the members” (NMSA 1978, § 53-19-15). I often see small LLCs here formed on default articles, so even a silent member may hold management power.

The passive member is harder. Denham describes Hardy v. Commissioner, T.C. Memo. 2017-16, where a surgeon with a minority stake in a surgery center, no management role, and a share driven by facility fees was held to receive it as an investor. Labels do not decide it; New Mexico even lets a true limited partner join in management and keep liability protection (NMSA 1978, § 54-2A-303).

What could Wade’s self-employment tax exposure be for 2023 through 2025?

Illustration only. Assume a $210,000 share for 2025 and no guaranteed payment. Under § 1402(a)(12), net earnings are 92.35 percent of that, or $193,935. The 12.4 percent tax stops at the 2025 wage base of $176,100 (Social Security Administration), producing $21,836, and 2.9 percent on everything adds $5,624, for $27,461. The extra 0.9 percent Medicare tax starts above $200,000, or $250,000 on a joint return (§ 1401(b)(2)), so it does not reach him.

Half, $13,730, is deductible under 26 U.S.C. § 164(f), lowering federal adjusted gross income, where New Mexico base income starts (NMSA 1978, § 7-2-2). With the same share in 2023 and 2024, when the bases were $160,200 and $168,600, the tax is $25,489 and $26,531. Three years total about $79,500 before interest, partly offset by the deductions.

A 20 percent member who contributed cash and does no work would have a $105,000 share. Taxed, it carries $14,836 a year; excluded, nothing.

How does a BBA partnership audit reach self-employment tax, and what is the exposure?

All three appeals arose under TEFRA, the pre-2018 regime. For later years, the BBA partnership audit rules (26 U.S.C. §§ 6221 to 6241) give a partnership representative “sole authority” (§ 6223(a)), and the entity generally pays any imputed underpayment (§ 6225(a)). But Treas. Reg. § 301.6241-6(a)(1) says the regime “only applies to tax imposed by chapter 1,” which leaves out self-employment tax; the IRS may adjust for it in a separate proceeding, taking any BBA determinations into account. My reading is that Wade’s tax would be assessed against him personally. Partnerships issuing 100 or fewer K-1s to eligible partners may also elect out on a timely return (§ 6221(b)).

The IRS’s “SECA tax” compliance campaign, active since March 2018, targets service partners, LLC members included. Assessment generally must come within three years after filing (26 U.S.C. § 6501(a)), so a 2023 return filed by April 15, 2024 stays open until April 15, 2027. A 20 percent penalty can apply (§ 6662). The Castigliola lawyers avoided it under § 6664(c)(1) by relying on a veteran CPA before Renkemeyer, a defense that gets harder for recent years.

Going forward, owners usually weigh guaranteed payments sized to the work against an S corporation election with wages (see the firm’s post on LLC versus S corporation in New Mexico). Some instead split capital from management through manager-managed articles.

Member type	Likely result under Soroban	What to document	Risk level
Full-time member-manager	No exclusion; whole share is self-employment income	Hours and duties usually confirm the result	High
Part-time member working in the field	Likely no exclusion if the work drives profit	Hours, duties, link between share and services	High to moderate
Passive member, member-managed LLC	Uncertain; statutory management rights cut against it	No role in decisions; capital at risk	Moderate
Passive capital member, manager-managed LLC	Exclusion plausible	Articles naming managers; share tied to capital	Lower
Limited partner in a New Mexico LP	Exclusion only if not managing in fact	Actual conduct, not the agreement’s label	Depends on role

Frequently Asked Questions

Is an LLC member a limited partner for self-employment tax?

Not automatically. The Tax Court asks whether the member functions like one. Members who run the business generally owe it on their full share.

Is a New Mexico taxpayer bound by the Soroban appeal?

Not directly, since New Mexico appeals go to the Tenth Circuit. But the Tax Court applies its own Soroban rule when the Tenth Circuit has not spoken, and it has not.

How many hours can a member work and still claim the exclusion?

No number controls. The 500-hour test in the 1997 proposed regulations was never adopted, and the Second Circuit described its test as depending on the totality of the circumstances.

Do guaranteed payments make the rest of the K-1 share exempt?

No. Guaranteed payments for services are self-employment income on their own terms. In Castigliola the members paid tax on market-rate guaranteed payments and still owed it on the rest of their shares.

Can the IRS still assess self-employment tax for 2023?

Generally yes, if the return was filed in 2024. The three-year period under § 6501(a) runs from filing, and an early return counts as filed on its due date.

How North Star Law Firm Can Help

North Star Law Firm advises New Mexico owners on business entity selection and other tax law questions, and represents members in IRS audits and Tax Court litigation when self-employment tax is in dispute.

Phillip Zagotti, JD/CPA, represents taxpayers before the IRS and the U.S. Tax Court and is admitted to the U.S. District Court and Bankruptcy Court for the District of New Mexico. The firm works alongside New Mexico-licensed counsel on state-law questions. If your K-1 shows no self-employment income and you spend your days running the business, contact North Star Law Firm.

Ignacio has guided elk hunters and fly fishermen out of Taos for other outfitters for a decade. This winter he and a partner plan to open their own operation, with horses, two trucks and an SBA loan application. The lender’s checklist asks what kind of entity the borrower is, and a friend swears an S corporation will save a fortune in taxes.

That is half a tax answer and no credit answer. What matters is the tax two owners will really pay at their profit level, and what the entity will not shield when a loan goes bad. This post states the law as of October 27, 2026.

Does forming an LLC protect me from an SBA loan I personally guarantee?

No. Under 13 C.F.R. § 120.160(a), holders of at least 20 percent of an SBA borrower “generally must guarantee the loan,” so both owners would sign personally regardless of entity. COVID-era EIDL loans above $200,000 worked the same way, according to the SBA Inspector General’s Report 25-23 (Aug. 12, 2025).

If the company files Chapter 7, it gets no discharge: 11 U.S.C. § 727(a)(1) grants one only to individuals, and § 524(e) says one debtor’s discharge does not change anyone else’s liability on the debt. The guaranty is resolved in the owner’s own case or by negotiation.

A quieter trap: EIDL loan documents restrict ownership and structural changes, which the SBA handles as servicing requests it must approve (see its COVID-19 EIDL page). An S election or conversion can create a technical default, and in my experience the preparer rarely reads the loan agreement first.

How much self-employment tax does a New Mexico LLC owner pay in 2026?

By default, a two-member LLC is a partnership and a one-member LLC is disregarded (Treas. Reg. § 301.7701-3(b)(1)). Either way, each owner’s share of profit is self-employment income under 26 U.S.C. § 1402(a), distributed or not. Section 1401 taxes 92.35 percent of it (after the § 1402(a)(12) adjustment) at 12.4 percent for Social Security, up to the 2026 wage base of $184,500 set by the Social Security Administration, and at 2.9 percent for Medicare with no cap. Above $200,000 for single filers ($250,000 joint), another 0.9 percent applies (§ 1401(b)(2)).

The offset is 26 U.S.C. § 199A, a deduction of up to 20 percent of qualified business income. The One Big Beautiful Bill Act (Pub. L. 119-21, § 70105) removed its 2025 sunset, making it permanent. For 2026, Rev. Proc. 2025-32, § 4.26, sets the threshold at $201,750 ($403,500 joint); below it, the wage and property limits do not apply.

When does an S corporation election pay for itself in New Mexico?

An S corporation pays working owners a salary, taxed under § 3101 and § 3111, and passes the rest through free of payroll tax. The salary must be reasonable. The IRS treats “dividends” paid in place of reasonable pay as wages (Rev. Rul. 74-44), and in Gale W. Greenlee, Inc. v. United States, 661 F. Supp. 642 (D. Colo. 1985), a working sole shareholder’s interest-free “loans” were held to be wages subject to FICA and FUTA. I found no Tenth Circuit decision on S corporation salaries. Salary also is not qualified business income (§ 199A(c)(4)(A)), so it shrinks the 20 percent deduction.

Illustration only. Assume a 50/50 split, each owner files single with no other income, takes the 2026 standard deduction of $16,100, and pays New Mexico tax at the single rates in NMSA 1978, § 7-2-7. At $140,000 of net profit and reasonable salaries of $55,000 each, the election saves each owner about $440 a year in combined payroll and income tax, roughly $870 for both. At $320,000 with $90,000 salaries, it saves about $4,225 per owner, near $8,450 together, or 6 percent of the $70,000 each moved out of salary. Unemployment taxes on salaries would trim both.

Hence my rule of thumb: an S election earns its keep only once the business throws off a few hundred thousand dollars a year, counting the owners’ pay. The saving runs around 6.5 percent of what shifts from salary to distributions and must cover payroll filings, a Form 1120-S, New Mexico’s S-Corp return with the $50 franchise tax (NMSA 1978, § 7-2A-5.1), plus salary audit risk. A two-member LLC swaps these for its Form 1065 and New Mexico PTE return; a one-member LLC adds them.

How does New Mexico tax LLCs, S corporations and C corporations?

An LLC is formed under the Limited Liability Company Act, NMSA 1978, § 53-19-1 et seq.; its tax treatment is a separate federal choice made on Form 8832 or Form 2553. Personal income tax starts from federal adjusted gross income (§ 7-2-2) and, for 2025 and later years, tops out at 5.9 percent above $210,000 of taxable income for single filers and $315,000 jointly. The corporate rate has been a flat 5.9 percent since January 1, 2025 (§ 7-2A-5). Gross receipts tax reaches “any person engaging in business in New Mexico” (§ 7-9-4), whatever the entity.

Many owners miss the elective entity-level tax in NMSA 1978, § 7-3A-10 (2022, amended 2023). A partnership or S corporation may elect, year by year, to pay New Mexico tax on its owners’ income at the higher of the top individual or corporate rate, 5.9 percent for 2026. The election binds every owner, and each gets a credit for tax paid on his share. Under IRS Notice 2020-75, the entity deducts it federally, outside each owner’s 2026 state and local tax cap of $40,400 (26 U.S.C. § 164(b)(7)). But the statute excludes “a single member limited liability company that is treated as a disregarded entity for federal income tax purposes” (§ 7-3A-2(H)(5)), so a one-owner LLC cannot elect unless it has made an S election.

Is the 21 percent C corporation rate a better deal for a small New Mexico business?

Usually not for owners who live on the profit: 26 U.S.C. § 11(b) sets the federal rate at “21 percent of taxable income,” and New Mexico adds 5.9 percent. Retained profit escapes self-employment tax but gets no § 199A deduction, and dividends are taxed again at up to 20 percent under § 1(h)(11), plus New Mexico income tax. It suits a business reinvesting for years. Qualified small business stock under § 1202 is the other draw; the firm’s post on gifting QSBS in New Mexico covers the basics, and a post publishing October 31 takes up QSBS held through an LLC.

The second tax returns at the end. A liquidating C corporation recognizes gain as if it sold its assets at fair market value (§ 336(a)), and shareholders treat what they receive as a sale of their stock (§ 331(a)). In a wind-down, that double layer lands when cash is shortest. See also the firm’s post on revoking an S election before a bankruptcy sale.

What happens to my LLC interest or S corporation stock if I file bankruptcy?

It becomes estate property. 11 U.S.C. § 541(a)(1) takes in “all legal or equitable interests of the debtor in property,” and § 541(c)(1) overrides transfer restrictions and bankruptcy-triggered clauses. A Chapter 7 trustee could sell Ignacio’s half.

New Mexico’s charging-order statute, NMSA 1978, § 53-19-35, limits a judgment creditor to an assignee’s rights and says nothing about one-member companies. In In re Albright, 291 B.R. 538 (Bankr. D. Colo. 2003), a sole member’s whole interest passed to the estate, and the trustee, as substituted member, could make the LLC sell its land, because the charging-order limit protects other members and there were none. Albright applied Colorado law and binds no New Mexico court. I have found no New Mexico decision on the point, but a trustee here would likely argue it.

In In re Majestic Star Casino, LLC, 716 F.3d 736 (3d Cir. 2013), the Third Circuit held that S status itself is not property of the corporation’s estate, rejecting earlier bankruptcy court rulings. I have found no Tenth Circuit decision. The firm’s post on Owoc and S elections in bankruptcy covers what that fight means here.

Issue	LLC taxed as partnership	S corporation	C corporation
Self-employment or payroll tax	On each owner’s full share	On reasonable salary only	On salary; dividends taxed again
§ 199A deduction	Up to 20% of share	Up to 20% of profit after salary	None
New Mexico return and entity-level election	Form PTE; may elect (not a disregarded one-member LLC)	Form S-Corp, $50 franchise tax; may elect	5.9% corporate tax, $50 franchise tax
Owner liability for business debt	Shielded except guaranties	Shielded except guaranties	Shielded except guaranties
What an owner’s Chapter 7 trustee gets	The interest; maybe control of a one-member LLC	The shares; S status itself contested	The shares

Frequently Asked Questions

Does an S election change how my New Mexico LLC is organized?

No. It remains a New Mexico LLC; only its federal tax classification changes. A timely Form 2553 also counts as the corporate classification election, so no Form 8832 is needed.

When is Form 2553 due for the 2027 tax year?

For a calendar-year company, by March 15, 2027, the 15th day of the third month under 26 U.S.C. § 1362(b)(1), or any time during 2026. Every shareholder must consent, and § 1362(b)(5) allows relief for a late election with reasonable cause.

Can a single-member LLC make New Mexico’s pass-through entity tax election?

Not while it is disregarded for federal tax purposes. If it elects S status, it files New Mexico’s S-Corp return and can make the annual election there.

Does my entity choice change New Mexico gross receipts tax?

No. It turns on what you sell and where, not on your entity type.

If my company files Chapter 7, am I off the hook on my SBA guaranty?

No. A company gets no Chapter 7 discharge, and 11 U.S.C. § 524(e) keeps a guarantor liable regardless. The guaranty must be resolved by negotiation or in the owner’s own case.

How North Star Law Firm Can Help

North Star Law Firm advises New Mexico owners on business entity selection, reading the loan documents alongside the tax math, and on gross receipts tax. For owners and businesses that cannot carry their debts, it handles bankruptcy for both.

Phillip Zagotti, JD/CPA, represents taxpayers before the IRS and the U.S. Tax Court and is admitted to the U.S. District Court and Bankruptcy Court for the District of New Mexico. The firm works alongside New Mexico-licensed counsel on state-law questions. If you are weighing an S election, or already made one after taking an SBA loan, contact North Star Law Firm.

Picture a social-services nonprofit in Gallup whose board is appointed by the local Catholic bishop. It runs a food pantry and a housing-assistance desk with 14 people on payroll, and it has paid New Mexico unemployment contributions every quarter since it opened. Now a board member has read that the U.S. Supreme Court sided with a diocesan charity in Wisconsin on the same tax.

Should the Gallup group stop paying? Not automatically. The case set a constitutional limit on how states read their religious-employer exclusions. Whether a New Mexico ministry fits our exclusion is still a state-law question, under a statute that borrows the Wisconsin words almost exactly.

Does New Mexico exempt church-controlled nonprofits from state unemployment tax?

It can. The New Mexico Unemployment Compensation Law brings nonprofit work into coverage in NMSA 1978, § 51-1-42(F)(8), which reaches service for “a religious, charitable, educational or other organization” that federal law leaves out. Paragraph (12) then takes some of it back. Under § 51-1-42(F)(12)(a), “employment” does not include service for a church or convention or association of churches, or for “an organization that is operated primarily for religious purposes and that is operated, supervised, controlled or principally supported by a church or convention or association of churches.” Subparagraph (b) separately excludes ministers performing their ministry.

That is the Wisconsin test nearly word for word, down to the phrase the Supreme Court had in front of it. Both halves matter: church control alone is not enough, and a devout charity with no church behind it does not qualify either.

I searched for a New Mexico appellate decision or a Tenth Circuit opinion applying this paragraph and found none. Disputes start with the Department of Workforce Solutions, which under § 51-1-13(A)(4) notifies nonprofits of their status and allows reconsideration and appeal.

Why does New Mexico’s exemption copy FUTA § 3309(b)(1)?

Because the federal statute wrote the words first. The Federal Unemployment Tax Act imposes a 6 percent tax on the first $7,000 of each employee’s wages (26 U.S.C. § 3301; § 3306(b)(1)), but § 3306(c)(8) takes work for a 501(c)(3) organization out of federal “employment” altogether. No 501(c)(3), church or not, pays FUTA.

Congress did not let charities skip unemployment coverage, though. Section 3309(a) tells each state what its law must do for 501(c)(3) employees: cover them, and under § 3309(a)(2) let those employers pay “in lieu of” contributions, reimbursing the fund for benefits actually drawn. Then § 3309(b)(1) carves out churches, religious elementary and secondary schools, and organizations “operated primarily for religious purposes” that a church operates, supervises, controls or principally supports. Since 1970, the Court noted, “over 40 States have adopted similar exemptions,” New Mexico among them.

So the religious carve-out is purely a state question. Federally, a church-run pantry and a secular food bank are already treated alike.

What did Catholic Charities Bureau v. Wisconsin actually hold?

In Catholic Charities Bureau, Inc. v. Wisconsin Labor & Industry Review Commission, 605 U.S. ___ (2025) (No. 24-154, June 5, 2025), a unanimous Court, per Justice Sotomayor, held that the Wisconsin Supreme Court’s application of the exemption violated the First Amendment. The Wisconsin court had denied the exemption because the charities did not proselytize and served people of every faith. That approach, the opinion said, “grants a denominational preference by explicitly differentiating between religions based on theological practices.” Drawing lines that way is “textbook denominational discrimination,” and it triggers strict scrutiny. Wisconsin’s two asserted interests, broad coverage and avoiding entanglement, failed it; the charities ran their own unemployment program, and the exemption covered “both the janitor and the priest in equal measure.”

The holding is narrow. Footnote 2 confines it to the denominational neutrality challenge, and the Court did not define “operated primarily for religious purposes.” The rule it applied comes from Larson v. Valente, 456 U.S. 228 (1982): one denomination may not be officially preferred over another. Justice Thomas would also have treated the charity as an arm of the diocese under church law. Justice Jackson read the federal phrase functionally, as turning on “what an entity does, not how or why it does it.”

On remand, the Wisconsin Supreme Court’s December 15, 2025 order directed the commission to declare the charities eligible.

How can New Mexico read “operated primarily for religious purposes” after Catholic Charities?

With care. Nothing in the opinion forbids the Department of Workforce Solutions from looking at what an organization does; the statutory question stays open. What an agency or court cannot do is decide eligibility by asking whether the ministry evangelizes or serves only its own members. Those are theological choices, and a test that rewards one tradition’s choices over another’s must survive strict scrutiny. Wisconsin’s did not.

St. Martin Evangelical Lutheran Church v. South Dakota, 451 U.S. 772 (1981), read “church” in § 3309(b)(1)(A) to mean the congregation or hierarchy, so a school with no separate corporate existence was the church. A separately incorporated affiliate like our Gallup group must clear the “primarily religious” test instead. The Jackson concurrence previews what a state could still argue: an activity-based reading applied evenhandedly to every faith. New Mexico’s answer is unsettled.

Exempt, reimbursing, or contributing: what does each cost a Gallup nonprofit?

Illustration only. Assume all 14 employees earn more than the 2026 New Mexico taxable wage base of $34,800 (the figure national payroll publishers report; confirm it with the department before relying on it). Taxable wages are 14 times $34,800, or $487,200.

As a contributing employer, under § 51-1-11, the group pays its industry’s average new-employer rate, never less than 1 percent, and experience-rated employers range from 0.33 to 5.4 percent. At the 1 percent floor the bill is $4,872 a year. At 5.4 percent it would be about $26,309.

As a reimbursing employer under § 51-1-13, it must post a bond or cash deposit equal to 2.7 percent of taxable wages, about $13,154 here, payable in three annual installments with the secretary’s consent. With no benefit charges in the prior year, it prepays one-eighth of 1 percent each quarter, $609. Now suppose a grant ends and two laid-off case managers draw an assumed $11,000 in benefits. The group is billed the full $11,000, and later quarterly prepayments become 25 percent of charges in the four quarters ending the preceding June 30, $2,750 a quarter. Reimbursing is cheaper in quiet years, dearer in a layoff year.

If the group is exempt under paragraph (12), it pays nothing, and those two case managers have no New Mexico claim based on their work there. Section 51-1-18(D) lets an employing unit elect coverage for services that are not “employment,” for at least two calendar years, with the secretary’s written approval. Whether a voluntarily covered ministry can then use the reimbursing method is a question to put to the department.

Does the unemployment exemption change FICA, 501(c)(3) status, or Form 990?

No, and boards often get confused here. Under 26 U.S.C. § 3121(b)(8)(B), work for a church or a qualified church-controlled organization escapes FICA only if the employer made a § 3121(w) election, certifying that it opposes the tax for religious reasons, on Form 8274 before its first quarterly employment tax return was due. Employees of an electing employer then owe self-employment tax on church employee income of $108.28 or more (§ 1402(a)(14), (j)). A church-controlled charity that sells services to the public and normally receives more than 25 percent of its support from government or fees cannot elect at all.

Filing follows yet another test. Section 6033(a)(3)(A)(i) excuses “churches, their integrated auxiliaries, and conventions or associations of churches” from Form 990. Under Treas. Reg. § 1.6033-2(h), an affiliate that sells services to the public and gets more than half its support from government grants, public solicitation and program receipts is not internally supported, so it files. The Gallup group could be exempt from state unemployment tax and still file a 990; the firm’s post on the Form 990 rewrite for grants and fiscal sponsors covers that return’s coming changes. Lose 501(c)(3) status, and § 3306(c)(8) no longer shields the group from FUTA; see what to do after a 501(c)(3) revocation.

Tax or filing	Church (parish, convention)	Church-controlled charity	Secular 501(c)(3)
FUTA	Not subject (§ 3306(c)(8))	Not subject (§ 3306(c)(8))	Not subject (§ 3306(c)(8))
New Mexico UI	Excluded, § 51-1-42(F)(12)(a); voluntary election possible	Excluded only if “operated primarily for religious purposes”; otherwise contributing or reimbursing	Covered; contributing or reimbursing under § 51-1-13
FICA	Applies unless a § 3121(w) election is in effect	Applies unless a qualifying § 3121(w) election is in effect	Applies
Form 990	Not required (§ 6033(a)(3)(A)(i))	Required unless an integrated auxiliary	Required (990, 990-EZ or 990-N)

Frequently Asked Questions

Does Catholic Charities Bureau v. Wisconsin automatically exempt New Mexico church charities from unemployment tax?

No. The Court decided how a state may not read its exclusion, not who qualifies under New Mexico’s statute. Each organization still has to satisfy both prongs of § 51-1-42(F)(12)(a).

Does New Mexico’s exclusion use the same “operated primarily for religious purposes” language?

Yes. Paragraph (12)(a) uses that phrase and pairs it with operation, supervision, control or principal support by a church. The wording tracks FUTA § 3309(b)(1)(B) and the Wisconsin statute the Court reviewed.

What is a reimbursing employer in New Mexico?

A nonprofit that elects under § 51-1-13 to repay the fund for benefits its former employees draw, instead of paying a rate. It must post security and keep the election at least two taxable years.

If a ministry is exempt, can its laid-off employees collect unemployment?

Not on wages from excluded service. The organization can apply for voluntary coverage under § 51-1-18(D), which requires the secretary’s approval and lasts at least two calendar years.

Does the unemployment exemption affect FICA withholding?

No. FICA applies to churches and church-controlled organizations unless they made a timely § 3121(w) election on Form 8274. The two exemptions use different tests and different agencies.

How North Star Law Firm Can Help

North Star Law Firm advises New Mexico nonprofits and their boards on federal tax law questions about payroll taxes and information returns, including how an entity structure affects which taxes apply. When the IRS questions an employment tax position or a filing exemption, the firm handles the tax defense work.

Phillip Zagotti, JD/CPA, represents taxpayers before the IRS and the U.S. Tax Court and is admitted to the U.S. District Court and Bankruptcy Court for the District of New Mexico. The firm works alongside New Mexico-licensed counsel on state-law questions. If your church-affiliated nonprofit is weighing its unemployment and payroll tax status, contact North Star Law Firm.

A software founder in Los Alamos and her husband put $200,000 of joint savings into her startup’s C corporation stock in 2021. A buyer is now circling at $28,000,000 for their shares, with a closing likely in 2027. Their CPA says most of the gain may be tax-free under Section 1202. Their estate planner wants to move shares into trusts for their two children first, so the family can claim more than one exclusion.

That can work. For a New Mexico couple, though, it runs into rules national QSBS commentary rarely mentions, because community-funded stock belongs to both spouses from day one.

What did the OBBBA change about qualified small business stock in New Mexico?

Section 1202 lets a noncorporate shareholder exclude gain on stock bought at original issue from a domestic C corporation that passed a gross assets test and ran a qualifying active business. Congress rewrote it in § 70431 of Pub. L. 119-21, signed July 4, 2025, leaving two generations of stock sorted by acquisition date.

Stock acquired after September 27, 2010 and through July 4, 2025, like the Los Alamos shares, kept its terms. Under 26 U.S.C. § 1202(a)(4), all of the gain is excluded after a holding period of more than five years. The per-issuer cap is the greater of $10,000,000 or ten times the basis of the shares sold that year, and the company needed $50,000,000 or less of aggregate gross assets at issuance.

Newer stock phases in under § 1202(a)(5): half excluded after three years, 75 percent after four, all after five. Its cap is $15,000,000, indexed after 2026, and the asset ceiling is $75,000,000. The unexcluded slice of a partial exclusion is “section 1202 gain” under 26 U.S.C. § 1(h)(7), taxed at up to 28 percent. Gain above the dollar cap is regular long-term gain at 20 percent plus the 3.8 percent tax in 26 U.S.C. § 1411. The AMT preference in 26 U.S.C. § 57(a)(7) now reaches only stock acquired by September 27, 2010.

Is the QSBS cap per spouse or per couple with New Mexico community property?

Property either spouse acquires during marriage is community property unless it fits a separate category, and New Mexico presumes it is community (NMSA 1978, § 40-3-8; § 40-3-12). Shares bought from joint savings are half hers and half his.

Does each half carry a cap? The text says no. Section 1202(b)(3)(A) gives a married person filing separately half the cap, and § 1202(b)(3)(B) splits joint-return gain “equally between the spouses” for later years. That describes one cap per couple, and separate filing doubles nothing. I found no regulation, ruling, or legislative history allowing two full caps on a joint return, and no Tax Court or Tenth Circuit decision. Some preparers claim two with a disclosure statement. I would plan around one.

Can one New Mexico spouse give away community property stock alone?

The joinder statute, NMSA 1978, § 40-3-13, covers community real estate, not stock. Under § 40-3-14, either spouse may manage and dispose of community personal property, but a spouse named alone on the ownership document controls it, and names joined by “and” need both signatures. The founder may have the power to sign by herself. Whether a one-spouse gift of community assets holds up is a state-law question for New Mexico counsel. My practice is to have both spouses sign.

The Form 709 instructions treat a gift of community property as made half by each spouse, and each spouse files a return. The split-gift election in 26 U.S.C. § 2513 exists to treat one spouse’s gift as half the other’s; community property already works that way. For 2026 each spouse has a $15,000,000 basic exclusion and a $19,000 annual exclusion per recipient (Rev. Proc. 2025-32).

How does Section 1202 gift stacking work with a trust for each child?

Shares that change hands usually lose QSBS status. Section 1202(h) carves out gifts, transfers at death, and some partnership distributions: the recipient steps into the donor’s manner of acquisition and the donor’s holding time. Carryover basis under 26 U.S.C. § 1015(a) and tacking under 26 U.S.C. § 1223(2) agree. The Code never defines “gift” here.

The cap is per taxpayer. A child gets one, and so does a trust that files its own returns. Because the recipient inherits the 2021 acquisition date, its cap is $10,000,000, not $15,000,000.

That trust must be non-grantor. A revocable trust or a grantor trust built to be disregarded drops out for income tax: 26 U.S.C. § 671 puts its income on the grantor’s return, and the IRS’s position in Rev. Rul. 85-13 is that the grantor owns its assets for income tax purposes. Shares there use the couple’s cap. Selling shares to such a trust for a note adds nothing, and no authority says whether switching off grantor status later qualifies under § 1202(h).

The main limit is Treas. Reg. § 1.643(f)-1, proposed in August 2018 and finalized by T.D. 9847 in February 2019. Trusts with substantially the same grantors and primary beneficiaries are combined when a principal purpose is avoiding federal income tax, and spouses count as one person. Both spouses are grantors of every community property trust, so beneficiaries carry the weight. One trust per child, with that child as primary beneficiary, is the conventional design.

Treasury’s 2026-2027 Priority Guidance Plan, released September 29, 2026, lists § 1202 regulations as item 32, and a senior official reportedly said in May that Treasury does not like stacking. Nothing has issued. A trust sited here is governed by New Mexico’s Uniform Trust Code, NMSA 1978, ch. 46A.

What does QSBS gift stacking save a Los Alamos family, federal and New Mexico?

Illustrative only; every figure is hypothetical. Assume the shares qualify, issued in March 2021, with a mid-2027 closing.

Without gifts, the gain is $27,800,000. Ten times basis is $2,000,000, so the $10,000,000 cap controls, leaving $17,800,000 taxable on the one-cap reading. At 23.8 percent, federal tax is about $4,236,400.

New Mexico starts from federal adjusted gross income under NMSA 1978, § 7-2-2, so the excluded $10,000,000 never reaches the state return, and nothing there adds it back. The New Mexico capital gains deduction in § 7-2-34, narrowed for tax years starting in 2025, is the greater of $2,500 or 40 percent of up to $1,000,000 of net capital gain “from the sale of a business” allocated or apportioned to New Mexico. Whether a stock sale counts is unstated. At the 5.9 percent top rate in § 7-2-7, state tax is about $1,026,600 with a $400,000 deduction, or about $1,050,000 without it.

Now the gift version. This November, well before any letter of intent, the couple gives one-third of the shares to each of two non-grantor trusts, one per child, and keeps a third. Each block carries $66,667 of basis and about $9,266,667 of gain, inside each holder’s $10,000,000 cap. All $27,800,000 is excluded. Federal tax is zero, and since a trust’s New Mexico base income starts from federal taxable income, the state collects nothing. The saving is about $5.26 million.

The cost is exclusion. If an appraisal made before any offer, with minority and marketability discounts, puts the gifted shares at $10,000,000, each spouse makes a $5,000,000 gift and keeps $10,000,000 of basic exclusion. Timing matters too: a gift after a sale is effectively locked in invites an assignment-of-income challenge, which is why I want trusts funded long before a term sheet.

When does holding QSBS until death beat gifting it?

Gifted shares keep the $200,000 basis. Shares the couple still owns at the first death do not. Under 26 U.S.C. § 1014(b)(6), the survivor’s half of community property also takes a fair market value basis if at least half the community interest is in the decedent’s gross estate. In a common law state only the decedent’s share resets. Here the whole block does, and the gain vanishes without using any cap.

With a sale in sight, gifting usually wins, because a step-up after closing is worth nothing. A family planning to hold for decades, or facing a serious illness, may do better holding, and with $15,000,000 of exclusion per spouse many couples owe no federal estate tax. The firm’s post on New Mexico estate tax and the community property step-up covers that side.

Holder at sale	Own § 1202 cap?	Basis	Main risk
Couple, joint return	One on the text; two untested	Original $200,000	Claiming two caps without authority
Spouses filing separately	Half cap each	Original	No gain over joint filing
Revocable or grantor trust	No, shares the couple’s	Original	Assuming it multiplies the exclusion
Non-grantor trust for one child	Yes, $10,000,000 for 2021 stock	Carryover	Multiple-trust rule; late gifts
Couple holding to death	Rarely matters	Full step-up on community stock	No liquidity before death

Frequently Asked Questions

Can a QSBS gift to a trust in New Mexico keep the exclusion?

Yes, if it is a true gift and the trust is a non-grantor trust. The trust inherits the founder’s acquisition date and holding period. A grantor trust adds no cap.

Do New Mexico spouses get two QSBS caps because the stock is community property?

Not on the statute’s text, which halves the cap for separate filers and splits joint-return gain equally. I located no IRS guidance or court decision approving two caps on a joint return.

Does New Mexico tax gain that Section 1202 excludes?

No. New Mexico starts from federal adjusted gross income for individuals and federal taxable income for trusts, with no add-back for excluded QSBS gain. Gain above the cap is taxed at up to 5.9 percent.

Do both spouses file a gift tax return for a gift of community property stock?

Yes. The IRS treats the gift as half from each spouse, so each files Form 709. No split-gift election is needed.

Is the IRS going to stop QSBS stacking?

Possibly. Treasury’s September 2026 plan lists new § 1202 regulations without a timetable. Until something issues, the multiple-trust regulation is the main limit.

How North Star Law Firm Can Help

North Star Law Firm advises New Mexico founders on business sale tax structuring and on trust and estate tax planning when shares move into trusts, and handles IRS audit defense if an exclusion is later questioned.

Phillip Zagotti, JD/CPA, represents taxpayers before the IRS and the U.S. Tax Court and is admitted to the U.S. District Court and Bankruptcy Court for the District of New Mexico. The firm works alongside New Mexico-licensed counsel on state-law questions. To test a QSBS gift plan before an exit is locked in, contact North Star Law Firm.

A Mesilla Valley pecan grower and a Hobbs family living on Permian royalties tend to ask the same first question: will there be a New Mexico estate tax when one of us dies? For nearly every family the answer is no, and the federal picture improved on January 1, 2026, when the basic exclusion amount in 26 U.S.C. § 2010(c)(3) rose to $15,000,000 per person.

The bigger New Mexico story is an income tax rule. Because this is a community property state, a married couple’s community assets can take a fresh market-value basis on both halves at the first death.

What did the 2025 tax law change about the federal estate tax exemption?

Section 70106 of Public Law 119-21, signed July 4, 2025 and commonly called the One Big Beautiful Bill Act, set § 2010(c)(3)(A) at $15,000,000 for estates of decedents dying and gifts made after December 31, 2025. For deaths after 2026 the figure is indexed from a 2025 base and rounded to the nearest $10,000. Rev. Proc. 2025-32 confirms the 2026 amount; the 2027 amount had not been published when this post was written.

The top rate in § 2001(c) stays at 40 percent, and the generation-skipping transfer exemption under § 2631(c) tracks the basic exclusion. The 2017 increase carried a built-in end date after 2025; the new text has none. If Congress later cuts it, Treas. Reg. § 20.2010-1(c) keeps gifts already sheltered by the higher exclusion from being pulled back into tax at death.

Is there a New Mexico estate tax or inheritance tax?

The Estate Tax Act remains at NMSA 1978, §§ 7-7-1 through 7-7-12, but it is a pick-up tax with nothing to pick up. Section 7-7-3 imposes a tax “in an amount equal to the federal credit,” which § 7-7-2 defines as the maximum credit for state death taxes under § 2011. For decedents dying after 2004, Congress swapped that credit for a deduction in § 2058, and it repealed § 2011 in 2014. No credit means the New Mexico estate tax computes to zero.

The Taxation and Revenue Department’s estate and fiduciary page says the estate tax was phased out as of January 1, 2005 and that New Mexico imposes no inheritance tax. It still asks any estate filing a federal Form 706 to file Form RPD-41058 too, and then issues a certificate of no tax due. No New Mexico gift tax was located on review.

Why does New Mexico community property get a step-up on both halves?

Under 26 U.S.C. § 1014(a), property acquired from a decedent takes its fair market value at death as basis. That covers the decedent’s half. Section 1014(b)(6) adds “the surviving spouse’s one-half share of community property,” provided at least half of the whole community interest was includible in the decedent’s gross estate. The entire asset resets. In a common-law state, a spousal joint tenancy is a “qualified joint interest,” and § 2040(b) puts only half in the estate, so only half steps up.

Character is a New Mexico law question. NMSA 1978, § 40-3-8 makes property acquired before marriage, or “by gift, bequest, devise or descent,” separate, and presumes that a deed to spouses as joint tenants holds community property. Section 40-3-12 presumes property acquired during marriage is community. A ranch one spouse inherited is separate, so it steps up only when that spouse dies. Commingling can blur the line, and the firm works alongside New Mexico-licensed counsel on characterization. Also watch § 1014(e): appreciated property given to a spouse who dies within a year, and that passes back to the giver, keeps its old basis.

Questions About Estate or Gift Tax on New Mexico Land or Minerals? Contact Us Now

What does the double step-up save a Las Cruces farm family?

Assume a Las Cruces couple with $11,000,000 of community property: a pecan farm worth $5,000,000 with a $1,200,000 basis, a $3,500,000 brokerage account with a $1,500,000 basis, and $2,500,000 in IRAs. The husband separately owns Eddy County minerals inherited from his father, worth $2,000,000 with a $600,000 basis. All figures are hypothetical.

He dies in 2027 and leaves everything to his wife. His $7,500,000 gross estate is half the community plus the minerals; the marital deduction in § 2056 brings the taxable estate to zero. Both halves of the farm and the account step up, and the minerals step up because they were entirely his. The IRAs do not: § 1014(c) excludes income in respect of a decedent, and her withdrawals are ordinary income under § 691.

Selling the farm and the account at those values, she reports no gain. Put the same family in a common-law state with both assets in joint tenancy and the sales produce $2,900,000 of gain. At the 20 percent top rate in § 1(h) that is $580,000, or $690,200 if the 3.8 percent tax in § 1411 also applies. A real sale would also sort out depreciation on trees and equipment.

Asset (hypothetical)	Value at death	Basis after, New Mexico community	Basis after, common-law joint tenancy	Gain avoided
Pecan farm	$5,000,000	$5,000,000	$3,100,000	$1,900,000
Brokerage account	$3,500,000	$3,500,000	$2,500,000	$1,000,000
Inherited minerals (separate)	$2,000,000	$2,000,000	$2,000,000	None
IRAs	$2,500,000	No step-up	No step-up	None

Why file Form 706 when no estate tax is due?

To keep the unused exclusion. Section 2010(c)(4) lets a widow add her late husband’s unused exclusion, called DSUE, to her own, but only if his executor elects it on a timely return under § 2010(c)(5)(A). Treas. Reg. § 20.2010-2(a)(1) makes that return due nine months after death, plus any extension. Executors who were not otherwise required to file can still elect under Rev. Proc. 2022-32 on a complete Form 706 filed by the fifth anniversary of death. In the Las Cruces example, that election would carry his full 2027 exclusion to her. The GST exemption does not port, since § 2631(c) ties it to the basic exclusion only. And § 2010(c)(5)(B) lets the IRS examine the first return to test DSUE even after the assessment period closes.

Which New Mexico families still face a federal estate tax bill?

With portability, a couple can shelter about $30,000,000 before indexing, so exposure sits mostly with larger land and mineral holdings, like a Chaves County dairy or a Lea County royalty family. Los Alamos retirees with large IRAs can owe estate tax and then income tax on the same dollars. For farmland, § 2032A allows valuation at farm use rather than highest and best use, with the 2026 reduction capped at $1,460,000 under Rev. Proc. 2025-32. Qualified-use property must be at least 50 percent of the adjusted gross estate and the land itself at least 25 percent, the family must have owned and materially participated for five of the eight years before death, and recapture applies if heirs sell or stop the use within ten years.

When a closely held business exceeds 35 percent of the adjusted gross estate, § 6166 allows up to five years of interest-only payments and then up to ten installments, with the “2-percent portion” under § 6601(j) keyed to $1,940,000 for 2026. Founders holding stock acquired after July 4, 2025 should also check § 1202, which now excludes 50, 75, or 100 percent of gain after three, four, or five years, with a $75,000,000 gross asset ceiling.

How do lifetime gifts of community property work?

The 2026 annual exclusion under § 2503(b) is $19,000 per recipient, and direct tuition and medical payments fall outside the gift tax under § 2503(e). The Form 709 instructions treat a gift of community property as made half by each spouse, so a $38,000 community check to a Rio Rancho grandchild is $19,000 from each grandparent without a § 2513 split election. Form 709 is due April 15 under § 6075(b), and under § 6501(c)(9) and Treas. Reg. § 301.6501(c)-1(f) tax on an inadequately disclosed gift can be assessed at any time. Gifts keep the donor’s basis under § 1015, so gifting the farm forfeits the step-up. See also the firm’s post on Trump account gifts.

Frequently Asked Questions

Does New Mexico have an estate tax in 2026?

No tax is collected. The Estate Tax Act imposes a tax equal to the federal credit for state death taxes, and that credit ended for deaths after 2004. The Taxation and Revenue Department still asks estates that file a federal Form 706 to file Form RPD-41058 and issues a certificate of no tax due. There is no inheritance tax.

What is the federal estate tax exemption for 2026?

It is $15,000,000 per person under § 2010(c)(3), as amended by Public Law 119-21 and confirmed in Rev. Proc. 2025-32. A married couple that elects portability can shelter up to twice that. The amount is indexed for deaths after 2026, and the top rate remains 40 percent.

Does a New Mexico widow get a step-up on both halves of community property?

Yes, if the asset is community property and at least half of it was included in the deceased spouse’s gross estate. Section 1014(b)(6) treats the survivor’s half as acquired from the decedent. Separate property, such as land one spouse inherited, steps up only when its owner dies.

Do IRAs get a step-up in basis at death?

No. Retirement accounts are income in respect of a decedent, which § 1014(c) excludes from the step-up rule, so beneficiaries pay ordinary income tax on withdrawals. If the estate paid federal estate tax, § 691(c) allows an income tax deduction for the estate tax attributable to those amounts.

Is it too late to elect portability if my spouse died two years ago?

Often not. If the estate was not otherwise required to file, Rev. Proc. 2022-32 allows a late portability election on a complete Form 706 filed by the fifth anniversary of the death, with a required statement at the top of the return. Estates that had to file must meet the regular deadline.

How North Star Law Firm Can Help

North Star Law Firm handles the federal tax side of New Mexico estates and gifts, including portability filings, post-death basis records, and special use valuation and installment elections for farm and ranch estates. See trust and estate tax planning, real estate tax strategy, and retirement accounts.

Phillip Zagotti, JD/CPA, represents taxpayers before the IRS and the U.S. Tax Court and advises on trust and estate taxation. Heirs selling stepped-up land may want the firm’s post on 1031 exchanges for ranches and mineral interests. On community property characterization and estate documents, the firm works alongside New Mexico-licensed counsel. To review your family’s numbers, contact North Star Law Firm.

An Albuquerque distribution company in Chapter 11 expects to sell its assets in July for a $3,000,000 gain. If it is still an S corporation then, the owners report the gain on their returns and the cash remains in the estate. Whether the owners can change that depends less on who may revoke an S corporation election than on when they do it.

The firm’s earlier post on Owoc and the S election in bankruptcy covered the first point: in Owoc v. Liquidating Trustee, No. 24-14048 (11th Cir. Aug. 10, 2026), the Eleventh Circuit held the election belongs to the shareholders, not the estate. This post takes up the mechanics of 26 U.S.C. § 1362, the timing math, and a Ninth Circuit affirmance on the reverse question: can an election end without anyone choosing to end it?

What does it take to revoke an S corporation election?

No IRS form exists. Under Treas. Reg. § 1.1362-6(a)(3), the corporation files a statement revoking its election with the service center where the election was filed, states the shares outstanding (nonvoting included), and attaches signed consents. Section 1362(d)(1)(B) requires consent from holders of more than one-half of the shares on the day of revocation. In a 70/30 company, the 70 percent holder can revoke alone.

Under § 1362(d)(1)(C) and (D), a revocation made by the 15th day of the third month (March 15 for a calendar-year company) reaches back to January 1. A later one takes effect the next January 1 unless it names a date on or after filing. Treas. Reg. § 1.1362-2(a) allows rescission before the effective date, with consent from everyone who signed and anyone who has bought in since. A March revocation is already effective when filed, so it leaves no window to rescind.

Why is March 15 the date that matters when a sale is coming?

A revocation effective January 1 avoids a split year, since under § 1362(e)(4) an S termination year is one in which termination takes effect after day one. The whole sale year becomes a C corporation year.

Owoc shows the cost of missing that window. The sale closed in July 2023, and by the appeal the 2023 dates had long passed, leaving the shareholder an uncertain private letter ruling request and a remand on whether he may still terminate under § 1362(d)(2) or is barred by laches (slip op. at 6 to 7, 20 to 22). No published Tenth Circuit or District of New Mexico decision on the stay question was located on review.

For a C year, 26 U.S.C. § 1399 creates no separate taxable entity for a corporate debtor; § 1398 covers only individuals. Tax incurred by the estate is an administrative expense under 11 U.S.C. § 503(b)(1)(B), with second priority under § 507(a)(2). The trustee can then request a prompt determination under 11 U.S.C. § 505(b); if the IRS does not select the return for examination within 60 days, paying the tax shown ends the estate’s liability.

What happens when the revocation takes effect mid-year?

After March 15, a prospective date splits the year into S and C short years under § 1362(e)(1). The default rule in § 1362(e)(2) then spreads the year’s income evenly across every day, whenever it was earned, so part of a July gain falls back on the shareholders.

A § 1362(e)(3) election substitutes normal accounting and leaves the gain in the C short year. Treas. Reg. § 1.1362-3(b)(1) requires consent from every shareholder during the S short year and on the first day of the C short year, so the 30 percent holder who could not stop the revocation can stop this. It is also the corporation’s election, filed with the C short year return (Treas. Reg. § 1.1362-6(a)(5)). In bankruptcy, the trustee makes that return under 26 U.S.C. § 6012(b)(3), or a debtor in possession does with a trustee’s powers under 11 U.S.C. § 1107(a). Owoc did not say who controls this election, and no decision on the point was located on review. An estate fiduciary has little reason to volunteer an election that doubles the estate’s tax.

Annualizing the C short year under § 1362(e)(5) is neutral at the flat 21 percent rate in 26 U.S.C. § 11(b), and the stock-sale exception in § 1362(e)(6)(D) does not reach an asset sale.

Facing a Pass-Through Tax Bill on a Company Sale in New Mexico? Contact Us Now

How do the numbers come out for an Albuquerque distributor?

Hypothetically, the distributor has been an S corporation since formation, is owned 70/30, and files Chapter 11 on February 8, 2027. Its assets sell in July for a $3,000,000 gain, operations otherwise break even, and the owners pay an assumed 30 percent federal rate. In the prospective cases, a May revocation names June 30, 2027, leaving a 180-day S short year and a 185-day C short year.

Daily proration sends $1,479,452 (180/365 of the gain) back to the owners and leaves the corporation $319,315 of tax on the rest. New Mexico runs parallel, since the corporate rate in NMSA 1978, § 7-2A-5 and the top joint-filer rate in NMSA 1978, § 7-2-7 are both 5.9 percent.

Hypothetical scenario	Who must sign	Gain taxed to owners	Corporate tax (estate)	Owners’ tax at 30%
No revocation	No one	$3,000,000	$0	$900,000
Revocation filed Mar. 10, 2027	Holders of over half	$0	$630,000	$0
June 30 revocation, daily proration	Holders of over half	$1,479,452	$319,315	$443,836
June 30 revocation plus § 1362(e)(3)	Majority, then all owners and the corporation	$0	$630,000	$0

What does a revocation cost if the company survives?

Under § 1362(g), a corporation cannot re-elect S status before its fifth taxable year after the termination without IRS consent. Treas. Reg. § 1.1362-5(a) says consent is ordinarily denied unless more than half the stock has changed hands or the event was outside the owners’ control and not part of a plan. A revocation is a plan. Inadvertent-termination relief under § 1362(f) reaches terminations under § 1362(d)(2) and (3), not revocations.

That matters little in a liquidation but a lot in a Subchapter V case where the owners keep a company that stays a C corporation for years. In New Mexico it owes the 5.9 percent corporate tax and the $50 franchise tax under NMSA 1978, § 7-2A-5.1, and it loses the elective entity-level tax in NMSA 1978, § 7-3A-10, which only a federal pass-through entity can use.

Can a co-owner’s misconduct end the election instead?

Not under Maggard. James Maggard owned 40 percent of a California engineering firm whose co-owners paid themselves far beyond their share and froze him out. He argued the payouts amounted to a second class of stock, which 26 U.S.C. § 1361(b)(1)(D) forbids. In Maggard v. Commissioner, T.C. Memo. 2024-77, the Tax Court disagreed. Treas. Reg. § 1.1361-1(l)(2)(i) tests rights under the governing provisions, and Rev. Proc. 2022-19, § 3.02, says unequal distributions do not create a second class when those provisions give identical rights. The documents were never amended, so Maggard was taxed on his share under 26 U.S.C. § 1366. The Ninth Circuit affirmed in an unpublished memorandum, Maggard v. Commissioner, No. 25-4131 (9th Cir. Aug. 26, 2026), citing Moore v. United States, 602 U.S. 572 (2024).

What can a New Mexico minority owner do instead?

A 30 percent owner cannot revoke, and Maggard rules out the misconduct route. Any shareholder can still terminate under § 1362(d)(2) by transferring shares to an ineligible holder such as a corporation, unless a shareholder agreement restricts transfers, and the lockout follows. An owner who sells out mid-year can split the year at the sale date under 26 U.S.C. § 1377(a)(2), if the corporation and all affected shareholders agree. Beyond that, the remedy runs against the co-owners under state law. In New Mexico, NMSA 1978, § 53-16-16 lets a court liquidate a corporation in a shareholder’s action where those in control acted illegally, oppressively, or fraudulently, or assets are being misapplied or wasted.

Frequently Asked Questions

What is the deadline to revoke an S corporation election for the current year?

For a calendar-year corporation, a revocation made by March 15 is effective January 1 of that year. A later one takes effect the next January 1 unless the statement names a date on or after filing. A deadline that falls on a weekend or holiday rolls to the next business day.

Can a 30 percent shareholder revoke an S election alone?

No. Revocation needs consent from holders of more than one-half of the shares on the day it is made, nonvoting stock included. A minority holder can, however, block the closing-of-the-books election under section 1362(e)(3), which requires consent from every shareholder of the S short year and on the first day of the C short year.

Do disproportionate distributions end an S election?

Not by themselves. The one-class-of-stock test looks at governing provisions, meaning the articles, bylaws, state law, and binding agreements, rather than what was actually paid. In Maggard the documents still gave identical rights, so the election survived and the frozen-out owner was taxed on his share.

How long must a company wait to become an S corporation again after revoking?

Generally until its fifth taxable year after the termination, unless the IRS consents earlier. Consent is ordinarily denied unless more than half of the stock has changed hands or the event was outside the owners’ control and not part of a plan, which a revocation never is.

Who owes the tax on a bankruptcy sale once the S election is revoked?

The corporation. A corporate bankruptcy creates no separate taxable entity, so the debtor owes tax for its C corporation period, and a tax incurred by the estate is an administrative expense with second priority. A prompt determination request under section 505(b) can fix the amount.

How North Star Law Firm Can Help

North Star Law Firm works with New Mexico S corporation owners on ending an S election before a sale, from shareholder consents to the C short year return, drawing on the firm’s tax law practice, its entity selection and sale structuring work, and Chapter 11 sales.

Phillip Zagotti, JD/CPA, represents taxpayers before the IRS and the U.S. Tax Court and is admitted to the U.S. District Court and Bankruptcy Court for the District of New Mexico. Owners weighing a filing can start with the firm’s guide to choosing a bankruptcy chapter in New Mexico. The firm works alongside New Mexico-licensed counsel on state-law questions. If a sale is on the calendar, contact North Star Law Firm before March 15, not after.

A German postdoc who starts at Los Alamos National Laboratory on a J-1 visa in September 2024 files as a nonresident, with a two-page IRS statement attached, for her first two years. Then, on January 1, 2026, every day she spends on the Pajarito Plateau starts counting toward U.S. tax residency.

New Mexico has more people on that clock than its size suggests: lab researchers, UNM and NMSU graduate students, H-1B engineers, foreign film crews, Canadian snowbirds in Las Cruces, and workers crossing from Ciudad Juárez. Each needs to know whether the IRS sees a resident alien taxed on worldwide income or a nonresident.

How does the substantial presence test count days in New Mexico?

Under 26 U.S.C. § 7701(b)(1)(A), a noncitizen is a U.S. resident for a calendar year only through a green card held at any time that year, the substantial presence test, or the first-year election.

The test in § 7701(b)(3) requires at least 31 days here this year and a weighted total of 183. This year’s days count in full, last year’s at one-third, and the year before that at one-sixth. Any part of a day counts.

Some days never enter the formula: days as an “exempt individual,” days a medical condition that arose here kept you from leaving, foreign-to-foreign transit under 24 hours, and regular commuting days from a home in Mexico or Canada. Under Treas. Reg. § 301.7701(b)-3(e), a Juárez resident working in Santa Teresa is a regular commuter only by commuting on more than 75 percent of workdays. Excluded days also stay out of later years’ formulas, per § 301.7701(b)-3(f).

When does a J-1 researcher or F-1 student stop being exempt?

Section 7701(b)(5) treats J and Q holders (other than students) as teachers or trainees, and F, M, and student J holders as students, if the person “substantially complies with the requirements for being so present.” The regulations extend the exemption to a spouse and unmarried children under 21 whose visas derive from the principal’s.

Under § 7701(b)(5)(E)(i), a teacher or trainee is not exempt this year if exempt as a teacher, trainee, or student in 2 of the preceding 6 calendar years, and the regulation counts “any part of” a year. So a September arrival spends a full exempt year on four months here. Students get five calendar years before they must prove they do not intend to reside permanently.

A regulatory example shows the trap: three exempt student years mean no exemption in the first year as a J-1 teacher. The NMSU doctoral graduate who stays on as a postdoc gets no fresh clock.

Which forms are due, and when, for nonresidents?

Treas. Reg. § 301.7701(b)-8 requires exempt individuals to claim the exclusion on Form 8843, attached to Form 1040-NR or, if no return is due, mailed alone to the IRS in Austin by the 1040-NR deadline. Per the Form 1040-NR instructions, that deadline is April 15 for anyone with wages subject to U.S. withholding and June 15 otherwise.

A missed 8843 is not always fatal. The forfeiture rule in § 301.7701(b)-8(d) omits the teacher and student statement, though late medical and closer connection claims are lost absent clear and convincing evidence of reasonable steps to comply.

Form 8840 claims the § 7701(b)(3)(B) exception: fewer than 183 days this year, a foreign tax home, and a closer connection to that country. It is unavailable in any year you pursued a green card. Form 8833 discloses a treaty tie-breaker under Treas. Reg. § 301.7701(b)-7; omitting it risks $1,000 per failure under 26 U.S.C. § 6712. A year that switches status needs a dual-status return.

Unsure of Your Residency Status or Missing Form 8843 Filings? Contact Us Now

How does the day count play out for a German postdoc at Los Alamos?

Dr. K arrives on a J-1 research scholar visa on September 3, 2024, having given up her Heidelberg apartment. Her 120 days in 2024 are exempt, so she counts zero; her 1040-NR and 8843 are due April 15, 2025. In 2025 she is present about 330 days, still exempt because only 2024 falls in the prior six years, and files the same pair by April 15, 2026.

In 2026 the exemption ends. She returns on January 4, every day counts in full, and she passes 183 days in early July, which rules out closer connection. Her residency starts January 4 under § 7701(b)(2)(A)(iii), making 2026 a dual-status year with a return due April 15, 2027. A treaty tie-breaker first requires German residence under German law, which she likely gave up with the apartment.

Her pay has a separate clock. Article 20(1) of the U.S.-Germany income tax treaty, as rewritten by the 2006 Protocol, may exempt public-benefit research pay “for a period not exceeding two years from the date of his arrival,” claimed from the employer on Form 8233 (the firm’s W-9 versus W-8 post covers the payer’s side). Amended Article 1(5)(b) keeps that benefit for residents without immigrant status, so becoming a resident does not end it; September 3, 2026 does.

What does resident alien status add beyond a bigger tax base?

The FBAR rule, 31 C.F.R. § 1010.350(b), defines a U.S. resident by reference to § 7701(b), and the IRS FBAR page requires a report once foreign accounts top $10,000 in aggregate, due April 15 with an automatic extension to October 15. Form 8938 applies to an unmarried U.S. resident with foreign assets over $50,000 at year end or $75,000 at any time. The Form 3520 instructions require reporting gifts over $100,000 from a nonresident alien individual, and § 6039F(c) charges 5 percent of the gift per month, up to 25 percent, for missing it.

In Aroeste v. United States, No. 22-cv-00682 (S.D. Cal. Nov. 20, 2023) (order), a lifelong Mexico resident with a green card claimed treaty residence in Mexico on a Form 8833 filed after his audit began. The court held that under the last sentence of § 7701(b)(6) he stopped being treated as a permanent resident, so no FBAR penalties applied, but upheld $2,000 in § 6712 penalties. The government reportedly dropped its appeal. FinCEN’s rule has not changed.

That sentence also traps long-term residents, green card holders in 8 of the last 15 taxable years under § 877(e)(2). The Form 8833 instructions warn that their treaty claim can end U.S. residency and bring tax under § 877A, which deems a covered expatriate’s property sold the day before expatriation.

Does New Mexico follow the federal residency answer?

No published Tenth Circuit decision construing the substantial presence test or a treaty tie-breaker was located on review. NMSA 1978 § 7-2-2 defines a resident as someone domiciled here during any part of the year or “physically present in this state for one hundred eighty-five days or more,” and § 7-2-3 taxes residents’ net income and nonresidents’ New Mexico income.

The German treaty covers only “the federal income taxes imposed by the Internal Revenue Code” on the U.S. side, so a scientist in Los Alamos for 300 days passes the state’s 185-day line however a tie-breaker resolves. How New Mexico then taxes her is for New Mexico-licensed counsel; the firm’s post on New Mexico residency audits covers domicile disputes.

Status	Days counted	Usual filing	Federal status	Foreign reporting
J-1 researcher, years 1 and 2	None	8843; 1040-NR if U.S. income	Nonresident	Generally none
J-1 researcher, year 3	All	1040, often dual-status	Resident at 183 days	FBAR, 8938, 3520
H-1B worker	All	1040-NR, then 1040	Resident at 183 weighted	Full once resident
Green card holder	Not needed	1040	Resident	Full; exit tax risk
Visitor over 120 days yearly	All, weighted	8840 if needed	Nonresident if 8840 holds	None

Frequently Asked Questions

Do J-1 researchers at Los Alamos or Sandia count days toward the substantial presence test?

Not while exempt. A J-1 researcher who substantially complies with the visa excludes days as a teacher or trainee, but loses that status after being exempt during any part of two of the six preceding calendar years. For most arrivals, every day counts from the third calendar year.

Is Form 8843 required if I had no U.S. income?

Yes, if you are excluding days as a student, teacher, trainee, or for a medical condition. With no 1040-NR to attach it to, Form 8843 is mailed alone to the IRS in Austin, Texas, by the 1040-NR due date, June 15 for someone without wages subject to withholding.

Can a Canadian snowbird in Las Cruces avoid U.S. tax residency?

Often, yes. A winter visitor whose weighted total reaches 183 but who spent fewer than 183 days here this year can stay a nonresident by timely filing Form 8840 showing a Canadian tax home and closer ties to Canada. Seeking a green card closes that route.

What is a dual-status tax return?

It covers a year split between nonresident and resident status, usually the year of arrival or departure. A person who was a resident on December 31 files Form 1040 marked as a dual-status return, attaching an unsigned Form 1040-NR for the nonresident months.

Does claiming a treaty tie-breaker end FBAR filing?

Not safely. In Aroeste v. United States, a California court held that a green card holder who claimed treaty residence in Mexico owed no FBAR penalties. That order binds no New Mexico court and FinCEN’s rule is unchanged, so filing remains the conservative course.

Does New Mexico treat me as a resident if the IRS treats me as a nonresident?

It can. New Mexico counts as a resident anyone domiciled in the state during any part of the year or physically present 185 days or more, and federal treaties address federal income taxes. A visiting researcher can be a nonresident alien federally yet meet the state definition.

How North Star Law Firm Can Help

North Star Law Firm helps foreign nationals and their New Mexico employers sort out federal residency status, catch up on Form 8843 and 1040-NR filings, and handle the foreign reporting that follows a status change, through its tax law practice, unfiled tax returns and IRS audit defense services, and exit tax and expatriation planning.

Phillip Zagotti is an Attorney and CPA admitted to practice before the Internal Revenue Service and the United States Tax Court. He is licensed by the State Bar of California and holds a Texas CPA license; he is not licensed by the State Bar of New Mexico, and the firm works alongside New Mexico-licensed counsel on state-law questions. See also the firm’s post on the October 15, 2026 FBAR deadline, or contact North Star Law Firm.

A ranch outside Roswell, a pecan orchard in the Mesilla Valley, or a royalty interest in Lea County all share one tax feature: sell it and buy other United States real estate inside a tight window, and the federal gain can be deferred under 26 U.S.C. § 1031. New Mexico follows along. The mechanics are simple but unforgiving. Miss a day, touch the money, or mislabel a water right, and the deferral is gone.

What does § 1031 still cover after the 2017 tax act?

For exchanges after December 31, 2017, only real property qualifies. Section 1031(a)(1) defers gain on real property held for productive use in a trade or business or for investment when it is exchanged solely for like-kind real property held for the same purposes. Equipment, vehicles, and livestock fell out of the statute, and property held primarily for sale never qualified under Treas. Reg. § 1.1031(a)-1.

The result is a deferral, not an exemption. Under § 1031(d) the replacement property takes the old basis, reduced by money received and increased by gain recognized, so the gain waits in the new property until a taxable sale or a stepped-up basis at death.

How do the 45-day and 180-day deadlines really work?

The calendar comes from § 1031(a)(3) and Treas. Reg. § 1.1031(k)-1. The identification period ends at midnight on the 45th day after the relinquished property is transferred. The exchange period ends at midnight on the earlier of the 180th day or the due date, including extensions, of the return for the year of sale. Weekends and holidays extend nothing.

The due-date prong catches late-year sellers. A ranch sold on November 20, 2026 has its 180th day on May 19, 2027, but without a filed extension the exchange period ends April 15, 2027.

Identification must be a signed writing delivered to the intermediary or another party to the exchange. The regulation allows up to three candidate properties of any value, or any number of properties whose aggregate value does not exceed 200 percent of the value of what was sold. Blow both limits and the exchange survives only if the taxpayer acquires at least 95 percent of everything identified.

Why can’t the seller hold the money, and what counts as boot?

Constructive receipt is the trap. Section 1.1031(k)-1(g)(6) requires the exchange agreement to deny the taxpayer any right to receive, pledge, borrow, or otherwise obtain the benefits of the proceeds before the exchange period ends, with narrow exceptions. The intermediary also cannot be a disqualified person, which includes the taxpayer’s regular attorney, accountant, or broker.

Boot is anything received that is not like-kind real property: cash left in the intermediary’s account, and debt paid off on the old property that is not replaced by new debt or fresh cash. Under § 1031(b), gain is recognized to the extent of the boot, up to the gain realized. Under § 1.1031(k)-1(g)(7), personal property typically transferred with real estate and worth no more than 15 percent of the larger property is disregarded for the identification and intermediary safe harbors, but gain on it is still recognized.

Are New Mexico water rights like-kind real property?

Treas. Reg. § 1.1031(a)-3 defines real property to include land, inherently permanent structures, unsevered natural products of land, and water and air space superjacent to land, and it defers to the law of the state where the property sits. New Mexico treats a water right as a property interest separate from the land. In KRM, Inc. v. Caviness, 122 N.M. 389, 925 P.2d 9 (Ct. App. 1996), the Court of Appeals held that under the appropriation doctrine the right to use water is a property right distinct from ownership of the land, and that only irrigation rights are appurtenant to specific land under NMSA 1978 § 72-1-2 and § 72-5-23. Irrigation rights pass with the deed unless severed with State Engineer approval; commercial and industrial rights do not pass by deed alone. Because these rights are conveyed by deed and recorded, the prevailing view is that a perpetual New Mexico water right is real property for § 1031, though no published ruling addresses New Mexico rights specifically. Get the classification confirmed in writing, and make sure the deed and the State Engineer filing under § 72-5-22 describe the right precisely.

Grazing privileges are the opposite story. A federal permit is not a property interest at all; 43 U.S.C. § 315b states that issuance of a permit “shall not create any right, title, interest, or estate in or to the lands.” A State Land Office grazing lease is a leasehold, but § 1.1031(a)-1(c) treats a leasehold as like kind to a fee only with 30 years or more to run, and state grazing leases are far shorter. Any price paid for the permit or lease is taxable boot. Permian royalty and working interests, by contrast, are interests in unsevered minerals and can be exchanged for a ranch or an apartment building in Rio Rancho; a production payment is treated as a loan under § 636 and does not qualify.

How does the math work for a Roswell ranch traded for a Las Cruces orchard?

A family sells 4,000 deeded acres near Roswell for $6,500,000, closing October 1, 2026, with a total adjusted basis of $1,100,000. The contract allocates $450,000 to equipment and $300,000 to the raised breeding herd, leaving $5,750,000 for land, improvements, and groundwater rights. A $1,200,000 mortgage is paid off, and the intermediary holds the remaining $4,550,000. Day 45 is November 15, 2026; day 180 is March 30, 2027, ahead of the April 15 return date.

The equipment and herd sit outside § 1031. With a $150,000 equipment basis, the $300,000 gain is ordinary income under § 1245. The raised cows have zero basis, so their $300,000 is § 1231 gain under § 1231(b)(3). Both are taxed for 2026 regardless of the exchange.

The real property carries a $950,000 basis and a $4,800,000 realized gain. The family identifies a pecan orchard near Las Cruces with Elephant Butte Irrigation District water and closes February 10, 2027 at $5,200,000, using $4,300,000 of exchange funds and a $900,000 new loan. They traded down by $550,000, which appears as $250,000 of cash returned by the intermediary plus $300,000 of net debt relief. Recognized gain is $550,000, deferred gain is $4,250,000, and under § 1031(d) the orchard’s basis is $950,000. Depreciation taken on barns, pivots, and wells makes the recognized gain unrecaptured § 1250 gain first, taxed at up to 25 percent, and § 1250(d)(4) caps that recapture at the gain actually recognized.

Item	Amount	Treatment	Taxed now?
Equipment gain	$300,000	§ 1245 ordinary income	Yes
Raised breeding herd	$300,000	§ 1231 gain, zero basis	Yes
Cash boot	$250,000	Recognized under § 1031(b)	Yes
Net mortgage boot	$300,000	Recognized under § 1031(b)	Yes
Deferred real property gain	$4,250,000	Carried into orchard basis	No
Orchard basis	$950,000	§ 1031(d) substituted basis	n/a

What does New Mexico do with the deferred gain?

New Mexico’s personal income tax begins with federal adjusted gross income and has no addback for § 1031 deferred gain, so the deferral flows through automatically. What changed is the capital gains deduction in NMSA 1978 § 7-2-34. For tax years beginning on or after January 1, 2025, the general deduction is net capital gain income up to $2,500, replacing the old greater-of-$1,000-or-40-percent formula. A separate track allows 40 percent of up to $1,000,000 of net capital gain from the sale of a business allocated or apportioned to New Mexico, and whether a working ranch sale fits that language deserves a written analysis before anyone relies on it.

That reverses what many sellers were told before 2025. At the 5.9 percent top rate, state tax on $4,800,000 of ranch gain is roughly $283,000 with only a $2,500 deduction, so the state-level value of a clean exchange now tracks the federal value closely. Reverse and improvement exchanges follow the parking safe harbor of Rev. Proc. 2000-37, as modified by Rev. Proc. 2004-51, which limits an exchange accommodation titleholder to 180 days combined. Every exchange is reported on Form 8824.

Frequently Asked Questions

Can I do a 1031 exchange on a New Mexico ranch that has both deeded land and a BLM grazing permit?

The deeded land, improvements, and appurtenant water rights can qualify as like-kind real property. The federal grazing permit cannot, because 43 U.S.C. § 315b says a permit creates no interest in the land. Any price attributable to the permit is taxable boot, so allocate it honestly and plan for the tax.

Do New Mexico water rights count as real property for a like-kind exchange?

Treas. Reg. § 1.1031(a)-3 treats property as real property for § 1031 if it is real property under the law of the state where it sits. New Mexico courts treat water rights as property interests conveyed by deed, and irrigation rights are appurtenant to the land under NMSA 1978 § 72-5-23. Perpetual rights conveyed with the land are the strong case; short-term leases are not, so get the classification confirmed before closing.

What happens if my 180-day exchange deadline falls after April 15?

The exchange period ends on the earlier of the 180th day or the due date of your return, including extensions, for the year you sold. To keep the full 180 days after a late-year sale, file an extension before April 15.

Does New Mexico tax the gain I defer in a 1031 exchange?

No. New Mexico taxable income starts from federal adjusted gross income, and the state has no addback for § 1031 deferred gain. Gain you do recognize, such as boot or gain on equipment and cattle, is taxed at rates up to 5.9 percent, and the state capital gains deduction under § 7-2-34 is limited to $2,500 for most taxpayers in tax years beginning in 2025 or later.

Can I sell my ranch to my brother's LLC and still defer the gain?

An exchange with a related person is allowed, but under § 1031(f) the deferral is lost if either party disposes of the property received within two years, with limited exceptions such as death or involuntary conversion. Using a relative as an indirect buyer to cash out is the pattern the IRS scrutinizes most closely.

Is the cattle herd and equipment sold with the ranch part of the exchange?

Not since 2018. Section 1031 now covers only real property, so livestock and equipment are taxed in the year of sale: equipment gain up to prior depreciation is ordinary income under § 1245, and raised breeding cattle produce § 1231 gain on a zero basis.

How North Star Law Firm Can Help

North Star Law Firm advises New Mexico landowners, ranch families, orchard operators, and mineral owners on the tax structure of property sales, including § 1031 exchanges, purchase price allocations, depreciation recapture, and the New Mexico income tax consequences that follow. Phillip Zagotti, JD/CPA, represents New Mexico taxpayers before the IRS and the U.S. Tax Court and brings an accountant’s eye to the boot calculation, basis carryover, and Form 8824 reporting. The firm’s real estate tax strategy and business sale tax structuring practices cover the planning side, and its IRS audit defense practice handles exchanges questioned after the fact. To discuss a pending sale or a replacement property purchase, contact North Star Law Firm.

On August 26, 2026, the IRS’s chief tax compliance officer told a tax conference in St. Louis that a redesigned Form 990 will be ready by the next tax year, aimed at government contracts, government grants, and fiscal sponsorship relationships. That followed the Treasury Department’s April 23, 2026 announcement of a Form 990 Transparency Initiative meant to expose “hidden funding” and illegal activity inside tax-exempt organizations.

New Mexico should pay attention. The state has an unusual number of small charities for its population, from tribal-serving organizations and Santa Fe arts groups to rural volunteer fire and water associations, and many of them run on grants and use fiscal sponsors. That is what the new form targets.

What is the IRS actually changing on Form 990?

Treasury’s April statement says the IRS will revise the form so that section 501(c)(3) organizations report government contracts, public grants, and fiscal sponsorships more clearly, with proposed changes going out for public comment first. The August remarks by Jarod Koopman, the IRS chief tax compliance officer, added a timeline (“by the next tax year”) and a method: with staffing down by roughly a third, enforcement will rely on automation and analytics rather than more agents.

The form itself has not been published. As of September 12, 2026, there is no draft schedule and no revised instructions. The likeliest reading of “next tax year” is that returns for tax years beginning in 2027 carry the new questions, though a faster rollout is possible. Either way, the 2026 return, due May 17, 2027 for calendar-year filers, is the year to get grant and sponsorship records in order.

Why are grants and fiscal sponsorships the target?

The current form reports government grants as a single line in Part VIII without naming the agency or showing whether the money was passed along. Fiscal sponsorship is less visible still: the sponsor reports the receipts as its own and the payouts as program expense, and the project’s name and leaders never appear. The IRS has long accepted that an exempt organization may fund a non-exempt group if it keeps control and discretion over the funds (Rev. Rul. 68-489, 1968-2 C.B. 210); a sponsor that merely forwards restricted money is a conduit and can lose its exemption. New Mexico acequia associations, arts collectives, and youth programs use sponsors constantly, usually under a two-page memorandum.

How does automatic revocation under § 6033(j) catch small nonprofits?

Organizations with gross receipts normally at or below $50,000 file the electronic 990-N notice under 26 U.S.C. § 6033(i); those under $200,000 in receipts and $500,000 in assets may use the 990-EZ; everyone else files the full return. Under § 6033(j), an organization that fails to file “for 3 consecutive years” loses its exemption by operation of law on the due date of the third missed filing. There is no hearing; the IRS simply posts the name on its Auto-Revocation List.

A volunteer fire association in Torrance County changes treasurers, the 990-N login leaves with the old one, and three Mays go by. Reinstatement under Rev. Proc. 2014-11 is available, often retroactively if the application is filed within 15 months, but the price is a new application, a user fee, and a state grant contract that may be terminated the day the revocation posts.

What do New Mexico charities owe the Attorney General’s registrar?

Under the Charitable Solicitations Act, NMSA 1978 § 57-22-1 et seq., a charitable organization that exists, operates, or solicits in New Mexico must register with the Attorney General (now the Department of Justice) unless exempt under § 57-22-4, mainly religious organizations and educational institutions with their booster groups. Section 57-22-6 requires an annual report within six months after fiscal year end, consisting of the federal return with Schedule A and attachments. For fiscal years beginning on or after January 1, 2024, an organization with total expenses above $750,000 must include an audit by an independent CPA; the old test was $500,000 of revenue. The late-filing penalty is only $100, but the registrar can suspend a registration, and once the Form 990 itemizes grants and sponsorships, that detail lands in the public file in Santa Fe too.

What should board members know about excess benefit under § 4958?

The “abuse” half of the IRS strategy is about money leaving a charity for insiders. Private inurement can cost the organization its exemption; the intermediate sanction under 26 U.S.C. § 4958 taxes the people instead. An excess benefit transaction is one in which the charity gives a disqualified person (an officer, director, substantial contributor, or their family or business) more value than it receives. The disqualified person owes 25 percent of the excess and must repay it; uncorrected, the tax becomes 200 percent. A manager who knowingly approved it personally owes 10 percent, capped at $20,000. The defense is procedural: approve the deal in advance on comparable data and document it in the minutes, which earns a rebuttable presumption of reasonableness under Treas. Reg. § 53.4958-6.

How does New Mexico gross receipts tax treat a 501(c)(3)?

This is the piece a pure exemption lawyer misses. New Mexico has no sales tax; it imposes gross receipts tax on the seller. Under NMSA 1978 § 7-9-29, receipts of an organization that has shown the Taxation and Revenue Department its 501(c)(3) determination are exempt, except receipts from an unrelated trade or business as defined in § 513 of the Internal Revenue Code, hospital receipts, and receipts from running a national laboratory or state research facility. A year-round merchandise operation unrelated to the mission is taxable at the full local rate and also belongs on a federal Form 990-T.

The exemption runs one way: when the charity buys, the vendor owes GRT and passes it through. For tangible personal property, the charity can hand the vendor a Type 9 nontaxable transaction certificate so the vendor can deduct the receipts under § 7-9-60. Type 9 does not cover services, leases, software licenses, or construction materials.

Obligation	Authority	Trigger or deadline	Consequence
Annual federal return or 990-N	26 U.S.C. § 6033	15th day of 5th month after year end	Daily penalty under § 6652(c)
Three missed years	26 U.S.C. § 6033(j)	Due date of third missed filing	Automatic revocation
NM annual charitable report	NMSA 1978 § 57-22-6	Six months after year end	$100 penalty, suspension
Independent audit with NM report	NMSA 1978 § 57-22-6	Total expenses over $750,000	Report incomplete
Excess benefit correction	26 U.S.C. § 4958	Before IRS assessment	25 percent, then 200 percent
GRT on unrelated receipts	NMSA 1978 § 7-9-29	Each CRS filing period	Tax, penalty, interest

What does this look like for an Albuquerque youth sports nonprofit?

Take a hypothetical Albuquerque youth soccer organization with a $600,000 budget for calendar year 2026: $310,000 in registration fees, $140,000 from a New Mexico Department of Health youth activity grant, $90,000 in donations, and $60,000 collected as fiscal sponsor for a South Valley skateboarding collective with no exemption of its own. Expenses are $585,000. Over $200,000 in receipts, it files the full Form 990 by May 17, 2027, and under the redesign should expect to name the state agency separately and to disclose the sponsorship: the collective’s name, the $60,000 in, the $52,000 out, and the soccer board’s approval of each payment. Expenses of $585,000 sit under the $750,000 audit line, so the Department of Justice report due June 30, 2027 needs no audit; if 2027 expenses cross $750,000, an audit becomes mandatory and should be budgeted now.

Two more issues: the executive director is the founder’s spouse at $95,000, which calls for comparable data and an independent vote, and $28,000 of branded gear sold online year-round is likely unrelated business income for the Form 990-T and the CRS return.

What should a New Mexico board do before the 2026 filing season?

Confirm on the IRS Tax Exempt Organization Search that the last three returns were accepted. Build a grant register listing each government funder, award number, amount received, and amount spent. Confirm every sponsorship agreement gives the sponsor full control over the funds and keeps project leaders off the bank account. Review related-party compensation against comparable data and record the vote. Reconcile GRT so that unrelated receipts are reported, Type 9 certificates sit only with tangible-property vendors, and the 990-T matches the CRS return. Then calendar the federal and state due dates and assign each to a named person.

Frequently Asked Questions

When will the new Form 990 questions about government grants and fiscal sponsorship take effect?

The IRS said in late August 2026 that the revised form will be ready by the next tax year, but no draft or instructions had been published as of mid-September 2026. Returns for tax years beginning in 2027 are the likeliest first targets.

Does a small New Mexico nonprofit that files the 990-N postcard need to worry about the redesign?

The 990-N asks only for identifying information and a confirmation that receipts are normally $50,000 or less, so the new detailed questions will land on the 990-EZ and full 990. The bigger risk for postcard filers is missing three years in a row, which revokes exemption automatically under § 6033(j).

What happens if our New Mexico charity's tax exemption is automatically revoked?

Exemption ends on the due date of the third missed return and the name is posted on the IRS Auto-Revocation List. Donations after that date are not deductible and grant contracts that require 501(c)(3) status can be terminated. Reinstatement requires a new application under Rev. Proc. 2014-11.

Does a New Mexico 501(c)(3) have to file an audit with the Attorney General every year?

Only if total expenses exceed $750,000, for fiscal years beginning on or after January 1, 2024. Below that line the annual report to the Department of Justice is the federal return with Schedule A, due within six months after fiscal year end.

Can a New Mexico nonprofit use its GRT exemption when it buys services?

No. The exemption under NMSA 1978 § 7-9-29 covers the nonprofit’s own receipts, not its purchases. A 501(c)(3) can give vendors a Type 9 nontaxable transaction certificate for tangible personal property only; services, leases, software licenses, and construction materials do not qualify.

Can board members be personally liable for an excess benefit transaction?

Yes. Under 26 U.S.C. § 4958 a manager who knowingly approves an excess benefit transaction owes 10 percent of the excess, capped at $20,000 per transaction, assessed against the individual. Advance approval on comparable data, recorded in the minutes, is the protection.

How North Star Law Firm Can Help

North Star Law Firm advises New Mexico nonprofits and their boards on federal exemption compliance, Form 990 and 990-T reporting, excess benefit exposure, reinstatement after automatic revocation, and gross receipts tax questions. Phillip Zagotti, JD/CPA, represents New Mexico taxpayers before the IRS and the U.S. Tax Court, and works with New Mexico-licensed counsel on Charitable Solicitations Act registration and state-court matters. The firm’s tax law practice covers exemption planning, its gross receipts tax practice handles TRD audits and NTTC questions, and its IRS audit defense practice responds when an examination letter arrives. Read the firm’s New Mexico gross receipts tax audit guide, then contact North Star Law Firm for a compliance review before the 2026 returns are due.