2015 Federal Tax Update - Elliott Davis · 2019. 3. 19. · 2015 Federal Tax Update1 Elliott Davis Decosimo Rick J. Taylor, CPA, MST | [email protected] Tuesday, November 10, 2015

2015 Federal Tax Update1 Elliott Davis Decosimo

Rick J. Taylor, CPA, MST | [email protected]

Tuesday, November 10, 2015

1This outline compiles and summarizes scintillating events in federal taxation occurring between November 15, 2014, and November 2, 2015. It covers the important cases, rulings, and regulations issued during the year.

mailto:[email protected]

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Important Note to Attendees • Due to printing schedules, the printed slides included in your

materials are current only through midday on 11-2-15. • To ensure a comprehensive and up-to-date presentation,

additional and revised slides will be used during the actual presentation. You can download a complete set of the final slide deck which has been updated through 11-8-15 at www.wipfli.com by accessing our TaxThink blog.

• The detailed technical materials supporting my presentation can be downloaded at www.wipfli.com by accessing our TaxThink blog. These materials have been updated through 11-8-15. Password = elliott davis decosimo 2015#

http://www.wipfli.com/


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Overview • Taxpayer Advocate’s Report to Congress • IRS Double Standards Driving us to the Brink • Tax Environment • Legislative Outlook • 2015 Tax Rates and Inflation Adjusted Amounts • New Legislation • Accounting Methods – Cases, Regulations and Rulings (CRRs) • Individuals - CRRs • Corporations, Partnerships and Business Related - CRRs • Retirement Planning and Transfer Taxes –CRRs • Practice and Procedure-CRRs • Expiring Provisions and Federal Reference Data

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Taxpayer Advocate’s Report to Congress • “For the majority of taxpayers who filed their returns and did

not require IRS assistance, the filing season was generally successful. For the segment of taxpayers who required help from the IRS, the filing season was by far the worst in memory.”

• The IRS answered only 37 percent of taxpayer calls routed to customer service representatives overall, and the hold time for taxpayers who got through averaged 23 minutes. This level of service represents a sharp drop-off from the 2014 filing season, when the IRS answered 71 percent of its calls and hold times averaged about 14 minutes.

• The IRS answered only 39 percent of calls from taxpayers seeking assistance from TAS on the National Taxpayer Advocate (NTA) Toll-Free hotline, and hold times averaged 19 minutes.

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Taxpayer Advocate’s Report to Congress • The IRS answered only 17 percent of calls from taxpayers who

called after being notified that their tax returns had been blocked by the Taxpayer Protection Program (TPP) on suspicion of identity theft, and the hold times averaged about 28 minutes. In three consecutive weeks during the filing season, the IRS answered fewer than 10 percent of these calls.

• The IRS answered only 45 percent of calls from practitioners who called the IRS on the Practitioner Priority Service line, and hold times averaged 45 minutes.

• The number of “courtesy disconnects” received by taxpayers calling the IRS skyrocketed from about 544,000 in 2014 to about 8.8 million this filing season, an increase of more than 1,500 percent. The term “courtesy disconnect” is used when the IRS essentially hangs up on a taxpayer because its switchboard is overloaded and cannot handle additional calls.

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Taxpayer Advocate’s Report to Congress • The IRS sharply restricted the availability of paper copies of

forms and publications, imposing burden on taxpayers without Internet access or online literacy. The IRS’s own Taxpayer Assistance Centers (TACs) and its Tax Form Outlet Partners such as libraries and post offices did not receive forms until February 28, almost halfway through the filing season. Once a TAC ran out of forms or publications, it could not order more.

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House Starts Impeachment of Koskinen • House Oversight Committee Chairman Jason Chaffetz (R-Utah)

and 18 other members of the committee introduced articles of impeachment against IRS Commissioner John Koskinen. – Failure to secure taxpayer data -the IRS revealed that the taxpayer

information of over 100,000 filers had been stolen – a number that was later revised to about 330,000 taxpayers.

– The IRS failed to search five of six possible sources of electronic media for Lois Lerner’s emails. The only source they searched – her hard-drive – was destroyed after a brief search deemed information unrecoverable. 24,000 Lerner emails were destroyed – Isn’t this the same thing that caused the demise of Arthur Andersen?

– Misallocation of IRS resources resulting in the worst filing season in history. See Taxpayer Advocate’s Report to Congress above.

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Double Standards • Agents ask you to complete the M-1 because they do not

understand how the M-3 works. • Agents lack understanding of TEFRA audit rules and propose

changes to individual items without opening individual audits. Spend more time on POA procedures than on researching the tax law.

• IRS blames identity theft on CPAs; is it a coincidence that 100% of our identity theft involves taxpayers who have overpayments applied? How do the ID thieves know that?

• IRS drags out audits, but is inflexible when it comes to providing requested information especially when opening audits shortly before major due dates.

• No usable assistance on practitioner line.

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Double Standards • IRS personnel routinely transfer you and disconnect you in what

appears to be an attempt to not address the issue or to just get you to go away.

• Focus on unimportant issues to burn time and slow down the process. For example, I recently had to call elderly clients with IRS on the line to verify signatures on POA that the IRS person said she could not read.

• IRS adds every conceivable argument to Notice of Deficiency – even when arguments not addressed during examination.

• All penalties are routinely assessed regardless of circumstances • Whenever go to appeals cases languish for at least 1 year (if not

longer).

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Double Standards • IRS is simply ignoring amended returns. Does not acknowledge

receipt and refuses to issue refunds. • IRS refusing to extend statute for refunds when at appeals for

significant periods of time. Often resolution is to file suit in the tax court in order to get bounced back to appeals where something will finally get done.

• IRS (as do the states) sending erroneous notices that require time and effort to resolve.

• Feels like a work slow-down to protest budget cuts. – Reminds me of the “infamous Wisconsin toilet paper

scandal” of the late 1970s or early 1980s.

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Tax Environment • Frequent tax legislation – 30 Major Laws in 14 years • Eleventh-hour tax bills (2014 extenders passed

December 19, 2014). • A large number of “extenders” expired at end of 2014

so we are back in the last minute “soup” again this year.

• Paul Ryan has express a strong desire to pass tax reform; his movement from Ways and Means to Speaker of the House creates some uncertainty.

• Judicial uncertainty-although the “rule of law” is professed, recent history shows that the law is whatever the President or his agencies want it to be. – Congress is “afraid” to challenge.

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Tax Environment • IRS in state of meltdown- it is completely overwhelmed

by identity theft issues as evidenced by recent Inspector General Report.

• IRS has not been successful in stopping earned income fraud, which is the biggest source of fraud.

• IRS is in charge of implementing many aspects of the ACA which is adding additional responsibilities at a time when it already is under tremendous strain.

• Unreasonable complexity -74,000 pages of tax law 523% increase in length of Code and 705% increase in length of Regs; based on pages).

• Agents open lots of new audits, but they are taking longer to close.

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Tax Environment • Tax Court imposes accuracy related penalties (Bobrow)

despite taxpayer relying IRS publication and proposed regulations! – Decision by Judge Nega – Barack Obama appointee.

• Questionable decision in Vanney denying deduction for year-end bonus from PSC because insufficient cash in bank account leaves practitioners wondering what will be challenged next. – Decision by another Obama appointee.

• IRS enforcement (and lack of enforcement) of ACA provisions clearly shows considerable political influence within the agency.

• Decision in King is impossible to reconcile with other tax cases.

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Legislative Outlook • Influential lawmakers promised significant tax reform during

2014; Camp’s proposal were dead on arrival because they had more in common with the Democrats than the Republicans. No appetite to get it done in 2015.

• Taxation has become a divisive issue with lots of rhetoric and almost no real truth (perhaps reflecting the discourse of our society in general).

• While nothing short of major tax reform is going to fix the problem, but there will be no “grand bargain” until there is a crisis to motivate.

• ACA problems will intensify significantly when IRS starts assessing penalties for failing to cover employees. That fiasco will start in January 2017! – 800,000 erroneous 1095-A is tip of big iceberg rolling in.

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President’s FY 2016 Proposals released February 2015.

• More items from the Joint Committee’s “Wish List” eventually will be enacted Implement – Buffett Rule Imposing “Fair Share Tax” – 30% flat tax

less a credit for charitable contributions – Applies starting at $1 million

– Reduce value of itemized deduction for higher income taxpayers

– Limit Accrued Retirement Benefits (Approx $3.2 million)

– Restore Estate/gift/GST exemptions rates to 2009 levels in 2018.

– Subject professional services S corporations to SE tax same as partnerships and LLCs.

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President’s FY 2016 Proposals released February 2015.

• More items from the Joint Committee’s “Wish List” eventually will be enacted Implement – Limit gain that can be deferred under §1031 from the

exchange of real property to $1 million – Prohibit §1031 use for art or collectibles. – Limit Roth conversions to pre-tax dollars – Repeal exclusion of net unrealized appreciation in

employer securities – Disallow the deduction for charitable contribution

that are a prerequisite for purchasing tickets to college sporting event.

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Joint Committee’s “Wish List” released February 2015.

• More items from the Joint Committee’s “Wish List” eventually will be enacted Implement – Tax Carried Interests as Ordinary Interest – Repeal LIFO Method of Accounting for Inventories – Repeal LCM Inventory Accounting Method – Expand Information Reporting – Eliminate Defective Grantor Trusts – Require GRATs Have a 10-Year Minimum Term – Modify Rules on Valuation Discounts

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Income Type Marginal Rate Health Care True Max Rate

Ordinary Income, but see next slide.

10% 15% 25% 28% 33% 35%

39.6%

0.9% 0.9% 0.9% 0.9%

28.9% 33.9% 35.9% 40.5%

LT capital gains and Qualified dividends

0% 15% 20%

3.8% 3.8%

18.8% 23.8%

2015: Same as 2014 with inflation adjustments

Modified Adjusted “GROSS” Income >200k/250k.

Based on TAXABLE income.

15.7% higher than ‘12

58.6% higher than ‘12

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Income Type Marginal Rate Health Care True Max Rate

Net Investment income: Interest, ordinary dividends, rents, royalties, passive activity income, and certain gains on dispositions of assets.

10% 15% 25% 28% 33% 35%

39.6%

3.8% 3.8% 3.8% 3.8%

31.8% 36.8% 38.8% 43.4%

2015: Same as 2014 with inflation adjustments

Modified Adjusted “GROSS” Income >200k/250k.

Based on TAXABLE income. 24% higher than ‘12

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AMT Exemption 2016 2015 2014 2013 2012 2011

MFJ $83,800 $83,400 $82,100 $80,800 $78,750 $74,450

Phase-out

Range

$159,700 -

$494,900

$158,900 –

$492,500

$156,500 -

$484,900

$153,900-

$477,100

$150,000 -

$465,000

$150,000-

$447,800

S $53,900 $53,600 $52,800

$51,900 $50,600 $48,450

Phase-out

Range

$119,700 -

$335,300

$119,200 –

$333,600

$117,300 -

$328,500

$115,400-

$323,000

$112,500 -

$314,900

$112,500-

$306,300

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AMT Observation • Breakeven analysis indicates a cross-over point into

AMT for a joint return with four exemptions and using a standard deduction at approximately:

Break-even 2015 $245,880* 2014 $241,610 2013 $237,750 2012 $231,500 2011 $217,500 2010 $212,200 *Calculation done using BNA 50 State Planner version 2015.1S

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AMT Observation • Although the specified rate for AMT is 28%, a 35%

effective AMT rate generally applies throughout the AMT phase-out range. 26% applies up to $92,700/$185,400 for 2015 $93,150/$186,300 for 2016.

• As additional income results, 25% of the AMT exemption phases out. At a 28% rate, with a 25% exemption phaseout, an additional 7% (28% x 25%) of “hidden AMT results. This effectively pushes the AMT rate from 28% to 35%.

• Personal exemption reduced as MAGI exceeds threshold.

• Reduced by 2% for every $2,500 of MAGI above threshold.

• Also known as the ‘haircut.’ • Itemized deductions reduced by 3% of MAGI above

threshold. • Maximum reduction is 80%. • Deductions not included:

• Investment interest expense. • Medical expenses (but after 7.5% and AMT [10%], does it matter?) • Casualty and theft losses. • Gambling losses.

PEP and Pease.

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• Thresholds for reductions: 2015 2014

$258,200 Single $254,200 $284,050 HOH $279,650 $309,900 MFJ $305,050 $154,950 MFS $152,525

• Threshold amounts indexed for inflation. • The 3% phase out of itemized deductions is designed

to create a 1% marginal rate increase to higher income filers.

• The 2% phase out of personal exemptions is designed to create a 1% marginal rate increase per exemption to higher income filers.

PEP and Pease.

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Bonus Depreciation

Bonus Depreciation Rates (inclusive dates)

9/11/2001 - 5/5/2003 30%

5/6/2003 - 12/31/2004 50%

1/1/2008 - 9/8/2010 50%

9/9/2010 - 12/31/2011 100%

1/1/2012 - 12/31/2013 50%

2014 50%

2015 Expired

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§179 Limitations –New & Used Boot Only; Election can be made on amended return

Tax Year Beginning in Annual §179 Expense Limitation

Asset Additional Phase-out Range

2007 $125,000 $500,000 - $625,000

2008 $250,000 $800,000 - $1,050,000 2009 $250,000 $800,000 - $1,050,000

2010 $500,0000 $2,000,000 - $2,500,000

2011 $500,000 $2,000,000 - $2,500,000

2012 $500,000 $2,000,000- $2,500,000 2013 $500,000 $2,000,000- $2,500,000 2014 $500,000 $2,000,000- $2,500,000 2015 $ 25,000 $200,000 - $225,000

S corporations are not aggregated with other S corporations or C corporations that are members of the same controlled group for §179 purposes.

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Qualified Leasehold Improvements

MACRS Lives

Bonus

3 Year Rule (1)

Unrelated Parties Rule (2)

Exclusions

(3) §179 Qualified Leasehold Improvements : 2001 - 2004 Partial

9/11/01 - 10/22/04 39 Year Y Y Y Y N/A

Qualified Leasehold Improvements: 2004 Partial – 2013

10/23/04 - 12/31/14 15 Year Y (4) Y Y Y

2010 - 2014 Up to $250k

Qualified Restaurant Property: 2004-2007

10/23/04 - 12/31/07

15 Year

N (5)

Y

N

N

N/A

Qualified Restaurant Property: 2008

1/1/08 - 12/31/08 15 Year Y Y N N N/A

Qualified Restaurant Property: 2009 - 2013

1/1/09 - 12/31/14

15 Year

N (6)

N

N

N

2010 - 2014 Up to $250k

Qualified Retail Improvement Property

1/1/09 - 12/31/14 15 Year N (6) Y N Y

2010 - 2014 Up to $250k

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Notes (1) The improvement must have been placed in service by the taxpayer

more than 3 years after the date the building was first placed in service

(2) Improvements must be made subject to a lease between unrelated parties.

(3) The enlargement of the building, any elevator or escalator, any structural component benefiting a common area and the internal structural framework of the building are excluded.

(4) Qualified leasehold improvements are not eligible for bonus depreciation if placed in service 1/1/2005 – 12/31/2007.

(5) Qualified restaurant property is eligible for bonus depreciation if placed in service 10/23/2004 – 12/31/2004.

(6) Rev. Proc. 2011-26 provides that if qualified restaurant property and/or qualified retail improvement property also meets the criteria as qualified leasehold improvements, then they are eligible for bonus depreciation.

Built in Gain Recognition Period • The ATRA changed the recognition period to 5 years for

purposes of determining the net recognized BIG for tax years beginning in 2011 - 2014.

• Due to the shortened recognition period, prior BIG in excess of the taxable income limitation disappears if carried into a year after the expiration of the recognition period, even if the 10-year recognition period again becomes operative for years beginning in 2015. – 1374(d)(7)(B)(ii) zero tax if 5 or more year prior S status – 1374(d)(7)(C) past recognition period – 1374(d)(2)(B) no carryover after expiration of recognition period

• A 2014 installment sale of assets subject to the BIG tax will avoid the BIG tax for S election effective January 1, 2009 and earlier, even though gain recognition is deferred to a later year.

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Blended Rates

Year Blended Rate Ruling 2015 .45% Rev. Rul. 2015-15 2014 .28% Rev. Rul. 2014-20 2013 .22% Rev. Rul. 2013-15 2012 .22% Rev. Rul. 2012-20 2011 .40% Rev. Rul. 2011-14 2010 .50% Rev. Rul. 2010-18

Interest Rate Environment.

ST AFR MT AFR LT AFR 7520 Rate

Nov 2015 0.49% 1.59% 2.57% 2.0% Nov 2014 0.39% 1.90% 2.91% 2.2% Nov 2013 0.27% 1.73% 3.37% 2.0% Nov 2008 1.63% 2.97% 4.24% 3.6% Nov 2003 1.50% 3.32% 4.99% 4.0%

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GRAT versus IDGT Comparison. GRATs IDGTs

Hurdle Rate Section 7520 rate (120% AFR) AFR

Initial Setup Transfer to trust and possible taxable gift

Sale to trust in return for note; no gain/loss

Upfront cash gift or personal guarantee

Payments to Grantors Fixed amount or

percentage; may vary up to 20% annually

May be interest only w/balloon; no prepayment

penalty

GST Planning None May be completely sheltered from GST

Legislative Support Included in Internal Revenue Code

Generally accepted by practitioners

Estate Inclusion A portion of the trust assets Only remaining note balance

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Transfer Taxes – Historical Information YEAR ESTATE

TAX GIFT TAX

GST TAX

STATE DEATH TAX

BASIS ADJUST MENTS

Max Rate Exemption Equivalent

Max Rate

Exemption Equivalent

Annual Exclusion

Flat Rate

Exemption Credit - Deduction

Step-up

1987-97 55% $600,000 (phase-out above $10M)

55% $600,000 $10,000 55% $1 million 100 % of credit

Step-up

1998 55% $625,000 55% $625,000 $10,000 55% $1 million 100 % of credit

Step-up

1999 55% $650,000 55% $650,000 1$0,000 55% $1.01 million 100 % of credit

Step-up

2000 55% $675,000 55% $675,000 $10,000 55% $1.03 million 100 % of credit

Step-up

2001 55% $675,000 55% $675,000 $10,000 55% $1.06 million 100 % of credit

Step-up

2002 50% $1 million 50% $1 million $11,000 50% $1.1 million 75% of credit Step-up

2003 49% $1 million 49% $1 million $11,000 49% $1.12 million 50% of credit Step-up

2004 48% $1.5 million 48% $1 million $11,000 48% $1.5 million deduction Step-up

2005 47% $1.5 million 47% $1 million $11,000 47% $1.5 million deduction Step-up

2006 46% $2 million 46% $1 million $12,000 46% $2 million deduction Step-up

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Transfer Taxes – Historical Information YEAR ESTATE

TAX GIFT TAX

GST TAX

STATE DEATH TAX

BASIS ADJUSTMENTS

Max Rate Exemption Equivalent

Max Rate

Exemption Equivalent

Annual Exclusion

Flat Rate

Exemption Credit - Deduction

2007 45% $2 million

45% $1 million

$12,000

45% $2 million

deduction

Step-up

2008 45% $2 million

45% $1 million $12,000

45% $2 million

deduction Step-up

2009 45% $3.5 million

45% $1 million

$13,000

45% $3.5 million deduction

Step-up

2010 35% (or 0%) $5 million if no election out of ET

35% $1 million

$13,000

0% n.a. deduction

Step-up (OR $1.3M limit plus $3M marital amount if elect out of ET)

2011 35% $5 million (portable) 35% $5 million

$13,000

35% $5 million

deduction Step-up

2012 35% $5.12 million (portable)

35% $5.12 million

$13,000

35% $5.12 million

deduction

Step-up


40% $5.25 million

$14,000 40% $5.25 million

deduction

Step-up


40% $5.34 million $14,000 40% $5.34 million deduction Step-up


40% $5.43 million $14,000

40% $5.43 million deduction

Step-up

2016 & after

40% $5.45 million (portable) (CPI adjust)

40% $5.34 million (CPI adjust)

$14,000 40% $5.45 million (CPI adjust)

deduction Step-up

Miscellaneous Issues

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April 18th Due Date • In Rev. Rul. 2015-13, the IRS noted that for most taxpayers, their

2015 federal income tax return will be due on Monday, April 18, 2016.

• D.C. observes Emancipation Day on Friday, April 15, when April 16 is a Saturday. This makes Monday, April 18, the ordinary due date for filing federal income tax returns otherwise due on Friday, April 15. – Taxpayers in Maine and Massachusetts have until April 19th

to file their returns, but must make estimates no later than April 18th!!!!

• Because 2016 also is a leap year, we get 4 extra days to meet our 4-15 deadlines. That an extra 48 working hours!!!

Current Due Dates 2016 Tax Year Due Dates

Partnership-1065 April 15 September 15

March 15 September 15

Accelerates original due date by 1 month

S Corporation-1120S March 15 September 15


No change

Trust & Estate-1041 April 15 September 15

April 15 September 30

Extends extended due date by 15 days

C Corporation (Other than 6/30)-1120


April 15 September 15

October 15 after 12/31/2025

Extends original due date by 1 month same extended due date until after 2025

C Corporation (6/30 Fiscal Year)-1120

September 15 March 15

September 15 October 15 after 12/31/2025

April 15

Due date remains the same at 2 ½ months, but extends extended due date by 1 month

C Corp Other than

6/30 and Calendar

2 ½ months 6 months

3 ½ months 6 months

Because does not defer revenue to different budgetary year, the non 6/30 and 12/31

corporations get 1 month longer to file on extension

Individual-1040 April 15 October 15

April 15 October 15

No change

Exempt organizations-990

May 15 August 15

November 15

May 15 November 15

Extension is a single, automatic 6-month extension, eliminating the need to process the

current first 90-day extension

New Filing Due Dates – 2016 Tax Year

Current Due Dates 2016 Tax Year Due Dates

Employee Benefit

Plans-5500

July 31 October 15

July 31 November 15

Extends extended due date by 1 month

Foreign Trusts with US

Owner 3520-A



No change

FinCEN-114 June 30 April 15 October 30

Shortens due date with extension possible

Information Returns To IRS/SSA February 28, and March 31 if filed

electronically

To IRS/SSA February 28, and March 31 if filed

electronically

No change

New Filing Due Dates – 2016 Tax Year

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Trade Preferences Extension Act of 2015 • President signed into law on June 29, 2015. • An increase in the required corporate estimated tax payments

for large corporations (assets of at least $1 Billion) will be increased by 8% for the payment due in July, August or September of 2020, with the following installment reduced to 92% of the amount otherwise due.

• Taxpayers claiming the American Opportunity Tax Credit, Hope Scholarship Credit, Lifetime Learning Credit, and the deduction for tuition and fees will be required to have a valid Form 1098-T from their educational institution. The provision is effective for all tax years beginning after the date of enactment.

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Trade Preferences Extension Act of 2015 • Relief would be granted to educational institutions unable to

obtain TINs to issue the above statements if they certify they properly requested the TINs from the students.

• Penalties for failing to file information returns and/or provide them to payees would be increased, effecting for filings required after December 31, 2015.

• Taxpayers who claim a foreign earned income exclusion would not longer be eligible to receive the refundable portion of the child tax credit for the year. This is effective for tax years beginning after December 31, 2014.

• The health care coverage tax credit under IRC §35 would be restored to the law and extended through 2019. This provisions is effective for tax years beginning after December 31, 2013.

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Information Returns • On 06/29/15, the President signed the Trade Preferences Extension Act of

2015 (P.L. 114-27) which contained a number of "offsets" or revenue raising provisions probably the most important of which is Section 806 entitled Penalty for Failure to File Correct Information Returns and Provide Payee Statements.

• The major changes made by this provision is to increase the penalty for failure to FILE "information returns" from $100 to $250 and to increase the penalty for failure to FURNISH "information returns" from $100 to $250.

• These changes apply with respect to returns and statements required to be filed after 12/31/15 which means with respect to information returns required to be filed for calendar 2015.

• For many of your clients, these changes may pose an compliance threat to their businesses since many clients fail to file the requisite information returns, and examining agents have been asking to see these information returns during the course of their examinations.

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TD 9730, p621

• The IRS has decided to shorten that time period by removing the automatic 30-day extension option for W-2s and by adopting only a single non-automatic extension.

• The regulations will also eventually remove the automatic 30 day extension of time to file other information returns, replacing that will the single 30 day non-automatic extension that must be requested.

• The current rules under old §1.6081-8 will remain in place for filing 2015 Forms W-2 filed in 2016, with the new rules becoming effective for the 2016 W-2 forms that will be filed in 2017.

– The IRS will keep the old rules in place for other information returns for at least one year, with the new rules not being required for those returns no earlier than information returns due on or after January 1 of the year the regulations are adopted as final or, if later, those due on or after January 1, 2018.

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§529A added by Extenders Legislation • The “extender” legislation in December of 2014 added §529A to

establish a tax-advantaged savings program for the purpose of meeting the qualified disability expenses of a disabled beneficiary.

• The ABLE savings program is to be established by a state. If a state does not establish its own ABLE program, it may enter into a contract with another state to provide its residents with access to a qualified ABLE program.

• The ABLE accounts and §529A are modeled after the Qualified Tuition Programs of §529 maintained by states for the purpose of meeting qualified higher education expenses. However, ownership of an ABLE account is more restrictive.

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§529A added by Extenders Legislation • The owner of an ABLE account is the disabled designated

beneficiary of the account; or a person with signature authority over the account who may not have any beneficial interest in the account and must administer that account for the benefit of the designated beneficiary.

• An ABLE account is exempt from income taxation. However, as with other exempt entities, the unrelated business income tax can apply.

• A person making contributions to an ABLE account does not receive a deduction for income tax purposes.

• Distributions are not included in income of the disabled beneficiary if the distributions do not exceed the qualified disability expenses of that individual.

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§529A added by Extenders Legislation • A disabled beneficiary is limited to one ABLE account. To

enforce the one ABLE account limit, the proposed regulations provide that the state ABLE program must obtain verification, signed under penalties of perjury, that the eligible individual has no other existing ABLE account.

• Contributions must be in cash. • Except in the case of a rollover contribution from another

account, an ABLE account must limit total contributions from all contributors for a tax year to the annual gift tax exclusion amount (currently $14,000 for 2015). Excess contributions must be return with associated earnings.

• Amounts in an individual’s ABLE account, as well as distributions to pay qualified disability expenses, are disregarded for purposes of any federal means-tested program. Special rules apply for SSI when account exceeds $100,000.

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§529A added by Extenders Legislation • Upon the death of a disabled individual, amounts in the ABLE

account are first used for unpaid disability expenses of the individual.

• Amounts in the account are next subject to the claim of the state for the total amount of medical assistance paid for the designated beneficiary under the state Medicaid plan since the opening of the ABLE account, net of any premiums paid to the Medicaid Buy-In Program.

• Any amounts remaining in the account after Medicaid reimbursements transfer to the decedent’s estate or to a designated beneficiary, and are subject to income tax on investment earnings, but not to the 10% penalty.

• In view of the statutory direction giving the state creditor status with the first claim on these accounts, there may be few ABLE accounts making distributions to family heirs.

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Partnership Audit Rules After 2017 • The new rules apply to partnership tax years that begin after

Dec. 31, 2017 (although taxpayers may generally elect to apply the provisions, except for the small partnerships election out rules, earlier).

• The Act repeals the current TEFRA uniform partnership audit rules.

• The Act similarly repeals the electing large partnerships rules. • These rules are replaced with a streamlined single set of rules

for auditing partnerships and their partners at the partnership level.

• Under the new streamlined audit approach, any adjustment to items of income, gain, loss, deduction, or credit of a partnership for a partnership tax year (and any partner's distributive share of such adjustment) is determined at the partnership level.

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Partnership Audit Rules After 2017 • Similarly, any tax attributable to such adjustment is assessed

and collected, and the applicability of any penalty, addition to tax, or additional amount which relates to an adjustment to any such item or share is determined, at the partnership level.

• IRS will examine the partnership's items of income, gain, loss, deduction, credit and partners' distributive shares for a particular year of the partnership, and any adjustments will be taken into account by the partnership—not the individual partners—in the “adjustment year.”

• What constitutes the adjustment year depends on how the adjustment was made; for example, if it was made pursuant to a court decision, the adjustment year is the year that that decision becomes final.

49

Partnership Audit Rules After 2017 • Partnerships generally must pay tax equal to the “imputed

underpayment,” which generally is the net of all adjustments for any reviewed year, multiplied by the highest individual or corporate tax rate.

• Partnerships may demonstrate that the underpayment would be lower if it were based on certain partner-level information and may pay that lower amount. This information could include amended returns of partners opting to file, the tax rates applicable to specific types of partners (e.g., individuals, corporations, tax-exempt organizations), and the type of income subject to the adjustments (e.g., ordinary income, dividends, capital gains).

50

Partnership Audit Rules After 2017 • As an alternative to taking the adjustment into account at the

partnership level, a partnership can make an election, not later than 45 days after a notice of final partnership adjustment, to issue adjusted information returns to the reviewed year partners, in which case those partners would take the adjustment into account on their individual returns in the adjustment year through a simplified amended-return process. – The election must be made in the time and manner prescribed by IRS and

once made could be revocable only with IRS's consent.

• A partnership would also have the option of initiating an adjustment for a reviewed year, such as when it believes additional payment is due or an overpayment was made, with the adjustment taken into account in the adjustment year.

51

Partnership Audit Rules After 2017 • The partnership generally would be allowed to take the

adjustment into account at the partnership level or issue adjusted information returns to each reviewed-year partner.

• On the partner's return, a partner must generally treat each item of income, gain, loss, deduction, or credit attributable to a partnership in a manner which is consistent with the treatment of the income, gain, loss, deduction, or credit on the partnership return.

• Any underpayment of tax by a partner because of failing to comply with the consistency requirement will be treated as a mathematical or clerical error (subject to a summary assessment procedures), except that the §6213(b)(2) rules on abatements of such assessments will not apply to the adjustment.

52

Partnership Audit Rules After 2017 • This consistency requirement does not apply where the

partnership has filed a return but the partner's treatment on the partner's return is (or may be) inconsistent with the treatment of the item on the partnership return, or the partnership hasn't filed a return, and the partner identifies the inconsistency on a statement filed with IRS on which (a) the partner shows to IRS's satisfaction that the treatment of the item on the partner's return is consistent with the treatment of the item on the statement furnished to the partner by the partnership, and (b) the partner elects to have this treatment apply with respect to that item.

53

Partnership Audit Rules After 2017 • Similar to the current TEFRA rule excluding partnerships with 10

or fewer partners, partnerships with 100 or fewer qualifying partners can elect out of the new rules for any tax year, in which case the partnership and partners would be audited under the general rules applicable to individual taxpayers.

• The election is made (in the manner set by IRS) with the partnership's timely filed return for the tax year and must disclose the name and taxpayer identification number of each partner of the partnership.

• The partnership must notify its partners of the election. • Generally, each of the partners of such a partnership has to be

an individual, a C corporation, a foreign entity that would be treated as a C corporation were it domestic, an S corporation, or an estate of a deceased partner.

54

Financial Strategy Group, PLC v. Continental Casualty Company, CA6, Docket No. 14-6296, 2015 TNT 152-16

• Failure to object to tax shelter by tax preparer treated as a recommendation of shelter allowing insurance carrier to deny coverage.

• A tax preparation firm discovered that its preparation of a tax return ended up being treated as part of a promotion of an illegal tax shelter by its liability insurance carrier, which meant the carrier refused coverage when clients sued the firm when the IRS came after the programs.

• Essentially the court held they had “blessed” the transaction because they had agreed to prepare the return in question and then claimed the losses on the individual return.

– The firm had effectively “endorsed” the program when it prepared the tax returns and did not inform the clients explicitly that this program had issues.

55

ACCOUNTING METHODS

56

Argo-Jal Farming Enterprises, p.1

• Field-packing materials that a farming corporation buys that are "on hand" are governed by §1.162-3, which does not require a cash-method taxpayer to defer its deductions until the materials are used or consumed if the taxpayer deducted such costs for a prior tax year.

• The treatment of materials and supplies for cash-basis farmers is governed by Reg. §1.162-12(a).

• This regulation allows a farmer to fully deduct amounts expended in conducting the farming business.

• For farmers, the deduction for nonincidental materials and supplies is limited to such items actually used or consumed during the tax year. Thus, the distinction in the new regulations between incidental and nonincidental materials and supplies is not applicable to farmers.

57

Materials and Supplies Summary

General Rules

Type When Deductible

Incidental supplies (1 year or less) When acquired

Nonincidental supplies (>1 year) When used or consumed

Rotable, temporary, or emergency spare parts When disposed

Special Rules

Type When Deductible

Rotable, temporary, or emergency spare parts Election to capitalize and depreciate

Materials and supplies Election to deduct when acquired under de minimis rule

Rotable, temporary, or emergency spare parts Optional method permits deduction when installed with add-back of FMV when removed

58

Brinkley, p.6

• Shareholder-employee of a corporation that received additional cash at closing as a result of negotiating a higher stock ownership percentage in the seller had ordinary income rather than capital gain even though he also relinquished any interest he held in intangibles that were sold as part of the deal.

• The facts were bad in this transaction and the employer had reported (probably correctly given the facts) the proceeds as W-2 income and the shareholder-employee took a contrary position.

• You need to carefully examine client transactions and not assume that because similar transactions generate capital gain that the current transaction will do so as well.

• IRS has no shame and will make any argument it can to increase your clients’ taxes.

59

Michael H. Dudek, p.8

• The Court of Appeals for the Third Circuit, affirming the Tax Court, has held that an over $800,000 bonus payment taxpayers received under an oil and gas agreement was taxable as ordinary income and not as capital gain as they had reported.

• This result was appropriate because the agreement was a lease and not a sale as they had claimed.

• With this case, we again see why it is critical to examine each and every transaction carefully and to no take the tax treatment for granted based on similar transactions.

60

Michael H. Dudek, p.8.

• The receipt of a bonus payment by a lessor pursuant to an oil and gas lease is taxable as ordinary income, not as gain from the sale of capital assets. (Burnet, David v. Henry Harmel, (1932, S Ct) 11 AFTR 1085)

• Where the owner of the land retains an economic interest in the deposits, the transaction is regarded as a lease, and the proceeds are taxable as ordinary income. (Laudenslager, Walter v. Commissioner., (1962, CA3) 10 AFTR 2d 5022)

61

Fargo, et al., p 10

• The Tax Court determined that taxpayers' extensive and ongoing efforts to develop a parcel of property demonstrated that their primary purpose was to sell the property in the ordinary course of business, and held that they were required to report their gain as ordinary income.

62

Fargo, et al., p10

• Tax Court factors 1. The purpose for which the property was initially acquired;

2. The purpose for which the property was subsequently held; 3. The extent to which improvements, if any, were made to the property by the

taxpayer; 4. The frequency, number, and continuity of sales; 5. The extent and nature of the transactions involved; 6. The ordinary business of the taxpayer; 7. The extent of advertising, promotion, or other active efforts used in soliciting

buyers for the sale of the property; 8. The listing of property with brokers; and 9. The purpose for which the property was held at the time of sale. (Maddux

Construction Co., (1970) 54 TC 1278)

63

Winthrop Factors

• Purpose for acquiring. • Purpose at time of sale (important in Bush). • Number and frequency of sales. • Extent of improvements. • Extend of sales activities. • Substantiality of income. • Time and effort expended. • Other:

– Corporate purpose per its charter – Individual’s occupation written on bottom of tax return – SIC activity code listed on tax return – How real estate is presented on balance sheet – Letterhead inference – Amended returns (after the fact)

64

Fargo, et al., p.10

• The Tax Court concluded that the property was held for development purposes and that it was sold in the ordinary course of business under §1221(a)(1).

• The property was purchased for development, and this intent was never abandoned.

• Even though the property was used as rental property, the Court found that such use was not GDLP's primary purpose of holding it-rather, it was just making the best use of the property as office and rental space while never abandoning its primary intent to eventually develop it.

65

Howard Hughes Company, 5th CA No. 14-50915

• Taxpayer could NOT use the completed contract method of accounting because its sales contracts were not “home construction contracts.”

• The contracts qualified as long term construction contracts for which percent of completion had to be used and not single year contracts as the IRS wanted.

• The sales in question encompassed more than just selling a lot. At the time of trial, the taxpayer still had to complete a water service line, traffic signals, landscaping and the construction of a park.

• The Court rejected the IRS position that the completion requirements were not contractual obligations so the income from the sale of the lots could not be delayed.

• Thus under the regulations, the contracts were not complete.

66


• The Court agreed with the IRS that to have a home construction contract, the taxpayer must build a dwelling unit or build improvements to real property directly related to and located on the site of dwelling units.

• Taxpayer's construction of improvements including rough grading, roadways, sidewalks, utility infrastructure, parks, trails, landscaping, entry features, signs and perimeter walls were not incurred "with respect to" qualifying dwelling units.

• Activities related to land which at some indeterminate future time may become the site of qualified dwelling units do not comprise the construction of a dwelling.

• The taxpayer must at some point incur some construction cost with respect to the dwelling unit.

67


• The Tax Court distinguished this case from its holding in Shea Homes, Inc. 142 TC No. 3, 2014, less than four months earlier, where it allowed the taxpayer to include the allocable share of the cost that the taxpayer reasonably expects to incur for any common improvement to be included in a home construction contract. "[A]t no point in Shea Homes did we say that a home construction contract could consist solely of common improvement costs."

• The opinion in Hughes establishes a bright line. A home construction contract must involve the taxpayer in building, constructing, rehabilitating or installing integral components to dwelling units or real property improvements directly related to and located on the site of dwelling units.

68

Long, p 16.

• The Court of Appeals for the Eleventh Circuit, reversing the Tax Court, has held that a real estate developer who sued a party who backed out of a contract to sell land to the developer, and then sold his rights as a plaintiff to a third party, had capital gain from that sale.

• The Tax Court had ruled in favor of IRS. (Long, TC Memo 2013-233)

• The Court also considered the frequency, continuity, and substantiality of Long's sales. And, it considered the extent to which Long developed and improved the property.

• Long used substantial efforts to develop the property: he hired architects, he obtained a zoning permit, he printed promotional materials, he negotiated contracts with residential customers, and he obtained deposits.

69

Long, p 16.

• Long did not sell the land itself, but rather his right to purchase the land, which is a distinct contractual right.

• The dispositive inquiry was not whether Long intended to sell the land to customers in the ordinary course of his business, but whether Long's purpose, with respect to the right to purchase the land, was to sell that right to customers in the ordinary course of his trade or business.

• There was no evidence that Long entered into the Riverside Agreement with the intent to assign his contractual rights in the ordinary course of business, nor was there evidence that, in the ordinary course of his business, Long obtained the state court judgment for the purpose of assigning his position as plaintiff to a third party.

•

70

Long, p 16.

• Rather, the record made clear that Long intended to fulfill the terms of the Riverside Agreement and develop the Las Olas Tower project himself.

• Long possessed a bundle of rights that reflected something more than an opportunity to obtain periodic receipts of income.

• Selling a right to earn future undetermined income, as opposed to selling a right to earned income, is a critical feature of a capital asset. (Dresser Industries, Inc., (CA 5 1963) 12 AFTR 2d 5895)

• The fact that the income earned from developing the project would otherwise be considered ordinary income was immaterial.

71

Allen, p.1 of the 2014 Outline

• Taxpayer had to recognize ordinary income from the sale of a single property.

• IRS auditors have consistently told me during audits that it was “impossible” for taxpayers to be in a trade or business if they developed only a single property – of course they were denying ordinary losses!

• An individual acquired a three-acre parcel of undeveloped land in 1987, and sold it to a developer in 1999. However, based on the taxpayer's activities with respect to the property, the court found that the sale must be reported as ordinary income.

• From 1987 to 1995, the facts indicated the taxpayer attempted to develop the property by himself. He paid for engineering plans, added a second mortgage, and solicited other investors to help develop and market the property.

72

Allen, p.1 of the 2014 Outline

• The taxpayer, an engineer, had created about 10 different sets of plans for the development as they pursued partners to complete the project.

• Although the court acknowledged that a taxpayer’s intent with respect to property held for development can change to investment, the there was no evidentiary showing in this case.

• Tibbals v US, 17 AFTR 2d 1213, Ct Cl., 1966 - Taxpayer's intent with respect to property can change from development to investment over time, observing that it is the dominant purpose during the period prior to sale which is critical.

• Cottle, 89 TC 467, 1987 - Taxpayer who engaged in only one venture or one sale has been held in the past to be conducting a trade or business with respect to that venture or sale.

73

Why is the Purpose Important? Current Enhance Locate Income Appreciation Value Buyers (Operator) (Investor) (Developer) (Dealer)

Gain Capital Capital Ordinary Ordinary

Loss Ordinary Capital Ordinary Ordinary

Interest Exp Ordinary Investment Capitalize Ordinary

Subj to PALS Yes No Yes Yes

Installment Sale

Yes

Yes

No

No

1031 Yes Yes No No

74

Current Enhance Locate Income Appreciation Value Buyers (Operator) (Investor) (Developer) (Dealer) Depreciable Yes Yes No No

NOL Yes No Yes Yes

1033 Yes Yes No No

Charitable FMV FMV Basis Basis

Gain on Sale of Ptrshp Int

Capital

Capital

Ordinary

Ordinary

754 Election Yes Yes No No

724(b) No No Yes Yes

Why is the Purpose Important?

75

Why is Purpose Held Important? Current Enhance Locate Income Appreciation Value Buyers (Operator) (Investor) (Developer) (Dealer) Elect Out Yes No Yes Yes

732(c) No No Yes Yes

Interest is PHC income

No

No

Yes

Yes

Collapsible Corporation

No-After Repeal

No

No-After Repeal

No-After Repeal

State Allocation Income

Apportion

Domicile

Apportion

Apportion

76

Frontier Custom Builders, Inc. p.12

• A custom homebuilder is subject to the §263A uniform capitalization (UNICAP) rules in the same way that a speculative homebuilder is.

• It rejected the taxpayer's argument that custom homebuilding is centered around sales and marketing, and not production-related services subject to UNICAP.

• IRS selects the simplified production method and simplified service cost method since this gives greatest capitalization and harms the taxpayer the most.

• Appeals court agrees with Tax Court and “hammers” the taxpayer (pun intended).

77

Frontier Custom Builders, Inc. p.12

• Frontier CEO's salary and annual bonus were partly allocable to production-related services and partly to non-production-related services, making his compensation subject to §263A as a mixed service cost.

• Project manager salaries are direct costs, since their labor can be identified with particular groups of homes, and therefore must be fully capitalized under §263A .

• Designers and decorators. In the absence of contemporaneous time records to show how many hours these employees spent on marketing, advertising or selling, or what portion of design services did not end up attaching to a custom home built by Frontier, designer and decorator costs had to be capitalized as indirect costs directly benefitting the production activities.

• Administrative assistant pay. In the absence of contemporaneous time records, this compensation was found to be a mixed-service cost.

• Accounting, billing, etc. Managing accounts receivable, client billings, and tax preparation are all deductible service costs; however, compensation for functions allocable to production activities, such as payroll functions, must be capitalized.

• Other expenses. The Court also applied UNICAP principles to other items such as payroll taxes, benefits, insurance, vehicle expenses, office expenses, mobile telephone expenses, office telephone expenses, tool expenses, annual retreat costs, utility expenses, and computer maintenance expenses.

78

Hawse, p. 13

• The Tax Court determined that, although the taxpayer's initial application for automatic consent to change its method of accounting was defective, its consistent use of the new method over seven years constituted a method change. Accordingly, the court rejected the taxpayer's attempt to revert back to its old method without IRS consent.

• The Tax Court has upheld IRS's denial of refunds to a car dealership that claimed them on the basis that its attempted accounting method change, to a method that it then used consistently for the next seven years, was defective due to lack of IRS consent.

• While the Court agreed with the taxpayer that the requirements for obtaining automatic consent were not satisfied, it concluded that the taxpayer nonetheless changed its method of accounting.

79

Hawse, p. 13

• Accordingly, the taxpayer's subsequent use of the prior method on amended returns constituted an accounting method change for which IRS consent was required but not received, and IRS was entitled to reject the amended returns and the refunds claimed thereon by the taxpayer.

• Having concluded that JHH did not receive automatic consent to terminate its use of LIFO for its vehicles inventory, the Tax Court then determined that JHH, by filing its 2001 through 2007 tax returns in accordance with a new method, nonetheless changed its method of accounting.

• The Court noted that §446(e) says that a taxpayer “shall “secure IRS's consent before computing taxable income under a new method-and this language, while clearly creating a legal duty to seek advance consent, does not foreclose as a factual matter any unconsented change

80

Lori M. Mingo and John M. Mingo, p.18

• The Court of Appeals for the Fifth Circuit, affirming the Tax Court, has held that an individual could not report the sale of her partnership interest as an installment sale for the portion of the proceeds attributable to the partnership's unrealized receivables.

• The year of the sale was closed, but IRS was permitted to require her to include income in the following year as an accounting method adjustment.

• Rev. Proc. 2015-13, §2.02 provides that if a practice does not permanently affect the taxpayer’s lifetime income, but does or could change the taxable year in which the income is reported, it is a method of accounting.

81


• Generally, the IRS has three years to assess additional tax due following the filing of a tax return. I.R.C. § 6501(a).

• There are exceptions explicitly set forth in the Code; for example, a false return, a willful attempt to evade tax or the failure to file a return mean there is no limitation on the power of the IRS to assess tax. I.R.C. § 6501(c)(1)-(3).

• A more limited exception exists where a return contains a substantial understatement of tax on a return, in which case there is a six year limitation period. I.R.C. § 6501(e).

• Less well-known is the ability of the IRS to assess tax for years that appear to be beyond the limitations period if an accounting change is involved.

82


• The Fifth Circuit held that the proceeds from the unrealized receivables, classified as ordinary income, did not qualify for installment method reporting because they did not arise from the sale of property.

• Therefore, the installment method did not adequately reflect the income the Mingos received from the unrealized receivables.

• Use of the installment method is mandatory unless the taxpayer elects out. Was this a bad method, or was there simply an unauthorized exclusion of income? What if the taxpayer had elected out of the installment method, but then erroneously excluded the income. After 3 or 6 years, the statute would be closed.

83

Stough, p27 • Elective one-time payment of $1 million rent made to

disregarded entity owned by sole shareholder of real estate development S corp constituted additional rental income since it was made pursuant to lease, was optional at lessee's election, was to reimburse lessor for project costs of bringing property into existence, and reduced lessee's future rents.

• Overall evidence showed that parties in fact intended payment to be rent. Evidence included that lease provision under which payment was made was entitled rent, that such provision was meant to give lessee flexibility in amount of rental payments it would be liable for in future, and that both lessee and taxpayers initially reported payment as rent, with taxpayers changing position only later/after IRS examined their return.

84

Stough, p27 • Had reported as rental income and then backed out as

“contribution to construction.” • 1099MISC showed the full $1 million, but after the audit began,

taxpayer asked the tenant to revise and exclude, which the tenant did.

• For a variety of reasons, §467 did not apply to “level” the rents. • Court held the §6662 substantial understatement penalty

applied and that the taxpayer could use reliance upon CPA as a defense.

• Unconditional reliance on a tax return preparer or CPA does not by itself constitute reasonable reliance in good faith; taxpayers must also exercise diligence and prudence.

• Taxpayer did not spend sufficient time reviewing and understanding the return.

85

North Central Rental & Leasing, p. 20

• Equipment rental and leasing business denied like kind exchange treatment on sale of used equipment that presumably was rented to customers because the new equipment was purchased from a related party –instead of from the unrelated manufacturer.

• The Court of Appeals for the Eighth Circuit has affirmed a District Court decision that a taxpayer could not avoid the §1031(f) like-kind exchange related-party rule by interposing a qualified intermediary (referred to in the case as “unnecessary parties”) into the exchange transactions.

• The Eighth Circuit found that the District Court did not err in finding that the evidence indicated the taxpayer intended to structure its transactions so as to avoid §1031(f).

86

North Central Rental & Leasing, p. 20.

• Under §1031(f), gain or loss on an exchange between related persons (under §267(b) or §707(b)(1)) must generally be recognized if either the property transferred or the property received is disposed of within two years after the exchange.

• The two-year disposition period does not apply, and hence nonrecognition is allowed, if neither the exchange nor the disposition had avoidance of federal income tax as a principal purpose. (§1031(f)(2)). – To my knowledge, there has never been a case or ruling

where this exception to nonrecognition between related parties has been permitted.

87

North Central Rental & Leasing, p. 20.

Caterpillar (manufacture and seller of equip) Daniel Butler And Family Butler Machinery Company - Caterpillar dealer North Central Rental & Leasing Cash to Butler

Accruit – qualified intermediary Third Party Purchasers - buy used equipment

88

North Central Rental & Leasing, p. 20

• Citing to Ocmulgee Fields and Teruya Bros., the Eighth Circuit found that injecting Butler and Accruit into the exchange transactions added unnecessary parties and complexity which supported the District Court's finding. – Ocmulgee Fields (CA11 2010), 106 AFTR 2d 2010-5820; – Teruya Brothers (CA9 2009), 104 AFTR 2d 2009-6274.

• Additionally, the Eighth Circuit noted that Butler obtained significant financial benefits as a result of these transactions in the form of hundreds of 6-month interest-free loans from Caterpillar.

89

Teruya Brothers Cert Denied p 10 of 2010 Outline

• Supreme court declined to review 9 CA holding. • 9th CA Court of Appeals held that taxpayer could not

avoid the like-king-exchange related-party rule by using qualified intermediary.

• Taxpayer had to recognize gain on its exchanges. • This was a prearranged transaction, but the

taxpayer thought that it could avoid §1031(f) by using a qualified intermediary.

• In Rev. Rul. 2002-83 and LTR 9748006 IRS had indicated that adding a QI did not cause §1031(f) to be inapplicable.

• 104 AFTR 2d 2009-6274

90

Ocmulgee Fields, CA 11 p. 6 of 2010 Outline

• Taxpayer could not avoid like-kind exchange related party rule by using qualified intermediary.

• Taxpayer had to recognize gain on its exchange even though it intended to effect a like-kind swap with non-related third party.

• Critical that neither related party “cashes out” their investment (if continue to hold like-kind property, gain should be deferred).

• If either ends up with cash, there will be gain recognition on both properties.

• 106 AFTR 2ds 2010-5820

91

PLR 201408019 p.88 of 2014 Outline

• The IRS approved a like-kind exchange under §1031 involving a safe harbor parking transaction in which the exchange accommodation titleholder (EAT) leased land from a person related to the taxpayer, constructed improvements on the land, and then transferred the leasehold interest and improvements to the taxpayer as replacement property in the exchange.

• PLR 201408019 is the third private letter ruling in which the IRS has approved of a safe harbor parking transaction involving improvements made to land leased by the EAT from a person related to the taxpayer. See PLR 200251008 and PLR 200329021.

92

PLR 201408019 p.88 of 2014 Outline

• This ruling is interesting because the law has long been that a taxpayer may not acquire as eligible replacement property in a like-kind exchange improvements on property the taxpayer already owns.

• See, e.g., Bloomington Coca-Cola Bottling Co. v. Commissioner, 189 F.2d 14 (7th Cir. 1951); see also Rev. Proc. 2004-51 (concluding that the Bloomington Coca-Cola principle will apply to an improvement exchange if the fee simple to the real estate on which the replacement property will be constructed had been owned by the taxpayer within 12 months of the exchange transaction).

• However, under PLR 201408019, it appears that this limitation can be avoided if the replacement property is constructed on property owned, not by the taxpayer, but by a person who is a related party to the taxpayer.

93

PLR 201408019 p.88 of 2014 Outline

• PLR 201408019 is the first private letter ruling, or guidance of any type, approving of this type of parking transaction since the publication of Rev. Proc. 2004-51 which indicated that Treasury and the IRS were studying parking transactions involving land leased from a person related to the exchanging taxpayer.

• Of significance in PLR 20148019, as in the prior two private rulings, at the time the taxpayer acquired the leasehold interest and improvements from the EAT, the leasehold had a remaining term of more than 30 years, thus allowing the property to be treated as real property of like-kind to the relinquished retail building, and the taxpayer represented that neither the taxpayer nor the Ground Lessee would dispose of their interests in the property prior to the end of the two-year period following completion of the exchange.

94

Like-Kind Exchange-Two Other Cases • Blangiardo, TC Memo 2014-110 - A taxpayer conducted a non-

simultaneous or deferred exchange, using a qualified intermediary to hold the funds from the sale of the relinquished property until acquisition of the replacement property. However, the qualified intermediary was a disqualified person (son who was a lawyer and who properly followed the rules) under the like-kind exchange regulations, and the exchange was treated as a taxable sale.

• North Central Rental & Leasing, LLC v US, 112 AFTR 2d 2013-7045 - A corporation conducting a Caterpillar heavy equipment sales business owned a subsidiary conducting an equipment leasing activity. The equipment leasing entity sold old equipment through a qualified intermediary, who purchased replacement equipment from the parent company, the heavy equipment dealership. The dealership held the cash, in some cases up to six months, before remitting to the manufacturer for the purchase of the heavy equipment. The court found that the dealership's unrestricted use of the cash for several months was a violation of the related party rule anti-abuse rule and required gain recognition on the exchange transactions

95

Reesink p.166 of 2014 Outline • Although a married couple ultimately used the replacement

property in a like-kind exchange as their personal residence, they had investment intent with respect to that property at the time that they acquired it and thus qualified for nonrecognition treatment under §1031.

• Owned multiple properties with mortgages and had gotten into financial trouble.

• Testified credibly they had not planned on the situation. • Tried to rent the property and showed it to potential renters. • Waited almost eight months before moving in. • This case is not a bright line but rather illustrates that investment

or business status of the replacement property is based on the taxpayer’s intent at the time of the exchange.

• Showed had requisite intent to rent and due to unforeseen circumstances had to move in

96

Pilgrim’s Pride, p. 21

• The Court of Appeals for the Fifth Circuit, reversing the Tax Court, has held that a corporation's loss from its abandonment of securities was an ordinary loss, rather than a capital loss.

• The Court concluded that §1234A(1) only applies to the termination of contractual or derivative rights, and not to the abandonment of capital assets.

• The Tax Court held the company was not entitled to claim an ordinary abandonment loss deduction in the amount of the purchase price reasoning that the surrendered securities were subject to §1234A, which required the resulting loss to be treated as from the sale of a capital asset and thus subject to §165(f). (Pilgrim's Pride Corporation, (2013) 141 TC No. 17)

97

Pilgrim’s Pride Corp. p. 21

• The Fifth Circuit concluded that neither §1234A(1) nor §165(g) required Pilgrim's Pride to treat its abandonment loss as a capital loss.

• After March 12, 2008, the definition of a worthless security for purposes of capital loss treatment under §165(g)(1) includes a security that has been abandoned, and otherwise meets the requirements for a deductible loss.

• To abandon a security, a taxpayer must permanently surrender and relinquish all rights in the security and receive no consideration in exchange for the security including no relief of liabilities.

• Unless the security is that of an affiliated corporation, the loss from the abandonment of securities is treated as a loss from the sale or exchange of a capital asset [§1.165-5(i)].

98

Pilgrim’s Pride Corp. p. 21

• Although the abandonment of securities no longer provides the same benefit of an ordinary loss deduction as a result of §1.165-5(i), the Fifth Circuit opinion does limit the application of §1234A in similar cases where the abandoned asset is not securities but some other capital asset that does not fit within the securities definition.

• Thus, partnership interests or real estate interests could be abandoned and ordinary losses claimed provided there is no relief of liabilities. – There is no de minimis amount of liability relief that is

permissible. Even $1 of liabilities with cause the disposition to be treated as a sale rather than as an abandonment.

99

SI Boo, LLC, p. 23

• Several related partnerships whose primary business was buying real property tax liens to earn income from the penalty paid by the owners when the liens were redeemed, but that sometimes took possession of the underlying real property if the liens were not redeemed, held such property for sale to customers in the ordinary course of their trades or businesses.

• As a result, the partnerships had ordinary income from the sale of the properties and could not use the installment method for those sales, and the partners had self-employment income from the sales.

100

Stine, p.26

• A district court has ruled against IRS's argument that §1.167(a)-11(e)(1)(i), which defines when property is “first placed in service, “requires, in the case of a building housing a retail store, that the store be open for business in order that the building be considered placed in service.

• Taxpayer built two new retail stores. As of December 31, 2008, both stores had been issued certificates of occupancy which allowed them to receive equipment, shelving, racks and merchandise as well as the appropriate personnel to install and or stock the equipment, shelving, racks and merchandise.

• On December 31, 2008, the stores were not open for business, and the certificates of occupancy did not allow customers to enter the buildings.

101

Stine, p.26 • §1.167(a)-10(b) provides that the depreciation period for an

asset begins when the asset, in this case, a building, is “placed in service. “

• §1.167(a)-11(e)(1)(i) provides that “[p]roperty is first placed in service when first placed in a condition or state of readiness and availability for a specifically assigned function.... In the case of a building which is intended to house machinery and equipment and which is constructed...for the taxpayer's use, the building will ordinarily be placed in service on the date such construction...is substantially complete and the building is in a condition or state of readiness and availability. Thus, for example, in the case of a factory building, such readiness and availability shall be determined without regard to whether the machinery or equipment which the building houses, or is intended to house, has been placed in service. “

102

Stine, p.26

• IRS's position was that, because the two buildings were not open for business, the taxpayer did not place them in service during calendar year 2008.

• In its opinion, the court noted the Brown decision and discounted that decision because of the lack of credible testimony by the taxpayer regarding the business travel that occurred near the end of the year.

103

Brown p. 6 of the 2014 Outline

• Tax Court holds that $22 million aircraft that was delivered and used for two separate business trips was not placed in service because it had to be modified for a conference table and a larger video display screen.

• Although the IRS and court agreed the plane argued the plane "was fully functional for air transportation." The IRS and the court agreed with this. However, the court, following the regulations, held that that is only one part of the definition to be "placed in service". The property has to be ready and available "for a specifically assigned function" [Reg. 1.167(a)-11(e)(1)(i)].

• The court concluded that based upon the taxpayer's own representations that the conference table and enhanced screen were necessary for the plane to meet his needs, the plane was not placed in service until these modifications were completed, which was in 2004.

104

Brown p.6 of the 2014 Outline

• The court noted that three elements are necessary to prove property is placed in service: Readiness, availability, and capability to perform the intended function. It is not necessary that the taxpayer actually use the asset.

105

Rev. Rul. 2015-11 p.33

• Capitalized costs of unrecoverable precious metals that are used in various manufacturing processes are depreciable under §167 and §168, but capitalized cost of any recoverable precious metal are not depreciable.

• The determination of whether metals, that are used up or whose purity declines as part of the process of manufacturing a product, are subject to depreciation, is based on an examination of the specific facts relating to the metals' use in a taxpayer's trade or business and whether the asset has a determinable estimated useful life.

• This ruling is a change in direction for the IRS in based on recent court decisions requiring analysis of specific facts surrounding asset's use in taxpayer's trade or business when determining whether and extent to which asset is depreciable.

106

Rev. Rul. 2015-11 p.33

• In Situation 2, approximately 10% of the platinum is lost over the course of its expected useful life and is not recoverable for reuse. Accordingly, approximately 10% of the platinum will undergo exhaustion, wear and tear, or obsolescence over a determinable useful life.

• To the extent that the platinum will be lost and is not recoverable for reuse, B may depreciate the capitalized cost of such platinum under §167 and §168.

• To the extent that any of the platinum is recoverable for reuse (i.e., approximately 90% of the total amount), B may not depreciate the capitalized cost of such platinum.

107

Rev. Proc. 2015-13 p.37

• IRS updates and revises the procedures under which a taxpayer may obtain automatic consent for a change in an accounting method. – Updates and replaces Rev. Proc. 2011-14

• Issued contemporaneously with Rev. Proc. 2015-14 which contains a list of automatic changes to which the automatic change procedures apply. – This list was the APPENDIX in Rev. Proc. 2011-14. Now it is

included in a separate Rev. Proc. • Additionally, the new Revenue Procedure modifies the general

procedures for obtaining IRS's advance consent to change to an accounting method (nonautomatic consent).

108

Rev. Proc. 2015-13 p.37

• § 7.03(3)(b) modifies the §481(a) adjustment period for taxpayers under examination with positive §481(a) adjustments. – In that case, the §481(a) adjustment period is two tax years,

unless the Form 3115 is filed in a three-month or 120-day window, the present method is not before the director, or the applicant is a new member of a consolidated group in CAP. (§ 18.01(11))

• § 7.03(3)(c) modifies the de minimis election for a one-year adjustment period for a positive §481(a) adjustment to make it available for a positive §481(a) adjustment that is less than $50,000. (§ 18.91(12))

109

Rev. Proc. 2015-13 p.37

• § 7.03(3)(d) provides an optional election for a one-year adjustment period for a positive §481(a) adjustment for taxpayers with an eligible acquisition transaction.

• § 6.03(4)(b) provides that a taxpayer is not eligible to make a late election except in unusual and compelling circumstances. (§ 18.01(13)).

• § 8.02(1)(c), § 8.02(1)(e), and § 8.02(1)(f), modify the rules for when a taxpayer under examination filing a Form 3115 may receive audit protection outside of a window period. – These rules replace the previous requirement that the

taxpayer acquire the director's statement consenting to the filing of the Form 3115 prior to filing the Form 3115.

110

Rev. Proc. 2015-13 p.37

• §12.02(2) clarifies the rules for a §481(a) adjustment to provide that if the director makes a correction to the amount of the §481(a) adjustment, ordinarily the director will take the entire amount of the correction into account for the earliest tax year in the §481(a) adjustment period that is under examination, regardless of whether the statute of limitations on the assessment of tax under §6501 has not expired for one or more taxable years in the adjustment period. (§18.01(21)).

• §13.01(1)(b), modifies the rules for revising the year of change to provide that, if a taxpayer files its Form 3115 on or before the last day of the sixth month of the year of change, it may submit a written request to revise the year of change on or after, but not before, the first day of the tax year following the original year of change. (§18.03(3))

111

Often Misunderstood Points • A cumulative accounting method change is NOT limited by the

statute of limitations; essentially, the taxpayer must go back to the time when the method being changed was first used and work forward

• Accounting method changes have different requirements and terms; the adjustments may be based on a cumulative adjustment, cutoff basis, or a modified cutoff basis

• Form 3115 should be filed with the IRS as soon as it is complete; do not wait until the taxpayer files the annual tax return to mail the Form 3115 to the IRS national office

112

Rev. Proc. 2015-33 p. 44

• The IRS has granted certain fiscal year taxpayers extended time to file Forms 3115 in consideration of the timing of the release of the final tangible property regulations. In addition, the IRS has made clarifying updates to earlier guidance on procedures for obtaining automatic consent for changes in accounting methods.

• Specifically, the revenue procedure modifies §15.02(1) of Rev. Proc. 2015-13 to allow a taxpayer to request an automatic change under the procedures of either former Rev. Proc. 2011-14 or current Rev. Proc. 2015-13 for a tax year ending on or after May 31, 2014, and beginning before January 1, 2015. – The transition relief provided in Rev. Proc. 2015-33 applies to

all automatic method changes, not just changes pursuant to the final tangible property regulations.

113

Rev. Proc. 2015-33 p. 44

• §§5.01(1)(c) and 5.02 provide that a taxpayer engaging in a liquidation or reorganization transaction to which §381(a) applies may not use the automatic change procedures to request a change to a principal method, as prescribed by §1.381(c)(4)-1(d)(1) and §1.381(c)(5)-1(d)(1), because, in general, an acquiring corporation does not need to secure the IRS's consent to use a principal method.

• The rules inadvertently excluded from the automatic change procedures certain changes other than a change to a principal method. Accordingly, Rev. Proc. 2015-33 modifies Rev. Proc. 2015-13 to exclude from the automatic change procedures only a change to the principle method, as described in §1.381(c)(4)-1(c)(1) and §1.381(c)(5)-1(c)(1).

114

Rev. Proc. 2015-33 p. 44

• §8.02(1)(a)(ii) of Rev. Proc. 2015-13 provides that a "three-month window" is the period beginning on the fifteenth day of the seventh month of the taxpayer's tax year and ending on the fifteenth day of the tenth month of the taxpayer's tax year. Because the rule is not expressed with reference to the first or last day of a specified calendar month, it is unclear how this provision applies to a taxpayer using a 52-53 week tax year.

• Accordingly, Rev. Proc. 2015-33 modifies Rev. Proc. 2015-13 to provide that, for determining the "three-month window," the tax year begins on the first day of the calendar month nearest to the first day of the 52-53 week tax year.

• The Ogden Utah mailing address for Forms 3115 is updated.

115

Rev. Proc. 2015-20, p.42

• Special procedures allow small businesses (under $10 million of assets or $10 million or less of gross receipts) to more easily adopt the tangible property Regulations that were issued in 2013.

• These procedures generally involve limiting the changes in accounting needed to adopt the Regulations to amounts paid or incurred, and dispositions, in tax years beginning on or after January 1, 2014.

• A small business taxpayer choosing the option of calculating a §481(a) adjustment that takes into account only amounts paid or incurred, and dispositions, in tax years beginning on or after January 1, 2014, does not receive audit protection under Rev. Proc. 2015-13, § 8.01 (or any successor) for tax years beginning prior to January 1, 2014.

116

Rev. Proc. 2015-20, p.42

• If a small business taxpayer chooses to make a §481(a) adjustment that does not take into account partial dispositions in tax years beginning before January 1, 2014, then the taxpayer must consistently apply this treatment to all dispositions (other than dispositions of assets in general asset accounts) covered by §§6.37−6.39 of Rev. Proc. 2015-14.

• In addition, the taxpayer also must choose to make a §481(a) adjustment that does not take into account amounts paid or incurred in tax years beginning before January 1, 2014, for any change made under §10.11(3)(a) of Rev. Proc. 2015-14.

117

At-a-Glance Summary Improvements Depreciation and

Dispositions Materials and Supplies Acquisitions

§1.263(a)-3 §1.168(i)-1,-8 (Proposed) §1.162-3 §1.263(a)-2

Refined UOP definition – functional interdependence – with special UOP rules for:

General Asset Accounts (GAA): • Establish GAAs with assets of

similar depreciation methods

Definition of M&S: • UOP ≤ $200 • Consumed in 12 months or

fewer • Replacement parts

De minimis safe harbor • Annual election to follow book

expense policy • Written policy must be in place

at BOY

• Buildings • Plant property • Leased property • Network assets

• Qualifying dispositions do not include partial dispositions (structural components of a building)

• Fuel, lubricants, etc. • Other M&S as identified in IRS

guidance

• If AFS then $5,000 per invoice or item

• If no AFS then $500 per invoice or item

Improvement defined: • Betterment • Adaption (to new or different

use) • Restoration

Dispositions: • General rules • Optional annual election to

recognize partial dispositions (structural components of a building)

• Reasonable valuation methods

Three categories: • Incidental (no record of

consumption or supply) when acquired

• Nonincidental (including emergency spare parts) when consumed

• Rotable and temporary spare parts when disposed

Facilitative costs for acquisition of property must be capitalized • 11 inherently facilitative costs • Must capitalize inherently

facilitative costs and recover as §165 loss or through cost recovery

Safe harbor for routine maintenance • Building >1 in 10 years • Non-building > 1 over class life • Annual election to follow book by

capitalizing repairs

Considerations: • Coordination of dispositions with

IRS examinations of repairs

Limited annual irrevocable elections (limited to rotable, temporary and emergency spare parts) If elect de minimis safe harbor then must apply to all eligible materials and supplies (other than rotable, temporary, and emergency spare parts subject to the election to capitalize)

Safe harbor annual election to capitalize either or both: • Employee compensation • Overhead

The regulations will affect all taxpayers with tangible property and will require accounting method changes effective for tax years beginning on or after January 1, 2014. 117

118

What Constitutes an “Improvement”?

Betterment? Restoration? New or Different

• Corrects preexisting material condition or defect

• Results in material addition or a material increase in capacity

• Materially increases the productivity, efficiency, strength, quality, or output of the UOP

• Replaces a component for which loss (other than casualty loss) is claimed

• Replaces a component for which gain/loss was recognized

• Restores UOP for damages for which (and to the extent) a casualty loss was claimed

• Returns UOP to ordinarily efficient operating condition if property deteriorated to a state of disrepair and no longer functional for intended use

• Rebuilt UOP to “like-new” condition at end of class life

• Replaces major component or substantial structural part of UOP

• Adapts UOP to a new or different use not consistent with the taxpayer’s ordinary use of the UOP at the time originally placed in service

Yes No No Yes Yes No

Capitalize Capitalize Capitalize

Potentially deductible subject to capitalization under 263A

Treasury refuses to provide quantitative bright lines; highly subjective

§1.263(a)-3(j) 23 examples §1.263(a)-3(k) 31 examples §1.263(a)-3(i) 7 examples

Summary of Conclusions From the §1.263(a)-3(j)(3) 23 Betterment Examples

Not a Betterment • Replacement of asbestos insulation

with similar non-asbestos insulation (Ex. 2)

• Minor repairs and maintenance shortly after purchase (Ex. 3 and 4)

• Retail refresh limited to cosmetic and layout changes (Ex. 6 and 7)

• Relocate cash registers (Ex. 9) • Add concrete lining to meat plant (Ex.

12)

Betterment • Remediation of soil by previous

owner (Ex. 1) • Bring assisted living building up to

higher standards (Ex. 5) • Retail refresh along with increased

storage, second loading dock (Ex. 7) • Major remodel of retail (Ex. 8) • Relocate machines increased

capacity (Ex. 10)

119

Summary of Conclusions From the §1.263(a)-3(j)(3) 23 Betterment Examples

Not a Betterment • Roof membrane (Ex. 13) • Removal of drop ceiling (Ex. 18) • Replace 2 of 10 HVAC units that are

10% more efficient (Ex. 20)

Betterment • Doubling depth of channel (Ex. 15) • 25% increase in depth of channel

(Ex. 17) • 50% reduction in energy or power

costs (Ex. 21) • Add restaurant drive-thru

120

Summary of Conclusions From the §1.263(a)-3(k)(7) 31 Restoration Examples

Not a Restoration • Replace power switch (Ex. 13) • Roof membrane (Ex. 15) • Replace 1 of 3 furnaces in HVAC

system (Ex. 16) • Replace of 3 of 10 roof-mounted

HVAC units (Ex. 18) • Replace 30% of electrical (Ex. 21)

Restoration • Replace entire roof (Ex. 14) • Replace single chiller in HVAC (Ex. 17) • Replace of sprinkler system (Ex. 19) • Replace entire electrical system (Ex.

20) • Replace all toilets and sinks with similar

quality and function (Ex. 22)

121

Summary of Conclusions From the §1.263(a)-3(k)(7) 31 Restoration Examples

Not a Restoration • Replace 8 of 20 sinks (Ex. 23) • Replace 100 of 300 exterior windows

comprising 8.3% surface area (Ex. 25) • Replace lobby floors that comprise <

10% square footage (Ex. 28) • Replace 1 of 4 elevators (Ex. 30)

Restoration • Replace 200 of 300 exterior windows

comprising 16.67% surface (Ex. 26) • Replace 100 of 300 exterior windows

comprising 30% of surface area (Ex. 27)

• Replace floors in all public areas comprising 40% of square footage (Ex. 29)

• Replace 1 of 4 elevators and claim partial disposition loss (Ex. 31)

122

Summary of Conclusions From §1.263(a)-3(l)(3) 7 Change-in-Use Examples

Not a Change in Use • Combine 3 leased retail spaces

into 1 leased retail space (Ex. 2) • Minor refresh of building in

anticipation of sale (Ex. 3) • Clean-up contamination after

closing manufacturing plant (Ex. 4) • Convert a portion of grocery store

space to a sushi bar (Ex. 6) • Convert a portion of hospital

emergency room to an outpatient surgery center (Ex. 7)

Change in Use • Convert manufacturing plant to

showroom space (Ex. 1) • Regrade land to accommodate sale of

land for residential development (Ex. 4)

• Reconfigure part of a retail pharmacy to a walk-in clinic (Ex. 5)

123

124

Critical Changes

• Change #184 – Correct repairs and maintenance, adopt safe harbor maintenance, and/or change UOP for building

• Changes #186 and #187 – Material and supplies • Change #192 – Acquisition costs • Change #7 – Correct depreciation methods and lives • Change #21 – Deduct removal costs • Change #196 – Late partial disposition election

125

New Elections

• De minimis safe harbor (statement required); §1.263(a)-1(f). Also, be sure that taxpayer has written policy in place treating as an expense for nontax purposes: (1) amounts paid for property costing less than a specified dollar amount; and (2) amounts paid for property with an economic useful life of 12 months or less

• Capitalize and depreciate rotable, temporary, or emergency spare parts (election made by capitalizing the amount paid and beginning to recover costs through depreciation),§1.162-3(d)

• Capitalize all repair and maintenance costs for both book and tax purposes (statement required); §1.263(a)-3(n)

126

New Elections

• Safe harbor for small taxpayers (statement required); §1.263(a)-3(h)(6)

• Partial disposition (election made by reporting the gain, loss, or other deduction on timely filed (including extensions) original federal tax return), 1.168(i)-8(d)(2)(i)

127

Rev. Proc. 2015-39 p.46 • Safe harbor that allows accrual method recipients of services to

treat economic performance as occurring ratably with respect to contracts under which the services are provided on a regular basis.

• Under the safe harbor, a taxpayer can ratably expense the cost of regular and routine services as the services are provided under the contract.

• The safe harbor is a welcome simplification for taxpayers that have eligible contracts and that, in the past, may have had difficulty attempting to apply the 3 ½ month rule and recurring item exception.

• IRS also provides procedures for obtaining IRS's automatic consent to change to this accounting method.

• The Revenue Procedure is effective for tax years ending on or after July 30, 2015.

128

Rev. Proc. 2015-39 p.46

• Under §1.461-1(a)(2)(i), a liability is generally incurred and taken into account under an accrual accounting method in the tax year in which: (1) all the events have occurred that establish the fact of the

liability; (2) the amount of the liability can be determined with

reasonable accuracy (these first two items are collectively referred to as the all events test); and

(3) economic performance has occurred with respect to the liability under §461(h).

• Exceptions are the 3 ½ month rule and the recurring item exception

129

Rev. Proc. 2015-39 p.46

• Under the 3 ½ month rule, a taxpayer is allowed to treat services or property as provided to the taxpayer (i.e., as constituting economic performance) as the taxpayer makes payment to the person providing the services or property if the taxpayer can reasonably expect the person to provide the services or property within 3 ½ months after the date of payment. (§1.461-4(d)(6)(ii))

130

Rev. Proc. 2015-39 p.46 • Under the §461(h)(3) recurring item exception to the general

rule of economic performance, a liability is treated as incurred for a tax year if: (1) at the end of the tax year, all events have occurred that establish the fact

of the liability and the amount can be determined with reasonable accuracy;

(2) economic performance occurs on or before the earlier of (i) the date that the taxpayer files a return (including extensions) for the tax year, or (ii) the 15th day of the ninth calendar month after the close of the tax year (8 ½ months after year end) ;

(3) the liability is recurring in nature; and (4) either the amount of the liability is not material, or accrual of the liability

in the tax year results in better matching of the liability against the income to which it relates than would result from accrual of the liability in the tax year in which economic performance occurs. (§1.461-5(b)(1))

131

Rev. Proc. 2015-39 p.46

• Ratable Service Contract if: (1) the contract provides for similar services to be provided on a regular

basis, such as daily, weekly, or monthly; (2) each occurrence of the service provides independent value, such that

the benefits of receiving each occurrence of the service is not dependent on the receipt of any previous or subsequent occurrence of the service, and;

(3) the term of the contract does not exceed 12 months (contract renewal provisions will not be considered in determining whether a contract exceeds 12 months). If a single contract includes services that satisfy the requirements of this §and services (or other items) that do not satisfy the requirements of this section, the services (or other items) that do not satisfy the requirements of this §must be separately priced in the contract for the contract to qualify as a Ratable Service Contract.

132

Rev. Proc. 2015-39 p.46

• Janitor service, $3,000 per month for 2016; paid $3,000 for first month (January) in December; permitted to deduct $3,000 in 2015.

• Landscape $4,000 per month for 2016; paid $48,000 for full year in December; permitted to deduct $34,000 which is 8 ½ * $48,000.

• $100,000 paid on November 30, 2015, $400,000 the following November when the study is complete. $500,000 deduction permitted for 2015.

133

PLR 201447004, p.53

• Participation payments made by a parts designer and manufacturer to a product's manufacturer do not have to be capitalized as amounts paid to acquire or create intangibles.

• The participation payments took the form of contributions to the manufacturer's development and marketing costs.

• Taxpayers are required to capitalize payments made to create a separate and distinct intangible asset or other future benefit, to create or acquire an intangible asset, and to facilitate the creation or acquisition of an intangible asset.

• The ruling illustrates how complex it can be to determine if the intangibles Regulations apply to payments made under manufacturing agreements.

134

PLR 201447004, p.53 • There was no creation of a separate intangible asset because

there was nothing the taxpayer could sell. If the agreement had been established as a forward purchase or similar option contract, there might have been a different result.

• There was no capitalizable asset because the taxpayer did not receive any rights to guaranteed sales or a fixed purchase price from the manufacturer. An amount paid to another party with the mere hope of continuing or maintaining a business relationship is not a capitalizable intangible asset.

• IRS regulations do not require capitalization of an exclusivity agreement related to the sale of tangible property. An agreement providing a taxpayer the right to use tangible or intangible property (such as a lease) or an agreement providing the taxpayer the right to provide or receive services, however, would be capitalizable.

135

PLR 201510027, p.61.

• Taxpayer was granted an extension of time to make an election to use a slower depreciation method.

• The tax preparer inadvertently failed to include the §168(g)(7) ADS election in the federal income tax return.

• When he noticed the failure to make the election soon after the timely filing of Taxpayer's federal income tax return, the tax preparer advised Taxpayer to remedy the missed election by filing a request with IRS for an extension of time to make the election to use ADS depreciation.

• This is an expensive “mistake” in that there is a $9,800 user fee for this ruling and it will probably take a minimum of 16 hours to properly complete the ruling request and associated checklist.

136

PLR 201518012 p.66

• A termination fee paid to end a nonexclusive management services agreement that facilitated an acquisition and reorganization did not have to be capitalized under §263.

• The termination fee, which was triggered by an initial public offering (IPO) of a company that had been revitalized as a result of the efforts of the management services provider, did not create a new intangible asset.

• The fee also did not facilitate the IPO and was not a condition in order to proceed with the IPO.

• Although Taxpayer's obligation to pay the termination fee was in part dependent on whether or not a public offering occurred, the fee was not paid to facilitate the IPO.

137

PLR 201518012 p.66

• Under Regulations §1.263(a)-4(d)(7)(i), a taxpayer must capitalize amounts paid to another party to terminate the following agreements: 1. a lease of real or tangible personal property between the

taxpayer (as lessor) and that party (as lessee); 2. an agreement that grants that party the exclusive right to

acquire or use the taxpayer's property or services or to conduct the taxpayer's business; or

3. an agreement that prohibits the taxpayer from competing with that party or from acquiring property or services from a competitor of that party.

138

PLR 201518012 p.66

• IRS Considerations 1. Services did not facilitate the IPO; 2. Payment was akin to additional compensation for past

services; 3. Payment not contingent on successful IPO; 4. MSA was in place before IPO, although unclear how far in

advance; and 5. Payment recorded as an expense.

139

Legal Advice 20133101F p.71 of 2013 Outline

• A taxpayer was not entitled to an abandonment loss deduction for various costs of a proposed stock offering.

• Although the reorganization plan that included the stock offering was terminated, the facts showed that the stock offering was not actually abandoned because the taxpayer had intended to complete it at a later date as part of a separate plan.

• If a taxpayer considers two (or more) mutually exclusive alternatives in pursuing a single transaction, then no abandonment loss is proper unless the entire transaction is abandoned.

140

PLR 201531009 p. 69

• Taxpayer's exchange of certain manufacturing and/or distribution rights with respect to a given group of products, for other manufacturing and/or distribution rights with respect to that same group of products, was a like-kind exchange with no recognition of gain or loss.

• While it is not uncommon for an exchange of the agreements discussed in this ruling to qualify for §1031 treatment, it is interesting that the Service did not address whether any goodwill was transferred in the exchange.

• To the extent a portion of the value transferred related to goodwill, such portion would not qualify for non-recognition treatment under §1031.

• Goodwill or going concern value of one business can never be like kind to that of another business.

141

PLR 201531009 p. 69

• This is a favorable ruling for taxpayers looking to exchange rights related to manufacturing and distribution and shows a willingness on the part of the Service to consider the historical business relationship of the assets.

• Taxpayers planning to engage in similar exchanges of intangible rights should carefully consider the possibility of the any residual goodwill being a component of the transaction (in addition to the general requirements of §1031), as this would have a negative effect on the ability to obtain non-recognition treatment on gain realized in the potential transaction.

142

PLR 201536006 p.70

• Amounts paid to protect against patent infringement were deductible as ordinary and necessary business expenses under §162.

• The payments arose out of a dispute over whether a competitor infringed on a patent and whether the patent was properly issued, not over the ownership of the patent.

• Deductibility of legal expenses is always a tricky issue for tax purposes. In this situation the litigation involved a potential infringement on a patent, with a key issue being whether the legal fees incurred represented a capitalizable payment in defense of title to the patent or an ordinary and necessary business expense arising from a dispute over whether there had been an infringement on the patent.

143

CCA 201451028 p.72

• Schools, exempts, and non-profits can allocate the newly extended §179D energy efficient commercial building deduction to a designer of energy efficient commercial building property only if they are governmental entities.

• All other entities are ineligible to make the allocation. • Tax-exempt entities and non-profit organizations (such as

charities, churches, and hospitals) cannot allocate the §179D deduction to the designer if they are not governmental entities.

144

CCA 201501010 p.72

• Taxpayer that produced print media in which its customers advertised could treat the costs of certain merchandise that it provided the customers as part of its services to them, as an adjustment to cost of goods sold.

• Generally, when payments are made by vendors to retailers as an inducement to purchase merchandise, the payments do not constitute separate items of gross income but instead are an adjustment to the cost or price of the merchandise purchased (purchase price adjustment). (Affiliated Foods, Inc., (2007) 128 TC 62)

145

CCA 201501010 p.72

• The test for whether a payment, credit, allowance or rebate is a purchase price adjustment is what the parties intend and for what purpose the payment, credit, allowance, or rebate was paid.

• If the purpose was to adjust the price of the item between the parties, then the consideration given, regardless of the time or manner of the adjustment, is a purchase price adjustment and is not a separate item of gross income.

• On the other hand, if an allowance is contingent upon performance of services by the purchaser (e.g., retailer), the allowance is not a trade or other discount and would be a separate item of gross income under §61.(Pittsburgh Milk, (1956) 26 TC 707)

146

CCA 201501010 p.72

• In Rev. Rul. 2005-28, 2005-1 CB 997, IRS held that Medicaid rebates incurred by a pharmaceutical company were purchase price adjustments that were subtracted from gross receipts in determining gross income.

• Whether a rebate was payable in merchandise or in cash also did not matter. (Max Sabel Wholesale Liquors, 69 TC 477)

147

CCA 201509029 p. 82

• Truck dealer’s service buildings not motor fuels outlet and thus had to use 39 rather than 15 year recovery period.

• Buildings that a taxpayer leased to a business engaged primarily in the sale, service, and leasing of trucks and trailers were neither retail motor fuels outlets under §168(e)(3)(E)(iii) nor includible in Asset Class 57.1, Distributive Trades and Services -- Billboard, Service Station Buildings, and Petroleum Marketing Land Improvements), and thus were nonresidential real property with a 39-year recovery period, for depreciation purposes.

• Had the property qualified as a retail motor fuels outlet, its depreciable life would have been 15 years instead of 39 years and could use 150% declining balance instead of straight line depreciation.

148

CCA 201521012 p. 84

• If a practice does not permanently affect the taxpayer’s lifetime income, but does or could change the taxable year in which the income is reported, it is a method of accounting.

• Where an adjustment would otherwise constitute an accounting method change, the fact that the adjustment permanently increases a partnership's basis in its property by changing the adjustment required by §734(b) does not create a change in “lifetime taxable income.” Accordingly, the adjustment is still an accounting method change.

149

CCA 201531016 p. 88 • A business legally selling marijuana under state law can treat the

payment of state excise taxes on the production, processing, or retail sale of the product as a reduction in the amount realized on the sale. As a result, the tax was not subject to the deduction bar under §280E.

• The Senate Report that accompanied the 1982 legislation that enacted §280E provided that “to preclude possible challenges on constitutional grounds, the adjustment to gross receipts with respect to effective costs of goods sold is not affected by this provision of the bill. “(S Rept No. 97-494)

150

CCA 201531016 p. 88 • The Supreme Court has held that the Sixteenth Amendment,

which authorized the income tax, precludes taxing the return of capital. (Doyle v. Mitchell Bros Co, (S Ct 1918) 3 AFTR 2979)

• Californians Helping to Alleviate Medical Problems, 128 TC 173 (2007) the COGS of the taxpayer are not disallowed under §280E.

• In Olive, (CA 9 7/09/2015) 116 AFTR 2d 2015-5150, the Court of Appeals for the Ninth Circuit, affirming the Tax Court, has held that a taxpayer was precluded under §280E from deducting expenses related to his legal medical marijuana dispensary business.

151

CCA 201531016 p. 88

• Beck, TC Memo 2015-149 taxpayers denied COGS deduction for seized marijuana since it was not “sold” so how could it be a cost of goods sold!

• CCA 201504011, taxpayer may not use §263A to increase COGS to increase amount deductible. Must use the inventory-costing regulations under §471 as existed when §280E was enacted.

• SBSE-04-0615-0045, dated 6/9/15 provides the IRS will not impose the failure to deposit penalty if a taxpayer can show reasonable efforts to obtain a bank account, but was unsuccessful.

152

Legal Advice 20153501F p.95

• A taxpayer could not deduct partially worthless debts because it failed to charge off the amounts on its books during the tax year.

• A deduction is allowed for partially worthless debts (§166(a)(2)) only if: 1. the debt is a business debt 2. IRS is satisfied that the specific debt is recoverable only in

part; 3. the amount deducted was charged off on the books during

the tax year; and 4. the debt is not evidenced by a security. (§166(d)(1) ,

§166(e) , Regulation §1.166-3(a)(2))

153


• A taxpayer may charge-off and deduct a debt for partial worthlessness as the worthlessness occurs.

• Alternative a taxpayer can defer the charge-off and deduction to a later year when partial worthlessness is greater, thus deducting several years' partial worthlessness in one year.

• Finally, a taxpayer can defer deduction until total worthlessness (but not beyond the year of total worthlessness). (Regulation §1.166-3(b))

154


• In International Proprietaries Inc., (1952) 18 TC 133, the Tax Court held that the taxpayer was not entitled to a partial bad debt deduction, finding that its bookkeeping entries did not comply with the statutory requirement that there be a charge-off.

• In Brandtjen & Kluge Inc., (1960) 34 TC 416, the Tax Court held that the taxpayer was entitled to a partial bad debt deduction, finding that there was an acceptable charge-off.

• On its books, the taxpayer increased its account entitled "Reserve for Doubtful Notes and Accounts" (which reduced its assets) and debited "bad debts" (which reduced its net income).

155


• IRS concluded that the taxpayer was not entitled to partial bad debt deductions for the tax years at issue because the amounts were not charged-off during the tax years in accordance with §166(a)(2) and Regulation §1.166-3(a)(2).

• IRS held that the taxpayer's case was controlled by International Proprietaries, not Brandtjen.

• An increase in a general reserve account did not constitute the required charge off; the taxpayer's intent to abandon the charged-off portion of the debt had to be reflected in its books and records.

156


• The cost of services that a taxpayer incurred on behalf of a joint venture in which it was a participant, was a capital contribution to the joint venture and a deductible expense of the joint venture.

• Taxpayer was a corporation that was a participant in a joint venture. Its employees performed services on behalf of the joint venture.

• IRS concluded that the expenses for the services provided to the joint venture should be treated as a contribution of capital to the joint venture by the taxpayer, accompanied by a constructive payment of the expenses by the joint venture for which it was entitled to a deduction.

157


• In Eskimo Pie Corporation., (1945) 4 TC 669, the court said that payments made by a stockholder of a corporation for the purpose of protecting his interest therein must be regarded as additional cost of his stock and such sums may not be deducted as ordinary and necessary expenses

• Rev. Rul. 84-68, 1984-1 CB 31, holds that a parent corporation may not deduct as a business expense under §162 the cash bonuses that it pays to employees of its wholly owned subsidiary. Instead, the payment is treated as a contribution to the subsidiary's capital accompanied by a constructive payment by the subsidiary of the cash bonuses to its employees for which the subsidiary is entitled to a deduction.

• LAFA 20132801F – Former corporate parent could not deduct business expenses of ex-subsidiary.

158


• TAM 9330001 –IRS ruled that, assuming automobile and club expenses are trade or business expenses that meet the requirements of §§162(a) and 274, the partner may deduct them from gross income under §62(a)(1). – cited Cropland, 75 T.C. 288 (1980), and other Tax Court

cases, as well as Rev. Rul. 70-253, 1970-1 C.B. 31, for the proposition that if under the partnership agreement or practice the partner is required to pay certain partnership expenses out of his own funds, then the partner is entitled to a §162 deduction for the amount of those expenses.

• TAM 9330004-Same ruling for partner in CPA firm.

159


• TAM 9316003 - If the partnership would honor a request for reimbursement, the expense is not deductible.

• McLauchlan, TC Memo 2011-289 - If the partnership would honor a request for reimbursement, the expense is not deductible.

• While the “requirement” that the partner incur the expense without right of reimbursement need not be in writing, it is a question of fact, and may be the subject of IRS dispute. As a consequence, the partners will benefit by making this requirement explicit.

160

LAFA 20150701F, p. 358

• Guidance as to whether certain amounts that were paid by one joint venturer, that he believed were covered by the joint venture agreement but for which his fellow joint venturers refused to reimburse him, were deductible under various Code provisions, including as ordinary and necessary business expenses or as bad debts.

161

INDIVIDUALS AND TRUSTS

162

Al-Soufi, p.104

• Taxpayer, a dual Syrian and U.S citizen who claimed that relevant documentation was destroyed in the civil conflict in Syria, failed to prove that he met the requirements for deducting qualified residence interest on a 2nd home in Syria.

• Al-Soufi testified that he was the obligor on the mortgage note but that his sister actually made the mortgage payments.

• He created his own amortization schedule showing $73,619 of mortgage interest, which he used in preparing the 2010 tax return.

• The couple was unable to provide the Tax Court with proper documentation, such as a certificate of title to the property, a copy of the mortgage note or a loan amortization schedule.

• During the trial, Al-Soufi stated that HARN Mortgage was out of business.

163

Conservation Easements • Generally, a charitable contribution deduction is not allowed for

a contribution of a partial interest in property that is less than the entire interest of the taxpayer in the property.

• An exception exists for a charitable contribution of a qualified conservation easement which is a contribution of a qualified real property interest exclusively for conservation purposes. – For a contribution to be deemed exclusively for a

conservation purpose, the charitable easement must be protected in perpetuity.

– Any interest in the property retained by the donor must be subject to legally enforceable restrictions that prevent uses of the retained interest inconsistent with the conservation objective of the donation.

164

Balsam Mountain Investments, LLC, p.106

• Taxpayer was not entitled to claim a charitable contribution deduction for a conservation easement because it failed to qualify as a “qualified real property interest “under §170(h)(2)(C).

• Taxpayer reserved the right to make minor alternations of boundary lines to a 22 acre tract of property in Jackson County, NC.

• The donated interest was not one in an identifiable, specific piece of real property because the taxpayer reserved the right to make boundary changes.

165


• In Belk, (2013) 140 TC No., the Tax Court held that a taxpayer was not entitled to claim a charitable deduction for a conservation easement because a provision in the grant allowed a substitution of the donated property.

• The Court found that this was inconsistent with Regulations §1.170A-14(b)(2)'s requirement that the conservation purpose be protected in perpetuity.

166


• Relying on its decision in Belk, the Tax Court held that the taxpayer's easement was not a “qualified real property interest “under §170(h)(2)(C).

• The Court reasoned that a conservation easement cannot qualify as such if the easement agreement allows the grantor to change what property is subject to the easement. This is because an interest in real property is a qualified real property interest only if it is an interest in an identifiable, specific piece of real property.

• Since the easement granted by Balsam Investments allowed it to change the boundaries of the Conservation Area, it was not an interest in an identifiable, specific piece of real property.

167

Belk, 114 AFTR 2d 2014-5537 • Fourth Circuit Court of Appeals agreed with Tax Court that a

taxpayer was not entitled to claim a charitable deduction for a conservation easement because a provision in the grant allowing a substitution of the donated property was inconsistent with Regulation § 1.170A-14(b)(2)'s requirement that the conservation purpose be protected in perpetuity.

• The agreement between the taxpayer and the tax-exempt trust to which the easement was made allowed the parties to change the property subject to the easement. It allowed for the substitution of land owned by the taxpayer contiguous to the conservation area for an equal or lesser area of land comprising a portion of the conservation area.

• This easement was made to the Southeast Regional Land Conservancy on 410 acres.

168

Belk, 114 AFTR 2d 2014-5537 • The 4th CA also refused to give effect to a savings clause in the

easement deed that prohibited the Land Trust from agreeing to any amendment (including an amendment to substitute the underlying land) if the amendment would cause the easement to fail to qualify as a charitable donation under §170(h).

• This decision will have far-reaching implications for taxpayers considering donation of conservation easements, and also for tax planners who use savings clauses in various contexts to protect the anticipated tax treatment of agreements.

169

Belk, 114 AFTR 2d 2014-5537 • Notably, the 4th CA limited the holdings of Simmons and

Kaufman, two Court of Appeals decisions holding that an easement deed meets the perpetuity requirements of the Code, even if it gives the donee the right to abandon the easement altogether.

• The 4th CA reasoned that Simmons and Kaufman concerned only perpetual protection of the conservation purpose (§170(h)(5)(A)) and did not address perpetuity of the use restrictions (§ 170(h)(2)(C).

• Under Simmons and Kaufman, a deduction did not fail merely because the land trust could choose not to enforce the easement. But under the Fourth Circuit's decision in Belk, a deduction fails if the landowner and land trust can agree to relocate the easement to other property.

170

Belk, 114 AFTR 2d 2014-5537 • The second notable aspect of the Belk opinion is the discussion

of savings clauses. • The Fourth Circuit previously rejected certain savings clauses

that were triggered by “conditions subsequent” that nullify a transaction if there is an adverse determination by a Court or the IRS.

• However, the savings clause in Belk prohibited the Land Trust prospectively from agreeing to any amendment that would cause the easement to fail to qualify for a charitable deduction under I.R.C. § 170. If the tax law developed such that a particular amendment would negate the deduction, the Land Trust was prohibited from agreeing to it.

171

Belk, 114 AFTR 2d 2014-5537 • The Fourth Circuit disagreed with the Belks' claim that the

clause was “interpretive,” serving to guide the Land Trust concerning types of amendments that were appropriate.

• Instead, the Fourth Circuit found that no interpretive assistance was needed where the deed included a provision such as the Substitution Provision that, in its view, was so evidently inconsistent with I.R.C. § 170(h)(2)(C).

• The Fourth Circuit disregarded the fact that an adverse decision was not necessary for the savings clause to be operative, saying this was a “distinction without a difference.”

• The Court found that the easement deed plainly permitted substitutions, and concluded that the only time the savings clause would be invoked to prohibit offending substitutions would be following an adverse determination by the IRS or a Court.

172

Belk, 114 AFTR 2d 2014-5537 • The Court apparently did not consider to be sufficient the Land

Trust's exercise of its judgment not to amend. In this context, the Fourth Circuit opinion can be viewed as broadening the types of savings clauses that will be deemed void for tax purposes.

173

Kiva Dunes, TC Memo 2009-145 • Tax Court valued conservation easement on golf course at

approximately $28.7 million, which was less than taxpayer's $31.9 million claim, but well above IRS's $10 million estimate.

• This case involved a syndicated partnership where partnership interest were sold prior to the eventual donation of an easement.

174

Reisner and Weintraub p.163

• The Tax Court found that a married couple was liable for a gross valuation misstatement penalty with respect to a charitable contribution of an easement that was ultimately found to be worthless.

• The contribution was made in 2004, and they claimed carryover deductions to 2005 and 2006.

• While they could use the reasonable cause defense to escape the penalty for 2004 and 2005, a 2006 law change precluded them from using it for that year because the law change applied to returns filed after July 25, 2006.

• Argument that applying statute to their return for year at issue amounted to retroactive imposition of penalty on conduct that occurred before statute's enactment was rejected.

175

Reisner and Weintraub p.163 • Prior to the enactment of Pension Protection Act of 2006, Pub. L.

No. 109-280, 120 Stat. 780 (“PPA”), taxpayers could assert a reasonable cause defense under §6664(c)(1) to the imposition of a gross valuation misstatement penalty under if they could show that the claimed value of the property was based on a qualified appraisal by a qualified appraiser and the taxpayer made a good-faith investigation of the value of the property.

• For returns filed after July 25, 2006, the PPA eliminated the reasonable cause exception in its entirety for underpayment attributable to gross valuation misstatement of charitable deduction property.

• If the overvaluation is substantial but not a gross misstatement, the taxpayers can still assert a reasonable cause defense (150% overvaluation instead of 200% ). See §6662(e)(1)(A))).

176

Reisner and Weintraub p.163

• The Tax Court further held that the imposition of the penalty was not retroactive as the taxpayers claimed. Citing to Chandler 142 T.C. No. 16 (May 14, 2014), the Tax Court said that the taxpayers “reaffirmed” their gross valuation overstatement when they filed the 2006 tax return after the enactment of PPA. – Taxpayers do not have to take advantage of carryover

deductions when filing a return; it is a choice. – The Tax Court stated that the taxpayers could have chosen not

to claim the carryover deduction for 2006 in view of the change in the law. Their choice to claim the carryover deduction caused the imposition of the penalty.

177

Bosque Canyon Ranch p.109

• A limited partnership was not entitled to claim a charitable contribution deduction for a conservation easement because it failed to qualify as a “qualified real property interest “under §170(h)(2)(C).

• Taxpayer was liable for the gross valuation misstatement penalty for both years under §§ 6662(e)(1)(A) and 6662(h).

• The restrictions on the use of the property were not granted in perpetuity as a result of the taxpayer's right to modify the boundary lines of the donated interest.

• In the alternative, the court determined that the taxpayer failed to satisfy § 1.170A-14(g)(5)(i), which provides that the donor must make available to the donee, before making the donation, sufficient documentation (known as “baseline documentation”) to establish the property’s condition at the time of the gift.

178


• This case also involved the distribution of 5 acre homesite that were considered “outparcels” fully exempt from the conservation easement as opposed to “Reserved Right Homesites” remain subject to the easement and its restrictions

• While seeming to acknowledge that the taxpayer's documentation fell within the general categories of documentation that the regulations say “may” be provided to satisfy the baseline documentation requirement, the Court concluded that the requirement was not met because the untimely documentation was “insufficient to establish the condition of the property prior to the dates of the transfers,” as required under § 1.170A-14(g)(5)(i). – The Bosque ruling will cause land trusts and taxpayers to rethink the

baseline documentation process and pay more attention to obtaining maps, descriptions, photographs, analyses, and signatures contemporaneously with the grant of an easement.

179


• Although the Bosque decision can be viewed as a logical extension of Belk, IRS now is attempting to extend Belk even further to invalidate traditional Reserved Right Homesites.

• Moreover, the IRS is now trying to extend Belk to attack traditional “amendment” clauses that merely allow the parties to the easement to amend it by mutual consent.

• Ironically, IRS has previously approved Reserved Right Homesites in PLR 200403044 and 9603018 as well as in §170A – 14(f) (Ex.4).

• Moreover, a model easement deed suggested by the Land Trust Alliance (and contained on its website) contains the same amendment clause the IRS now argues is impermissible under Belk. – Most states permit amendment of easement deeds by mutual consent,

even if the deed is silent.

180


• This is the first time a court has applied the gross valuation misstatement penalty in an instance where the value of the charitable contribution was never addressed.

• The Bosque opinion departs from the Tax Court's prior rulings that a valuation misstatement penalty would not apply in instances where a charitable contribution deduction was denied on technical grounds. See, e.g., Derby, TC Memo 2008-45 (“Because there is a separate, independent ground for disallowing those deductions, the overvaluation penalty may not be imposed.”).

• The Bosque penalty holding will have drastic consequences. Bosque apparently applies the strict liability, 40% penalty to every charitable contribution of property in which a deduction is disallowed, even if only on technical grounds. – The gross valuation misstatement penalty would apply even if all parties

recognize and stipulate that the value of the donated property was exactly what was claimed on the taxpayer's return. Furthermore, the normal “reasonable cause” relief would not apply; in effect imposing strict liability. I.R.C. § 6664(c)(3).

181

Costello p. 115 • A taxpayer could not take a charitable deduction with respect to

a land preservation easement that he granted to a county government as a condition for being able to sell development rights pertaining to that land.

• The Court found a lack of donative intent and also that the taxpayer failed to satisfy applicable reporting requirements.

• Taxpayers sold the development right to a developer, but then needed to convey an easement to Howard county to sever the development rights and prohibit all future development on the property.

• Original appraisal was defective and original Form 8283 was not signed.

• Taxpayers obtained amended appraisal and got the Form 8283 signed and amended their return to take a smaller deduction.

182

Costello p. 115. • Finding that neither the appraisal nor the Form 8283 met the

relevant requirements and that the easement was not made with donative intent, IRS fully disallowed the Costellos' charitable deduction.

• As the Tax Court mentions in its opinion, a qualified appraisal must be made by the due date of the first return on which the deduction for the property contributed is claimed. – However, if the deduction is first claimed on an amended

return, that date is changed to the filing date of the amended return.

– Thus, if a taxpayer has failed to obtain an appraisal by the due date, the chance for a deduction for a charitable contribution can be preserved by first claiming the deduction for the contribution on an amended return.

183

Kaufman v. Commissioner p. 139

• The Court of Appeals for the First Circuit, affirming the Tax Court, has held that taxpayers were liable for the substantial valuation misstatement penalty for an underpayment caused by a deduction for the charitable contribution of an easement.

• The donation of the façade preservation easement that taxpayers granted to an exempt organization had no value because the façade was already subject to similar restrictions as a result of the property being in an historic district.

• Despite the appearances of significant victories in the circuit courts with respect to technical, legal arguments by the IRS, including the recent decision of the First Circuit in Kaufman, the Tax Court has settled on a valuation analysis that has rewarded the victors with zero-value holdings and substantial (and automatic) penalties.

184

Kaufman v. Commissioner p. 139 • Kaufman I and II Tax Court agrees with IRS that provisions that

are standard practice with respect to a mortgage holder result in denial of charitable deduction based on strict technical reading of regulations.

– Consistent with standard practice, the Kaufmans asked their mortgage holder to subordinate its mortgage to the easement.

– Consistent with standard practice, the separate agreement with the mortgage holder reserved its rights to condemnation and insurance proceeds from a judicial extinguishment of the easement.

• The IRS claimed this reservation violated an obscure provision in the regulations, Reg. 1.170A-14(g)(6)(ii) .

• The Tax Court agreed, holding that the easement holder must have an ‘absolute right’ to the condemnation and insurance proceeds.

185

Kaufman v. Commissioner p. 139 • In Kaufman III, the First Circuit disagreed and reversed the Tax

Court, respecting the traditional rights of the mortgage holder to such proceeds

• In Kaufman IV, the IRS won the case at the end of the day. On remand, the Tax Court agreed with the IRS that the easement had no value because it duplicated local government restrictions on the property’s facade. The Tax Court imposed 40% penalties to boot.

• Could not rely upon valuation to avoid penalties.

186

Minnick, p. 153

• The Court of Appeals for the Ninth Circuit, affirming the Tax Court, has upheld IRS's disallowance of a qualified conservation contribution deduction for property subject to a mortgage, where the taxpayers did not have a subordination agreement from the bank in place on the date of the gift. – Easement contribution occurred in 2006 and the bank

subordination was not completed until 2011. • In Mitchell, (2012) 138 TC 324, aff’d (CA 10 2015) 116 AFTR 2d

2015-346, the Tax Court and the Tenth Circuit upheld IRS's disallowance of a qualified conservation contribution deduction where the taxpayer failed to have a subordination agreement in place on the date of the gift.

187

Mitchell p. 154

• The Court of Appeals for the Tenth Circuit, affirming the Tax Court, has upheld IRS's disallowance of a qualified conservation contribution deduction in respect to property subject to a mortgage, where the mortgagee's rights were not subordinated to those of the donee organization on the date of the gift.

• In so holding, the Court rejected the taxpayer's argument that Regulations §1.170A-14(g)(3) 's “so remote as to be negligible “standard can relieve a donor from having to meet the subordination requirement in Regulations §1.170A-14(g)(2). – The taxpayer did not subordinate the debt to the

conservation easement until two years later.

188

Scheidelman II p. 253 of 2014 Outline

• Second decision on this case by 2nd Circuit where it was remanded to Tax Court. This decision agrees with the Tax Court.

• Taxpayer was not entitled to a charitable deduction for a façade easement because the easement was not more restrictive than existing local requirements already on the property.

• In the remand, the Tax Court found the appraisals obtained by the taxpayer were flawed and merited no evidentiary weight. The court instead relied on the experts for the IRS, who determined that the value of the property before and after the donation had not changed. Local restrictions on the property were substantially similar to those imposed in the conservation easement.

• In affirming the Tax Court's decision, the Circuit Court emphasized the importance of the "before and after" valuation of the property, looking at the difference in the property value with and without the easement.

189

61 York Acquisition LLC p. 269 of 2014 Outline

• A partnership's contribution of a façade easement to a qualified organization did not qualify for a charitable deduction because the easement did not preserve the entire exterior of the building.

• Ownership of the property was divided into two parts: the "office property," which consisted of the first 14 floors of the property, and the "residential property," which consisted of residential condominium units on the top 6 floors of the property.

• Partnership owned the office property but entered into an agreement with the owner of the other 6 floors that authorized the donor to make a conservation easement of the property.

• Court ruled because could not put easement on all floors, not “qualified real property interest.”

190

77 Sherman Street p. 260 of 2014 Outline

• The Tax Court disallowed the deduction for a conservation easement because the donor failed to value a zoning variance recommendation received in exchange for the easement.

• Because the value of the variance was not determined, the donor could not prove the value of the easement given exceeded the value of the benefit received

• When a taxpayer grants a conservation easement as part of a quid pro quo transaction and fails to identify or value all of the consideration received in the transaction, the taxpayer is not entitled to any charitable contribution deduction with respect to the grant of the conservation easement because he has failed to comply with Regulation § 1.170A-1(h)(1).

191

Gorra p. 192 of 2014 Outline

• The Tax Court rejected all objections raised by the IRS to the contribution deduction for a historic preservation conservation easement on couple’s townhouse.

• However, the court concluded that both expert witnesses made material errors in their valuation reports and determined its own value for the donation, adjusting the taxpayer's donation from $600,000 to about $104,000.

• The taxpayers hired a qualified appraiser, had their tax return prepared by a CPA, and complied with all aspects of the law.

• Nevertheless they were subject to the 40% gross valuation misstatement penalty. The penalty applies to a 200% overstatement of a valuation and has no reasonable cause exception.

192

Chandler p. 165 of 2014 Outline

• Preservation easement that taxpayers granted had no value because the façade was already subject to similar restrictions as a result of the property being in an historic district. – NAT case - Boston

• Accordingly, no charitable contribution deduction was allowed. • The court found the report contained numerous errors and was

not credible.

193

Esgar Corporation p. 184 of 2014 Outline

• Appeals Court agrees property's current use was its highest and best use, and accordingly there was no value to the conservation easement.

• The court noted that while highest and best use can be any realistic, objective potential use of the property, it is presumed to be the use to which the land is currently being put absent proof to the contrary.

• The court agreed with the IRS that if the asserted highest and best use differs from the current use, the use must be reasonably probable and have real market value.

• The court stated the conversion to gravel pit usage was not practical in the reasonably foreseeable future.

194

Mountanos p. 234 of 2014 Outline

• Taxpayer was not entitled to a carryover of a claimed charitable contribution deduction because he failed to show that a conservation easement had any value.

• In what the Court characterized as a calculated maneuver to avoid a 40% gross valuation misstatement penalty, the taxpayer had asked the Court to address alternative grounds raised by IRS (that would not have resulted in such a high penalty) in disallowing the deductions.

• He failed to show that, before the easement, either residential development and vineyard use or subdivision and vineyard use were the highest and best use of Blue Lakes Ranch.

• He failed to show that vineyard use was a legally permissible, physically possible, or economically feasible use of Blue Lakes Ranch.

195


• Access to the property required a right-of-way easement over Federal land, and the Land Management Bureau had granted only a restricted single-family use easement.

• Mountanos also failed to show that water from sources on the property, other than the Black Oak Springs (for which he did not have a permit), was sufficient to support vineyard use.

• He failed to show that it was likely that either a more expansive access easement or a water permit would be granted.

• In addition, he failed to introduce persuasive evidence (i.e., objective data and analysis) showing demand for 287 acres of vineyard-suitable property.

196


• The Tax Court found that Mountanos was liable for the gross valuation misstatement penalty for the underpayments for the years at issue.

• While a taxpayer generally is not liable for an accuracy-related penalty if he acted with reasonable cause and in good faith with respect to any portion of the underpayment, §6664(c)(3) provides that the reasonable cause exception does not apply in the case of a gross valuation overstatement with respect to property for which a charitable contribution deduction was claimed under §170.

197

Palmer Ranch Holdings Ltd. p. 245 of 2014 Outline

• In a rare win for the taxpayer involving conservation easements, the Tax Court ruled there was a reasonable probability that property on which the taxpayer had contributed a conservation easement could have been successfully rezoned.

• The Court found that the potential for neighborhood opposition did not bar the reasonable probability of a successful rezoning.

• The court held the rezoning defeat was no longer determinative. The vote had been held more than two years prior, the closeness of the vote and recent rezoning approvals in nearby developments all indicated the property had a good chance to get rezoned.

198

Palmer Ranch Holdings Ltd. p. 245 of 2014 Outline

• However, the court adjusted the valuation of the donor's expert for certain erroneous assumptions, reducing the claimed $24 million donation by $4 million.

• Even when a taxpayer has the more reasonable valuation, as in this matter, it is common for courts to apply their own analysis to determine a value between that of the taxpayer and the IRS.

199

Schmidt p. 255 of 2014 Outline

• Easement donated on land that a taxpayer intended to develop and subdivide, but on which he ultimately constructed a single personal residence, was worth about $500,000 less than reported by the taxpayer but about $1 million more than asserted by IRS.

• The Court disagreed with aspects of the valuation methodology employed by both parties' experts and provided a detailed and thorough account of the "proper" application of the discounted cash flow method.

200

Wachter p. 280 of 2014 Outline

• State law which limits the term of an easement to 99 years precludes real property easements from being granted in perpetuity.

• As a result, summary judgment was awarded to the IRS.

• However, the Court denied IRS summary judgment on whether the taxpayers were entitled to claim charitable deductions for related cash contributions.

• Under North Dakota law, there is a 99-year maximum term for easements.

201

Whitehouse p. 287 of 2014 Outline

• Tax Court methods of valuing a conservation easement and determination of amount were approved by the 5th Circuit.

• Rejected the reproduction cost method because reproducing the historical façade after complete destruction would make no business sense.

• Rejected the income method because the evidence upon which the appraisers income calculations were based was found unreliable.

• Rejected non-local comparable sales method since there were not enough local comparable sales.

• Overturned the valuation misstatement penalty. Obtaining a qualified appraisal, analyzing that appraisal, commissioning another appraisal, and submitting a professionally-prepared tax return is sufficient to show a good faith investigation as required by law.

202

IR 2014-31 p. 332 of 2014 Outline

• Settlement between its Office of Professional Responsibility (OPR) and a group of appraisers that has been accused of aiding in the understatement of federal tax liabilities by overvaluing facade easements for charitable donation purposes.

• The news release specifically states that, in valuing the façade easements, the appraisers applied a flat percentage diminution (generally 15%) to the fair market values of the underlying properties prior to the easement's donation.

• The Tax Court had previously held that percentage-based appraisals were not qualified appraisals, but was subsequently reversed by the Second Circuit.

203

IR 2014-31 p. 332 of 2014 Outline

• Although the validity of these types of appraisals is uncertain in other circuits, this news release makes IRS's disfavor clear.

• IRS announced that OPR had reached a settlement under which certain appraisers admitted to violating §’s10.22(a)(1) and (2) of Circular 230 (failing to exercise due diligence in the preparation of documents relating to IRS matters, and failing to determine the correctness of written representations made to the Treasury Department, respectively) and agreed to a 5-year suspension from valuing façade easements and "undertaking any appraisal services that could subject them to penalties" under the Code.

204

IRS Lost the Battles, but Won the War

• Simmons, TCM 2009-208 the Tax Court and the DC Circuit had found that a 5% reduction in value was appropriate and declined to impose penalties. IRS lost attempt to establish a per se zero value.

• Kaufman III, IRS lost its attempt in the 1st CA to use longstanding language in mortgage documents to disallow the charitable contribution. throw of against taxpayers in Kaufman III in the First Circuit.

• Scheidelman II (2nd CA) and Kaufman III, IRS lost its attempt to bootstrap deficiencies in valuation analysis into a default under the qualified appraisal requirements.

• Scheidelman II and Kaufman II, lost its attempt to deny charitable deductions for standard cash contributions made to tax-exempt organizations for monitoring and administration.

205

IRS Lost the Battles, but Won the War

• Kaufman III and Simmons (DC Circuit) IRS lost its attempt to turn standard ‘consent’ provisions in easement documents into a violation of the perpetuity and conservation purposes requirements.

• With the Service’s legal arguments held to be unsound, the current state of the facade easement litigation is focused on valuation.

• Reliance on a ‘safe harbor’ diminution value and the Primoli article is out. In order to prevail, taxpayers must engage appraisers who can advance credible differences between the easement restrictions and local government restrictions.

206

IRS Lost the Battles, but Won the War • The Tax Court’s most recent opinion in Chandler, 142 TC No 16

(2014) signals a possible reversal of its position in Simmons. • Judge Joseph Goeke, who authored Simmons, declined to

engage in that same type of analysis and, referring to the analysis in Kaufman IV, stated: ‘We see no reason to break with that result here.’ – The Tax Court may have reached the limit of its patience with all the

litigation in the facade easement area. • The Tax Court in Kaufman IV signaled that taxpayers will be held

to a higher standard of due diligence in investigating the value of their facade easements and that their relative personal sophistication will be taken into account in evaluating reasonable cause. This was not the case in some of the earlier facade easement cases, in which penalties were not imposed.

207

IRS Lost the Battles, but Won the War • The PPA has made effectively automatic the 40% penalty—i.e.,

taxpayers must substantially prevail on their valuation and slide under the 200% threshold for a gross valuation misstatement if they are to escape these penalties. – And then they must still defend against 20% substantial understatement

and negligence penalties, which may be difficult after Kaufman IV.

208

Charitable Contributions • No deduction is allowed for any contribution of $250

or more unless the taxpayer has a contemporaneous written acknowledgement from the charity indicating the amount of the contribution or a description of the property contributed.

• The acknowledgement must be in hand by the date of the filing of the tax return.

• The acknowledgement must state whether the charity provided any goods or services in consideration for the contribution.

209

Charitable Contributions • Both the “contemporaneous” (i.e., earlier of the date of

filing the tax return or the due date, including extensions) requirement and the “any goods or services in consideration” requirement are statutory. – $250 or more

• Taxpayers need to understand that there is no leeway regarding either of these requirements and failure to obtain a proper receipt results in loss of the deduction. Gomez, TC Summary 2008-93.

• Taxpayers who contribute property, other than publicly-traded securities, valued at more than $5,000 during the taxable year must obtain a qualified written appraisal.

210

Critical - Noncash Contributions • You must obsess about securing a proper written acknowledgement,

and for property contributions, and ensuring that there is a qualified appraisal completed by a qualified appraiser.

• Additionally, it is vitally important to completely report the contribution on Form 8283.

• The IRS will scrutinize the transaction (they call it “nitpick”) to find the slightest reason to toss the deduction because it does not meet the onerous paperwork requirements of the regulations.

• Got through the appraisal “line-by-line” and eliminate anything that does not conform exactly to the regulations.

• Critically important the appraisal is a “qualified appraisal” and the appraiser is a “qualified appraiser.”

• See §1.170A-15, §1.170A-16, and §1.170A-17.

211

Kunkel p.141

• Taxpayer’s claimed deduction of $37,315 for clothing, books, and various household items donated to four charitable organization disallowed because he failed the charitable contribution substantiation tests.

• In addition, the taxpayer was liable for a §6662 accuracy-related penalty.

• The Tax Court found that Kunkel did not meet the substantiation requirements with respect to any of the contributions and therefore disallowed the entire charitable contribution deduction in dispute.

• He testified he intentionally made all contributions in batches less than $250. This means he would have had to make at least 150 separate contributions!

212

Kunkel p.141

• In addition to meeting the general substantiation requirements under §170(f)(8) for any contribution, Kunkel would have to satisfy the additional requirements in §170(f)(11)(B) (for gifts exceeding $500) for all seven categories of gifts. – Written records on cost basis and FMV

• In addition, for the two categories with alleged values exceeding $5,000 (clothing and books), he would have to meet the rigorous substantiation requirements imposed by §170(f)(11)(C). – Furnish a qualified appraisal signed under penalties of

perjury with his return. • Also failed to present credible evidence that these items were

“in good used condition or better.

213

Legaspi, TC Summary 2015-14

• Noncash contributions to Goodwill lacked a statement from Goodwill saying no goods or services were given to donor in receipt for the noncash contributions.

• The Court seems to imply that something more than simply a list of articles given by the taxpayer is required to document the donation and the Court was certainly critical of the taxpayer valuing the property on his own, virtually suggesting that the lack of an appraisal was a problem with the contribution.

• Tax Court noted the basic unfairness of these rules that Congress wrote into the law in the case of Durden v. Commissioner, TC Memo 2012-140, where the lack of those magic words (no goods or services were provided in exchange for the contribution) on a charitable contribution receipt obtained before the return was filed caused the taxpayer to lose a contribution of over $20,000.

214

Zavadil v. IRS, p. 177

• Affirming the Tax Court, the Eighth Circuit has ruled that the chief executive officer (CEO) of a company could not claim charitable contributions made by his company.

• The contributions were made using a ledger account and a circular flow of funds and the CEO could not prove what part, if any, of the disputed charitable contributions were paid with his own funds and not funds advanced by his company.

• The CEO would reimburse the corporation for amounts in his personal account at the end of each month. However, during the last six months of the last year at issue, the CEO never paid off the entire amount of funds advanced from the corporation, and instead had the corporation repay his monthly advances. There were no notes evidencing the amounts advanced from the corporation

215

Zavadil v. IRS, p. 177

• The court refused to acknowledge the advances as a bona fide liability of the CEO since he introduced no evidence to validate the indebtedness, such as a note payable.

• Various amounts over $250 were disallowed by the court due to missing acknowledgements.

216

Prop. Regs. §1.170A-13 p. 179

• On September 16, 2015, Proposed Regulations were issued under§ 170(f)(8)(D) that would create a new, separate form that a charity would need to complete and file - in the absence of contemporaneous written acknowledgment of a donor's gift - in order for a donor to receive a deduction.

• The proposed regulations, which would add new §1.170A-13(f)(18), implement the exception under § 170(f)(8)(D) to the ‘contemporaneous written acknowledgement’ requirement for substantiating charitable contribution deductions of $250 or more. The donee reporting under the proposed regulations would be optional on the part of any donee, including small entities.”

217

Kalapodis p. 212 of 2014 Outline

• Taxpayers, husband and wife, were not entitled to a charitable contribution deduction for scholarship payments made by a trust that they established as a scholarship fund and which they funded with the proceeds of life insurance on their late son.

• Cannot benefit an individual-must be paid to a charity.

218

Smith, p. 267 of 2014 Outline

• Even though the Tax Court had no doubt that the taxpayer donated property to a charitable organization, none of the taxpayer’s contributions were deductible because he failed the charitable contribution substantiation tests.

• Received blank signed forms and later filled them out. • Maintained no photographs or records of donated

items; used values higher than the high value on Salvation Army website

• No qualified appraisals.

219

Koriakos p. 217 of 2014 Outline

• Married couple’s cancellation of indebtedness income (CODI) on home equity line of credit (on Arizona home) did not qualify for a CODI exclusion because the money was used to purchase a different home in Florida.

• Alternative argument that COD excludible under §121 also did not work.

• Taxpayer claimed $2,000 of deductions for noncash contributions to Salvation Army but said all receipts shredded when moved to Florida

• Although Court believed they made the donations, they could not use the Cohan rule to support the deductions. The forms were not filled out completely and the shredding was not beyond their control.

220

Boneparte p. 107

• Taxpayer was not a professional gambler even though he gambled regularly, did not maintain a permanent residence, and generally stayed in Atlantic City, New Jersey casino hotels.

• Boneparte did not maintain complete and accurate records of his gambling activity. He testified that he kept only a running total in his head.

• The handwritten records he provided were not kept contemporaneously but rather were created while his return was being audited.

• He did not testify that he spent any time honing or adjusting his system or attempting to improve his profitability by adopting new methods.

221

Clark p. 113

• The fact that a financial institution creditor turned over a debt to a collection agency after the expiration of the non-payment period described in Regulation §1.6050P-1(b)(2)(i)(H) was insufficient to overcome a rebuttable presumption in the Regulations that the debt had already been discharged.

• There is a rebuttable presumption that an identifiable event under Regulation §1.6050P-1(b)(2)(i)(H) has occurred during a calendar year if a creditor has not received a payment on a debt at any time during a testing period ending at the close of the year.

• The testing period is generally a 36-month period. (Regulation §1.6050P-1(b)(2)(iv))

222

Clark p. 113. • The presumption that an identifiable event has occurred can be

rebutted by the creditor if the creditor or a third-party collection agency acting on its behalf has engaged in significant bona fide collection activity at any time during the 12-month period ending at the close of the calendar year, or if facts and circumstances existing as of January 31 of the calendar year following the expiration of the 36-month period indicate that the indebtedness has not been discharged.

• Proposed Regulations, which would apply on the date they are published in the Federal Register as Final Regulations, would remove the Regulation §1.6050P-1(b)(2)(i)(H) rule that a deemed discharge of indebtedness occurs at the expiration of a 36-month non-payment testing period and, accordingly, would remove Regulation §1.6050P-1(b)(2)(iv) .

223

Copeland p.114

• A cash-basis taxpayer could not currently deduct unpaid residence interest that was capitalized into mortgage principal as part of a loan modification.

• It rejected the taxpayer's argument that the loan arrangement was the economic equivalent of having taken out another mortgage and used the proceeds to pay off principal and past-due interest, pointing out that cash-basis taxpayers may only deduct otherwise allowable interest paid in cash or its equivalent.

• The Tax Court reached a similar conclusion last year in Smoker, TC Memo 2013-56, which involved a variable rate mortgage note where interest in excess of a stated amount was capitalized (added) into the note principal.

224

Cutler p.121

• State nonresident income taxes paid by a lawyer on his law firm's income sourced in four states cannot be deducted on Form 1040, Schedule E and are not deductible in arriving at adjusted gross income (AGI).

• These taxes may only be claimed below-the-line as itemized deductions.

225

DeBough p.122

• Affirming the Tax Court, the Eighth Circuit has ruled that a taxpayer who sold his principal residence and excluded gain under §121, then reacquired it after the buyers defaulted, had to recognize long-term capital gain on the reacquisition including amounts previously excluded under §121.

• The special exception in §1038(e) did not apply because the taxpayer did not resell the home within one year after the repossession.

• Thus, the taxpayer was subject to the general gain recognition rules of §1038 .

226

Greenberger v. U.S., p. 127 • A district court has held that a taxpayer could not claim a theft

loss deduction for exchange-listed stock that became worthless due to the “pump and dump “fraud of company executives.

• The district court also rejected the taxpayer's judicial estoppel claim.

• Greenberger was attempting to bypass the capital loss limitation rules that restrict losses to the extent of capital gains plus (if the losses exceed the gains) the lower of: (1) $3,000 ($1, 500 in the case of married individuals filing separate returns), or (2) the excess of the losses over the gains.

• By contrast, a theft loss is not subject to these limitations and may be deducted against ordinary income, subject to limits under §165.

227

Haff, p.132

• The Tax Court has concluded that an individual was not entitled to a theft loss deduction for amounts that a partnership, that was alleged to be a Ponzi scheme, owed him for fees for his services in the development, sales, marketing, and construction of condominiums and townhouses.

• The taxpayer, who had not included the amount in income, nevertheless maintained that a deduction was authorized under Rev. Proc. 2009-20, which provides safe harbors to Ponzi scheme victims in measuring their losses.

• Cannot get a deduction for losses associated with income you have not reported.

228

MIDCO Transactions • Midco transactions generally involve a sale of a corporation's

stock to a specially designated corporation (an “intermediary corporation” or, more commonly, “Midco”) and a sale of the target assets to a different person or entity.

• The effect of the transaction is to separate the stock sale from the purchase of the target assets, and the intent is to try to provide the selling shareholders with capital gains treatment with respect to the sale of their shares, and the buyer of the target business with a step-up in the basis of the assets, without the significant corporate-level tax that would otherwise have been imposed if the target had completed the transaction as an asset sale and if the cash proceeds had been distributed to the target shareholders.

229

MIDCO Transactions • Generally, following the stock sale, the target corporation is

included as a member of the affiliated group that includes Midco, which in turn files a consolidated return, and the affiliated group reports losses (or credits) to offset the gain (or tax) resulting from the sale of the target corporation's assets.

• In another version, Midco may be an entity that is not subject to tax, and Midco liquidates the target corporation without tax.

• In any event, Midco itself is likely to be relatively immune from significant tax exposure, in many cases because it is a corporate shell or is otherwise without significant corporate cash to satisfy claims in the case of a subsequent tax audit.

230

MIDCO Transferee Liability

• See Midco Litigation, Transferee Liability, and Civil Fraud Penalties, Robert W. Wood, 2015 TNT 107-10 (6/1/15).

• Because the liability is derivative, the IRS must first calculate the tax to the taxpayer. Only then can the agency turn its collection efforts toward the transferee. Plus, the burden of proof is on the IRS rather than the taxpayer to establish the technical requirements for transferee liability under section 6901.

• To determine transferee liability, the IRS must resort to state law or the Federal Debt Collection Act and meet the requirements there.

231

MIDCO Transferee Liability

• Although the Fourth Circuit in Starnes v. Commissioner, No. 11-1636 (4th CA 5/31/12) declined to impose transferee liability on former shareholders of a company sold through a purported intermediary tax shelter, issues created by the IRS's efforts to use federal substance-over-form principles to recast so-called Midco transactions as generating state law transferee liability could open the door to other creditors attempting to do the same.

232

Jacoby, p. 133

• That a taxpayer who entered into a “Midco transaction “to convert ordinary income into capital gain income, and who took deductions based on a questionable tax-favored investment product, significantly understated his tax liability but had none of the badges of civil fraud.

• This decision resulted because of a failure of proof on the part of the IRS. Fraud requires a heavy evidentiary burden.

• In conducting its fraud analysis, the court found that Jacoby lacked tax expertise which was surprising given his position and his legal background. The court noted that Jacoby did not specialize in tax law in law school nor did he have an LLM in taxation.

233

Jacoby, p. 133 • In Starnes, 109 AFTR 2d 2012-2326 no transferee liability based

on insufficiency of and burden of proof. • In Feldman, TC Memo 2011-297 Tax Court found transferee

liability in Wisconsin. • Frank Sawyer Trust, T.C. Memo. 2011-298 no transferee liability

based on insufficiency of and burden of proof. • Griffin, T.C. Memo. TC Memo 2011-61 no transferee liability

because after the transaction with MidCoast, the target corporation retained substantial assets and was not thereby rendered insolvent. Additionally, the taxpayer filed a lawsuit and obtained a State court judgment against MidCoast in an effort to get the taxes paid.

• In Starnes, Griffin, and Frank Sawyer Trust, the facts as found did not establish that the taxpayers knew that MidCoast intended not to pay the taxes.

234

Shockley, TC Memo 2015-113

• The Tax Court, on remand from the Eleventh Circuit, held the former shareholders of a dissolved corporation liable for the corporation's unpaid taxes, finding that a stock sale was, in fact, a liquidation and the shareholders were liable as transferees under §6901 and state fraudulent transfer law.

235

Tricarichi, T.C. Memo. 2015-201

• The Tax Court held that the sole shareholder of a corporation was liable as a transferee for the corporation's unpaid tax liability after he sold his stock in a Midco transaction, finding that he was liable as a transferee under §6901and under Ohio fraudulent transfer laws for deficiencies and penalties assessed against the corporation.

236

Slone p.599

• The Court of Appeals for the Ninth Circuit has vacated and remanded a Tax Court decision which held that shareholders were not liable as transferees under §6901 for tax liabilities arising from a sale of all their company’s assets followed by a sale of all the company's stock.

• The Ninth Circuit found that the Tax Court applied the wrong legal standard in reaching its decision.

237

William Scott Stuart p. 603

The Tax Court held that shareholders who transferred all of their corporation's cash to a third party, without first paying corporate taxes, were liable as transferees for the unpaid taxes.

However, the court found that under state law the shareholders were only liable for the amount of the benefit they received from the transaction.

The Tax Court has again rejected IRS's attempted use of federal law, (i.e., the federal substance over form doctrine, to recast a transaction for purposes of applying a provision of §6901’s transferee liability rule.)

§6901 requires that transferee liability only applies if there is an independent basis under applicable state law or state equity principles for holding the transferee liable for another taxpayer’s tax.

238

Salus Mundi Foundation, p. 235

• In a case involving whether shareholders were liable for their corporation's tax under the Code's transferee liability rules, the Court of Appeals for the Ninth Circuit has reversed a Tax Court decision that held that they did not make a fraudulent conveyance under state law and remanded to the Tax Court to decide the remaining transferee liability issues.

• In so doing, the Court closely followed the decision and analysis of the Second Circuit in a case involving a different taxpayer who was in the same position with respect to the same transaction as the taxpayer here.

239


• The Second Circuit, noting that the First and the Fourth Circuits had both ruled that the two prongs are independent (Frank Sawyer Trust of May 1992 (CA 1 2013), 111 AFTR 2d 2013-1434; Starnes (CA 4 2012), 109 AFTR 2d 2012-2326), concluded that the taxpayer was right, i.e., that the two prongs are independent.

• It said that had it accepted IRS's argument that state law liability is assessed based upon the transaction as recharacterized by federal tax law, it would place IRS in a substantially different position than ordinary creditors under state law.

240


• That is, IRS would be able to collapse the transaction based upon federal law, thus transforming it into a conveyance under the applicable state statute, while an ordinary creditor would be required to collapse the transaction under state law-which may require, as it did in this case, a different showing-in order to collect from a transferee.

• This distinction demonstrates that the position urged by IRS imports federal law into the substantive determination of liability, in contravention of long settled law that §6901 is only a procedural statute, creating no new liability.

241

Andrew v. U.S. p.514

• A district court has found that shareholders in an investment club that operated as a C corporation were not liable for the corporation’s tax under the transferee liability rules where the corporation liquidated its stock portfolio and then the shareholders sold the corporation to a third party who did not pay corporate tax for the year of the transactions.

• The shareholders were not liable because they did not make a fraudulent conveyance under state law.

• The court found that former shareholders did not know, and under principles of constructive knowledge, should not be treated as knowing, how Newco intended to manage GNC post-closing, what its tax strategies were, or that Newco would cause GNC to fail to pay its taxes. The shareholders were represented by an attorney and a businessman neither of whom questioned the propriety of the transaction.

242

Andrew v. U.S. p.514

• The court rejected IRS contention that the fact that MidCoast offered to pay a premium was enough to put the former shareholders on notice that MidCoast would cause GNC not to pay its taxes, since MidCoast offered to pay more for the company than its balance sheet showed that it was worth.

• The court noted that IRS introduced no testimony that would suggest that a person offering “independent tax advice” to the plaintiffs in 2000 would have advised them that there was no legitimate tax strategy behind this transaction. The district court pointed out that Notice 2001-16, which was intended to put taxpayers on notice that such transactions were fraudulent, was not issued until 2001.

243

Karagozian, p. 137 • The Court of Appeals for the Second Circuit, affirming the Tax

Court, has held that an employee who underpaid his 2008 income tax and overpaid his 2002-2008 FICA tax, as a result of his employer misclassifying him as self-employed, could not use the equitable recoupment doctrine to offset his underpayment with any of the previous year overpayments.

• The Second Circuit also rejected Karagozian's contention that the doctrine of equitable recoupment allowed him to offset monies previously paid in error, for which the statute of limitations had now run, against his present tax liability.

244

Lamas, p. 144

• A taxpayer that stepped in during the 2008 financial crisis to rescue several related family businesses in which he held interests did so as a material participant, not as an investor.

• On the facts, the passive activity loss rules of §469 did not apply, and he could carry back a large loss to 2006 and thereby generate a refund of over $5 million.

• To establish the hours spent on an activity, taxpayers are not required to keep contemporaneous daily time reports, logs, or similar documents to substantiate their participation if the extent of their participation may be established by other reasonable means.

245

Lamas, p. 144

• Generally reasonable means includes the identification of services performed over a period of time and the approximate number of hours spent performing such services during such period, based on appointment books, calendars, or narrative summaries. (Regulations §1.469-5T(f)(4)) T

• The courts have held that taxpayers cannot merely make a ballpark guesstimate of their participation.

• The Tax Court found the Taxpayer worked at least 691 hours meeting the 500 hour test. – Credible testimony and phone records supported this

conclusion. • Disgruntled brother-in-law and former corporate officer

provided inconsistent statements to IRS regarding Taxpayer’s activities.

246

Lamas, p. 144

• The Tax Court rejected IRS's contention that Taxpayer’s work did not qualify because he was merely working in an investor capacity and was not involved in day-to-day management and operations.

• The Court found that Taxpayer worked in the day-to-day management and operations because he was working to meet its need for capital for its projects, an essential part of the business during 2008.

247

Wade p. 281 of 2014 Outline

• Taxpayer who turned over certain management responsibilities with respect to two S corporations to his son, but remained involved and was in fact vital to the businesses' survival during an economically difficult time, was not subject to the passive activity loss (PAL) limitations.

• The Court further found that the taxpayer's met the seventh test of regular, continuous and substantial involvement. §1.469-5T(1)(7).

• Taxpayer and wife resided in Florida and the manufacturing activities of the two corporations were conducted in Louisiana.

• Taxpayer generally have not been successful using the seventh test. The Tax Court has said this test applies only in exceptional circumstances where the more specific detailed requirements of the other six test are not met – Truskowsky, TC Summary Opinion 2003-130.

248

Williams, p. 174

• The Tax Court held that income taxpayers received through their S corporation for property rented to their C corporation was nonpassive income, and could not be used to offset their passive losses.

• The passive activity loss rules in §469 do not say that they apply to S corporations, those rules, and specifically the passive loss self-rental rule which treats otherwise passive income as nonpassive income, do in fact apply to rentals by S corporations.

• This “self-rental rule “blocks a taxpayer with passive activity losses from one activity from artificially creating passive activity income from another activity in order to absorb those losses.

249

Williams, p. 174

• §1.469-4(d)(5)(ii) provides that an activity that a taxpayer conducts through a C corporation may be grouped with another activity, but only for purposes of determining whether the taxpayer materially or significantly participates in the other activity.

• Net rental income received by a taxpayer for the use of property in a business in which the taxpayer materially participates is treated as income that is not from a passive activity. §1.469-2(f)(6).

• Material participation only counts if the taxpayer has an ownership interest in the activity. §1.469-5(f)(1).

250

CCA 201504010, p. 188

• A real estate agent who brings together buyers and sellers of real property can be a so-called “real estate professional “who is engaged in a real property brokerage trade or business as described in §469(c)(7)(C) of the passive activity loss (PAL) rules.

• However, a mortgage broker who is a broker of financial instruments is not engaged in a real property brokerage trade or business.

• Agarwal, TC Summary Opinion 2009-29 real estate agent is a real estate professional

251

Escalante, TC Summary Opinion 2015-47

• Taxpayer’s logs found not to be credible so could not prove he was a real estate professional.

• Activity logs not found to be useful. Understated time as a teacher and overstated time working on real estate.

• 1 hour to write each check. • 25 hour day question met with flip remark.

252

Kline v. Commissioner, TC Memo 2015-144

• Taxpayer was considered active because proved he participated in activity for more than 100 hours and his participation was not less than anyone else including individuals who were not owners.

– §1.469-5T(a)(3) provides that a taxpayer will be treated as materially participating in any activity if the individual participates in the activity for more than 100 hours during the taxable year, and such individual's participation in the activity for the taxable year is not less than the participation in the activity of any other individual (including individuals who are not owners of interests in the activity) for such year.

• Williams v. Commissioner, TC Memo 2014-158 and there had concluded the taxpayer failed to meet this test even though he had a contract with those who provided other services that no single person would allowed to be involved for more than 100 hours.

– Key difference was here the Taxpayer proved his (and others) involvement (or lack thereof) instead of relying on contract.

253

Padilla, TC Summary Opinion 2015-38

• Taxpayer not a real estate professional after throwing out hours attributable to investor activities.

• Pre §1.469-5T(f)(2)(ii)(A) activities of an investor do not count towards material participation under the passive activity rules.

• Most of the hours for each month were in the following generic categories: research properties near properties already owned; refinance research; foreclosure research (which appears to be considering properties that could be purchased); and researching new businesses.

• Petitioner hired a management company to manage the four Texas properties. Additionally, he hired a real estate company to find tenants and lease the San Francisco property. Accordingly, petitioner had relatively little personal involvement in the operation of the rental real estate activity that was regular, continuous, and substantial.

254

Smith, T.C. Summary Opinion 2014-112 • A taxpayer was able to persuade the Tax Court that he was a

real estate professional who materially participated in the rental of a triplex next door to his home.

• The taxpayer in question was a 63-year-old disabled veteran. The Veteran’s Administration had determined the taxpayer was 60% disabled and is paying the taxpayer monthly disability assistance. During his service in the U.S. Marine Corps he sustained injuries that left his right arm 50% disabled and his feet 30% disabled. The foot disability required the taxpayer to wear orthopedic shoes. He in need of knee replacement surgery and has difficulty seeing.

• Had daily routine, never took vacations. • Had no logs, but court said because disable it would take him

longer to do. Reconstructed and said over 750 hours.

255

O’Neill, TC Summary Opinion 2015-27

• Tax Court accepts taxpayer's reconstruction of travel hours to push over 750 hour real estate professional limit.

• Rental properties were located in Austin, Texas. The taxpayers lived on a ranch approximately 26 to 30 miles from the rental properties. Driving to the properties took from 42 to 55 minutes depending on the route that was taken and the traffic that was encountered on the trip.

• The IRS noted the Tax Court had regularly denied taxpayers credit for “reconstructed” records in an attempt to prove qualification, citing Bailey, T.C. Memo 2011-296, Speer, T.C. Memo. 1996-323 and Goshorn, T.C. Memo. 1993-578.

256

Maines, p. 146

• The Tax Court held that taxpayers had to include in income portions of refundable state tax "credits" received from participating in a New York economic development program. The court found that, contrary to the state's characterization, the refundable credits were effectively taxable subsidies.

257

McMillan, p.147

• The Tax Court has allowed business deductions to an individual taxpayer for legal fees that included fees paid to defend the taxpayer against criminal charges and interest paid with respect to a loan that, in a prior Tax Court case, the Court ruled was not a business loan.

• This was a botched case and the Tax Court apparently decided to teach the IRS a lesson. The decisions may be technically correct, but only because of deficiencies in the IRS case and improper procedure in the courtroom.

258

Methvin, p. 149

• An individual who acquired small working interests in several oil and gas ventures was a partner in a partnership for tax purposes.

• Despite his lack of active involvement in the operation of the wells and an election-out of the partnership rules, the working interest owners and well operator had created a pool or joint venture for the operation of the wells.

• As a result, the taxpayer's income from the working interests was income from a partnership, and he was liable for self-employment tax on the net income received from his working interests.

259

Methvin, p. 149

• A working interest in any oil or gas property held by the taxpayer, either directly or through an entity that does not limit the taxpayer's liability with respect to the interest, is not a passive activity regardless of the taxpayer's participation.

260

Minchem International, Inc., p. 151 • Married taxpayer who is owner of C corporation and wife were

denied investment interest expense deduction for portion of interest paid on home equity loan that they deposited in the C corporation’s bank account.

• Taxpayers failed to show that funds, which were disbursed for mortgage to finance ancillary loan to corporation were actually used for investment or that §1.163-10T(e)(4)(ii) 's potentially deductible treatment for “excess” interest applied.

• The Tax Court-while noting that the qualified residence interest Regulations allow debt exceeding the applicable limit to potentially be allocated to an otherwise deductible category of interest-has denied the taxpayers' investment interest deduction because they failed to show that the funds, which were from a loan secured by a qualified residence, were actually used for investing.

261

Minchem International, Inc., p. 151 • Taxpayer also was required to recognize taxable income when

he misappropriated funds entrusted to him for investment purposes by an overseas friend and deposited directly in his C corporation.

• Despite the large understatement of tax the Taxpayer incurred by not reporting the funds received from overseas friend as income, the Tax Court declined to impose a fraud penalty, finding the Taxpayer did not display the requisite "badges of fraud" under Spies v. U.S., 317 U.S. 492 (1943). The court did, however, impose the 20 percent accuracy related penalty under §6662(a).

262

Moore v. U.S., p. 156

• A district court has largely dismissed a taxpayer's challenges to his penalty for failing to file FBARs (Report of Foreign Bank and Financial Account) with respect to his foreign account, finding that he failed to make the required filings, he had no reasonable cause for that violation, and his constitutional objections were without merit.

• Taxpayer failed to exercise ordinary business care and prudence in determining if required to file FBAR reports.

263

Van Malssen, p.166

• After analyzing numerous trips to a vacation home to determine if they were for business or personal purposes, the Tax Court concluded that the taxpayer spent more than 14 personal use days at the property, thereby limiting rental use deductions under §280A.

• Taxpayer tried to argue that excess days were to perform repairs and maintenance and that brother’s use was personal.

• Because of the taxpayers' personal use of rental real estate, a condo, deductions for rental real estate losses were limited by §280A for two tax years.

• It also resolved a dispute between the parties as to the proper business use percentage during a third year.

264

Van Malssen, p.166

• Under §280A(c)(5), when a taxpayer rents a dwelling unit to others but also uses it a residence during the same year, the deductions attributable to the rental use cannot exceed gross rental income.

• Under §280A(d)(1), a dwelling unit is considered a residence if the taxpayer uses it for personal purposes for a number of days exceeding the greater of: (1) 14 days, or (2) 10% of the number of days during the year for which the unit is rented at a fair rental value.

• Under §280A(d)(2), if a taxpayer uses a dwelling unit for personal purposes for any part of a day, that day is counted as a personal use day. But if the taxpayer is engaged in repair and maintenance of the residence on a substantially full-time basis for any day, that day is not considered a personal use day.

265

Van Malssen, p.166

• Any personal use by a qualifying relative is imputed to the taxpayer.

• Even if a taxpayer avoids having a dwelling classified as a residence, §280A(e) requires a taxpayer who uses the dwelling unit for personal purposes for even a single day during the tax year to limit his or her deduction for any rental activity by allocating expenses between personal uses days and rental use days. Days spent performing repairs and maintenance are disregarded when making the allocation.

266

Redisch, TC Memo 2015-95

• Florida condo purportedly converted to rental was found to have never been converted to rental and lasses were disallowed.

• Although listed for rent, the unit was never rented. • Taxpayers claimed did not want to stay in condo after their

daughter died.

267

Van Phan p.168

• In a summary opinion, the Tax Court has concluded that a taxpayer could claim home mortgage interest deductions for making payments on a mortgage even though it was not held in his name, and even though he did not hold legal title to the underlying property.

• An oral agreement granting him an interest in the home in return for paying the mortgage and property expenses, coupled by the fact that his name ultimately was added to the legal title, established that he was an equitable owner of the property.

268

CCA 201451027 p. 188

• IRS addresses the issue of who is entitled to claim a home mortgage interest deduction where the underlying property is one by more than one taxpayer, and mortgage payments are made by one or both of them.

• After reviewing a number of cases and rulings on the subject, the CCA concludes that funds paid from a joint account with two equal owners are presumed to be paid equally by each owner, in the absence of evidence showing that that is not the case.

• It also says that a person who is jointly and severally liable on a home mortgage debt is entitled to deduct all the otherwise allowable interest on that debt, provided that person actually pays all the interest.

269

DeFrancis p. 177 of 2014 Outline

• Couple could not deduct as qualified residence interest the interest they paid on a loan from the wife's mother that was secured by an unrecorded mortgage and the couple's taking that deduction did not generate an accuracy-related penalty.

• The Court held that the interest was not deductible because the debt did not meet two of the three requirements to be secured debt.

• Requirements for secured debt: (1) The residence is security for payment of the debt; (2) In the event of default, the residence can be taken in satisfaction of the debt with the same priority as a mortgage or deed of trust in the jurisdiction in which the property is located; and (3) it is recorded, where permitted, or is otherwise perfected in accordance with State law. §1.163-10T(o)(1).

270

Puentes, TC Memo 2014-224

• The Tax Court ruled that a taxpayer could not claim home mortgage interest deductions for making loan payments on a mortgage obtained by her brother on a home owned by him.

• The taxpayer was not able to establish that she was an equitable owner of the property.

• After brother became unemployed, sister made all payments including upkeep. IRS denied and Tax Court agreed in Puentes, TC Memo 2013-277.

• She litigated again for 2010 because she lived in the property during 2010, paid the insurance and property tax.

271

Sophy/Voss, p.170

• A divided Court of Appeals for the Ninth Circuit, reversing a Tax Court decision, has concluded that the §163(h)(3) limitations ($1 million of acquisition indebtedness and $100,000 of home equity indebtedness) are applied on a per-individual basis, and not a per-residence basis.

• Thus, unmarried co-owners were collectively limited to a deduction for interest paid on a maximum of $2.2 million, rather than $1.1 million, of acquisition and home equity indebtedness.

272

Webber, p. 172

• Under the “investment control “doctrine, a taxpayer who established a grantor trust that purchased “private placement “variable life insurance policies insuring the lives of two elderly relatives was the actual owner of the assets in the separate accounts underlying the policies.

• Where the policyholder is treated as the owner of the investments, the income from the investments is not considered to be derived under a life insurance contract.

• This means that the policyholder is taxed on the interest (or dividends) in the year in which the amounts are earned, without the benefit of any deferral.

273

Webber, p. 172

• Private placement variable life insurance policies are a popular investment and estate planning technique for the very, very wealthy. Webber does not suggest that these vehicles will not, in appropriate cases, avoid both income and estate taxes on substantial assets. Rather, it demonstrates that even the best-planned and structured technique can fail if it is not carefully and correctly administered. – The insurer should not have allowed the insured to dictate the

investments that would be made as the policy did not give the insured that right.

– The insured should not have tried to make all of the decisions regarding investment and administration of the policy assets.

– The insured’s professionals should have recognized that failure to adhere to the terms of the policy could result in a court’s refusal to view the policy terms as a true limitation on the investor control.

274

Webber, p. 172

• It is interesting that the IRS built its case significantly from e-mails that were sent by the taxpayer, his attorney, and his accountant.

• There were over 70,000 e-mails examined, despite testimony that most of the taxpayer’s communications with his attorney and accountant were oral.

• This may be a cautionary note to attorneys who are less guarded in what they tell clients in electronic communications than in what they tell them in letters.

• E-mails are often discoverable and, in this case, provided most of the evidence against the taxpayer.

275

Wyatt, p. 176

• Guaranteed payments made from a hospital in an underserved community to a doctor as part of its efforts to recruit and retain physicians, which he was not required to repay because he stayed in the community, constituted bona fide loans, the forgiveness of which gave rise to cancellation of debt (COD) income.

• In so holding, the Court rejected the doctor's argument that he was not personally liable for repayment and thus could not have received income from the loan's forgiveness.

276

PLR 201506015, p. 183 • Taxpayer was allowed to recharacterize his traditional-IRA-to-

Roth-IRA conversion even though the deadline for doing so had expired.

• The PLR involved a taxpayer who unwittingly invested Roth IRA funds in a scheme that yielded significant, fraudulently misrepresented losses.

• The taxpayer did not discover that his investment plummeted in value until after the recharacterization deadline had passed.

• This is a §301.9100-3 ruling request for which there is a $9,800 user fee.

• PLR 201530024 - Taxpayer who erroneously established non-IRA account with online bank allowed late rollover relief. Recent rulings have taken a broader view than the IRS did in the past of a financial institution “error” for which the IRS deem to meet the test in Revenue Procedure 2003-16.

277

PLR 201536017, p.186

• An individual can claim a 30% residential energy efficient property credit under §25D for the cost of solar panels (and a partial ownership interest in related equipment) installed in an offsite community-shared solar project.

• The Clean Energy States Alliance, an industry group, says the PLR is significant because it is the first one allowing the §25D credit for owners of solar panels in a shared, offsite array.

278

Announcement 2015-22, p. 198

• When an individual receives identity protection services from an organization at no cost following a data security breach, the individual is not required to include the value of those services in gross income, and the organization is not required to report these amounts on information returns filed with respect to these individuals.

279

Personal Goodwill Cases

• Martin Ice Cream Co., 110 TC 189, 1998 - the Tax Court divided the intangible assets into two groups. One group represented the property of the corporation and included assets such as business records. Other intangibles, including the value of the owner's relationships with customers of the business, were found to be assets of the shareholder. A factor in this decision was the lack of any non-compete agreement between the individual and the corporation.

• Norwalk, TC Memo 1998-279 - the Tax Court similarly found that no corporate goodwill existed because the business of the corporation, a professional accounting practice, was dependent upon the key employees of the corporation. There were no non-compete agreements between the corporation and the shareholders, and the court found that the personal ability and reputation of the shareholders were the assets of the shareholders and not part of the liquidation gain, labeling these assets as "personal goodwill."

280


• Solomon, TC Memo 2008-102 - the Tax Court found that the proceeds from the sale of a business were properly allocable to non-compete covenants rather than the sale of personal goodwill. This resulted in ordinary income treatment to the sellers rather than capital gain. No mention of personal goodwill in the purchase agreement.

• US v Howard, 108 AFTR 2d 2011-5993 2011- The Ninth Circuit, affirming a federal District Court, ruled that amounts received by the sole shareholder in a professional practice represented the sale of corporate assets rather than the sale of personal goodwill. The courts noted that the taxpayer had a non-compete agreement with his own dental corporation, and this agreement converted the rights and relationships of the individual's services into a corporate asset. See page 93 of my 2010 outline.

281


• South Tulsa Pathology Laboratory, Inc., 118 TC 84 (2002)-After a blown §355 transaction taxpayer argued that value of the distributed stock was only $1 million, and that most of the $5.53 million paid by the purchaser was allocable to the physician-shareholders' personal goodwill. The court rejected this argument because it was simply not credible on the facts.

282


• Kennedy, TC Memo 2010-206 -Portion of payments that employee benefits consulting business owner received on sale of business were taxable as ordinary income and not capital gain from the sale goodwill. Although operative contracts allocated 75% of payments to goodwill, such allocation lacked economic reality where it was effected late in negotiations as tax-motivated afterthought and did not reflect value of goodwill in relation to other valuable aspects of transaction. Taxpayer's position/capital characterization was also belied by facts that he had promised to work for purchaser for 5 years until his planned retirement and to not compete. Moreover, he subsequently worked for purchaser for period of time without compensation.

283

Personal Goodwill Cases • See also Estate of Franklin Z. Adell, TC Memo 2014-

155 – where corporation’s value was found to be significantly less as a result of a finding the a good portion of the goodwill the IRS was valuing belonged to the son and was personal goodwill.

• Bross Trucking, TC Memo 2014-107 Father quit his trucking business and his sons began an enterprise serving the same primary customers as those of their father’s company. The court concluded that Mr. Bross' personal goodwill remained a personal asset separate from Bross Trucking's assets. Consequently, since the company did not own the goodwill, Bross Trucking did not transfer any goodwill to Mr. Bross' sons.

284

Personal Goodwill – Be Careful • Any determination of personal goodwill should be done by a

qualified valuation expert and it should consider the unique nature of personal goodwill.

• Predetermined percentages should not be used. • We are aware that a large West Coast firm has been promoting

the use of predetermined percentages attributable to personal goodwill; certain of their professionals have indicate to clients they can “back into” the number necessary to “make it work.”

• This approach is dangerous. As you have seen in the area of facade easements, the IRS will attack predetermined percentages or attempts to back into numbers.

285

Draft of 1040

• The IRS has released draft 1040 forms for the 2015 tax year. Some of the key changes between 2015 and 2014 include: (1) no bonus depreciation for 2015 (in December 2014, bonus depreciation was extended as part of the tax extenders legislation); (ii) lower §179 expensing for 2015 than for 2014 ($25,000 limit is in effect for 2015 as of today); and (iii) the standard mileage rate is $0.575.

• In July 2015, the Senate Finance Committee voted to extend bonus depreciation and increased §179 expense limitations, but there has been little movement other than this vote. If there is any change to the status of the extension of bonus depreciation and/or increased §179 expense limitations, we will provide an update.

286

CORPORATIONS, PARTNERSHIPS,

LLCS AND BUSINESS RELATED

287

S Corp Shareholder Basis

• Court have been sympathetic to IRS challenges of loans between related entities where no evidence the loans were ultimately with the shareholder.

• Broz v. Commissioner, 112 AFTR 2d 2013-5823. • Preamble indicates that the guidance leaves

unchanged the existing interpretation that the contribution of the shareholder’s own unsecured demand promissory note to the S corporation does not increase basis in stock. Rev. Rul. 81-187.

288

T.D. 9682 p. 421 of 2014 Outline

• Final regulations that provide that S corporation shareholders may increase their adjusted basis in any indebtedness of the S corporation to them.

• S corporation shareholder does not need to satisfy the economic outlay standard, which required the shareholders to be made “poorer in a material sense” in order to have basis in debt.

• The debt of the S corporation must be bona fide indebtedness to the shareholder under established federal tax principles.

• Guarantees of a shareholder do not result in basis in indebtedness until payment made on guarantee.

289

Back to back loans acceptable- §1.1366-2(a)(2)(iii) Ex 2

Individual Individual loans $200 to S2 S1 loans $200 to Individual

S1 S2

290

Entity loan followed by distribution - §1.1366-2(a)(2)(iii) Ex 3

Individual S1 loans $200 to S2 S1 distributes $200 note receivable to Individual S1 S2

291

Bedrosian, 143 TC No 4.

• A divided Tax Court considered how TEFRA applied when both the IRS and the taxpayers (and arguably the court itself) had previously made numerous procedural errors.

• The court eventually concluded that it lacked jurisdiction in the matter on the grounds that the audit should have been conducted under TEFRA, even though the IRS had previously treated the audit as not subject to TEFRA.

• As a result, as the dissent bitterly complained, a taxpayer was effectively denied, solely for procedural reasons, his "day in court" to consider the validity of the IRS's adjustments.

292

Bedrosian, 143 TC No 4.

• The Bedrosian decision would have been somewhat more alarming were it not for the fact that the taxpayer would almost certainly have lost on the merits in any event the case involved a typical "son of Boss" tax shelter, so the taxpayer had virtually no chance of winning.

• That said, the decision is mandatory reading for anyone who practices in the partnership area because it illustrates the important procedural issues that must be considered in every audit of a partnership that is (or could be) subject to TEFRA.

293

Bedrosian, p208.

• The Tax Court has held that the issue of whether legal fees paid by a partner in a sham partnership were deductible, where it was not clear which of the partner’s matters were covered by those fees, was a factual affected item.

• The Court had jurisdiction with respect to the issue in a partner-level proceeding.

• The Tax Court had previously ruled on the deductibility of the fees and, here, denied the partner’s untimely motion for reconsideration of the issue because reconsideration would not have yielded a different result.

294

Bell, p. 210 • The transfer of a sole proprietorship's assets to a corporation

wholly owned by the taxpayer and his wife was a capital contribution rather than a sale of property and payments subsequently received by the taxpayers was dividend income rather than capital gains.

• The Tax Court agreed that the payments made to the taxpayer were in fact dividends and that the assets transferred to the corporation could not be amortized or depreciated because they had no basis.

295

Bell, p. 210 • With respect to the characterization of the transfer of assets,

the court examined various factors, noting that an appeal in this case would go to the Ninth Circuit, which has applied an 11-factor test to determine whether a shareholder's transfer to a corporation is a sale or capital contribution.

• The Tax Court noted that the sole purpose of the corporation’s organization was to incorporate the taxpayer’s sole proprietorship and that the inseparable relationship between the corporation’s organization and the transfer of the sole proprietorship's assets weighed in favor of finding that the transfer was a capital contribution. This was particularly so, the court said, in the light of the lack of evidence of a business purpose for the transaction.

296

Loss Ordering Rules

• §1.469-2T(d)(6) provides the various loss limitation rules apply in this order – First – basis limitations – Second – at risk limitations – Third – passive activity limitations

• A final question is whether the activity is entered into for profit or whether it is a hobby? – Hobby expenses are deductible as an itemized deduction – Hobby income, less COGS is reported as “other income”

297

Coastal Heart Medical Group, Inc., p. 212

• IRS's disallowance of a partner's claimed loss deduction upheld because he had insufficient basis in the partnership.

• The taxpayer claimed that his basis should be increased to reflect the contribution of property subject to a liability that he assumed, but the Court found that the property was never actually contributed to the partnership and thus the partnership never had a liability to be assumed.

298

Davidson v. Henkel Corporation, p.214

• A district court has held a corporation liable to a group of its employees for failing to properly withhold FICA taxes on their nonqualified deferred compensation (NQDC) plan benefits.

• In arriving at this conclusion, the court rejected several or the corporation's arguments involving Code sections that would have barred the employees' suit.

• Employer had not properly withheld employment taxes at the time the employees vested in nonqualified deferred compensation. – If the employer fails to withhold upon vesting, then

withholding is required upon payment

299


• Employer informed employee that FICA taxes were not withheld on his benefits and the employee would be liable for FICA taxes on a “pay as you go” basis for the tax years still open.

• The employee brought suit against Henkel arguing that he suffered a reduction in his benefit under the NQDC plan because of the improper way Henkel administered the plan.

• If done properly in the year of retirement, none or only a portion of the benefits would have been subject to the lower tier OASDI portion of FICA. Thus, under the nonduplication rule, none of the NQDC payments would have been subject to FICA in later years when paid.

300


• After examining the provisions of the NQDC plan, the court found that the participants owed more in FICA taxes than they would have owed had the employer properly paid taxes when they were due. Thus, the employer was liable to the employees.

• Failure to follow the special timing rule typically results in higher FICA taxes on nonqualified deferred compensation. Although the Code does not mandate the use of the special timing rule, if employers fail to use this rule they risk being liable for any additional FICA taxes that may result. – Since 2003 when the employee vested in this case (and when

the FICA would have been imposed), the amount of wages subject to the first tier OASDI has gone up by over $30,000.

– Taxing all of the deferred compensation in 2003 would have subjected it to the first tier OASDi only once.

301

Research Credit Overview

• 20% of the excess, if any, of a taxpayer's annual qualified research expenses (QREs) over a base amount. In no event may the base amount be less than 50% of the QREs for the credit year .

• Alternative Simplified Credit (ASC) equals 14% of the excess of the QREs for the tax year over 50% of the average QREs for the three tax years preceding the tax year for which the credit is being determined.

• If a taxpayer has no QREs in any one of the three preceding tax years, the ASC is 6% of the QREs for the tax year.

• The ASC election applies to the tax year for which made and all succeeding tax years unless revoked with IRS consent.

302

Geosyntec Consultants, Inc., p. 220

• The Court of Appeals for the Eleventh Circuit, affirming the district court, found that Geosyntec was not eligible for research tax credits for research expenses incurred under two “capped contracts, “because the research was funded by Geosyntec's clients.

• Under the contracts, Geosyntec was entitled to payment regardless of whether its research was successful, and thus Geosyntec did not bear the financial risk of failed research.

303

Geosyntec Consultants, Inc., p. 220

• The Regulations allocate the research tax credit to the entity or person that bears the financial risk of failure of the research to produce the desired product or result. As a result, a client may claim the credit only if the agreement requires the client to pay for the research even if it is unsuccessful. (Fairchild Industries (CA FC 1995) 76 AFTR 2d 95-7707; Regulations §1.41-2 (e) (2)).

• If, on the other hand, the client need not pay unless the research is successful, the client is paying for a product or result rather than performance of the research, and the researcher is eligible to claim the research tax credit because the research is not funded. (Fairchild Industries; Regulations §1.41-4A (d)).

304

Research Credit Observation • The U.S. Federal R&D tax credit was first enacted in

1981 in an effort to encourage innovation and new technology, but was never made a permanent credit, resulting in 9 expirations and 16 extensions since 1981. Only once in its 32-year history was the tax credit not retroactively re-enacted, which was from July 1, 1995 through June 30, 1996. Since 1981, the research credit has been significantly modified 5 times.

• The 2014 Tax Increase Prevention Act (signed by President Obama on 12/16/14) extended the research credit through December 31, 2014.

• The R & D credit expired on December 31, 2014.

305

Research Credit – Fed. Challenges • IRS does not wants you to claim the credit and assumes you do

not qualify for any credit claimed. • Most IRS agents do not understand the application of the

rules, although the IRS has now started to use specialist to audit the credit.

• Even the specialists will deny the credit based on a misunderstanding of documentation rules.

• Agents continue to deny the credit based on the application of the discovery test (which was eliminated in 2001).

• We have successfully defended our research credit claims and have significant success this year given the recent court cases.

• The discovery test may be satisfied by research that is intended to eliminate certain uncertainty concerning development or improvement of a business component.

306

Key Points to “Remind” Agents • The 2003 final Regulations confirm that there is no separate

discovery test. • Instead, §41(a)(1)(B)(i) is satisfied when the taxpayer is seeking

information that is technological in nature, regardless of whether that information already is known by others.

• This is particularly important for customary product development activities, which were vulnerable to challenge under the old discovery test on grounds that the activities were not sufficiently "pioneering.“

• It irrelevant whether the taxpayer is seeking information that exceeds the common knowledge of skilled professionals in its industry.

• Even if a particular taxpayer is "behind the curve" compared with what its competitors already know, its product development activities still may be eligible for the research credit.

307

Key Points to “Remind” Agents • Final regulations (T.D. 9104, 12/31/03) eliminate the

requirement that qualified research does not include activities of selecting among alternatives that are "readily discernible and applicable.“

• Eliminates the IRS argument that the taxpayer already should have known this information or could have "worked smarter."

• Instead, what matters is whether the taxpayer actually conducted an evaluative process (modeling, simulations, etc), not whether a reasonable scientist in the taxpayer's position could have reached the solution through more efficient means (e.g., a literature or Internet search).

308

Key Points to “Remind” Agents • Even if the taxpayer "reinvents the wheel,” it still may be

eligible for the credit. • Regulation §1.41-4(a)(5) specifically provides that, even if

there is no uncertainty as to the capability or method of achieving a desired result, qualified research may be undertaken if the taxpayer is uncertain as to the appropriate design of the business component.

• Consequently, even if a taxpayer is supremely confident of its ability to achieve a desired result, and it is also certain of the established techniques that will be used to develop or update its product, the fact that the taxpayer is uncertain as to the ultimate design of its product would be sufficient.

309

Prop. Reg. §1.41-4, p. 240

• Proposed Regulations on various aspects of software developed primarily for internal use, for purposes of the research credit.

• The research credit provides that, except to the extent provided by regulations, research with respect to computer software that is developed by (or for the benefit of) the taxpayer primarily for internal use by the taxpayer (internal use software) is excluded from the definition of qualified research under §41(d).

• These Regulations provide helpful guidance including a much improved definition of internal use software and have been widely praised by tax practitioners.

• Despite the 2015 proposed Regulations ' prospective date, taxpayers should generally be able to apply the most important provisions of the Regulations , i.e., the definition of internal use software and the high threshold of innovation test, to years prior to their publication.

310

Prop. Reg. §1.41-4, p. 240

• In the preamble to the proposed regulations, the IRS again expressly indicates that there is no test of “common knowledge of skilled professionals” to determine if internal-use computer software is innovative or involves significant economic risk. – This standard was included in final regulations in 2000, but

was subsequently dropped in 2001 regulations.

311

T.D. 9712 §1.41-9, p.279

• Final regulations related to the timing and manner of electing the alternative simplified credit (ASC) under §41(c)(5).

• Under the final regulations, taxpayers may make an ASC election on an amended return if the taxpayer had not previously claimed a §41 credit for that year.

• In addition, the final regulations provide that a taxpayer that is a member of a controlled group may not make an ASC election for that year on an amended return if any member of the controlled group claimed the research credit using a method other than the ASC.

• The Final Regulations replace, largely follow, and somewhat liberalize, Temporary Regulations that were issued in 2014.

312

T.D. 9712 §1.41-9, p.279

• Under the previous regulation, businesses that wanted to apply the research credit to an amended return were required to use the regular method of calculating the credit, which is generally more complicated. The ASC allows a computation of the credit without the need to substantiate costs for a base period now 30 years removed. In the past that could be an insurmountable hurdle for some businesses.

• §280C(c)(3) allows a taxpayer to make an annual irrevocable election to claim a reduced research credit. This election trades off a lower tax credit for the need to reduce the research expense deduction by the amount of the credit, as required by §280C(c)(1). This election must be made in an original return; it cannot be made on an amended return.

313

T.D. 9712 §1.41-9, p.279

• The reduced credit election is generally desirable because it may save state income taxes (no addback of a federal-only credit to state taxable income) and also save AMT (the research credit does not reduce AMT). – When a taxpayer files an amended return to claim the ASC

version of the research credit, the reduced credit election is not available on an amended basis.

– Also cannot claim the reduced credit on an amended return when claiming the regular research credit.

• An election cannot be revoked on an amended return, and an extension of time to revoke the election will not be granted under Regulation §301.9100-3.

314

T.D. 9712 §1.41-9, p.279

• The preamble to the final Sec. 41 regulations references a limited work-around.

• The preamble notes that if a taxpayer is undecided about whether to claim the regular credit (or perhaps unable to complete the credit computations by the extended filing deadline for the tax return) but wants to preserve the operative effect of the Sec. 280C(c)(3) reduced credit election, the taxpayer may make the reduced credit election on line 17 of Form 6765, Credit for Increasing Research Activities, but leave the remaining section of the form blank. – This action in and of itself does not constitute a research

credit claim, and does not preclude the taxpayer from making an ASC election on an amended return when the data becomes available.

315

LAFA 20144701F, p. 354

• A parent corporation could not include the qualified research expenditures (QREs) paid or incurred by a target corporation for the short period before the target was acquired, in computing the parent's §41 research credit on its consolidated income tax return. IRS found that a technical amendment for acquisitions and dispositions in §41 (f) (3) made by the 2012 American Taxpayer Relief Act did not alter its conclusion.

316

Shami et al p. 378 of 2014 Outline

• The Court of Appeals for the Fifth Circuit has clarified the application of the Cohan rule, under which courts may estimate amounts of expenses if the taxpayer can establish that some expenses were incurred.

• The Fifth Circuit held that, although the Cohan rule can apply in the context of research credits, the Tax Court properly declined to make an estimate in this case because the taxpayer failed to show that it was entitled to at least some amount of tax benefit.

• In McFerrin v. U.S., (CA 5 2009) 103 AFTR 2d 2009-2566, the Fifth Circuit held that the Cohan rule applies in the context of the research credit.

• The takeaway from this case is that while it is possible for the founder to also be a top researcher for the company, it is critical to substantiate such activities.

317

Shami et al p. 378 of 2014 Outline

• In affirming the Tax Court's holding that the Cohan rule did not provide relief to the taxpayer, the Court noted that Cohan did not compel the Tax Court to make an estimate in this case.

• The Cohan rule is not implicated unless the taxpayer proves that he is entitled to some amount of tax benefit.

• In the context of the research credit, a taxpayer would do so by proving that its employee performed some qualified services.

• The Fifth Circuit said that the Tax Court's opinion revealed that the Tax Court made no such finding.

318

Suder p. 379 of 2014 Outline

• In consolidated cases, the Tax Court has concluded that expenses for 11 out of the 12 projects of a company designing telephone systems satisfied the 4-part test for qualified research expenses (QREs) for purposes of claiming the §41 research credit. 1. Qualifies as research expenditure under §174 2. Relates to research undertaken to discover info that is

technological in nature 3. Research is intended to be useful in developing a new

or improved business component 4. Substantially all (80%) of the activities constitute

elements of a process of experimentation that related to function, performance reliability or quality.

319

Suder p. 379 of 2014 Outline

• Court found there was no requirement to “reinvent the wheel.”

• Vast amount of planning, testing and bug fixing established the company did not know the appropriate design.

• The Court also found that the wages of the founder and chief executive officer (CEO), which were includible in the QREs, were unreasonable under§174(e) .

• Agreed to compensation in the 90th percentile, but disallowed the royalty component of the salary.

• The takeaway from this case is the IRS argument that “routine research” or “routine engineering” does not qualify. Hopefully, this ends the IRS backdoor “discovery test.”

320

Trinity Industries Inc. p. 382 of 2014 Outline

• The Court of Appeals for the Fifth Circuit has largely affirmed a district court's determinations with respect to the amount of research credit that a corporation that designed and built boats was entitled to for two tax years, including the court's decision to not use the "shrinking-back rule" in calculating either the corporation's claim year qualified research expenses (QRES) or its base period QREs.

• However, it remanded the case for the lower court to decide whether, based on its exclusion of certain vessels from the corporation's calculation of base period QREs, it was required under the consistency rule, as the taxpayer contended, to exclude QREs attributable to four other base period vessels as well.

321

Sun Capital Partners III LP • The Court of Appeals for the First Circuit, reversing the district

court's decision, held that an investment fund was a trade or business for [ERISA] purposes of determining whether the fund has withdrawal liability with respect to the unfunded vested benefits in a multi-employer pension fund of a bankrupt portfolio company under Title IV of the Employee Retirement Income Security Act (ERISA). – Today there are 2,797 private equity firms headquartered in the United

States, and each firm sponsors one or more private equity funds. These funds now back, control, or operate 17,744 U.S. companies that employ more than 7.5 million workers.

• Following the First Circuit's decision, private equity funds would be advised to consider the possibility that the ERISA joint and several withdrawal liability rules may apply with respect to their portfolio companies.

322

Sun Capital Partners III LP • If private equity funds are found to be in a trade or business for

tax purposes, this could threaten capital gains treatment benefiting fund managers and investors and could mean that the returns received by foreign and tax-exempt investors might constitute, respectively, effectively connected income and unrelated business taxable income.

• Seems to me that the managers themselves may be in a trade or business, but I find it hard to believe the funds themselves are in a trade or business – but we are in a “results oriented,” who cares what the law says, era when anything goes as long as it means eat the rich and/or the successful.

323

Sun Capital Partners III LP • The U.S. Supreme Court announced it will not review an

appellate court decision holding that private equity funds could be liable for a portfolio company's multiemployer pension plan withdrawal liability—and potentially higher tax rates – Sun Capital Partners III , LP v. New England Teamsters &

Trucking Indus. Pension Fund, No. 13-648 ( U.S. cert. denied 3/3/14).

324

Notice 2014-52, 2014-42 p. 503 of 2014 Outline

• Regulations IRS intends to issue under §367, §7701(l), and §7874 with respect to corporate inversion transactions.

• In a broad send, the forthcoming regulations will prevent inverted companies from using certain techniques to access the overseas earnings of the U.S. company’s foreign subsidiaries without paying U.S. tax, close a loophole to prevent inverted companies from transferring cash or property from a controlled foreign corporation (CFC) to a new parent to completely avoid U.S. tax, and make it more difficult for U.S. entities to invert.

• The regulations will generally apply to transactions completed on or after September 22, 2014.

• To avoid being treated as a U.S. corporation under the above rules, the resulting entity must be more than 20% foreign-owned.

• As a result, the target foreign company must be at least 25% the size of the U.S. corporation.

325

§199 Overview • 9% of the lesser of qualified production activities income (QPAI) or

taxable income determined without regard to the DPAD deduction. • The DPAD cannot exceed 50% of the Form W-2 wages. • Taxpayer needs to have altered the qualified production property

(QPP) by manufacturing, producing, growing, or extracting (MPGE). • If the taxpayer packages, repackages, labels, or performs minor

assembly and does not engage in other manufacturing with respect to the qualifying property, the activity does not qualify.

• At least 50% US content. • Must comply with §263A to claim. • DPAD does not reduce basis.

– §1.199-9(b)(1)(i) partnership; §1.199-9(c)(1) S Corp

• Often overlooked point – must have benefits and burdens of ownership of the property during the manufacturing.

326

Domestic Production Activities Deduction - DPAD • DPGR does NOT include

– Activities in which taxpayer packages, repackages, labels, or performs minor assembly

– Non trade or business activities – Sale of food and beverages prepared at retail establishment – Property leased, licensed, or rented for use by any related person – Lease rental license, sale, exchange or other disposition of land – Transmission or distribution of electricity, natural gas or potable

water, – Advertising and product placement that do not involve printed

publications or qualified films (e.g., online advertising) – Customer and technical support

327

Precision Dose, Inc. p.226

• A company's business of selling unit doses of medicines involved the sale of qualifying production property which was manufactured, produced, grown, or extracted and the company thus qualified for the §199 domestic production activities deduction.

• Court cited Dean favorably and ruled that the unit dose was a unique product, and not mere packaging.

• Example 9 of Proposed Regulations 1.199-3(e)(5) contains an example illustrating that revenue derived from the assembly of gift baskets is non-DPGR.

• CCA 2012246030 provider of pharmaceutical products that purchased pills in bulk form and placed these pills in “blister packs” that it manufactured was eligible for the §199 deduction.

328

Dean p.268 of the 2013 Outline • A district court has determined that an S corporation's

production process for putting together gift baskets of various food and wine items qualified it for the domestic production activities deduction under§ 199.

• In so holding, the court found that the process effectively transformed the individual items into a new and distinct product.

• Accordingly, the two shareholders of the corporation were entitled to the § 199 deductions claimed on their amended returns, and IRS's action to recover the refunds issued to them was denied on summary judgment.

329

Dean p.268 of the 2013 Outline

• Taxpayers should be careful following the Dean decision. Other courts are unlikely to be as generous in their interpretation that combining finished goods within a new container overcomes the packaging-minor assembly exclusion.

• Reg §1.199-3(e)(2) provides that if the taxpayer packages, repackages, labels, or performs minor assembly and does not engage in other manufacturing with respect to the qualifying property, the activity does not qualify for the deduction.

330

LB&I-04-0315-001-Mandate to Examiners • Provides a mandate to examiners on whether certain activities

meet the definition of "manufactured, produced, grown, or extracted" (MPGE) under §1.199-3(e) when performed in a retail setting.

• The directive lists the following examples of activities that are generally not MPGE when performed at a retail level: – Cutting blank keys to a customer's specification – Mixing base paint and a paint coloring agent – Applying garnishments to cake that is not baked where sold – Applying gas to agricultural products to slow or expedite fruit

ripening – Storing agricultural products in a controlled environment to

extend shelf life – Maintaining plants and seedlings

331

LB&I-04-0315-001-Mandate to Examiners • The directive also advises that other similar activities may be

non-MPGE activities depending on the facts and circumstances of the taxpayer's activities, the processes through which the activities are performed, and the taxpayer's industry.

• If a case involves a taxpayer that claimed the §199 deduction for activities that are different from, but similar to, the activities listed above, the directive advises examiners to contact the Corporate Income & Losses Issue Practice Group so that the aforementioned list of non-MPGE activities may be expanded.

• A sale harbor applies when the direct labor and overhead of the taxpayer to manufacture or produce accounts for at least 20% of the taxpayer’s COGS for the property.

332

LB&I-04-0315-001-Mandate to Examiners • Rev. Rul. 74-204 – blending two kinds of oil is a manufacturing

activity • PLR 9108053- blending of an additive with gasoline constitutes

manufacturing • PLR 8942049 – combining two materials is manufacturing

333

T.D. 9731, §1.199-2, §1.199-2T, §1.199-8, §1.199-8T, p.297

• Temporary Regulations that provide guidance for purposes of the §199 domestic production activities deduction (DPAD) on the allocation of W-2 wages paid by two or more taxpayers that are employers of the same employees during a calendar year, and the determination of W-2 wages if the taxpayer has a short tax year.

• They provide a rule for acquisitions and dispositions if one or more taxpayers may be considered the employer of the employees of the acquired or disposed of trade or business during that calendar year. – The W-2 wages paid during the calendar year to employees of the

acquired or disposed of trade or business are allocated between each taxpayer based on the period during which the employees of the acquired or disposed of trade or business were employed by the taxpayer.

334

T.D. 9731, §1.199-2, §1.199-2T, §1.199-8, §1.199-8T, p.297

• Also provide a rule to apply in the case of a short tax year in which there is no calendar year ending within such short tax year (short-tax-year rule).

• Wages paid by a taxpayer during the short tax year to employees for employment by such taxpayer are treated as W-2 wages for such short tax year for purposes of §199(b)(1).

• Prior to the temporary regulations, Form W-2 wages included only wages reported on Form W-2 for the calendar year ending within the short year. Consequently, the earlier guidance did not provide any wages for the 50% limitation computation unless December 31 was included in the short year.

335

PLR 201445010, p.318

• For purposes of the domestic production activities deduction under §199, a taxpayer derived domestic production gross receipts (DPGR) from the license of computer software to contracting parties, rather than non-DPGR from providing services to end users.

336

LB&I-04-1013-008, October 29, 2013

• The Internal Revenue Service has backed off requiring its examiners to apply a three-part test to determine which party in a contract manufacturing arrangement had the benefits and burdens of ownership of a qualifying property for taking the Section 199 deduction.

• The agency said that instead, examiners only have to figure out which unrelated party in an arrangement can claim the deduction because it satisfies the benefits and burdens test.

• A prior directive (LB&I-4-0112-001) from February 2012 had required a three-part test to determine which party in a contract manufacturing arrangement had the benefits and burdens of ownership over the activity. The multi-step tests related to contract terms, production activities and economic risks

• In addition, the latest guidance also updated a second directive (LB&I-04-0713-006) from July that superseded the prior directive. The latest directive said that if the benefits and burdens determination was under examination on July 24, 2013, the taxpayer must provide benefits and burden statements saying that he or she is entitled to the deduction, along with signed certification statements, to the examiner within 60 days of the date of the directive.

337

LB&I-04-1013-008, October 29, 2013

• The guidance said that if the taxpayer thinks more time is needed, an extension of time can be requested, but that any extension must be approved by the territory manager.

• The burdens and benefits test was designed to keep more than one taxpayer in a contract manufacturing arrangement from claiming the Section 199 deduction, a tax break for companies that perform domestic manufacturing and certain other production activities.

• Under the benefits and burdens test, only the party with the benefits and burdens of ownership over the qualifying property during the period of the qualifying activity is entitled to the deduction.

• Often both parties to a contract manufacturing arrangement have some of the indicia of benefits and burdens over the qualifying property, IRS said, so it may be difficult to determine which party may claim the deduction with respect to the same activity.

• Appendix 1 and 2 of LB&I-04-1013-008 includes sample certification agreements.

338

PLR 201447027, p.320

• Explanation of how a business with a 52-53 week tax year ending near the end of the calendar year should compute the W-2 wage limitation on the §199 domestic production activities deduction (DPAD).

339

CCA 201446018, p. 332

• For purposes of computing its domestic production activities deduction (DPAD), a taxpayer properly allocated to tax years that preceded the effective date of the DPAD amounts that it paid as damage awards.

• IRS's conclusion here meant that the taxpayer could take a larger DPAD than it would have had IRS come to the opposite conclusion.

340

CCA 201446022, p. 336

• IRS has drawn various conclusions involving a cable TV operator and the domestic production activities deduction (DPAD), including that, under the applicable non-safe-harbor rules, the taxpayer did not establish that subscription packages that the taxpayer sold were qualified films and that, even if it had, the taxpayer was not the producer of qualified films.

341

Legal Advice 2014-008, p. 377

• A bank does not derive domestic production gross receipts, for purposes of the domestic production activities deduction, from the disposition of computer software when it allows customers to download a free mobile phone app that gives customers access to the bank's online fee-based services.

342

Important §199 Cases/Rulings • Advo Inc. – company was not entitled to DPAD deductions regarding direct

mail advertising activities. Printing was contracted out to 3rd parties who had benefits and burdens.

• CCA 201302017 - Mobile billboards are tangible personal property and thus qualify for DPAD. Traditional and modern billboards are real property and do not qualify for the DPAD.

• CCA 201313020 – A book publisher’s activities of producing an electronic book do not qualify for DPAD.

• LAFA 20133302F – Photo processing activities of drugstore chain qualify for DPAD.

• LAFA 20132701F – A cooperative’s DPAD could only be used to reduce patronage sourced income, not nonpatronage sourced income.

• LAFA 20131802F – Taxable cooperative could not compute DPAD by aggregating patronage and nonpatronaged sourced activities.

• PLRs 200909020, 200909016, 200852022 – Pooling cooperatives are essentially allowed to calculate QPAI without any cost of sales so that the 9% deduction is based on gross income.

343

SWF Real Estate LLC, p.228

• Following Fourth Circuit precedent, the Tax Court has determined that the §707 disguised sale rules applied to a transaction involving a contribution of cash to a partnership in exchange for an allocation of state tax credits.

• Rev. Proc. 2014-12, 2014-3 IRB 415 provides a safe harbor under which IRS will not challenge partnership allocations of §47 rehabilitation credits by a partnership to its partners.

• But the revenue procedure specifically provides that it does not indicate the circumstances under which a transfer of state credits by a partnership may be treated as a disguised sale under §707(a)(2) (B).

344

SWF Real Estate LLC, p.228

• In Virginia Historic Tax Credit Fund 2001, LP v. Commissioner, (CA4 2011) 107 AFTR 2d 2011-1523 (Va. Historic), three individuals set up a series of partnerships (funds) that solicited investors who were willing to contribute capital in exchange for the allocation of Virginia tax credits.

• If the promised tax credits could not be obtained, the funds agreed to refund the investor's capital, net of expenses. IRS determined that the transactions between the investors and funds were disguised sales under §707, and the Fourth Circuit (reversing the Tax Court) agreed.

345

Gateway Hotel p. 357 of 2014 Outline

• Although Partner who contributed proceeds from a bridge loan had a disproportionately large allocation of the tax credits and did not have to return the tax credits to the partnership, the transaction was not a disguised sale

• Tax Court considered whether three transfers made by a partnership resulted in taxable sales under the disguised sale rules, substance over form principles. – Only two of ten factors indicated disguised sale treatment.

• A disguised sale occurs if, on the basis of facts and circumstances, the partnership would not have transferred money or other property to the partner but for the transfer of money or property to the partnership (the "but for" test).

• If not simultaneous, the subsequent transfer of either money or property is a disguised sale if it is not dependent on the entrepreneurial risks of the partnership operations.

346

Route 231, LLC p. 372 of 2014 Outline

• The §707 disguised sale rules applied to a transaction involving a contribution of cash to a partnership in exchange for an allocation of state tax credits.

• The contribution of $3.8 million for a one percent interest in the partnership would not have occurred "but for" the entitlement to $7.2 million of Virginia tax credits to be allocated to it (53 cents per dollar contribution).

• The Court also determined that there were no entrepreneurial risks involved because the credit entitlement had no connection to partnership operations.

• The income from the disguised sale is triggered in the year of the contribution and the allocation of the credits, rather than the subsequent year when the credits were registered and received by the partners.

347

Historic Boardwalk Hall, LLC (CA 3 10/22/2012) 110 AFTR 2d 2012-6433, cert denied 5/28/2013. • The Supreme Court has declined to review a decision of the

Court of Appeals for the Third Circuit that a corporate investor was not a bona fide partner in an LLC and thus was not entitled to claim its share of historic rehabilitation tax credits.

• The Third Circuit found that the investor had no "meaningful stake" in the LLC's failure or success, and that the transaction was in substance a prohibited sale of the tax credits.

• At this point the case is considered settled. • See also LAFA 20124002F where the Service determined that a

partnership created to allocate historic rehabilitation credits is a sham because the partners do not share the benefits and burdens of ownership.

348

Other Tax Credit Disguised Sale Cases • TIFD III-E, Inc., (CA 2 08/03/2006) 98 AFTR 2d 2006-5616 - Second

Circuit found that a purported partnership interest was more akin to a secured lender's interest, in that it was largely unaffected by the partnership's success or failure (despite the fact that the underlying documents showed an unrealistic possibility for upside potential), and that it more closely resembled debt than equity.

• Virginia Historic Tax Credit Fund LP, (CA 4 03/29/2011) 107 AFTR 2d 2011-1523 - The Fourth Circuit reversing the Tax Court, held that the §707 disguised sales rules applied where investors contributed cash to partnerships engaged in rehabilitating historic buildings and were allocated state tax credits from the partnerships.

349

Revenue Procedure 2014-12 p. 430 of 2014 Outline

• Safe harbor requirements are: 1. The principal/manager must have a minimum 1% interest in each

material item of partnership income, gain, loss, deduction and credit at all times during the existence of the partnership.

2. Investor partners must have a minimum interest in each of these items equal to at least 5% of the investor's percentage interest.

3. The investor's interest must constitute a bona fide equity investment, and an arrangement cannot be in place to reduce the value of the investor partners' interest through fees, lease terms, or other arrangements that are not comparable to real estate development projects that do not qualify for §47 credits.

4. The safe harbor contains provisions for minimum investor contributions, guarantees, loans and purchase and sale rights. The investor may not acquire the partnership interest with the intent of abandoning the interest after the completion of the qualified rehabilitation.

350

CCA 201524024, p.350

• A limited liability company (LLC), which entered into a number of transactions designed to generate §48 energy credits with respect to solar energy property, could not rely on a safe harbor to support its allocation of the credits among its members.

• The CCA concluded that the safe harbor was clearly limited to partners and partnerships with §45 wind energy production tax credits, and that in any event, the LLC failed to satisfy the conditions required for the safe harbor to apply.

351

AOD 2015-001 Nonacquiesence Gracia, Mirarchi, Price, Estate of Martinez, p. 238

• IRS has announced its nonacquiesence with four Tax Court cases each of which held that a partner, who guaranteed the debt of a partnership and was not in bankruptcy in his individual capacity, may exclude from gross income under §108 (a), partnership debt cancelled in a title 11 case of the partnership.

• §108(d)(6) For partnership discharges, the debtor's status as bankrupt or insolvent is decided at the partner level—not at the partnership level.

• The bankruptcy/insolvency exception applies at the S corporation level, not at the S corporation shareholder level.

– Not all debt cancellations are excludible, even in bankruptcy. The AOD points out that all testing for debt relief income exclusion is at the partner level. To use the bankruptcy exception of §108(a)(1)(A), the partner is advised to seek counsel as to filing a personal bankruptcy action, and not rely on being within the bankruptcy court’s jurisdiction with respect to partnership debts.

352

TD 9728, p293 • Final regulations under IRC §706 dealing with the issue of when

partners hold varying interests in a partnership during the year. • There are two exceptions to the applications of these rules.

1. “Contemporaneous partners” – the rule does not apply to modifications of distributive shares among partners who were members of the partnership during either the entire year; and

2. Service partnership exception—So long as capital is not a material income producing factor, the partnership can choose to allocate items using any reasonable method that satisfies the provisions of §704(b) and the related regulations regardless of a change in interest.

• This represents an expansion of this rule compared to the proposed regulations which limited the partnerships qualifying for this rule to only those in specified personal service industries.

353

Prop. Reg. §1.707-1, §1.707.2, §1.707.9, §1.736-1, p. 252

• Proposed Regulations that would provide guidance to partnerships and partners regarding when an arrangement will be treated as a disguised payment for services under §707(a)(2)(A).

• Notably, the Proposed Regulations would establish a test, based on §707(a)(2)(A) 's legislative history, under which payments made pursuant to an arrangement that lacks “significant entrepreneurial risk “are treated as disguised payments for services.

• The preamble to the Proposed Regulations contains a surprising interpretation of, and the promise of a future modification of, a 1993 Revenue Procedure.

354

Prop. Reg. §1.707-1, §1.707.2, §1.707.9, §1.736-1, p. 252 • In 1993, IRS issued Rev. Proc. 93-27, 1993-2 CB 343, to provide

safe harbor guidance regarding the tax treatment of the issuance of a profits interest, in order to prevent continued litigation regarding the value of a profits interests.

• Rev. Proc. 93-27 generally provides that, if a person receives a profits interest for the provision of services to or for the benefit of a partnership, IRS will not treat the receipt of such interest as a taxable event for the partner or the partnership.

• However, the Revenue Procedure provides that its general rule does not apply if (i) the profits interest relates to a substantially certain and predictable stream of income, (ii) within two years of receipt, the partner disposes of the profits interest, or (iii) the profits interest is a limited partnership interest in a publicly traded partnership.

355

Prop. Reg. §1.707-1, §1.707.2, §1.707.9, §1.736-1, p. 252

• Typically, private-equity firms and hedge funds charge their investors a 2% fee on their assets and also keep 20% of profits. The latter is referred to as carried interest.

• In many cases, the above arrangement is accompanied by a “management fee waiver “arrangement. In such an arrangement, the private equity or hedge fund manager exchanges all or a portion of its not-yet-earned 2% fee for a profit interest in the fund under management.

• The mechanics and features of a management fee waiver arrangement vary from fund to fund, but a common goal of such arrangements is to exchange income subject to tax currently and at ordinary tax rates for income that is taxed at capital gains rates and is subject to potential deferral.

356

Prop. Reg. §1.707-1, §1.707.2, §1.707.9, §1.736-1, p. 252

• The preamble to the Proposed Regulations also makes two comments about Rev. Proc. 93-27.

• First, it states that IRS has determined that Rev. Proc. 93-27 's safe harbor will not apply to an arrangement in which one party waives a management fee and another party receives a profits interest.

• Second, IRS plans to issue a revenue procedure providing the following additional exception to the safe harbor in Rev. Proc. 93-27: profits interests issued in conjunction with a partner forgoing payment of an amount that is substantially fixed (including a substantially fixed amount determined by formula, such as a fee based on a percentage of partner capital commitments) for the performance of services.

357

Rev. Rul. 2015-10, p.312

• Tax consequences of a series of transactions where a parent corporation transferred all of its interests in a LLC through various subsidiaries, ending with the LLC electing to be treated as a disregarded entity.

• Transaction involved the transfer of a wholly-owned limited liability company (LLC) taxable as a corporation from a parent corporation to its subsidiary and then successively to two lower-level subsidiaries, followed by the LLC electing to be treated as a disregarded entity.

• This is a so-called “triple drop and check “ involving a domestic corporation. Rev. Rul. 2015-9 is the same ruling involving a foreign corporation.

358

Rev. Rul. 2015-10, p.312

• A transfer of property may be respected as a §351 exchange even if it is followed by subsequent transfers of the property as part of a prearranged, integrated plan. (Rev. Rul. 77-449, 1977-2 CB 110, amplified by Rev. Rul. 83-34, 1983-1 CB 79, and Rev. Rul. 83-156, 1983-2 CB 66)

• However, a transfer of property in an exchange otherwise described in §351 will not qualify as a §351 exchange if, for example, a different treatment is warranted to reflect the substance of the transaction as a whole. (Rev. Rul. 54-96, 1954-1 CB 111; Rev. Rul. 70-140, 1970-1 CB 73)

359

Rev. Rul. 2015-9, p.314

• IRS addressed the tax consequences of a similar series of transactions (as that involved in Rev. Rul. 2015-10) involving foreign corporations, revoking Rev. Rul. 78-130.

• IRS stated that it would not challenge a position taken by a taxpayer that relied on the 1978 ruling with respect to a transaction that occurs on or before, or is effective pursuant to a written agreement that is binding as of, May 5, 2015.

• Triple drop and check involving foreign corporation.

360

Rev. Rul. 2015-17, p. 316

• IRS has announced that the interest rates for tax overpayments and underpayments for the calendar quarter beginning October 1, 2015 will remain the same as for the third quarter of 2015.

• The interest rates for tax overpayments and underpayments have remained constant for 17 quarters in a row (i.e., beginning October 1, 2011 and ending on December 31, 2015).

361

PLR 201504007, p. 324

• Where two wholly owned subsidiaries elect to be treated as disregarded entities, their parent's transfer of a portion of the subsidiaries' assets to a controlled entity will not preclude their constructive liquidations from being treated as complete liquidations under §332.

362

PLR 201506008, p. 325

• When stock is acquired in a §351 (a) exchange and is subsequently transferred to a partnership as part of the same transaction, the subsequent transfer will not cause the first exchange to fail to qualify as a nontaxable transfer to a controlled corporation under §351 (a).

363

PLR 201506008, p. 325 • Courts have held that the control requirement of §351 (a) is not

satisfied where, under a binding agreement entered into by the transferor before the §351 (a) exchange, the transferor loses control of the corporation by a taxable sale of all or part of that stock to a third party who does not also transfer property to the corporation in the §351 (a) exchange. (Klein on the Square, Inc., (CA 2 1951) 40 AFTR 369; Hazeltine Corporation., (CA 3 1937) 19 AFTR 38)

• However, IRS has ruled that a tax-free §351 (a) exchange was not disqualified by a subsequent transfer of the controlled corporation stock to another corporation where the second transfer was a nontaxable disposition, the transferor retained a continuing interest in the property transferred, and the transferor could have taken an alternative path to achieve nonrecognition treatment. (Rev. Rul. 2003-51, 2003-21 IRB 938)

364

RVI Guaranty Co & Subsidiaries, 145 TC No. 9

• The U.S. Tax Court has ruled in favor of an insurance company that was selling residual value policies that insured against the risk that a leased vehicle or other asset would be returned at the termination of the lease with a much lower than predicted value, overruling the arguments of the IRS that such insurance was not insurance at all for federal income tax purposes since it inherently covered risks that the Service claimed were fundamentally economic in nature.

365

CCA 201511021, p. 345

• IRS has concluded that the arrangement between members of an affiliated group of corporations and the group's affiliated insurance company, involving foreign currency fluctuations, failed to qualify as insurance for Federal tax purposes.

366

PLR 201517018, p. 325

• In a redacted Technical Advice Memorandum (TAM), IRS has concluded that a corporation did not qualify as an insurance company under §501 (c) (15) for the years at issue because the majority of its business was not related to insurance and it failed to achieve adequate risk distribution during those years.

367

PLR 201522001, p. 328

• The administrative dissolution of a corporation under state law, followed by its reincorporation, did not terminate the entity's status as a corporation for federal tax purposes.

• Under the facts of the ruling, the corporation did not initially know of the dissolution and continued to file federal returns and pay all corporate taxes due during the period when it was unaware of the dissolution.

368

PLR 201528016, p. 331

• A distributing corporation's acquisition of a business segment through its acquisition of an interest in a partnership constituted an expansion of the distributing corporation's business under Regulations §1.355-3(b)(3)(ii), and not an acquisition of a new or different business.

• In Rev. Rul. 2007-42, 2007-2 CB 44, IRS said that to satisfy the active trade or business requirement, above, through a limited liability company (LLC) classified as a partnership for federal tax purposes, a corporation either: (1) had to have a significant interest in the LLC-i.e., at least a 33 1/3% interest-and the LLC had to perform the required activities that constituted an active trade or business; or (2) did not have to have a significant interest in the LLC but had to have at least a 20% interest and had to perform active and substantial management functions for the LLC.

369

CCA 201446021, p. 334

• The accumulated adjustments account (AAA) of a corporation that elected, terminated, then re-elected S status, was zero.

• It found that the plain language of §1368 (e) (2), which defines the “S period “during which the AAA is adjusted as the most recent continuous period during which the corporation has been an S corporation, foreclosed the taxpayer's argument that its AAA balance from the initial S period survived the break in S status.

370

CCA 201505038, p. 341

• Where a lessor qualifies for the §47 rehabilitation credit but elects to treat his lessee as qualifying for the credit, the lessee must include in his gross income, over a period of years, 100% of the credit amount, notwithstanding a drafting error that might lead one to believe otherwise.

371

CCA 201507018, p. 342

• A transaction involving a newly formed charitable organization and a wholly owned corporation was to be recast under the "substance over form" doctrine, denying the claimed charitable deduction.

• According to IRS National Office, it was appropriate to recast a partner's purported transfer of partnership units to a charitable organization under the substance-over-form doctrine.

• The actual substance of the transaction was the transfer of a mere promise to pay, with the charity never being a bona fide partner in the partnership.

• Because the transaction was, in substance, a contribution of a promissory note to a charitable organization, the partner was not entitled to a charitable deduction as per Rev. Rul. 68-174.

372

CCA 201507018, p. 342

Partners Charitable Organization Trust Partnership For Profit Corporation

373

CCA 201507018, p. 342

• In Palmer (1974), 62 TC 684, a taxpayer donated shares of a corporation's stock to a foundation and then caused the corporation to redeem the stock from the foundation.

• The Tax Court rejected IRS's attempt to recast this transaction under the substance-over-form doctrine, in part, because it found that the foundation was not bound to go through with the redemption at the time it received title to the shares.

• In Rev. Rul. 78-197, 1978-1 CB 83, IRS stated that it would follow Palmer, and would treat the proceeds from a stock redemption as income to the donor only if the donee was legally bound, or could be compelled by the corporation, to surrender the shares for redemption.

374

CCA 201525010, p. 352

• For purposes of determining whether a limited liability company (LLC) taxed as a partnership has either cancellation of debt (COD) income under §61 (a) (12) or gains from dealings in property under §61 (a) (3) upon foreclosure of its property, the Regulations under §752 do not govern whether the debt at issue was recourse or nonrecourse.

• In this case, the CCA instructed the examining agent to determine whether the Notes were recourse by making a factual analysis of the operating and loan documents and any relevant state law.

• In this case, the CCA instructed the examining agent to determine whether the Notes were recourse by making a factual analysis of the operating and loan documents and any relevant state law.

375

COD vs. Amount Realized • §108 relief pertains only to COD income; so it is critical for you to determine if there is COD income or gain from sale of property.

• If the transaction involves a foreclosure or deed in lieu of foreclosure and nonrecourse debt, there is no COD because the full amount of the liability relief is considered an amount realized (Commissioner v. Tufts, ET AL., 103 S.Ct. 1826, 05/02/1983).

• If the transaction involves a foreclosure or deed in lieu of foreclosure and recourse debt, there is COD only to the extent property’s FMV is less than the face of the debt. Relief of debt up to FMV is considered an amount realized.

• However, if in lieu of foreclosure, a lender agrees to reduce the principal balance of a nonrecourse debt, such reduction is treated as discharge of indebtedness to the borrower eligible for exclusion under IRC Sec. 108 ( Rev. Rul. 92-53 ). No sale or exchange of the property has occurred.

376

LAFA 20153001F, p.370

• Last-in, first-out (LIFO) recapture consequences resulting from the C corporation parent of a consolidated group merging with an S corporation's subsidiary, followed by that S corporation electing to treat the parent's consolidated group as qualified subchapter S subsidiaries (Qsubs).

377

Notice 2015-54, p. 387

• IRS has announced that it intends to issue Regulations under §721(c) to ensure that, when a U.S. person transfers certain property to a partnership that has foreign partners related to the transferor, income or gain attributable to the property will be taken into account by the transferor either immediately or periodically.

• IRS also intends to issue Regulations under §482 and §6662 applicable to controlled transactions involving partnerships to ensure the appropriate valuation of such transactions.

• According to the notice, the IRS and Treasury are aware that certain taxpayers purport to be able to contribute—consistently with sections 704(b), 704(c), and 482—property to a partnership that allocates the income or gain from the contributed property to related foreign partners that are not subject to U.S. tax.

378

Notice 2015-54, p. 387

• The notice further states that many of these taxpayers choose a §704(c) method other than the remedial method and/or use valuation techniques that are inconsistent with the arm’s length standard.

• Based on the experience of the IRS with such taxpayer positions, it has been decided that it will be appropriate to exercise the regulatory authority granted in §721(c) to override the application of §721(a) to gain realized on the transfer of property to a partnership (domestic or foreign) in certain circumstances in which the gain, when recognized, ultimately would be includible in the gross income of a foreign person.

• Use of the remedial method will be mandatory

379

Comparison of Methods

379

Traditional Curative Remedial

Property Contributor Maximizes deferral

Minimizes deferral

Intermediate result, but maximizes allocation of nonrecourse debt under Rev. Rul. 95-41.

Cash Contributor Minimized depreciation

Maximizes depreciation

Intermediate result

380

Selecting An Advantageous Method • The most advantageous method to the contributing partner is the traditional method

because no additional income is allocated to him or her to offset the ceiling rule effects. • The traditional method is least beneficial to the noncontributing partner because a

smaller amount of depreciation is allocated to him or her for tax purposes, due to the ceiling rule limitation.

• The remedial allocation method is more beneficial to the contributing partner than the traditional method with curative allocations when the property has built-in gains.

• Even though both methods increase the contributing partner’s taxable income by creating an offset for the ceiling rule, the remedial allocation method spreads the effects of these allocations over the new life of the property’s built-in gain as opposed to the remaining life of the contributed property itself in the manner done in the traditional method with curative allocations.

• The traditional method with curative allocations will prove to be the most beneficial method to the noncontributing partner because he or she will receive the entire share of tax depreciation over the contributed property’s remaining life.

• The remedial allocation method basically will do the same thing, but the recovery period will be extended to include the new life assigned to the built-in gain portion of the property.

380

381

PLR 201505008 • LLC issuance of preferred interests to IRA and issuance of other

classes of interest terminated S election, IRS grants retroactive relief.

• The Preferred Units were created to be issued to IRAs. The IRS held in Revenue Ruling 92-73 that IRA accounts are not eligible S corporation shareholders, a position upheld in a split decision by the Tax Court in the 2009 case of Taproot Administrative Services, Inc., 133 TC No. 9.

• The good news is that if taxpayers can get the situation corrected and come forward to the IRS voluntarily, the IRS has most often been willing to grant relief. Such a result may very well not be obtained, though, if the issue first comes to the IRS’s attention during an exam—and almost certainly will not be obtained if it becomes clear the taxpayer was aware of the problem but decided to either “play the audit lottery”.

382

PLR 201505008 • The problem with a “quiet fix” (that is, getting rid of the bad

equity rights or shareholders without asking for IRS relief) is that the terminating event still has taken place and the taxpayer therefore has been a C corporation since the date the problem first arose.

• The fact that it may be more than 3 years in the past is not relevant—so there is no legal statute of limitations on the IRS raising this issue in any later year if the matter comes to the agency’s attention.

383

RETIREMENT PLANS, EMPLOYEE BENEFITS

AND ESTATE PLANNING

384

Tibble v. Edison, US Supreme Court No. 13-550 • Supreme Court looked at the period of time a plan fiduciary may

be held liable for a breech of fiduciary duty related to the selection of investments made available to qualified plan participants.

• The Court did not decide that a breech had occurred by failing to remove imprudent investments during the six year period or even that there was a requirement to consider the specific funds.

• Given the unanimity of the Court, it seems reasonable to assume that some level of review is necessary and that those who sponsor such plans should consider carefully reviewing investment offerings for the underlying costs of the investments.

385

IRS Will Challenge FLPs with Regulations • The IRS will soon release proposed regulations under Code

§2704 that are expected to limit the use of valuation discounts in the case of family limited partnerships.

• Code §2704 provides that certain restrictions are disregarded for valuation purposes. The law also permits the IRS to issue regulations providing for other restrictions (as determined by the IRS) to be disregarded in determining the value of a transfer to a family member, if a restriction has the effect of reducing the value of the transferred interest but does not ultimately reduce the value of such interest to the transferee.

• After including new Code §2704 regulations on its list of priority guidance for the past 11 years, it appears (based on comments made by an IRS spokesperson to the ABA Tax Section) that the IRS will soon issue these regulations.

386

IRS Will Challenge FLPs with Regulations • While the scope and specifics of the regulations are unknown, it

is expected that the proposed regulations will restrict the use of discounting by defining new restrictions that are to be disregarded when valuing a transfer of an interest in a family entity.

• The effective date of the proposed regulations and possible “grandfathering” opportunities is unknown.

387

FLP Scorecard • Scorecard of §2036 (retained interest) FLP Cases (13-21, With 2 on

Both Sides). Of the various FLP/LLC cases that the IRS has chosen to litigate, thirteen have held that at least most of the transfers to an FLP qualified for the bona fide sale exception. Including the partial inclusion of FLP assets in two cases, 21 cases have held that §2036 applied to FLP or LLC situations. – Must use the bona fide sale exception announced in Bongard to

avoid; must be a legitimate and significant nontax reason for the partnership.

• In addition to the §2036 issue, the IRS has been arguing that gifts of FLP interests do not qualify for the $14,000 annual exclusion.

• Mirowski – it was ok to pay post-death payments of estate tax and other liabilities from the FLP; but many Tax Court judges are think such payments evidence a retained interest under §2036

388

PFP/LLC Discount Table* Case Assets Court

Discount from

NAV/Proportionate Entity

Value

Strangi I Securities Tax 31%Knight Securities/real estate Tax 15%Jones Real estate Tax 8%; 44%Dailey Securities Tax 40%Adams Securities/real estate/minerals Fed. Dist. 54%Church Securities/real estate Fed. Dist. 63%McCord Securities/real estate Tax 32%Lappo Securities/real estate Tax 35.4%Peracchio Securities Tax 29.5%Deputy Boat company Tax 30%Green Bank stock Tax 46%Thompson Publishing company Tax 40.5%Kelley Cash Tax 32%Temple Marketable securities Fed. Dist. 21.25%Temple Ranch Fed. Dist. 38%Temple Winery Fed. Dist. 60%Astleford Real estate Tax 30% (GP); 36% (LP)Holman Dell stock Tax 22.5%Keller Securities Fed. Dist. 47.5%Murphy Securities/real estate Fed. Dist. 41%Pierre II Securities Tax 35.6%Levy Undeveloped real estate Fed. Dist. (jury) 0 (valued at actual

sales proceeds with no Giustina Timberland; forestry Tax 25% with respect to

cash flow valuation (75% weighting to cash flow factor and

Gallagher Publishing company Tax 47%Koons Cash Tax 7.5%

* From 2015 Heckerling Institute - prepared by John Porter, Houston, Texas

389

Taxpayer wins Case Challenge Comments Church §2036 Preserve family ranching enterprise, consolidate undivided ranch interests

Eugene Stone §2036

Partnerships to settle family hostilities

Kimbell §2036 “Substantial business and other nontax reasons” including maintaining a single pool of investment assets, providing for management succession, and providing active management of oil and gas working interests

Bongard §2036 Placing ownership of closely held company in a single entity for purposes of shopping the company by a single seller rather than by multiple trusts

Schutt §2036 Maintaining buy and hold investment philosophy for family du Pont stock

Mirowski Bona fide sale Joint management and keeping a single pool of assets for investment opportunities

Miller §2036 Continue investment philosophy and special stock charting methodology

Keller §2036 Protect family assets from depletion in divorces

Murphy §2036 Centralized management and prevent dissipation of family legacy assets

Black §2036 Maintaining buy and hold investment philosophy for closely held stock

Shurtz §2036 Asset protection and management of timberland following gifts of undivided interest

Joanne Stone §2036 Managing woodland parcels as a family asset for later development and sales of lakeside homes

Kelly Bona fide sale Ensure equal distribution of decedent’s estate thereby avoiding litigation, provide effective management of quarries and other real estate requiring active management and minimize potential liability concerns

390

Taxpayer Losses Schauerhamer Reichardt Harper Thompson Strangi Abraham Hillgren Bongard Bigelow Edna Korby Austin Korby Rosen Erickson Gore Rector Hurford Jorgensen Miller (as to transfers made 13 days

before death but not prior transfers Turner – plus valuation mismatch between amount included under §2036 and amount allowed as §2056 deduction; opposite Estate of Chenoweth, 88 TC 1577(1987)

Kimbell in district court,but 5th CA reversed

Liljestrand Malkin

391

Annual Exclusion for FLP Interests

Annual Exclusion No Annual Exclusion Estate of Wimmer, TC Memo 2012-157 Hackl, 118 TC 279 (2002), aff’d, 335

F.3d 664 (7th CA, 2003) Price, TC Memo 2010-2 Fischer, 105 AFTR2d 2010-1347 (S.D. Ind. 2010)

• Estate of Turner, TC Memo 2011-209, Tax Court noted the annual exclusion applied whether or not the beneficiaries were aware of the indirect gifts or their withdrawal powers.

• There is absolutely NO AUTHORITY for the position that notice is required; for example, notice was NOT required in the initial Crummey case.

• However, best to not challenge the government on this issue and provide notice each year. IRS agents have been asking us for such notices.

392

Defined Value Clauses • “Excess to Charity” - Formula clause used to determine gift and

to the extent there is an adjustment in value, the excess goes to charity. – McCord, 120 TC 358 (2003), rev’d 98 AFTR 2d 2006-6147 (CA-

5, 2006). – Estate of Petter, TC Memo 2009-280 aff’d 108 AFTR 2d 2011-

5593 (CA-9, 2011). – Hendrix, TC Memo 2011-133 – Estate of Christiansen, 130 TC 1 (2008) 104, AFTR 2d 2009-

7352 (CA-8, 2009)

393

Defined Value Clauses • “Defined value” – Formula clause of a fixed dollar amount to a

noncharitable beneficiary without any express provision governing disposition of any excess over that dollar amount. Any excess remains with the transferor and not transferred to charity. Essentially, this method allows transferor to give “$15,000 of LLC units” for example. – Wandry, TC Memo 2012-88 – this is the “Blockbuster Case of

the Year”. • Careful when reporting the gift – IRS tried to use the manner in

which the gift was reported on the 709 in both Knight and Wandry to assert the transfers were not formula transfers. Practitioners should remove this argument from the Service by reporting the gifts as formula and attaching copies of the formula documents.

394

Wandry, TC Memo 212-88 • The Tax Court held that taxpayers who gave membership units

in a family LLC to their children and grandchildren could, under a formula clause triggered by a post-audit revaluation, reallocate the LLC units so that the value of the number of units to each donee equaled the dollar amount specified in the transfer documents. – The transfer documents included an adjustment formula

clause that provided that the number of LLC units was based on the FMV of gifted units. This number could not be known on the date of the gift, but was to be determined later through an independent appraisal.

395

Wandry, TC Memo 2012-88

– The taxpayers were not bound by the LLC percentage limitations described in the gift tax return. Those percentages were adjustable based on the new valuation and the formula clause.

• IRS initially filed an appeal of the Wandry Tax Court decision to the 10th CA, but later withdrew that appeal.

• Subsequently, the IRS published its non-acquiescence to the Tax Court’s Wandry opinion. AOD 2012-004, 2012-46

• Wandry is not a regular decision; it is a memorandum opinion decided by a single Tax Court judge.

396

Lingering Danger? • Even if the IRS is precluded, under the reasoning of Wandry,

from increasing the value of a dollar-formula gift, the IRS might still attempt to decrease the portion of the property that was successfully transferred and thereby increase the portion remaining in the hands of the taxpayer.

• If the portion remaining in the hands of the transferor is subsequently transferred by gift or at the taxpayer's death, the IRS could claim that the value of that portion is substantially greater than the taxpayer supposes.

• Thus there is a danger the IRS will come back and change the AMOUNT of the gift transferred after the statute has expired leaving the donor with a larger amount in estate (or transferred as a subsequent gift) than anticipated.

397

Types of Formula Clauses • Formula allocation clause, allocating portions of a transferred asset between

taxable and non-taxable transfers based on the subsequent agreement of the parties (McCord, Hendrix)

• Formula allocation clause, allocating portions of a transferred asset between taxable and non-taxable transfers based on values as finally determined for federal gift tax purposes (Christiansen, Petter)

• Clause defining the amount transferred based on values as finally determined for federal gift tax purposes (Wandry)

• Price adjustment clause (King; but McLendon and Harwood did not recognize price adjustment clauses)

• Reversions to donor of excess over a specified value (Procter)—this condition subsequent approach does NOT work. The clause in Procter provided that any amount transferred that was deemed to be subject to a gift tax was returned to the donor.

398

Types of Formula Clauses • Sample Price Adjustment Clause.

The face amount of the Note shall be the fair market value of the Interest on <Date> as determined by an appraisal by <Appraiser>. To the extent it is finally determined for federal gift tax purposes that the fair market value of the Interest on <Date> exceeds the fair market value determined by <Appraiser>, the face amount of the note shall be increased by an amount equal to 99.9997 percent of that excess, rounded down to the nearest whole dollar.

• Sample Defined Transfer Clause. • I transfer that number of units in <Entity> that has a fair market value on the

date of the transfer, as finally determined for federal gift tax purposes, of $<Appraised Value> plus 0.0003 percent of the amount, if any, rounded up to the nearest whole dollar, by which the fair market value of <Target Number> units in <Entity> on the date of the transfer, as finally determined for federal gift tax purposes, exceeds $<Appraised Value>.

399

IRS Hot Audit Issues

• Installment sales to grantor trusts- Woelbing cases (Docket Nos. 30261-13 and 30260-13) scheduled for Trial in TC in Milwaukee on 2/29/16 was recently postponed.

• §2036 retained interests associated with FLPs • Valuations associated with discounts • Formula clauses • Promissory note valuation • GRAT audits

400

Defective Grantor Trust Sales • IDIT sales have been challenged in Karmazin, Docket 2127-03,

Woelbing 30260-13 and 30261-13 and Davidson 13748-13 stipulated decision 7/6/15. – Settlements in Karmazin and Davidson are considered

taxpayer successes. – Woelbing trial recently was postponed again—was scheduled

for 2/29/16. • The President’s Greenbook contains a proposal that, if enacted,

would effectively shut down IDIT sales. General Explanation of the Administration’s Fiscal Year 2016 Revenue Proposals, Department of the Treasury (Feb. 2, 2015).

• Avoid the §2036 issue by having the grantor’s spouse or another grantor trust loan funds to the trust that will purchase the assets from the grantor, so that note payments will not thereafter be made to the grantor/seller.

401

Defective Grantor Trust Sales

• Another strategy to consider is to be sure there is sufficient see money. In a private annuity case, (Trombetta), Judge Cohen refused to give effect to personal guarantees.

402

FLP Challenges • The most litigated issue is whether assets contributed to an

FLP/LLC should be included in the estate under §2036 (without a discount regarding restrictions applicable to the limited partnership interest).

• There have been about 37 reported cases. – The IRS typically argues that assets should be included under §2036(a)(1)

as a transfer to the FLP/LLC with an implied agreement of retained enjoyment.

– In a few cases, it has also made a §2036(a)(2) argument, that the decedent has enough control regarding the FLP/LLC to designate who could possess or enjoy the property contributed to the entity. The government wins about 2/3 of those cases. (In some of those cases, the FLP/LLC assets have been included in the estate under §2036 even though the decedent had transferred the partnership interests during life (Harper, Korby).)

403

FLP Challenges • Almost every one of the FLP cases that the taxpayer has won

was based on the bona fide sale for full consideration exception to §2036. (The two exceptions are Kelly and Mirowski, which held there was no retained enjoyment under §2036(a)(1) as to gifts of limited partnership interests.)

• The key is whether there were “legitimate and significant nontax reasons” for using the entity.

404

FLP Challenges • Factors that have been recognized as constituting such a

legitimate nontax reason. – Centralized asset management (Stone, Kimbell, Mirowski,

Black) – Involving the next generation in management (Stone,

Mirowski, Murphy) – Protection from creditors/failed marriage (Kimbell, Black,

Murphy, Shurtz) – Preservation of investment philosophy (Schutt, Murphy,

Miller)

405

FLP Challenges • Section 2036(a)(1) Implied Agreement of Retained Enjoyment.

Courts have considered the following factors in determining that there was an implied agreement of retained enjoyment – Non pro-rata distributions (Harper, Korby, Thompson) – Personal expenditure with partnership funds (Strangi,

Hurford, Rector) – Personal use assets in partnership (Strangi) – Payment of estate tax and expense when assets were

transferred to the FLP/LLC close to death (Miller, Strangi, Erickson, Jorgenson, Bigelow)

– Accurate books and records not kept (Harper) – Insufficient assets outside of FLP/LLC for living expenses

(Thompson, Miller, Strangi, Rector)

406

Cavallaro, p. 517 of the 2014 Outline

• A merger of two family companies, one owned by the parents of the family and one owned by their sons, resulted in a taxable gift being made from the parents to the sons because the parents' company was undervalued.

• The dispute largely revolved around whether the ownership of certain valuable technology had been informally transferred to the sons' company when it was initially incorporated or whether it remained with the parents' company at the time of the merger.

407

Law Office John H. Eggertsen, p. 402

• The Court of Appeals for the Sixth Circuit, in a divided opinion in which it affirmed the Tax Court and agreed with the IRS, has held that the general statute of limitations (SOL) on assessment rules contained in §6501 apply to §4979A(a)’s excise tax on employee stock ownership plans (ESOPs).

• It also held that the general SOL never started running on the assessment of that excise tax in this case, and the Tax Court acted properly when it reconsidered its earlier decision that only the SOL contained in §4979A itself applied.

• Because the Law Office failed to file a Form 5330 for 2005, or another document that qualified as a return for §4979A(a) purposes, the excise tax under §4979A could be assessed at any time under §6501(c)(3).

408

Ellis, p. 405

• The Court of Appeals for the Eighth Circuit, affirming the Tax Court, has concluded that where an individual taxpayer had his IRA own the shares of his business, a limited liability company (LLC), the LLC’s payment of compensation to the taxpayer for his services to the LLC was a prohibited transaction resulting in disqualification of the IRA and a deemed distribution of its assets.

• The Tax Court also rejected the claim that §4975(d)(10) exempted the transaction. That provisions provides an exemption for reasonable compensation paid to a fiduciary for performance of duties of the plan. The Court found the payments were not for his duties of managing the investments of his IRA, but rather being the general manager of the car dealership.

409

In re: Kellerman, Docket No. 4:09-bk-13935

• The Court agreed with the creditor’s that the taxpayer’s IRA had engaged in prohibited transactions when it purchased real estate in partnership with a controlled entity.

410

Estate of Ellen D. Foster, p.407

• The Supreme Court declined to review a decision of the Court of Appeals for the Ninth Circuit, which affirmed the Tax Court's estate tax valuation determinations, including a determination that claims against the estate did not create valuation discounts for certain of the estate’s assets and did not meet the relevant tests for deductibility as liabilities of the estate.

• The Tax Court ruled against all of the Estate’s arguments. – As to the litigation hazards argument, it said that a willing buyer would not have

insisted on a discount on the assets of the marital trusts because the Keach lawsuit could not have affected a buyer’s rights.

– As to the lack of marketability, it said that the freeze may have prevented decedent from selling any of the assets of marital trust #3, but it did not affect the value of those assets.

– And as to the Estate’s liability resulting from the Keach lawsuit, the Court found the Estate failed to establish the amount of the liability with reasonable certainty, as required by the applicable Regulation.

The Ninth Circuit said the Tax Court did not err in declining to apply discounts for hazards of litigation or lack of marketability.

411

Hughes, p.409

• A purported gift of shares by a retired partner of KPMG, LLP to his nonresident alien spouse did not result in a stepped-up basis of the shares in her hands.

• Even if a gift had been made, the shares would have had a zero basis because gifts are not income taxable events.

• The former partner was hit with a substantial valuation misstatement penalty on the general premise that “he should have known better than to claim a stepped up basis for the shares.”

412

King v. Burwell, p. 411

• The Supreme Court, by a 6-3 margin, determined that premium tax credits under §36B, also known as health insurance subsidies, are not limited solely to taxpayers who live in states that have established their own Health Insurance Exchange but are also available to taxpayers residing in states that have a Federal Exchange.

• The Court, while acknowledging that the challengers’ plain-meaning arguments were strong, concluded that allowing the subsidies for insurance purchased on any Exchange was consistent with the purpose of the ACA.

413


• The scathing dissent, written by Justice Scalia and joined by Justices Thomas and Alito, found that the language “Exchange established by the state “was clear and unambiguous, that buying health insurance on such a state-established Exchange is a prerequisite to receiving health insurance subsidies, and that the subsidies are thus not available to taxpayers who purchase health insurance on Federal Exchanges.

• Justice Scalia criticized the majority’s position as “absurd” and wrote that “normal rules of interpretation seem always to yield to the overriding principle of the present Court: The ACA must be saved. “

• He later stated that the ACA should instead be referred to as “SCOTUScare.”

414


• The dissent stated its agreement that context matters, but stated that context is “a tool for understanding the terms of the law, not an excuse for rewriting them.” The dissent also noted that the phrase “by the state” was used not just once in the ACA, but seven times in connection with tax credits.

415

Klaassen, 83 AFTR 2d 99-1750 (4/7/99)

• “In the absence of exceptional circumstances, where a statute is clear and unambiguous our inquiry is complete….If, as the Klaassens claim, Congress had intended the AMT to apply only to taxpayers whose incomes reached a certain threshold, or only to taxpayers with §57 tax preferences, it could have easily drafted the statute to achieve that result. Instead, as the tax court correctly held, the statute's plain language unequivocally reaches the Klaassens, and our inquiry is therefore complete. While the law may result in some unintended consequences, in the absence of any ambiguity, it must be applied as written. It is therefore from Congress that the Klaassens should seek relief.”

• There are numerous cases where the court has acknowledged the law was unfair, but the redress was to Congress.

416

Balestra, 113 AFTR 2d 2014-887 • “suboptimal tax laws are still valid tax laws” in upholding the

taxation of deferred compensation in 2004 for a taxpayer that was clear even when included in the employee’s income would never be paid.

• The Court note that, under the standard imposed by the U.S. Supreme Court in the case of Mayo, 131 S. Ct. 704, a regulation interpreting a ambiguous provision of the statute must be upheld if it is reasonable. – The Court found, given its analysis, that the IRS’s

interpretation was a reasonable one for what might be charitably called a “flawed” statute.

• Cal Pure Pistachios, Inc. v. United States, 115 AFTR 2d ¶2015-643 -merely because the Code produces harsh results that does not change the fact that the law must be applied as written.

417

Guralnik v. Commissioner, Docket No. 4358-15 • Taxpayer’s attorney chose “First Overnight” as option to send

petition to Tax Court. • However reasonable it may appear. “First Overnight” did not

exist as a service when Notice 2004-83 was issued, being added by FedEx after that notice was issued in 2004.

• To qualify for §7502’s timely mailing is timely filing rule the service must be one that is on the IRS approved list.

• First Overnight was not added to that list until May of 2015 in Notice 2015-38. Thus, the IRS argued, the taxpayer did not have the protection of §7502 and the petition had to reach the Tax Court by the final day for filing.

418

Kott, p. 414

• A taxpayer who was younger than age 59-1/2 was liable for the 10% early distribution penalty when he withdrew funds from a §401(k) plan because he was delinquent in his mortgage payments and wanted to avoid foreclosure.

• Roth recharacterizations must be added back to the year end account balance before determining the RMD for the year.

• If this is not done, there will be an underpayment of the RMD which is subject to a 50%. The penalty is reported and calculated on IRS Form 5329.

• Form 5329 is considered a tax return because it has a signature line. If the penalty is not reported on Form 5329, the statute of limitations does not start to run. Thus the taxpayer will continue to owe the penalty, year after year, plus interest, plus failure to file penalties, and perhaps accuracy related penalties, plus interest.

419

Israel Mikel, TC Memo 2015-64 • Married taxpayers granted partial summary judgement that

each of their multiple separate gifts of applicable annual exclusion amount to family trust's 60 beneficiaries was gift of present interest, not future interest as IRS determined, because trust declaration clearly gave beneficiaries unrestricted right during subject year to withdraw amount equal to maximum gift tax exclusion amount.

• Their demands could not be “legally resisted” by trustees. – IRS's argument that withdrawal right must not only be legally irresistible

under trust instrument but also legally enforceable, and that such in turn meant beneficiaries had to be able to go before state court to enforce same, was flawed and contrary to fact that trust provided for enforcement through other means. Or, even if state court enforcement remedy were required, such was both literally and practically available in this case under operative in terrorem provision.

• In WI terrorem clauses are not useful.

420

Estate of Pulling, TC Memo 2015-134

• Mere fact land would be more valuable if sold along with tracts owned by other party (in which had a 28% ownership interest) does not mean assumption of combination is to be made to value estate property

• The estate held three parcels of land that were part of a set of five contiguous parcels of land that, if combined, could be developed. However unless that combination took place then development of the three parcels held by the estate was not economically feasible. At the moment the land was zoned for agricultural use.

• The other two parcels were held by an entity in which the decedent held a 28% interest and over which he had influence, but he could not unilaterally cause the related entity to dispose of its parcels. Over 50% was held by Pulling family members.

421

Our Country Home Enterprises, p. 414 • In consolidated cases, the Tax Court concluded that a purported

welfare benefit plan was really a split-dollar insurance arrangement, corporate employers could not deduct payments made to the plan. Further, the court held that the shareholder-employees for whom the insurance was purchased were required to realize income from the policies.

• Decision involved test cases involving “Sterling Plans” that were widely marketed as ways to get tax free benefits to owners and employees.

• Decision by Judge Laro who also decided Booth, 108 TC 524 (1997) and Neonatology Assocs., P.A. v. Commissioner, 115 T.C. 43 (2000), aff'd, 299 F.3d 221 [90 AFTR 2d 2002-5442] (3d Cir. 2002), and its progeny.

• This plan was tweaked based on informal IRS feedback, but still was found deficient by the Tax Court.

422

QinetiQ U.S. Holdings Inc. p.417

• Where a corporation issued 49.75% of its stock to an employee shortly after the formation of the corporation, a successor corporation could not take a compensation deduction with respect to the stock many years later. – After th merger, QinetiQ tried to claim a $118 million

deduction under §83 arguing that although the stock was transferred in 2002, it was transferred in connection with the performance of services and did not vest until the end of 2009.

• Although there was some question as to whether the stock was issued in the connection with the performance of services; there was no substantial risk of forfeiture at the time of the stock issuance. – Being subject to buy-back provisions in a shareholders agreement is not a

substantial risk of forfeiture.

423

Ries Enterprises Inc., p.422

• The Court of Appeals for the Eighth Circuit has affirmed a Tax Court decision that an S corporation was liable for a $161, 200 excise tax because its employee stock ownership plan (ESOP) violated the anti-abuse provisions of §409(p) by allocating shares during the tax year at issue to the plan’s sole participant and sole employee, who was a disqualified person.

• Essentially, the owner of an S that sells to an ESOP cannot be part of the plan.

424

Specht, p.426

• A district court has held that, where the attorney for an estate failed to perform numerous duties with respect to the estate, including timely filing the estate tax return, and told the unsophisticated executor that the attorney had received all necessary extensions, the estate did not meet the reasonable cause/not willful neglect standard for avoiding late filing and late payment penalties where the executor had evidence that the attorney was lying.

• Repeated malpractice by return preparer not reasonable cause for estate's late filing

425

Jean Steinberg, p. 427

• Where a taxpayer gave her children property in exchange for their promise to pay any estate tax liability arising under §2035(b)’s “gross-up rule,”—which increases a decedent’s gross estate by the amount of any gift tax paid by the decedent or the decedent’s estate on any gift made by the decedent during the three-year period preceding the decedent’s death—the fair market value of that property for gift tax purposes was reduced by the value of the children’s assumption of the potential §2035(b) estate tax liability.

• This is a so-called “net net gift.” It is a valuable planning technique that is drawing IRS objections because of its tax-savings feature.

426

Jean Steinberg, Donor

• In McCord, (2003) 120 TC 358, the Tax Court held that the value of a gift could not be reduced on account of the donees’ agreement to pay any increased estate tax that would occur under §2035(b) if the donors were to die within three years of the gifts.

• The Tax Court found the assumption of the taxpayers’ potential estate tax liability was too speculative to be reduced to a monetary value.

• However, the Fifth Circuit reversed and remanded this decision. (McCord v. Comm., (CA5 2006) 98 AFTR 2d 202006-6147)

427

U.S. v. Marshall, p.432 • The Court of Appeals for the Fifth Circuit, withdrawing its earlier

decision and reversing in part the district court, has ruled that donees of an indirect gift were liable for gift tax and interest only to the extent of the value of the gift.

• Indirect gift occurred when shareholder redeemed shares at less than FMV.

• The Code imposes the gift tax on the donor, but it also imposes transferee liability for the gift tax on the donee if the tax is not paid when due.

• In that event, the donee of any gift is made personally liable for the tax to the extent of the value of that gift.

• The Fifth Circuit looked at the plain language of §6324(b), which it noted was the sole basis for imposing liability on a donee for gift taxes unpaid by the donor.

428

Vee’s Marketing, p. 434

• A district court held that an S corporation participated in a 10-or-more employer welfare benefit fund that was the same as or substantially similar to the arrangement described in Notice 95-34, 1995-1 CB 309, which requires taxpayers to file a disclosure form if the taxpayer participates in a listed transaction, (i.e., a transaction that is identified by IRS as a tax avoidance transaction).

• Accordingly, the district court denied the taxpayer’s refund claim for penalties it had paid for its failure to disclose the required information.

429

PLR 201528001, p.481

• A taxpayer who wished to elect to recognize income in the year that he received property as compensation, notwithstanding the fact that the property was subject to a substantial risk of forfeiture when he received it, had effectively made that election despite the fact that he did not submit to IRS a statement required by the relevant Regulation.

• IRS said that the taxpayer fulfilled the requirements for a valid election under §83(b) when his statement was mailed to the IRS office.

• Failure to submit a copy of the statement with his tax return did not affect the validity of the election. Therefore, to the extent that taxpayer's receipt of Company A stock constituted a transfer of property under §83, the election under §83(b) with respect to that stock was in effect.

430

Prop. Reg. §1.83-2, p. 447

• The Proposed Regulations eliminate the requirement that taxpayers must submit a copy of a §83(b) election with their tax return for the year in which the property subject to the election was transferred. (Proposed Regulation §1.83-2(c)) This is accomplished by removing the second sentence from the current version of Regulations §1.83-2(c).

• The Regulations are Proposed to apply as of January 1, 2016, and would apply to property transferred on or after that date.

• However, taxpayers may rely on these Proposed Regulations for property transferred on or after January 1, 2015.

431

TD 9725 Portability, p.458

• Final regulations concerning electing portability of the DSUE amount to the surviving spouse.

• An election for portability is required. • Upon the timely filing of a complete and properly prepared

estate tax return, the estate of a decedent survived by a spouse will have elected portability of the DSUE unless the executor chooses not to elect portability by an affirmative statement on the estate tax return.

• The failure to timely file a Form 706 is a failure to elect portability.

• An extension under §301.9100-3 to elect portability is not available to an estate required to file a return.

432


• The extension may be available to estates that are under the value threshold for required estate tax return filing, because that due date for portability is prescribed by regulation.

• The election is irrevocable after the due date of the estate tax return, including extensions actually granted, is passed.

• The appointed executor is permitted to make the election. If there is no appointed executor, any person in actual or constructive possession of any property of the decedent may elect portability.

433


• The identity of the last deceased spouse is unchanged by subsequent marriage or divorce of the surviving spouse.

• A surviving spouse with multiple deceased spouses may have previously applied DSUE amounts to taxable gifts. In that case, special rules apply to determine the DSUE.

• Executors of estates that are not otherwise required to file an estate return but file for portability election reasons are not required to report the value of certain property that qualifies for the marital or charitable deduction.

• The executor is required to report the best estimate of the value of properties subject to the marital and charitable deduction that are excluded from detailed valuation reporting, and to do so within a particular range in accordance with IRS instructions for Form 706.

434


• Recapitulation of Form 706, line 10 is used to disclose the range of estimated value of the properties excluded because of eligibility for the marital or charitable deduction. The Form 706 instructions contain a table directing that the total estimated value of these assets be disclosed within a series of ranges that move in $250,000 increments.

• Although a range of estimated values can be reported on Form 706 for marital and charitable deduction property associated with a portability election, the tax basis of marital property is important to the surviving spouse. Accordingly, in the estate administration process, the executor still has a need to identify and value each asset.

435

Consistency of Basis • The Highway Bill imposed new reporting requirements with

regard to the value of property included in a decedent’s estate. • The executor of any estate (or if no executor, the person or

persons in actual or constructive possession of the decedent’s property required to file a Form 706 must furnish a statement identifying the value of each interest in property as reported on the estate tax return.

• The information return must be furnished by the earlier of 30 days after Form 706 is actually filed or the due date including extensions. If there is an adjustment to the information, supplemental statements are required within 30 days of the adjustment.

• The requirement is imposed for property with respect to which an estate tax return is filed after July 31, 2015.

436

Consistency of Basis • The IRS delayed the due date until February 29, 2016 for the

filing of any basis information returns due earlier, in order to allow for guidance to be issued. No statements should be filed until the issuance of forms or further guidance. Notice 2015-57.

• The failure to file the information returns for estates filing Form 706 after July 31, 2015 causes a $500 penalty for each failure to provide a copy to the beneficiary and another $500 penalty for each failure to provide a copy to the IRS.

• The statute does not apply to IRD property that does not receive an adjustment to basis at death.

437

Consistency of Basis • Effective for property with respect to which an estate tax return

is filed after July 31, 2015, the basis of inherited property may not exceed the final value imposed for purposes of the estate tax.

• If the final value has not been determined, the basis cannot exceed the value reported on an information return.

• This basis limit only applies to property included in the estate which increased the liability for the estate tax (reduced by allowable credits).

• The determination of value is based on one of three situations 1. The value of property is that reflected on Form 706 if the value is not contested

before the statute of limitations expires for assessing the estate tax. 2. Otherwise, the value is as specified by the IRS and that value is not timely

contested by the executor; or 3. The value is determined by a court or pursuant to an IRS settlement agreement.

438

PLR 201446030, p.470

• The acquisition of shares of a trust invested in gold by either an IRA or an individually directed account under a qualified retirement plan will not be considered the acquisition of a collectible under §408(m).

• The amount invested will not be treated as distributed under §408(m)(1).

• IRS reached this result even though trust shares are designed to mirror the physical market in gold.

439

PLR 201510060, p.474

• Two additional payments received in one tax year will not result in a modification to a series of substantially equal periodic payments being made under §72(t), and will not subject the recipient to the 10% additional tax on early distributions from IRAs.

• The additional payments were the result of a financial institution’s error and were not intended to be a modification to the substantially equal payments.

440

PLR 201523003, p.475

• A married couple’s elections to split gifts with respect to property that the husband contributed to several trusts over several years were improper because the wife was a potential beneficiary of the trusts, but that the election was nonetheless effective for those years for which the statute of limitations on assessment had expired. – Spouses may elect to treat a gift made by one spouse to a third person as

if the gift had been made half by each. – Treating half of the gift as made by each spouse, regardless of who actually

made the gift, allows the annual exclusion and applicable credit amount available to each spouse to be used to offset the gift.

– However, if the election to split gifts is made, all gifts made by the spouses during the calendar year must be split (which means the election cannot be made on a gift-by-gift basis).

441

CCA 201519031, p.487

• Guidance on whether stock that an employee purchased via an incentive stock option is considered disposed of, for purposes of the incentive stock option rules, when his employer is merged into another corporation.

• Generally, has to qualify as a tax-free reorganization even if there is boot.

442


• Taxpayer failed to disclose gifts (a transfer of interests in two partnerships) to his daughter in a manner adequate to apprise IRS of the nature and amount of the gifts.

• He failed to sufficiently identify one of the partnerships and to adequately describe the method used to determine the fair market values of both partnership interests. As a result, the period of limitations for the gift tax was held open indefinitely under §6501(c)(9).

• National Office of the IRS personnel have stated publicly that one of their strategies is to “nitpick” disclosure to avoid the running of the statute of limitations.

443

PROCEDURES, PENALTIES AND OTHER ADMINISTRATIVE

444

BASR Partnership v. U.S. p.517 • The Court of Appeals for the Federal Circuit, affirming the Court of

Federal Claims, has determined that there can be a suspension of the three-year limitation period for fraud under §6501(c)(1) only when the taxpayer, and not a third party, acts with the requisite intent to evade tax.

• Thus, a final partnership administrative adjustment (FPAA) issued by IRS to a family limited partnership, which was used as part of a tax shelter transaction, was untimely, where there was no allegation that the taxpayers themselves—as opposed to the tax shelter promoter—had any intent to evade tax.

• Allen TC 128 TC No. 4 – Tax Court held unlimited statute applied to taxpayer even though did not have fraudulent intent.

• City Wide Transit, Inc. v. Commissioner, TC Memo 2011-279, the Tax Court did not allow unlimited statute to apply where fraud on part of tax preparer—but the Second Circuit disagreed with the Tax Court, finding that the IRS could proceed with assessing unpaid payroll taxes (2013-1 U.S.T.C. ¶50,211).

445

Gann v. U.S. p. 537

• The Court of Federal Claims has determined on summary judgment that the director/majority shareholder of a staffing company was a “responsible person” for purposes of the §6672 penalty, but found that whether he acted willfully in failing to pay the company’s payroll taxes was in dispute.

• The court found that what he knew, when he knew it, and whether he was specifically misled as to whether payments were being made after initially learning of the company's tax problems, were material questions of fact to be resolved at trial.

446

John C. Hom & Associates, Inc. p. 546 • In a summary opinion, the Tax Court has held that where an

owner-president of a small corporation failed to file the corporation’s Forms W-2 with the Social Security Administration (SSA), but sent Forms W-2 to his employees and believed he sent them to SSA, the corporation was liable for the failure-to-file penalty but not the intentional disregard penalty.

• The Court also ruled on the effect of prohibited communication between an IRS revenue agent and an IRS Appeals Division settlement officer.

• It came to light that the revenue agent in the case had engaged in prohibited communication with Cochran, which included his statement to Cochran that Hom was “difficult to deal with” and “very argumentative and unwilling to listen.”

447

John C. Hom & Associates, Inc. p. 546

• The Tax Court noted cases in which prohibited communication between and IRS agent and an IRS Appeals SO resulted in a remand to the Appeals Office for a new §6330 hearing with an independent Appeals officer who had received no communication relating to the credibility of the taxpayer or the taxpayer's representative.

• See, e.g., Drake, (2005) 125 TC 201.

448

Ibrahim, p. 549

• The Court of Appeals for the Eighth Circuit, reversing the Tax Court, has held that a taxpayer who had incorrectly filed using the head-of-household status was not barred under §6013(b) from changing his status to "married filing jointly.“

• In general, a taxpayer may amend in order to file a joint return for a prior year, if the taxpayer filed separately but could have filed a joint return. But the statute prohibits filing a joint return in these circumstances after a notice of deficiency has been mailed to either spouse, if the notified spouse has filed a timely petition with the Tax Court.

• In Glaze, (CA 5 1981) 47 AFTR 2d 81-1224, the Court of Appeals for the Fifth Circuit held that “separate return” as used in §6013(b) refers only to married filing separate status and not to any other filing status.

449

Ibrahim, p. 549

• In Rev. Rul. 83-183, 1983-2 CB 220, IRS announced that it will not follow Glaze.

• The Tax Court has held that §6013(b)(2) applies to married taxpayers who file returns with an incorrect status, such as head of household or single filer. See, e.g., Currie, TC Memo 1986-71 and Blumenthal, TC Memo 1983-737.

• The reason this case is important is that because the individual could no longer file married filing jointly, he was denied the earned income tax credit. As a result, the taxpayer went from receiving a large refund to having a tax due.

450

Kardash, p.555

• Taxpayers who were both minority shareholders and high-level employees of a corporation from which the majority shareholders siphoned substantially all the cash without paying the corporation’s income taxes, were liable for those taxes as transferees, with respect to some monies the taxpayers received from the corporation but not with respect to other monies.

451

Levi, TC Memo 2015-118

• Attorney could not sign tax return on behalf of taxpayer even with an executed Power of Attorney (Form 2848).

• Under §1.6012-1(a)(5) a third party can sign a return on behalf of the taxpayer only in the following circumstances: 1. Disease or injury that renders the taxpayer unable to sign

the return, 2. Continuous absence from the United States (including

absence from Puerto Rico) for a period of at least 60 days prior to the date required by law for filing the return, or

3. Specific permission is requested of and granted by the IRS for other good cause.

452

Musa, p.576

• A restaurant owner who did not report significant amounts of cash that he skimmed from his restaurant, lied to his accountant and payroll service company, and committed other misdeeds was liable for the civil fraud penalty with respect to his entire underpayment.

• The Court also applied the Cohan rule to allow some of his business deductions but not others.

• This case involved a popular Milwaukee restaurant as well as a number of individuals in Milwaukee’s legal community - needless to say, it is interesting reading.

453

Petaluma FX Partners LLC, p.583

• In the latest in a long series of cases involving whether certain issues can be decided in partnership-level court proceedings, the Court of Appeals for the District of Columbia has held that the Tax Court, in a partnership-level proceeding, had jurisdiction to determine the applicability of accuracy-related penalties to partners.

454

William R. Shore v. U.S. p. 597

• A district court has denied a refund of a responsible person penalty that had been paid by the owner of a company who had delegated duties to a manager who ended up embezzling funds from the company.

• While the court sympathized with the owner, it found him liable for the penalty because he was a responsible person and he paid unsecured creditors after learning of the manager’s failure to pay IRS.

455

Waterhouse, p. 610

• The Court of Federal Claims has held that the 40%-owner vice president of a corporation, who had agreed with the 40%-owner president of the corporation not to exercise any independent authority over the corporation's finances, was nonetheless a responsible person for purposes of §6672.

• The Court acknowledged that it is important for partners to divide up duties and to not interfere with each other; but in this case, what makes sense from a business perspective, did not mean that the noninvolved partner could escape his responsible person penalties.

456

Legal Advice 2015-003, p. 632

• In generic legal advice, the Associate Chief Counsel (Procedure & Administration) has concluded that in the course of a TEFRA partnership exam, IRS is not required to link or not link any, all, or some partners in a partnership on its Partnership Control System (PCS) database.

• The Associate Chief Counsel also concluded that IRS is not required to issue any notice to a partner if it decides not to make adjustments to the partnership return, and it does not need to notify a partner that it will not be subject to an assessment.

457

CCA 201519029

• Preparer penalty for understatement of liability due to willful or reckless conduct may be assessed if the return preparer made an amended return which was never filed.

• Preparer penalty for understatement of liability due to willful or reckless conduct may be assessed if amended returns were filed but the Internal Revenue Service (Service) disallowed the refund.

• The mere preparation of a claim for refund after the statute of limitations had expired does not give rise to a preparer penalty. the three penalties.

• 201514008 -Penalty under §6694 may be assessed against preparer within three years after meritless refund claim was filed.

458

Schedule of User Fees User Fees

Category of Request

Prior to Feb. 2, 2015

After Feb. 1, 2015

Accounting Periods –Form 1128, Application to Adopt, Change or Retain a

Tax Year $2,700 $4,200

–Form 2553, Part II, Election by a Small Business Corp. to use a fiscal year based on business purpose

$2,700 $4,200

– Letter ruling request under Reg. 301.9100-3for extension of time to file Form 1128, Part II of Form 2553, or Form 8716, Election to Have a Tax Year Other Than a Required Year

$2,000 $3,700

Accounting Method Changes – Advance consent: Form 3115 $7,000 $8,600 –Letter ruling request under 301.9100-3 for extension of

time to file Form 3115 $9,000 $9,100

Private Letter Ruling (PLR) Requests – For late election relief under Reg. 301.9100-3 $6,900* $9,800* – All other PLR requests $19,000 $28,300 Reduced user fees for filers with gross income: – Under $250,000 $2,000 $2,200 – Under $1,000,000 but > $250,000 $5,000 $6,500

* Note: Reduced user fees are not available for general late election relief under Reg.

301.9100-3

459

“Hall of Fame” Tidbits from prior years’ presentations

460

William P. Adams p.1 of 2013 Outline • A taxpayer satisfied the "held for productive use in a trade or

business or for investment" requirement of §1031(a) with respect to a single-family residence acquired as replacement property in a like-kind exchange that was subsequently rented out to the taxpayer's son. – The son and his family completed a substantial rehabilitation

of that residence, and several months later began living in the property paying rent of $1,200 a month. The court considered the rent a FMV because of the substantial work the son did in rehabilitating the residence.

461

Reesink p.166 of 2013 Outline • Although a married couple ultimately used the replacement

property in a like-kind exchange as their personal residence, they had investment intent with respect to that property at the time that they acquired it and thus qualified for nonrecognition treatment under §1031.

• Owned multiple properties with mortgages and had gotten into financial trouble.

• Testified credibly they had not planned on the situation. • Tried to rent the property and showed it to potential renters. • Waited almost eight months before moving in. • This case is not a bright line but rather illustrates that investment

or business status of the replacement property is based on the taxpayer’s intent at the time of the exchange.

• Showed had requisite intent to rent and due to unforeseen circumstances had to move in

462

Dagres, (2011) 136 TC No. 12.

• The Tax Court has determined that a venture capitalist was entitled to claim a §166(a) business bad debt deduction for the amount that he forgave on a loan made to a business acquaintance to ensure that the borrower would first inform him of any promising investment opportunities.

• Court determined that the taxpayer was in the trade or business of managing venture capital funds and that his bad debt loss was proximately related to that trade or business, and rejected IRS’s argument that the debt was personal in nature.

463

Morton v. U.S. (Ct Fed C14/27/2011) 107 AFTR 2d ¶2011-762. • The Court of Federal Claims has held that an individual

could treat his individual business activities, and those of his controlled S corporations, as one "unified business enterprise" for purposes of deducting business expenses and depreciation relating to several airplanes.

• However, the Court deferred judgment on whether the writeoffs could be claimed (and whether a like-kind exchange of planes qualified under §1031) until it was presented with evidence substantiating the business purpose of the planes’ usage.

• Important case for clients with airplanes. • One of the founders of Hard Rock Café.

464

Morton v. U.S. (Ct Fed C14/27/2011) 107 AFTR 2d ¶2011-762.

• The Court of Federal Claims has held that an individual could treat his individual business activities, and those of his controlled S corporations, as one "unified business enterprise" for purposes of deducting business expenses and depreciation relating to several airplanes.

• However, the Court deferred judgment on whether the writeoffs could be claimed (and whether a like-kind exchange of planes qualified under §1031) until it was presented with evidence substantiating the business purpose of the planes’ usage.

• Important case for clients with airplanes. • One of the founders of Hard Rock Café.

465

Barry Moore, TC Memo 2007-134

• Vacation home does not qualify for §1031 treatment. • Cannot argue holding for longer-term appreciation and

therefore it constitutes an investment. • Rev. Proc. 2008-16 safe harbor: the IRS will not challenge that a

property qualifies for §1031 gain deferral if the relinquished property has been held for at least 24 months immediately preceding the exchange and in each of the two 12-month periods immediately preceding the exchange, – the taxpayer rents the residence to another person at fair

market value for at least 14 days, and – the taxpayer does not use the property more than the

greater of 14 days or 10% of the total number of days the property was used; and

466

Barry Moore, TC Memo 2007-134

• Rev. Proc. 2008-16 safe harbor: the IRS will not challenge that a property qualifies for §1031 gain deferral the replacement property is held for at least 24 months immediately after the exchange and in each of the two 12-month periods immediately following the exchange, – the taxpayer rents the residence to another person at fair

market value for at least 14 days, and – the taxpayer does not use the property more than the

greater of 14 days or 10% of the total number of days the property was used.

467

Vanney Associates, Inc. p. 39

• Company was not entitled to deduct the portion of a bonus paid to its Chief Executive Officer (CEO) and sole shareholder that it did not have the funds to honor and that the CEO returned to the company in the form of a loan.

• The Court found that the CEO did not truly have unrestricted use of the funds and rejected the company’s argument that it could have acquired a loan to cover the payment.

• On December 30, 2008, in accord with the Vanneys’ practice of paying Vanney Associates’ remaining profits at year-end to Mr. Vanney as a bonus, Vanney Associates paid Mr. Vanney $815,000 (after tax withholding, etc., $464,183).

468

Vanney Associates, Inc. p. 39

• Court disallowed the entire deduction and not just the amount for which there was insufficient funds.

• Mr. Vanney signed the check on behalf of Vanney Associates then endorsed it in his own name and made it payable to Vanney Associates, without ever attempting to cash it.

• Ms. Vanney recorded the payment on the books as a loan from Mr. Vanney, and the company repaid him in March 2009.

• Tax Court Judge Ronald Buch – Obama appointed.

469

Stephen G. Woodsum and Anne R. Lovett, (2011) 136 TC No. 29.

• The Tax Court has held that an investment firm director and his wife could not avoid an accuracy-related penalty arising from their return preparer's failure to include a $3.4 million capital gain on their return.

• Although the taxpayers hired competent professionals and provided them with all relevant information, including over 160 information returns, their argument that they relied professional advice was rejected where the overall facts of the case showed that the omission was not the result of any analysis or judgment.

470

Community Property Issue • Married filing separate returns generally must report 50% of

community income, regardless of who earns. • §1.66-2(a) can report 100% on return of spouse who earns

provided: 1. the spouses must have been married to each other at some time during

the calendar year; 2. the spouses must have lived apart at all times during the calendar year; 3. the spouses must not have filed a joint return under section 6013 for a

taxable year beginning or ending in the calendar year; 4. at least one of the spouses must have earned income during the

taxable year that is community income; and 5. the spouses must not have transferred any of the income (directly or

indirectly) to each other before the close of the calendar year. De minimis transfers do not negate this rule.

471

Recission

• Recission - Rev. Rul. 80-58 -you can undo a transaction in the same taxable year. IRS cites favorably in

• PLR 200923010 where undid a distribution of subsidiary stock

• PLR 200613027 where rescinded conversion of LLC to C corporation.

• 200533002 and 200613027 rescinded transfers of ownership to re-establish favorable entity level tax treatment.

472

Comparison of Methods

Traditional Curative Remedial

Property Contributor Maximizes deferral

Minimizes deferral

Intermediate result, but maximizes allocation of nonrecourse debt under Rev. Rul. 95-41.

Cash Contributor Minimized depreciation

Maximizes depreciation

Intermediate result

473

Investor Status Case Year # of trades $ Volume Days of Trading

Holsinger v. Comm., 2001 289 $754K 63

TC Memo 2008-191 2002 372 110

Kay v. Comm., 2000 313 $20M 73

TC Memo 2011-159 2001 172 $1M-2.5M 18

2002 84 $1M-2.5M 21

van der Lee v. Comm., 2002 189

TC Memo 2011-234

Nelson v. Comm., 2005 535 $33M 121

TC Memo 2013-259 2006 235 $24M 66

Endicott v. Comm., 2006 204 $7M 75

TC Memo 2013-199 2007 303 $15M 99

2008 1,543 $16M 112

Assaderaghi v. Comm., 2008 535 $2.7M 154

TC Memo 2014-33 2009 180 $350K 94

474

Reasonable Compensation Mayson Manufacturing 38 AFTR 1038 (CA-6, 1949) Elliotts, Inc. 52 AFTR 2d 83-5976 (CA-9, 1983)

Employee’s qualifications Employee’s role in the company

Nature, extent, and scope of work External comparison to other companies

Size and complexity of business Character and condition of company

Comparison of salaries paid with employer’s gross income and net income

Conflict of interest from perspective of hypothetical independent investor

General economic conditions Internal consistency from perspective of hypothetical independent investor

Comparison of salaries with distributions to shareholders Prevailing rates of compensation for comparable positions in comparable businesses Employer’s overall salary policy with respect to all employees

Note: While the Mayson and Elliots multi-factor tests are different, Dexsil Corp 81 AFTR 2d 98-2313 (CA-2, 1998) noted the ultimate analysis is similar

Amount paid in prior years

475

Independent-Investor Test • Exacto Spring Corp., 84 AFTR 2d 99-6977 (CA-7 1999). The

relevant inquiry is whether an inactive, independent investor would be willing to compensate the employee as he was compensated

• The nature and quality of the services is considered as well as the effect of those services on the return the investor is achieving on his investment.

• “When, notwithstanding the CEO’s ‘exorbitant’ salary (as it might appear to a judge or other modestly paid official), the investors in his company are obtaining a far higher return than they had any reason to expect, his salary is presumptively reasonable.”

• Two exceptions: (1) high return not due to efforts or (2) the intent was to disguise dividends as salary.

476

Circuits

Circuit Method 1st Elliotts – Dismissed independent-investor test 2nd Elliotts – viewed through eyes of independent investor 3rd Mayson – viewed through eyes of independent investor 4th Mayson 5th Mayson 6th Mayson 7th Independent investor 8th Mayson – viewed through eyes of independent investor 9th Elliotts – using independent-investor test

10th Mayson – plus analysis of return on equity 11th Mayson DC Multifactor test viewed through eyes of independent investor

477

Final Weasel Words • Please be sure to read the main outline in conjunction with slides.

Download from our TaxThink blog at www.wipfli.com. • Every effort has been made to offer the most current, correct, and

clearly expressed information possible in the preparation of these slides. Nonetheless, inadvertent errors can occur, and tax rules and regulations often change. The information included in these slides is intended to afford general guidelines on the matters discussed. However, the application and impact of tax laws and financial matters can vary widely from case to case based on the specific or unique facts involved. Accordingly, the information in these slides is not intended to serve as legal, accounting, or tax advice.

• Readers are encouraged to conduct their own independent research of the matters discussed in these slides.

• You may download an updated version of these slides by accessing our TaxThink blog at www.wipfli.com.

• The password = elliott davis decosimo 2015#



Documents

2015 Federal Tax Update - Elliott Davis · 2019. 3. 19. · 2015 Federal Tax Update1 Elliott Davis Decosimo Rick J. Taylor, CPA, MST | [email protected] Tuesday, November 10, 2015