Healthcare Employer Mandate and Insurance Reporting Requirements Delayed Until 2015

On July 2, 2013, the Treasury Department announced that key parts of the Affordable Care Act (ACA) the mandatory employer and insurer reporting requirements will not take effect until 2015, one year later than originally planned. As a result, businesses to which the law applies (generally those with 50 or more full-time employees or full-time equivalents) are not required to provide healthcare to employees until 2015.  

In making the announcement, Assistant Treasury Secretary Mark Mazur said the delayed implementation is designed to meet two goals. First, it will allow the IRS time to consider ways to simplify the new reporting requirements. Second, it will provide employers time to adapt health coverage and reporting systems while moving toward making health coverage affordable and accessible for their employees. According to Mr. Mazur, the delay in implementing these key provisions of the ACA was the result of concerns expressed by employers about the complexity of the requirements and the need for more time to implement them effectively.

A week after the announcement, the IRS issued Notice 2013-45 which provides transition relief for 2014 from (1) the information reporting requirements under Code Sec. 6055 applicable to insurers, self-insuring employers, and certain other providers of minimum essential coverage, (2) the information reporting requirements under Code Sec. 6056 related to applicable large employers, and (3) the employer shared responsibility provisions under Code Sec. 4980H.

Observation: The delay does not affect other aspects of the ACA, the Treasury Department said. Thus, the individual mandate the requirement that individuals have health insurance beginning in 2014 is still in effect.

Background

On March 23, 2010, the ACA was enacted into law. The ACA provisions added Code Secs. 6055, 6056, and 4980H. Code Sec. 6055 requires annual information reporting by health insurance issuers, self-insuring employers, government agencies, and other providers of health coverage. Code Sec. 6056 requires annual information reporting by applicable large employers relating to the health insurance that an employer offers (or does not offer) to its full-time employees. Code Sec. 4980H(a) imposes an assessable payment on an applicable large employer that fails to offer minimum essential coverage to its full-time employees (and their dependents) under an eligible employer-sponsored plan if at least one full-time employee enrolls in a qualified health plan for which a premium tax credit is allowed or paid. Code Sec. 4980H(b) imposes an assessable payment on an applicable large employer that offers minimum essential coverage to its full-time employees (and their dependents) under an eligible employer-sponsored plan but has one or more full-time employees who enroll in a qualified health plan for which a premium tax credit is allowed or paid (for example, if the coverage offered either does not provide minimum value or is not affordable to that full-time employee).

Notice 2013-45 Transition Relief

As previously noted, the ACA provisions require information reporting by insurers, self-insuring employers, government agencies, and certain other parties that provide health coverage and requires information reporting by applicable large employers with respect to the health coverage offered to their full-time employees. Proposed rules for the information reporting provisions are expected to be published in the summer of 2013. According to the IRS, the proposed rules will reflect the fact that transition relief will be provided for information reporting under Code Sec. 6055 and Code Sec. 6056 for 2014. The transition relief, the IRS said, will provide additional time for dialogue with stakeholders in an effort to simplify the reporting requirements consistent with effective implementation of the law. It will also provide employers, insurers, and other reporting entities additional time to develop their systems for assembling and reporting the needed data.

The IRS is encouraging employers, insurers, and other reporting entities to voluntarily comply with the information reporting provisions for 2014 (once the information reporting rules are issued later this summer) in preparation for the full application of the provisions for 2015. However, information reporting under Code Sec. 6055 and Code Sec. 6056 will be optional for 2014. Accordingly, no penalties will be applied for failure to comply with these information reporting provisions for 2014.

Under the employer shared responsibility provisions of Code Sec. 4980H, an applicable large employer generally must offer affordable, minimum value health coverage to its full-time employees or a shared responsibility payment may apply if one or more of its full-time employees receive a premium tax credit under Code Sec. 36B. The Code Sec. 6056 information reporting is integral to the administration of the employer shared responsibility provisions. In particular, because an employer typically will not know whether a full-time employee received a premium tax credit, the employer will not have all the information it needs to determine whether it owes a payment under Code Sec. 4980H. Accordingly, the employer is not required to calculate a payment with respect to Code Sec. 4980H or file returns submitting such a payment. Instead, after receiving the information returns filed by applicable large employers under Code Sec. 6056 and the information about employees claiming the premium tax credit for any given calendar year, the IRS will determine whether any of the employer's full-time employees received the premium tax credit and, if so, whether an assessable payment under Code Sec. 4980H may be due. If the IRS concludes that an employer may owe such an assessable payment, it will contact the employer, and the employer will have an opportunity to respond to the information the IRS provides before a payment is assessed.

For this reason, the transition relief from Code Sec. 6056 information reporting for 2014 is expected to make it impractical to determine which employers owe shared responsibility payments for 2014 under the employer shared responsibility provisions. Accordingly, no employer shared responsibility payments will be assessed for 2014. However, in preparation for the application of the employer shared responsibility provisions beginning in 2015, the IRS is encouraging employers and other affected entities to voluntarily comply for 2014 with the information reporting provisions (once the information reporting rules have been issued later this summer) and to maintain or expand health coverage in 2014. Real-world testing of reporting systems and plan designs through voluntary compliance for 2014, the IRS said, will contribute to a smoother transition to full implementation for 2015.

Effect on Employees' Access to the Premium Tax Credit

According to Notice 2013-45, individuals will continue to be eligible for the premium tax credit by enrolling in a qualified health plan through the Affordable Insurance Exchanges (also called Health Insurance Marketplaces) if their household income is within a specified range and they are not eligible for other minimum essential coverage, including an eligible employer-sponsored plan that is affordable and provides minimum value.

Effect on Other ACA Provisions

This transition relief through 2014 for Code Sec. 6055 information reporting, Code Sec. 6056 information reporting, and the employer shared responsibility provisions under Code Sec. 4980H has no effect on the effective date or application of other PPACA provisions, such as the premium tax credit under Code Sec. 36B and the individual shared responsibility provisions under Code Sec. 5000A.

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D.C. Circuit Reverses Tax Court; Nixes IRS's Approach to Calculating Gambling Gains of Nonresident Aliens

The IRS taxes nonresident alien gamblers differently than U.S. citizen gamblers. One difference concerns the period of time over which gambling winnings from casino games, such as slots, are measured. The IRS allows U.S. citizens to subtract losses from their wins within a gambling session to arrive at per-session wins or losses. However, the IRS applies a per-bet rule, rather than a per-session rule, for nonresident aliens. In Park v. Comm'r, 2013 PTC 185 (D.C. Cir. 7/9/13), the D.C. Circuit rejected this approach, reversed the Tax Court, and concluded that the relevant provision of Code Sec. 871 allows nonresident aliens to calculate winnings or losses on a per-session basis.

Background

Sang Park is married and is a full-time, high-ranking business executive for a large chemical company in South Korea. Sang's employer pays for the Sangs' son to attend school in the United States and for the Sangs to travel to the United States to visit their son. Sang's wife also has other family living in the United States.

During the years in issue, the Sangs traveled to the United States for vacation and to visit family a number of times. Sang enjoys gambling and, during these trips, he frequented the Pechanga Resort & Casino (Pechanga) in Temecula, California, to play the slot machines. Sang gambled at Pechanga on 20 of the approximately 68 days that he was in the United States in 2006 and on 11 of the approximately 46 days that he was in the United States in 2007. Sang's wife had no involvement in any gambling or gaming activities.

In 2006, Sang won 138 slot machine jackpots of $1,200 or more, with total gambling winnings of approximately $432,000. Pechanga withheld 30 percent of the winnings for payment of federal income tax on three of those jackpots (two jackpots of $50,000 and one of $1,600), for a total of $30,480 withheld for taxes. A report prepared by Pechanga showed that Sang had losses that exceeded his 2006 winnings by $4,663.

In early 2007, Sang provided his social security number to Pechanga and signed a Form W-9, Request for Taxpayer Identification Number and Certification, certifying that he was not subject to backup withholding and that he was a U.S. person (including a U.S. resident alien). In 2007, Sang won 43 slot machine jackpots of $1,200 or more, with total gambling winnings of approximately $104,000. Pechanga withheld 30 percent of the winnings for payment of federal income tax on three jackpots, for a total withholding of $1,632. A report prepared by Pechanga showed that Sang had losses that exceeded his 2007 winnings by almost $46,000.

Sang received from sources within the United States other income that was not effectively connected with a U.S. trade or business in 2006: (1) interest income of $6,585; (2) capital gain income of $52,792; and (3) dividend income of $7,471 (taxable at a rate of 15 percent under the U.S. S. Korea tax treaty). Sang's wife had no U.S. source income.

The Sangs filed a Form 1040, U.S. Individual Income Tax Return, for 2006 as married filing jointly, prepared by a bookkeeping service. The Sangs did not report any gambling winnings or any associated expenses. They did report their other U.S. source income.

In 2007, Sang also received from sources within the United States income that was not effectively connected with a U.S. trade or business: (1) interest income of $11,830 and (2) dividend income of $3,046 (taxable at a rate of 15 percent under the U.S. - S. Korea income tax treaty).

The Sangs filed a Form 1040 for 2007 and reported the interest and dividend income from sources within the United States, but did not report the gambling income or any associated expenses. The Sangs' 2007 return was prepared by a CPA.

Pechanga reported Sang's jackpot winnings of $1,200 or more to the IRS on Forms W-2G, Certain Gambling Winnings, for 2006 and 2007. The IRS examined the 2006 and 2007 tax returns and determined that Sang received unreported gambling income of almost $432,000 in 2006 and almost $104,000 in 2007. The IRS sent a notice of deficiency to the Sangs and assessed deficiencies and an accuracy-related penalty with respect to their 2006 and 2007 tax returns.

The parties agreed that Sangs were nonresident aliens and, that for both 2006 and 2007, Forms 1040 were erroneously filed instead of Forms 1040NR, U.S. Nonresident Alien Income Tax Return.

The Parties' Arguments

According to the IRS, under Code Sec. 871, Sang should pay taxes on every winning pull at the slot machine. The IRS argued that Code Sec. 873 does not allow nonresident aliens to deduct recreational gambling losses from their income on their tax returns. In other words, once wins and losses are calculated whether on a per-bet or per-session basis nonresident aliens may not deduct losses from wins when doing their annual income taxes. As a result, the IRS said that that nonresident aliens should be required to pay taxes on each winning pull of the slot machine lever. The IRS also cited the decision in Barba v. U.S., 2 Cl. Ct. 674 (1983), in which the Claims Court ruled out a per-year approach to measuring taxable gambling winnings.

Sang disputed the IRS's interpretation of Code Sec. 871 and argued that the IRS should allow him to calculate his winnings on at least a per-session basis. More than a $100,000 of tax turned on that question for Park and the IRS.

The D.C. Circuit's Analysis

The D.C. Circuit noted that the IRS's interpretation of Code Sec. 871 as covering every winning pull of the slot machine i.e., a per-bet approach was not promulgated in an authoritative interpretation that required the court's deference. Thus, the court looked to the statutory language independently.

Code Sec. 871(a)(1)(A), the court noted, taxes nonresident aliens on all interest . . . , dividends, rents, salaries, wages, premiums, annuities, compensations, remunerations, emoluments, and other fixed or determinable annual or periodical gains, profits, and income received from sources in the United States. For purposes of Sang's situation, the court identified gains as the key term and observed that this term also appears in Code Sec. 165(d), which governs U.S. citizens. Under Code Section 165(d), losses from wagering transactions are allowed only to the extent of gains from such transactions.

The court observed that the IRS has persuasively interpreted the term gains in Code Sec. 165(d) to allow U.S. citizens to measure gains on a per-session basis. Citing a memorandum from the Office of Chief Counsel (AM 2008-11), the court noted that the IRS has stated that gain or loss may be calculated over a series of separate plays or wagers. In the memorandum, the IRS states, with respect to gambling, that the fluctuating wins and losses left in play are not accessions to wealth until the taxpayer redeems his or her tokens and can definitively calculate net gains. Because gain or loss may be calculated over a series of wagers, the memorandum says, a taxpayer who plays the slot machine recognizes a wagering gain or loss at the time he or she redeems the tokens. Therefore, U.S. citizens do not treat every play or wager as a taxable event. The result is that U.S. citizens can measure their gambling winnings and losses on a per-session basis.

Nothing in the IRS's Code Sec. 165(d) ruling on gains, the court stated, turned on the fact that the gamblers were U.S. citizens. Rather, the court found that the IRS, in its memorandum, was trying to sensibly interpret and apply the term gains to casino gambling. The court found the IRS's reading of the term gains in Code Sec. 165(d) to be the most sensible interpretation of casino gambling gains. The court agreed with the IRS explanation that the per-session approach avoids the considerable administrative and practical difficulties that would arise if slots players had to track the wins from every pull of the slot machine lever.

The court said that the IRS's argument that nonresident aliens may not deduct gambling losses from winnings did not tell the court how to measure those losses and winnings in the first place.

With respect to the IRS's reliance on the Barba case, the court noted that the case did not consider whether to measure gains on a per-session basis or a per-bet basis and expressly left that question open.

The D.C. Circuit concluded that, with respect to calculating gambling gains, the per-session approach and not the per-bet approach was the better approach. The court declined to read the term gains in Code Sec. 871 to mean something different from what it has been interpreted to mean in Code Sec. 165(d). Thus, nonresident aliens can calculate gambling winnings or losses on a per-session basis.

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IRS Postpones FATCA Implementation by Six Months

The IRS has revised the timelines for implementing the requirements of the Foreign Account Tax Compliance Act (FATCA) and for implementing guidance on the treatment of financial institutions located in jurisdictions that have signed intergovernmental agreements (IGAs) for the implementation of FATCA but have not yet brought those IGAs into force. Notice 2013-43.

The Hiring Incentives to Restore Employment Act of 2010 added new Code Secs. 1471 through 1474. These provisions require withholding agents to withhold 30 percent of certain payments to a foreign financial institution (FFI) unless the FFI has entered into an agreement (FFI agreement) with the IRS to, among other things, report certain information with respect to U.S. accounts. The provisions also impose on withholding agents certain withholding, documentation, and reporting requirements with respect to certain payments made to certain nonfinancial foreign entities (NFFEs).

According to the IRS, comments have indicated that certain elements of the phased timeline for the implementation of FATCA present practical problems for both U.S. withholding agents and FFIs. In addition, while comments from FFIs overwhelmingly supported the development of intergovernmental agreements (IGAs) as a solution to the legal conflicts that might otherwise impede compliance with FATCA and as a more effective and efficient way to implement cross-border tax information reporting, some commentators noted that, in the short term, continued uncertainty about whether an IGA will be in effect in a particular jurisdiction hinders the ability of FFIs and withholding agents to complete due diligence and other implementation procedures.

As a result of these comments, and to allow for a more orderly implementation of FATCA, the IRS intends to amend the final regulations to postpone by six months the start of FATCA withholding, and to make corresponding adjustments to various other time frames provided in the final regulations. In addition, the IRS intends to provide a list of jurisdictions that will be treated as having in effect an IGA, even though that IGA may not have entered into force as of July 1, 2014.

Under the revised timeline, withholding agents generally will be required to begin withholding on withholdable payments made after June 30, 2014, to payees that are FFIs or NFFEs with respect to obligations that are not grandfathered obligations, unless the payments can be reliably associated with documentation on which the withholding agent can rely to treat the payments as exempt from withholding. The definition of grandfathered obligation will be revised to include obligations outstanding on July 1, 2014 (and associated collateral).

Notice 2013-43 does not affect the timing provided in the final regulations for withholding on gross proceeds, pass-through payments, and payments of U.S. source fixed or determinable annual or periodical income with respect to offshore obligations by persons not acting in an intermediary capacity.

For a discussion of FATCA, see Parker Tax ¶203,180.

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IRS Loosens Wash Sale Rules for Certain Money Market Funds

A proposed revenue procedure describes circumstances in which the IRS will not treat a redemption of shares in a money market fund as part of a wash sale. Notice 2013-48.

Code Sec. 1091(a) (i.e., the wash sale rule) disallows a loss realized by a taxpayer on a sale or other disposition of shares of stock or securities if, within a period beginning 30 days before and ending 30 days after the date of such sale or disposition, the taxpayer acquires (by purchase or by an exchange on which the entire amount of gain or loss is recognized by law), or enters into a contract or option to so acquire, substantially identical stock or securities (unless the taxpayer is a dealer in stock or securities and the loss is sustained in a transaction made in the ordinary course of such business).

In Notice 2013-48, the IRS issued a proposed revenue procedure describing circumstances in which the IRS will not treat a redemption of shares in a money market fund (MMF) as part of a wash sale under Code Sec. 1091.

Constant share prices have simplified the taxation of MMF share transactions because a shareholder does not realize gain or loss when a share is redeemed for an amount equal to its basis. Shareholders will typically realize gain or loss, however, on redemptions of floating net asset value (floating-NAV) MMF shares. A floating-NAV MMF is an MMF that uses market factors to value its securities and uses basis point rounding to price its shares for issuance and redemption. A floating-NAV will have a share price that changes frequently, or floats.

According to the IRS, the redemptions of shares of MMFs, which have relatively stable values even when share prices float, do not give rise to the concern that Code Sec. 1091 is meant to address. Moreover, given the expected volume of transactions in MMF shares, tracking wash sales of MMF shares will present shareholders of floating-NAV MMFs with significant practical challenges. Therefore, it is in the interest of sound tax administration to prescribe circumstances in which the IRS will not treat a redemption of these MMF shares as part of a wash sale under Code Sec. 1091. Those circumstances are set forth in sections 3 and 4 of the IRS's proposed revenue procedure.

The proposed revenue procedure provides that if a taxpayer realizes a loss upon a redemption of certain MMF shares and the amount of the loss is not more than a specified percentage of the taxpayer's basis in such shares, the IRS will treat the loss as not realized in a wash sale.

The proposed revenue procedure applies to a redemption of one or more shares in an investment company registered under the Investment Company Act of 1940 if (1) the investment company is regulated as an MMF under SEC Rule 2a-7 and holds itself out to the public as an MMF; and (2) at the time of the redemption, the investment company is a floating-NAV MMF.

If a redemption is within the scope of the revenue procedure and results in a de minimis loss, the IRS will not treat such redemption as part of a wash sale. Therefore, Code Sec. 1091(a) will not disallow the deduction for the resulting de minimis loss in the year realized and Code Sec. 1091(d) will not cause the basis of any property to be determined by reference to the basis of the redeemed shares. The term de minimis loss means a loss realized upon a redemption of a share of stock of an MMF the amount of which (expressed as a positive number) is not more than one half of one percent (0.5 percent) of the taxpayer's basis in that share.

For a discussion of the wash-sale rules, see Parker Tax ¶116,100.

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Asset Allocation Agreements Determined a Purchaser's Method of Depreciation; Agreement Modification Properly Denied

A purchaser of two poultry processing plants must depreciate the acquired assets according to the purchase price allocations made in the asset purchase agreements entered into when the company acquired the assets; the company's unilateral modification of the agreements was denied. Peco Foods, Inc. & Subsidiaries v. Comm'r, 2013 PTC 174 (11th Cir. 7/2/13).

Peco Foods, Inc. & Subsidiaires, a poultry processing business, was seeking to expand and, in the mid-to-late 1990s, acquired two poultry processing plants in Mississippi the Sebastopol plant and the Canton plant. With respect to the Sebastopol plant acquisition in 1995, Peco entered into an asset purchase agreement to acquire certain assets of the plant for $27,150,000. The agreement included a schedule that allocated the purchase price of the acquired assets between two of Peco's subsidiaries. Peco and the seller also agreed to allocate the purchase price among 26 assets for all purposes, including financial accounting and tax purposes. With respect to the Canton plant acquisition in 1998, Peco entered into an asset purchase agreement to acquire certain assets of the plant for $10,500,000. This agreement included a schedule that allocated the purchase price of the acquired assets between two of Peco's subsidiaries. Peco and the seller also agreed to allocate the purchase price among three assets for all purposes, including financial accounting and tax purposes. The second agreement also included a merger clause stating that the contract constituted the entire agreement between Peco and the seller.

On its 1997 corporate income tax return, Peco used the straight-line method of depreciation, depreciating the nonresidential property acquired in its Sebastopol plant over a period of 39 years. For the 1998 through 2001 tax years, Peco used accelerated methods of depreciation for its Canton plant, which involved either a seven-year or a 15-year recovery period, and a double declining or 150-percent methodology. In 1999, Peco hired an appraiser to conduct a cost segregation analysis of the two poultry processing plants. The study contained revised allocation schedules that indicated Peco could take an additional depreciation expense of $5,258,754 from 1998 to 2002. Peco filed its 1998 corporate income tax return and attached Form 3115, Application for Change in Accounting Method. On its 1998 return, Peco adopted an accelerated method of depreciation for its Sebastopol plant, using either seven-year or 15-year class life, with a double declining or 150-percent depreciation method. The IRS issued notices of deficiency, disallowing the retroactive adjustments in the allocation schedules. The Tax Court held that Peco was bound by, and could not modify, the original purchase price allocations provided in the purchase agreements.

Observation: Under Code Sec. 446(e), once a taxpayer has used an accounting method and filed a first return, the taxpayer must receive approval from the IRS before making any change to that accounting method. The purpose of the consent requirement is to assure consistency in the method of accounting for tax purposes.

Under Code Sec. 1060(c), an applicable asset acquisition is any transfer of assets that constitutes a trade or business, and the purchaser's basis in the acquired assets is determined wholly by the consideration paid for them. Where parties to an asset acquisition agree, in writing, to the allocation of any amount of consideration or to the fair market value of any of the assets transferred, that agreement is binding on the seller and purchaser unless the IRS determines that the allocation or fair market value is not appropriate.

The Eleventh Circuit agreed with the Tax Court's finding that the purchase agreements allocating the purchase price of the two poultry processing plants among the acquired assets were binding on Peco and that Peco's unilateral modification of the agreements was inappropriate. Both agreements stated that the allocations would be used for all purposes, including financial accounting and tax purposes. The court rejected Peco's claim that the agreements were ambiguous and, therefore, unenforceable. The court noted that the term Poultry Plant Building in the Sebastopol agreement was not ambiguous and clearly classified the building as nonresidential property intended by the parties to be treated as a single asset. Similarly, the court found that the Canton agreement's allocation of the purchase price among three assets clearly showed Peco's intent not to allocate any part of the purchase price to the subcomponent assets. Thus, the court concluded that Peco was not allowed to change its accounting method to depreciate the plants according to the cost segregation study to obtain favorable tax benefits.

For a discussion of accounting method changes, see Parker Tax ¶241,590.

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IRS Finalizes Rules for 2009 and 2010 Deferral of COD Income for Partnerships and S Corporations

The IRS issued final regulations relating to the application of Code Sec. 108(i) to partnerships and S corporations. T.D. 9623 (7/3/13).

Code Sec. 108(i) was added to the Code by the American Recovery and Reinvestment Tax Act of 2009, and generally provides for an elective deferral of cancellation of debt income (COD income) realized by a taxpayer from a reacquisition of an applicable debt instrument that occurs after December 31, 2008, and before January 1, 2011. An election under Code Sec. 108(i) election is irrevocable. COD income deferred under Code Sec. 108(i) is included in gross income ratably over a five tax-year period (inclusion period) beginning with the taxpayer's fourth or fifth tax year following the tax year of the reacquisition.

Previously, the IRS issued Rev. Proc. 2009-37, which provides election procedures for taxpayers (including partnerships and S corporations) and other guidance under Code Sec. 108(i). In 2010, the IRS issued temporary and proposed regulations under Code Sec. 108(i). The IRS has now finalized Reg. Sec. 1.108(i)-2 relating to the application of Code Sec. 108(i) to partnerships and S corporations.

Under Code Sec. 108(i)(6), any decrease in a partner's share of partnership liabilities as a result of a debt discharge is not taken into account for purposes of Code Sec. 752 at the time of the discharge to the extent it would cause the partner to recognize gain under Code Sec. 731 (i.e., a Code Sec. 108(i)(6) deferral). The decrease in a partner's share of a partnership liability under Code Sec. 752(b) resulting from the reacquisition of an applicable debt instrument that is not treated as a current distribution of money to the partner under Code Sec. 752(b) by reason of the Code Sec. 108(i)(6) deferral is referred to as a partner's deferred section 752 amount. Under the proposed regulations, a partner's deferred section 752 amount could not exceed the partner's share of deferred COD income. The partner's deferred section 752 amount is treated as a distribution of money to the partner under Code Sec. 752(b) at the same time and, to the extent remaining, in the same amount as the partner recognizes the deferred COD income (the last sentence of Code Sec. 108(i)(6)). Some practitioners said they were unsure how to apply the last sentence of Code Sec. 108(i)(6) during the inclusion period when a partner's deferred section 752 amount is less than the partner's deferred COD income. The final regulations clarify the last sentence of Code Sec. 108(i)(6) by adding an example to illustrate that the deferred section 752 amount is treated as a deemed distribution under Code Sec. 752(b) in a tax year of the inclusion period to the extent that the deferred section 752 amount (less any deferred section 752 amount that has already been treated as a deemed distribution under Code Sec. 752(b) in a prior tax year of the inclusion period) is equal to or less than the partner's deferred COD income that is recognized in such tax year.

The proposed regulations also provide an exception to the acceleration rule for Code Sec. 381 transactions. Under the proposed regulations, a C corporation partner's share of an electing partnership's deferred items is not accelerated if the assets of the C corporation partner are acquired by another C corporation in a transaction that is treated as a transaction to which Code Sec. 381(a) applies. Similarly, an S corporation partner's share of an electing partnership's deferred items is not accelerated if the assets of the S corporation partner are acquired by another S corporation in a transaction to which Code Sec. 381(a) applies. Since the issuance of the proposed regulations, the IRS has been considering whether an exception should apply when an electing partnership terminates under Code Sec. 708(b)(1)(A). In that situation, the electing partnership no longer exists and cannot report any deferred items to its partners. Therefore, the final regulations clarify that the exceptions to acceleration for distributions of entire separate interests and for Code Sec. 381 transactions do not apply if the electing partnership terminates under Code Sec. 708(b)(1)(A).

For a discussion of the rules relating to the deferral of discharge-of-indebtedness income for 2009 and 2010, see Parker Tax ¶72,320.

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Circuit Court Affirms Denial of Tax-Exempt Status for Special Needs Trust

Where there was no donative element to fees charged by a trust, which to all appearances operated as a commercial, for-profit enterprise, the trust did not qualify as a tax-exempt organization. Family Trust of Massachusetts, Inc. v. U.S., 2013 PTC 179 (D.C. Cir. 6/18/13)

The Family Trust of Massachusetts, Inc. (FTM) was founded by Peter Macy, a private Massachusetts attorney who specializes in elder law. Peter incorporated FTM as a special needs trust in 2003. He serves as President, Treasurer, and sole Executive Director, and his law office is listed as FTM's principal place of business. His duties include supervising the day-to-day business matters of the FTM, including financial matters, bookkeeping, and corresponding directly with outside parties. He works with the FTM daily, averaging 260 hours a year.

In 2005, FTM applied for a determination from the IRS that it is a Code Sec. 501(c)(3) organization and therefore tax exempt. Since 2005, FTM's clientele has increased from 20 beneficiaries to over 300. After the IRS failed to issue a notice of determination, FTM filed suit in district court, seeking the court to declare FTM exempt from federal income tax. The IRS argued that FTM acts as an adjunct to Peter's private elder law practice, reaching only a select group of the relatively affluent disabled to whom trustee services might be provided profitably.

The district court concluded that FTM had not demonstrated that it met the requirements necessary to be a Code Sec. 501(c)(3) tax-exempt organization. The critical inquiry, the court said, was whether FTM's primary purpose for engaging in its sole activity was an exempt purpose, or whether its primary purpose was the nonexempt one of operating a commercial business producing net profits for FTM. The court observed that, in applying the operational test to determine whether an organization meets the requirements to be tax-exempt, courts have relied on the commerciality doctrine. The major factors courts have considered in assessing commerciality are the particular manner in which an organization's activities are conducted, the commercial hue of those activities, and the existence and amount of annual or accumulated profits.

The district court found it difficult to escape the obvious correlation between FTM's increasing profits and the Peter's increasing salary derived from those profits. When examining this fact in light of other factors, such as the absence of the solicitation of charitable contributions, the court concluded that FTM's profit margin appeared to be more a product of a growing commercial enterprise than a tool for expanding the pooled investments that might enable beneficiaries to reap a greater return or enjoy reduced fees. Further, the court said, the manner in which Peter and other members of the legal community went about connecting eligible individuals with FTM's services suggested that those services were a commercial product in disguise being touted by Peter and others who made referrals to the trust. The fact that Peter founded the program as a result of his law firm's specialization in advice regarding trusts, estate planning, guardianship, and probate matters for elderly clients, and that his legal office remained listed as FTM's principal place of business, only reinforced for the court the idea that FTM's services provided a marketable product to offer potential clients. And though procurement of new clientele for Peter's law practice may not have been the sole purpose of FTM, the district court viewed this inevitable benefit as amounting to more than just an incidental nonexempt purpose. FTM appealed.

The D.C. Circuit affirmed the lower court's decision and held that FTM was not operated exclusively for a charitable purpose. To all appearances, the D.C. Circuit said, FTM operates as a commercial, for-profit trustee because it charges fees to establish and manage the pooled trusts and retains residual fundsthe residualsfrom the accounts of deceased beneficiaries. The court saw no evidence that the fees FTM charged were below market rate, much less below costat least if the residuals were taken into account. Nor, the court noted, had FTM used its burgeoning residuals revenue to offset or waive trust management fees. The charitable purpose of FTM's operations was further undercut by the commercial trappings of its operations, the court stated. The interrelationship between FTM and Peter's law firm, with FTM's headquarters being in Peter's law offices, and the fact that Peter referred clients to FTM and performed legal services for it as well, cast FTM's operations as a commercial offshoot of Macy's elder law practice.

For a discussion of the tests that must be met for an organization to be classified as a Section 501(c)(3) organization, see Parker Tax ¶60,510.

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No Home Office Deduction for Employee Working from Home for Her Own Convenience

While the taxpayer could deduct home office expenses for the portion of time she was an independent contractor, she could not deduct such expenses once she became an employee because working at home was at her request and for her convenience. Fontayne v. Comm'r, T.C. Summary 2013-54 (7/3/13).

Jean Marie Fontayne and Yves Fontayne were married and timely filed their 2008 federal income tax return. In 2008, Yves worked full time as an employee of a semiconductor sales company. From January to July 2008, Jean Marie worked part-time from her home as an independent contractor for the same company. In July 2008, Jean Marie became a full-time employee of the company. Per her request and for her convenience, the company allowed her to work from home up to three days a week.

In January 2008, Jean Marie and Yves moved into a new home. Jean Marie designated a room, which included a bathroom and a closet, as her home office. She did not see any clients or anyone from her company at her home office. In November 2008, the couple improved the home office area. They moved walls to increase the size of the office, replaced carpeting, retiled the bathroom, installed a central vacuum and under-the-floor heating system, and installed a fireproof safe in the closet. On their Schedule C, Profit or Loss From Business, the couple reported a tentative profit of $24,728 from Jean Marie's work for the company and expenses of $24,728 for the business use of their home. The couple's home was 3,100 square feet and they claimed that 554 square feet, or 17.87 percent, was used regularly and exclusively for business.

Observation: A taxpayer can deduct the business portion of general repairs that benefit the taxpayer's entire home and maintain it in good working condition over its useful life. Generally, the business portion of such general repairs is determined by applying the home's business use percentage to the full cost of the repairs.

After auditing the couple's 2008 return, the IRS issued a notice of deficiency disallowing some claimed business expenses as personal expenses, reducing the percentage of business use of the couple's home used to calculate business expenses, and prorating other claimed home office expenses reflecting Jean Marie's change of employment status from part-time independent contractor to full-time employee.

Code Sec. 262 precludes deductions for personal, living, or family expenses. Code Sec. 280A(a) denies deductions with respect to the use of a dwelling unit that the taxpayer uses as a residence during the tax year. However, Code Sec. 280A(c)(1)(A) allows the deduction of expenses allocable to a portion of a dwelling unit that the taxpayer uses exclusively and regularly as the principal place of business for a taxpayer's trade or business. In the case of an employee, the exception applies only if the use of the home office is for the convenience of the employer.

The IRS asserted that the home office expenses should be limited to the time period when Jean Marie was a part-time independent contractor. The IRS also adjusted the percentage of the couple's home used for business and disallowed business expenses deductions claimed for repairs and maintenance, utilities, and other expenses.

The Tax Court agreed with the IRS that only home office expenses incurred when Jean Marie was a part-time independent contractor were deductible. Because she was allowed to work from home part-time at her own request and for her own convenience once she became an employee, she was not entitled to any home office expense deduction for that time period. In determining the portion of the home used as a home office, the court rejected Jean Marie and Yves inclusion of the square footage of a hallway, bathroom, entryway and closet since those areas were not used exclusively as a home office. The court disallowed deductions for the costs of moving walls to increase the size of the home office, replacing carpeting, retiling the bathroom, installing a central vacuum and under-the-floor heating system since those expenses were capital expenditures and were not currently deductible. Deductions for telephone expenses at the home were also disallowed as personal expenses.

Finally, the court imposed the accuracy-related penalty. The court concluded that Jean Marie and Yves were negligent in preparing their return.

For a discussion of the home office deduction, see Parker Tax ¶85,500.

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IRS Issues Prop Regs on Information Reporting Relating to the Health Insurance Premium Tax Credit

Proposed regulations provide rules relating to requirements for certain insurance exchanges to report information relating to the health insurance premium tax credit. REG-140789-12 (7/2/13).

Beginning in 2014, small businesses will be able to purchase private health insurance through competitive marketplaces called Exchanges (also called Health Insurance Marketplaces). Code Sec. 36B allows a refundable premium tax credit to help individuals and families afford health insurance purchased through an Exchange. The Code Sec. 36B credit makes health insurance affordable by reducing a taxpayer's out-of-pocket premium cost. An Exchange makes an advance determination of credit eligibility for individuals enrolling in coverage through the Exchange and seeking financial assistance. Using information available at the time of enrollment, the Exchange determines (1) whether the individual meets the income and other requirements for advance credit payments, and (2) the amount of the advance payments. Advance credit payments are made monthly to the issuer of the qualified health plan in which the individual enrolls.

Taxpayers who receive advance credit payments must reconcile the amount of the advance payment with the amount of the premium tax credit computed on the taxpayer's income tax return. A taxpayer who receives excess advance payments must treat the excess amount as additional tax. Taxpayers whose credit amount exceeds the amount of advance payments for the tax year may receive the excess as additional credit. Taxpayers who do not seek advance credit payments also may claim the premium tax credit on the income tax return.

Exchanges must report to the IRS and to taxpayers certain information required to reconcile the premium tax credit with advance credit payments and to administer the premium tax credit generally. The required information relates to the enrollment of a taxpayer and taxpayer's family in a qualified health plan through the Exchange and includes (1) the level of coverage, (2) identifying information for the primary insured and each enrollee, (3) the amount of premiums and advance credit payments for the coverage, (4) information (concerning, for example, a change in circumstances) provided to the Exchange necessary to determine eligibility for and the amount of the credit, and (5) other information necessary to determine if a taxpayer has received the appropriate advance credit payments.

When the IRS issued final regulations under Code Sec. 36B in May 2012, it issued Reg. Sec. 1.36B-5, which identifies the information (primarily based on the statutory language) that Exchanges must report to the IRS and taxpayers. The IRS has now provided proposed regulations that provide more detailed rules for information reporting by Exchanges.

The proposed regulations require Exchanges to report information concerning individuals enrolled in qualified health plans, including the monthly amount of advance credit payments, if any. Consistent with the statute, the proposed regulations require Exchanges to report taxpayer identification numbers. It is anticipated that Exchanges will report only social security numbers and provide an individual's date of birth if a social security number is not available.

The proposed regulations direct Exchanges to furnish to each taxpayer or responsible adult who enrolled, or whose family member enrolled, in a qualified health plan through the Exchange a written statement that includes the information the Exchange must report to the IRS annually. Exchanges may use Form 1095-A for this statement and must furnish the statement on or before January 31 of the year following the calendar year of coverage.

For a discussion of the reporting requirements for the premium assistance tax credit, see Parker Tax ¶102,680.

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IRS Acquiescences to Expanded Review by Tax Court in Innocent Spouse Cases

The IRS will no longer argue that the Tax Court should limit its review of Code Sec. 6015(f) cases to the administrative record. AOD-2012-07 (6/17/13).

Under Code Sec. 6015(e)(1)(A), an individual may petition the Tax Court to determine the appropriate innocent spouse relief available. In Wilson v. Comm'r, T.C. Memo. 2010-134, the Tax Court relied on its prior interpretation of Code Sec. 6015(e)(1) in Porter v. Comm'r, 130 T.C. 115 (2008), and Porter v. Comm'r, 132 T.C. 203 (2009), and applied both a de novo standard and a de novo scope of review to grant the taxpayer relief. The de novo scope of review allowed the taxpayer to introduce evidence outside the administrative record, and the de novo standard of review allowed the court to determine whether the taxpayer was entitled to relief without regard to the IRS's determination. The IRS appealed.

Affirming the Tax Court, the Ninth Circuit in Wilson v. Comm'r, 2013 PTC 5 (9th Cir. 2013), held that the word determine, as used in Code Sec. 6015(e)(1)(A), provides both a de novo standard and a de novo scope of review in Code Sec. 6015(f) cases. The Ninth Circuit interpreted Code Sec. 6015(e)(1) in conjunction with the mandate under Code Sec. 6015(f) to consider the totality of the circumstances before making an equitable relief determination, which the court noted would be impossible if the Tax Court limited its review to the administrative record. The majority of the Ninth Circuit rejected the IRS's argument that the phrase the Secretary may relieve in Code Sec. 6015(f) means that the Tax Court should review the IRS's Code Sec. 6015(f) determinations for an abuse of discretion, limiting its review to evidence in the administrative record.

In June 2013, the IRS released AOD 2012-07. In AOD 2012-07, the IRS stated that, while it disagreed with the Ninth Circuit's decision in the Wilson case, it would no longer argue that the Tax Court should limit its review of Code Sec. 6015(f) cases to the administrative record.

For a discussion of innocent spouse relief, see Parker Tax ¶260,560.

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IRS Entitled to Seek Records Previously Reviewed

An IRS agent's review of a taxpayer's records did not give the IRS permanent possession of all the information in those records, and a later summons for the same records is permissible. Action Recycling, Inc. v. U.S., 2013 PTC 184 (9th Cir. 7/9/13).

Action Recycling, Inc. produced its 2009 bank statements at the request of the IRS in connection with an examination of its return. The IRS agent took notes and made a table of the total value of the bank deposits, transfers, and withdrawals but did not copy or retain any of the statements. The investigation was transferred to a second IRS agent who requested further review of the bank statements. Action Recycling refused to make the records available to the second IRS revenue agent. The IRS then issued summonses to two banks for the statements, as well as account signature cards and deposit slips from 2009 and 2010 and bank statements from 2010. The IRS also served Action Recycling with notice of the third-party summonses and Action Recycling timely moved to quash the summonses.

Under Code Sec. 7602, the IRS may issue a summons for the purpose of determining the correctness of any return, preparing a substitute return when the taxpayer has failed to do so, or determining the tax liability for any person. If the IRS issues a summons to a third party, the taxpayer is entitled to notice of the summons and has a right to intervene and to move to quash or invalidate the summons.

Action Recycling argued that the IRS had possession of all of its bank statements at one time from which the IRS was able to obtain the information sought by the summonses.

The Ninth Circuit affirmed a district court ruling and held that the IRS did not permanently possess all the information in Action Recycling's records once it reviewed but did not retain those records, and a later summons was permissible. The court looked to case law in U.S. v. Powell, 379 U.S. 48 (1964), and found that the IRS established that the investigation had a legitimate purpose, the records sought were relevant to that purpose, and the IRS followed the required administrative procedures. The court noted that the Internal Revenue Code did not expressly prohibit the issuance of a summons for information already in the possession of the IRS.

The Ninth Circuit, following the conclusions of the Fourth Circuit in Spell v. U.S., 907 F2d. 36 (4th Cir. 1990), the Fifth Circuit in U.S. v. Texas Heart Inst., 755 F2d. 469 (5th Cir. 1985), and the Seventh Circuit in U.S. v. Lenon, 579 F2d. 420 (7th Cir. 1978), found that the IRS did not already possess summoned information simply by previously reviewing the documents. The record demonstrated that the summonses were not issued in bad faith or for an improper purpose. The court construed the limitation against unnecessary summonses narrowly and noted that it was not designed to obstruct the IRS's ability to obtain information relevant to a legitimate investigation. Thus, the court concluded that the IRS was in compliance with the factors in Powell and the summonses were ordered enforced.

For a discussion of the IRS procedures for examining returns, see Parker Tax ¶263,110.

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Suspension of Corporate Powers Didn't Preclude Finding that Owner Was Corporate Employee

The fact that a taxpayer's wholly owned corporation had its corporate powers suspended for failing to pay state income taxes did not mean that it lacked the power to appoint officers under California law. Hom v. Comm'r, T.C. Memo. 2013-163 (7/8/13).

John Hom, an engineer, registered his wholly owned C corporation, John C. Hom & Associates (JCHA), as a California corporation in 1986. John was JCHA's president and chief executive officer. John managed JCHA's day-to-day operations and provided engineering services to the corporation for the years in issue (i.e., 2005-2008). In 2004, JCHA's corporate powers, rights and privileges were suspended for failure to pay state income taxes. However, JCHA continued its business operations. After John failed to respond to information document requests from the IRS, the IRS issued a summons for the corporation's bank records and conducted a bank deposit analysis. In April 2010, John filed Forms 1120, U.S. Corporation Income Tax Return, for JCHA for tax years 2005-2008, and reported paying officer's compensation totaling approximately $150,000 for the four years. Also for those years, John made net withdrawals from JCHA's bank account of over $374,000. He contended the withdrawals were loan repayments but provided no documentation.

John played poker regularly and was in the trade or business of gambling. For 2005-2008, he reported gambling receipts of approximately $159,000; $149,000, $245,000, and $58,000 and gambling losses of approximately $181,000, $135,000, $100,000, and $72,000, respectively. Thus, John had a small gain in 2006 but losses in the other years. John also reported additional expenses for his gambling business for airline tickets, hotels, parking and car rentals. John timely filed his 2005 and 2006 Form 1040, U.S. Individual Income Tax Return, but failed to timely file his 2007 and 2008 Form 1040 returns. John did not report any wage income and reported losses from his gambling business.

The IRS assessed deficiencies based on numerous findings including (1) for FICA tax purposes, John was an officer, and thus an employee, of JCHA; (2) the net withdrawals by John from his company were really unreported wage income, not loan repayments; and (3) John's net gambling losses were nondeductible because his records did not clearly show his gambling losses and because he was uncooperative.

John argued that he was not an officer of JCHA, and thus not an employee, because its corporate powers were suspended in 2004 for failure to pay state income taxes, and that it therefore lacked the power to appoint officers under California law.

The Tax Court held that John was an officer of JCHA during the years at issue and, thus, an employee. The court noted that John could not cite any authoritative California law to support his contention that he could not be an officer of JCHA while its powers, rights, and privileges were suspended. The court also noted that, during the years in issue, John and JCHA continued to conduct business in the same manner as before.

The court also rejected John's contention that the net withdrawals from JCHA were loans to JCHA. John failed to produce records reflecting loans or establish that a bona-fide debtor-creditor relationship existed.

With respect to the gambling losses, the court concluded that John could deduct his gambling losses to the extent of his gambling winnings since he was in the trade or business of gambling. However, the court held he could not deduct any claimed transportation and lodging expenses for his gambling because he failed to substantiate any of the expenses.

The court held that John was liable for the accuracy-related penalty because he failed to show that he acted with reasonable cause and in good faith with respect to his underpayment of tax.

For a discussion of recordkeeping requirements with respect to income tax return deductions, see Parker Tax ¶250,160.