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We hope you find our complimentary issue of Parker's Federal Tax Bulletin informative. Parker Tax Pro Library gives you unlimited online access to 147 client letters, 21 volumes of expert analysis, biweekly bulletins via email, Bob Jennings practice aids, time saving election statements and our comprehensive, fully updated primary source library.


Parker's Federal Tax Bulletin
Issue 24     
November 21 , 2012     
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 1. In This Issue ... 

 

Tax Briefs

Certain MI&E Allowances Were Not Per Diem Allowances; DPAD Exception Doesn't Apply to Repackaging of Pills; IRS Issues Nonacquiesence to Wandry Decision; Lack of Consideration for Debt, Precludes Estate Deducting the Debt ...

Read more ...

Experts Identify Opportunities and Traps Relating to New Capitalization Rules

David Strong and Natalie Tucker of the AICPA Tangible Property Task Force emphasize year-end strategies in a discussion of sweeping new capitalization rules. (T.D. 9564)

Read more ...

Lawyer's Mistake Costs Estate $1 Million

Attorney's failure to file a request for an extension of time to pay estate taxes on illiquid assets of a closely held business results in $1 million in penalties and interest; court rejects argument that reliance on a professional was reasonable cause for not filing.

Read more ...

IRS Issues More Hurricane Sandy Tax Relief

The IRS said it is supporting leave-based donation programs to aid victims who have suffered from the extraordinary destruction caused by Hurricane Sandy. Notice 2012-69; IR-2012-88 (11/6/12).

Read more ...

Income Recharacterized as Nonpassive under 30-Percent Rule

Because less than 30 percent of the unadjusted basis of the property leased by customers in the taxpayer's rental activity was subject to depreciation, the income from that activity was nonpassive and could not be offset against passive activity losses from other related rentals. Dirico v. Comm'r, 139 T.C. No. 16 (11/13/12).

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Payment for Gout Study Not Excludable from Income

A payment received for participating in a gout study was not excludible from income as compensation received on account of physical illness; nor was it excludible as a gift. O'Connor v. Comm'r, T.C. Memo. 2012-317 (11/14/12).

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Taxpayer Loses Deductions that Should Have Been Taken Earlier

A taxpayer could not use alleged promises of reimbursement from a former TV sitcom star to take a deduction for expenses years incurred years earlier. Alioto v. Comm'r, 2012 PTC 290 (6th Cir. 11/7/12).

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Paying Adult Children's Expenses Negates Finding of Economic Hardship

Where a taxpayer spent a large portion of her monthly income on her adult children's living expenses, she could not prove economic hardship and thus was not eligible for innocent spouse relief. Karam v. Comm'r, 2012 PTC 289 (6th Cir. 11/5/12).

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Hiding Assets Overseas Leads to Large FBAR Penalties

The fact that a taxpayer's failure to comply with FBAR was the result of his belief that he did not have a reportable financial interest in the foreign accounts was irrelevant, and the fact that he did not disclose his interests in the accounts was willful and the taxpayer was subject to a $100,000 fine for each year. U.S. v. McBride, 2012 PTC 295 (D. Utah 11/8/12).

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Recomputation of Minimum Tax Credit Carryover Required when Taxpayers Carry Back ATNOL

Because an alternative tax net operating loss (ATNOL) carryback to a prior tax year can reduce the alternative minimum tax imposed in that prior year and affect the amount of minimum tax credit available for use by the taxpayer in a later year, a taxpayer's minimum tax credit carryover must be recomputed when a taxpayer carries back an ATNOL. CCA 201246034.

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 2. Tax Briefs 

 

Deductions

Certain MI&E Allowances Were Not Per Diem Allowances: In CCM 201246031, the Office of Chief Counsel advised that the meal and incidental expense (MI&E) allowances paid by a transportation industry employer to (a) nontravelers and (b) day-travelers were not per diem allowances because the amounts were not deductible travel expenses under Code Sec. 162. However, the M&IE allowances paid by the employer to overnight travelers might qualify as per diem allowances if they otherwise meet the requirements of Code Sec. 162 and the remaining requirements of the definition of per diem allowance. Further, the periodic rule does not permit an employer to average the number of meals provided in kind to an employee in determining whether the M&IE allowance provided to employees is includible in wages. [Code Sec. 274].

DPAD Exception Doesn't Apply to Repackaging of Pills: In CCM 201246030, the Office of Chief Counsel advised that, for purposes of the domestic production activities deduction, the exception for repackaging and labeling activities to the definition of manufactured, produced, grown, or extracted (MPGE) under Reg. Sec. 1.199-3(e)(2) did not apply to the taxpayer's activities where the taxpayer repackages and labels pills it did not manufacture, but manufactures blister packs and sells the blister packs containing the pills in the normal course of its business to customers. According to the Chief Counsel's Office, for the taxpayer's gross receipts from the sale of blister packs containing the pills to qualify as domestic production gross receipts (DPGR), the taxpayer must meet the other applicable requirements, including the in whole or in significant part requirement of Code Sec. 199(c)(4)(A)(i)(I) and Reg. Sec. 1.199-3(g)(1). To the extent the gross receipts do not qualify as domestic production gross receipts (DPGR), the taxpayer can apply Reg. Sec. 1.199-3(d)(1)(ii) to determine whether the gross receipts from the sale of any component of the property (the blister packs containing the pills) qualify as DPGR. [Code Sec. 199].


Estate, Gifts, and Trusts

IRS Issues Nonacquiesence to Wandry Decision: In IRB 2012-46, the IRS issued a nonacquiesence to the Tax Court's decision in Wandry v. Comm'r, T.C. Memo. 2012-88. That case involved gift tax returns that reported gifts with a total value equal to the maximum gift exclusion amounts. The Tax Court concluded that the taxpayers consistent intent and actions proved that dollar amounts of gifts were intended and not percentages of an LLC interest that the taxpayers' CPA also included on return schedules that described the gifts. The court concluded that the donors transferred percentage interests to the donees equal in value to the amounts set forth in the gift documents, and those dollar amounts were the value of the gifts. [Code Sec. 2512].

Lack of Consideration for Debt, Precludes Estate Deducting the Debt: In Est. of Derksen v. U.S., 2012 PTC 292 (E.D. Pa. 11/8/12), a district court disallowed an estate's deduction of a debt the estate claimed the decedent owed pursuant to an agreement between the decedent and her husband to keep their estates equal in size. The decedent had signed a promissory note to her husband before his death. The court disallowed the deduction citing lack of consideration for the agreement that created the debt. [Code Sec. 2053].

No Estate Deduction for Settlement Paid to Decedent's Caregiver: In Est. of Bates v. Comm'r, T.C. Memo. 2012-314 (11/7/12), the Tax Court held that, where a claim by the decedent's caregiver represented a beneficiary's claim to a distributive share of the estate rather than a creditor's claim against the estate, the estate could not take a deduction for a settlement payment made to the caregiver. In addition, where the estate representative concluded that she lacked authority to file the estate tax return and did not petition the court for authority to do so, seek additional advice, or otherwise attempt to resolve the issue, she could not claim reasonable cause for late filing. Thus, the estate was assessed a penalty for late filing of the estate tax return.[Code Sec. 2053].


Gross Income

Per Capita Payments to Tribal Members Generally Nontaxable: In Notice 2012-60, the IRS provides that per capita payments made from the proceeds of an agreement between the United States and an Indian tribe settling the tribe's claims that the United States mismanaged monetary assets and natural resources held in trust for the tribe's benefit are excluded from the gross income of the members of the tribe receiving the per capita payments. Per capita payments that exceed the amount of the case settlement proceeds and that are made from an Indian tribe's private bank account in which the tribe has deposited the settlement proceeds are included in the gross income of the members of the tribe receiving the per capita payments under Code Sec. 61. [Code Sec. 117].


Information Returns

IRS Asking for Comments Regarding Section 6050P Rules: In Notice 2012-65, the IRS is asking for public comments regarding guidance to be provided to governmental and financial entities (applicable entities) described in Code Sec. 6050P(c), who discharge indebtedness and may be required to furnish Form 1099-C information returns under Code Sec. 6050P. Code Sec. 6050P(b) provides that an applicable entity must issue an information return if $600 or more of indebtedness is discharged. The corresponding regulation, Reg. Sec. 1.6050P-1(b)(2), lists eight identifiable events that trigger a reporting obligation, including the expiration of a nonpayment testing period that results when a creditor does not receive payment or engage in bona fide collection activity for specified periods of time. [Code Sec. 6050P].


Insurance

IRS Issues Loss Payment Patterns and Discount Factors for 2012: In Rev. Proc. 2012-44, the IRS prescribes the loss payment patterns and discount factors for the 2012 determination year. These factors are used to compute discounted unpaid losses under Code Sec. 846. [Code Sec. 846].

IRS Issues Salvage Discount Factors for 2012: In Rev. Proc. 2012-45, the IRS issued the salvage discount factors for 2012 that must be used to compute discounted estimated salvage recoverable under Code Sec. 832. [Code Sec. 832].


Original Issue Discount

IRS Issues December 2012 AFRs: In Rev. Rul. 2012-31, the IRS issued the December 2012 AFRs. [Code Sec. 1274].


Retirement Planning

IRS Provides Corporate Bond Weighted Average Interest Rate: In Notice 2012-66, the IRS provides guidance as to the corporate bond weighted average interest rate and the permissible range of interest rates specified under Code Sec. 412(b)(5)(B)(ii)(II) as in effect for plan years beginning before 2008. It also provides guidance on the corporate bond monthly yield curve (and the corresponding spot segment rates), and the 24-month average segment rates under Code Sec. 430(h)(2), among other rates. [Code Sec. 412].

Over-Age-55 Exception Did Not Apply to Preclude Early Distribution Penalty: In Vigil v. Comm'r, T.C. Summary 2012-111 (11/13/12), the Tax Court held that the separation-from-service-after-age-55 exception to the early distribution penalty did not apply with respect to early distributions from a taxpayer's qualified retirement plan where the taxpayer's spouse was over 55 and was never an employee of the taxpayer's employer. The fact that the taxpayer and spouse lived in a community property state was not relevant [Code Sec. 72].


Tax Accounting

Bonus Liability Not Fixed Until Year Paid: In CCM 201246029, the Office of Chief Counsel was asked for help in determining when a taxpayer's liability arising from bonus compensation is taken into account. The Chief Counsel's Office advised that the taxpayer's liability arising from bonus compensation is taken into account in the year the bonuses are paid because taxpayer's employees must still be employed to receive their bonuses and because forfeited amounts revert back to taxpayer. The taxpayer's liability to pay bonuses was not a fixed liability in the year of the related service. Rather, the liability became fixed only if the contingency was satisfiedthat is, when the employee was still employed on the date of payment and receives the bonus compensation. The Chief Counsel's Office noted that there is no de minimis exception to this rule. [Code Sec. 461].

 

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 3. In-Depth Articles 

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Experts Identify Opportunities and Traps Relating to New Capitalization Rules

On November 7, at the AICPA Federal Tax Conference in Washington, D.C., two members of the AICPA Tangible Property Task Force reviewed the temporary regulations on capitalization issued at the end of 2011. David Strong, Director at Crowe Horwath LLP, and Natalie Tucker of the Washington D.C. National Tax Office of McGladrey LLP, emphasized certain year-end strategies practitioners must consider in dealing with the new capitalization rules, as well as opportunities for mitigating some of its more onerous provisions.

On December 27, 2011, the IRS issued temporary regulations (T.D. 9564) aimed at assisting taxpayers in determining whether amounts paid to acquire, produce, or improve tangible property must be capitalized. The temporary regulations are generally effective for amounts paid after 2011. The regulations clarify and expand prior proposed regulations, which had been issued in 2008.

Taxpayers Have Two Years for Automatic Consent Method Changes to Comply with the New Rules

In the wake of the revised capitalization rules, the IRS issued Rev. Proc. 2012-19 and Rev. Proc. 2012-20 to help taxpayers in obtaining automatic IRS consent to change to methods of accounting provided in the capitalization rules. These revenue procedures modify Rev. Proc. 2011-14.

To encourage taxpayers to adopt the methods contained in the regulations, Rev. Proc. 2012-19 and 2012-20 favorably waive the scope limitations under Rev. Proc. 2011-14 (i.e., the limitations that preclude certain taxpayers from eligibility for the automatic consent procedures) for accounting method changes filed for a taxpayer's first or second tax year beginning after December 31, 2011. The method changes provided by Rev. Proc. 2012-19 and 2012-20 will still be automatic after this two-year period, but the normal scope limitations will apply, which could limit a taxpayer's ability to file an automatic Form 3115 (e.g., if it is under exam, has changed its method of accounting for the item within the last five years, etc.).

Rev. Proc. 2012-19 deals with accounting method changes relating to the treatment of tangible property and covers changes to the methods of accounting relating to materials and supplies, relating to repairs and maintenance, general capitalization rules, relating to amounts paid or incurred for acquisition and production of tangible property, and relating to amounts paid or incurred for the improvement of tangible property. Rev. Proc. 2012-20 deals with changes relating to dispositions and depreciation.

A taxpayer that properly files a Form 3115 under Rev. Proc. 2012-19 or 2012-20 generally receives back year audit protection for the item for which the change is being made. Furthermore, the IRS Large Business and International (LB&I) Section issued Directive LB&I-4-0312-004 that applies to exam activity relating to positions taken on original returns relating to the following issues: (1) whether costs incurred to maintain, replace, or improve tangible property must be capitalized under Code Sec. 263(a); and (2) any correlative issues involving the disposition of structural components of a building or dispositions of tangible depreciable assets. LB&I-4-0312-004 indicates that the IRS will not assert penalties arising from a taxpayer's noncompliance with the temporary regulations for the taxpayer's first tax year beginning after December 31, 2011, provided the taxpayer complies for its second tax year ending after December 31, 2011.

Caution: Because Rev. Proc. 2012-19 and Rev. Proc. 2012-20 waive the scope limitations under Rev. Proc. 2011-14 only for the two tax years after 2011, any taxpayer that undergoes a reorganization or any other transaction that cuts its year in half or creates a short year must be especially careful. Such transactions will accelerate the timeframe in which the taxpayer has to avail itself of the favorable provisions relating to the waiver of scope limitations.

Most of the changes under these revenue procedures involve taking into account a Code Sec. 481(a) adjustment based on comparing what the adjustment would be under the new rules compared to the old rules. However, some changes relating to depreciation and dispositions involve applying a cut-off method.

One key point specific to these revenue procedures, Mr. Strong noted, is the ability to use statistical sampling to determine the Code Sec. 481(a) adjustment. This is particularly helpful to taxpayers that have mass amounts of information in their repair and maintenance accounts that they can't look at by transaction. By using statistical sampling, they can look at a sample size and then extrapolate across the population, thus simplifying the Code Sec. 481(a) computation.

One of the things these procedures allow is the ability to file for multiple accounting method changes within one Form 3115. There are 19 different accounting method changes associated with the temporary regulations, and practitioners must consider if their clients need to file any number of them.

Caution: To implement these regulations for 2013, there are some things taxpayers must do this year. First, to obtain automatic IRS consent under Rev. Proc. 2012-19 or Rev. Proc. 2012-20 to change to one of the methods in the new capitalization rules, a taxpayer must currently be using a Code Sec. 263A methodology. If a taxpayer is not currently in compliance with Code Sec. 263A, the taxpayer must first file a Form 3115 requesting an accounting method change to bring the taxpayer into compliance with Code Sec. 263A before the taxpayer can file a Form 3115 to take advantage of the automatic accounting method changes in Rev. Proc. 2012-19 or Rev. Proc. 2012-20. So practitioners with clients on a facts-and-circumstances methodology should be considering whether this is appropriate for their client. Additionally, practitioners need to understand how these method changes and the resulting Code Sec. 481(a) adjustment will affect the client's inventory calculations.

As Ms. Tucker noted, there is no statute of limitations for accounting method changes. In computing a Code Sec. 481 adjustment, the taxpayer must calculate what a particular expenditure would have been as if the taxpayer had always used the new method and compare that to what the taxpayer actually did under method the taxpayer is changing from, and the difference is the Code Sec. 481 adjustment. She noted that the statute of limitations comes into play when there is an error, but there is no statute of limitations with respect to accounting method changes. Thus, taxpayers may have to go back three or four years or 15 years or more to calculate the cumulative effect of how an expenditure was treated compared to how it would have been treated under the new rules. Taxpayers who do not do this to come into compliance with the new rules could be subject to the IRS doing the calculation and making the taxpayer take the adjustment into income in one year as opposed to four years for adjustments calculated by the taxpayer. Thus, one of the benefits of doing the voluntary method changes under Rev. Proc. 2012-19 and Rev. Proc. 2012-20 is that if its an unfavorable adjustment, the taxpayer can spread it over four years and there are no penalties and interest. Otherwise, if the IRS does it under exam, the adjustment must be taken into income in one year with interest and penalties.

Under the new capitalization rules, the definition of a disposition is expanded to take into account a structural component of a building (e.g., a roof). Thus, Ms. Tucker noted, under the new rules, when doing a method change, if the taxpayer had two roofs on a building, the taxpayer could write off the basis in the first one and capitalize the second one and depreciate it over 39 years under the new method. So if a taxpayer had three roofs, the taxpayer could use the method change to write off the bases of the first two roofs and then depreciate the third so the taxpayer would do the disposition method change to write off the first two roofs. Previously, if it was a structural component, the taxpayer had to depreciate both roofs.

If the taxpayer previously deducted a replacement as a repair, the taxpayer has to look at whether, under the new rules, it should have been deducted as a repair. If it should not have, the taxpayer has to go back and capitalize and depreciate it.

Deduction Opportunities under the Restoration Rules

Ms. Tucker then presented some options for mitigating the effects of the new restoration rules. Under Reg. Sec. 1.263(a)-3T, a taxpayer must capitalize amounts paid to restore a unit of property, including amounts paid in making good the exhaustion for which an allowance is or has been made. An amount is paid to restore a unit of property where it:

(1) is for the replacement of a component of a unit of property and the taxpayer has properly deducted a loss for that component (other than a casualty loss);

(2) is for the replacement of a component of a unit of property and the taxpayer has properly taken into account the adjusted basis of the component in realizing gain or loss resulting from the sale or exchange of the component;

(3) is for the repair of damage to a unit of property for which the taxpayer has properly taken a basis adjustment as a result of a casualty loss;

(4) returns the unit of property to its ordinarily efficient operating condition if the property has deteriorated to a state of disrepair and is no longer functional for its intended use;

(5) results in the rebuilding of the unit of property to a like-new condition after the end of its class life; or

(6) is for the replacement of a part or a combination of parts that comprise a major component or a substantial structural part of a unit of property.

Thus, under (1), above, the replacement of a structural component of a building is capitalized where a loss is deducted for that component. Ms. Tucker gave as an example a company that has a broken window that must be replaced. It's appropriate for the taxpayer to take a loss on the broken window and then the replacement window qualifies as a structural component of the building. By taking the loss, the taxpayer kicks the replacement window into the restoration rules, thus requiring the capitalization of the replacement window.

However, as Mr. Strong pointed out, taxpayers can get around such treatment by electing to use the general asset account (GAA) rules, not taking the loss, and instead deducting the new window as a repair and maintenance cost. The purpose of the GAA rules is to mitigate the more onerous aspects of the disposition rules. Under the GAA rules, assets that are subject to the election are grouped into one or more general asset accounts. Assets that are eligible to be grouped into a single general asset account may be divided into more than one general asset account. Each general asset account must include only assets that (i) have the same applicable depreciation method; (ii) have the same applicable recovery period; (iii) have the same applicable convention; and (iv) are placed in service by the taxpayer in the same tax year. Mr. Strong stated that, especially with respect to real property, it is generally beneficial to make the GAA election.

Thus, the taxpayer in the example above could put the entire building in one general asset account. In that case, the taxpayer would not deduct the broken window, but instead would take a repair and maintenance deduction for the new window and just continue depreciating the broken window in the building group under the GAA rules.

Ms. Tucker noted there is also an opportunity to deduct rather than capitalize the restoration of property described under (5) and (6) above (i.e., the rebuilding of a unit of property to a like-new condition after the end of its class life, or replacing a part or a combination of parts that comprise a major component or a substantial structural part of a unit of property) by using the safe harbor for routine maintenance as provided in Reg. Sec. 1.263(a)-3T(g)(1).

Observation: As the routine maintenance safe harbor rule is currently written, it applies only to tangible personal property

Under the routine maintenance safe harbor rule, an amount paid for routine maintenance performed on a unit of property other than a building or a structural component of a building is deemed not to improve that unit of property and thus may be deducted. Routine maintenance is the recurring activities a taxpayer expects to perform as a result of the taxpayer's use of the unit of property to keep the unit of property in its ordinarily efficient operating condition. Routine maintenance activities include, for example, the inspection, cleaning, and testing of the unit of property, and the replacement of parts of the unit of property with comparable and commercially available and reasonable replacement parts. The activities are routine only if, at the time the unit of property is placed in service by the taxpayer, the taxpayer reasonably expects to perform the activities more than once during the class life of the unit of property. Among the factors to be considered in determining whether a taxpayer is performing routine maintenance are the recurring nature of the activity, industry practice, manufacturers' recommendations, the taxpayer's experience, and the taxpayer's treatment of the activity on its applicable financial statement.

Planning for the De Minimis Rule

One of the highlights of the new capitalization provisions is the de minimis rule. A taxpayer is not required to capitalize amounts paid for the acquisition or production of a unit of property (excluding inventory and land) if the taxpayer meets the following requirements:

(1) the taxpayer has applicable financial statements (AFS);

(2) the taxpayer has at the beginning of the tax year written accounting procedures treating as an expense for nontax purposes the amounts paid for property costing less than a certain dollar amount;

(3) the taxpayer treats the amounts paid during the tax year as an expense on the AFS in accordance with its written accounting procedures; and

(4) the total aggregate of amounts paid and not capitalized for the tax year are less than or equal to the greater of (i) 0.1 percent of the taxpayer's gross receipts for the tax year as determined for federal income tax purposes; or (ii) 2 percent of the taxpayer's total depreciation and amortization expense for the tax year as determined in its AFS.

Taxpayers may also elect to apply this rule to materials and supplies. Ms. Tucker noted that, while many small businesses do not have applicable financial statements and thus cannot avail themselves of the de minimis rule, the rule may subsequently be broadened to apply to smaller businesses. Alternatively, a business may grow to the point where it does have applicable financial statements and can take advantage of the de minimis rule. In either case, to avail themselves of this rule, taxpayers must have in place written accounting procedures treating as an expense for nontax purposes the amounts paid for property costing less than a certain dollar amount.

Thus, practitioners should advise clients to put into place, as soon as possible, these written accounting procedures so they can take advantage of the de minimis rule should they otherwise be able to. For example, if a calendar-year business otherwise qualifies for the de minimis rule in 2013, it must have the written accounting procedures in place by the end of 2012. Often, these written policies will just be written clarification of procedures the taxpayer already has in place.

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Lawyer's Mistake Costs Estate $1 Million; Reliance on Attorney Wasn't Reasonable Cause to Avoid Penalty

Special rules allow an estate to pay its taxes on an installment basis without penalty. However, the request for an extension of time to pay those taxes must be filed when the estate tax return is due, even if the amount of taxes cannot be determined. Not doing so can result in penalties and interest. This was the situation in Est. of Thouron v. U.S., 2012 PTC 291 (E.D. Pa. 11/7/12). The fact that the attorney hired by the estate to oversee its tax compliance did not recognize this did not excuse the estate from the nonfiling. As a result, the estate was hit with penalties and interest of $1 million and its' claim that it had reasonable cause for not filing the extension to pay because it relied on a professional was rejected.

Background

On February 6, 2007, John Thouron died at age 99. He was predeceased by his wife and only child and was survived by two grandchildren who were not familiar with his financial affairs. Thouron's will appointed Charles Norris as the estate's personal representative. Norris hired attorney Cecil Smith of Cecil Smith & Associates, P.C. to provide legal services regarding tax compliance of the estate.

Under Code Sec. 6075, the estate was required to file Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return, and pay any tax by November 6, 2007, nine months after Thouron's death. On November 6, 2007, the estate filed Form 4768, Application for Extension of Time to File a Return and/or Pay U.S. Estate (and Generation-Skipping Transfer) Taxes, requesting only an extension of time to file the federal estate tax return. That same day, the estate paid $6.5 million in taxes, which was approximately one-third of the total tax liability ultimately owed by the estate.

The $6.5 million payment by the estate was allegedly calculated by Smith under the assumption that certain assets would qualify for treatment under Code Sec. 6166, which provides for a deferral of taxes for certain assets. The estate did not file a request for an extension of time to pay the estate tax when it filed its extension request. According to Norris, Smith advised the estate that the form for an extension of time to pay the tax was not due on November 6, 2007, but rather was due when the tax return was filed. Moreover, in the weeks before the filing and payment deadline Smith advised the estate that its illiquid assets may qualify for treatment under Code Section 6166, which would defer a tax on assets that qualify as assets of a closely held trade or business. Smith further advised that if the assets did not qualify for this treatment, there would be no penalty imposed and that the estate need only file for an extension of time to file the tax return.

On May 5, 2008, the estate filed its Form 706 estate tax return. That same day, the estate submitted Form 4768 requesting, for the first time, an extension of time to pay the estate tax under Code Section 6161. The IRS denied the estate's request as untimely and assessed a late-payment penalty for failure to timely pay the tax. The estate unsuccessfully appealed the penalty. On July 1, 2010, the estate executed Form 890, the Estate Tax Waiver of Restrictions on Assessment and Collection of Deficiency and Acceptance of Overassessment, which is the form used to resolve all remaining issues with the IRS. Subsequently, the estate paid all amounts due, including the penalty, and interest accrued on the penalty, to the date of payment. The estate then filed Form 843 seeking a refund of approximately $1 million resulting from penalties and interest.

District Court's Analysis

The court began by noting that Reg. Sec. 20.6161-1(b) governs extensions of time to pay an estate tax and provides that an application for an extension of time to pay the estate tax will not be considered unless the extension is applied for on or before the date fixed for payment of the tax. This rule, the court stated, is reiterated in the instructions for completing Form 4768, which provides that an application for an extension of time to pay estate tax applied for after the estate tax due date will generally not be considered by the IRS.

The court also noted that, under Code Sec. 6161(e), a taxpayer must file separate requests with the IRS for an extension of time to file a tax return and for an extension of time to pay the tax. This rule, the court stated, is also set forth in the instructions for completing Form 4768, which states that an extension of time to file does not extend the time to pay.

With respect to the estate's argument that it had reasonable cause, based on its reliance on the erroneous advice of Smith, a hired professional, the court cited the Supreme Court court's decision in U.S. v. Boyle, 469 U.S. 241 (1985). The Boyle case involved the late filing of an estate tax return. In Boyle, the Supreme Court noted that Congress's purpose in enacting the civil penalty was to ensure timely filing of tax returns to the end that tax liability will be ascertained and paid promptly. The Court established a bright-line rule that the failure to make a timely filing of a tax return is not excused by the taxpayer's reliance on an agent, and such reliance is not reasonable cause' for a late filing.

When an accountant or attorney advises a taxpayer on a matter of tax law, such as whether a liability exists, it is reasonable for the taxpayer to rely on that advice. Most taxpayers, the court observed, are not competent to discern error in the substantive advice of an accountant or attorney. By contrast, one does not have to be a tax expert to know that tax returns have fixed filing dates and that taxes must be paid when they are due. In short, tax returns imply deadlines. Reliance by a lay person on a lawyer is common, the court noted; but that reliance cannot function as a substitute for compliance with an unambiguous statute. Among the first duties of the representative of a decedent's estate is to identify and assemble the assets of the decedent and to ascertain tax obligations.

The district court then looked at a decision of the Ninth Circuit that applied the reasoning in Boyle to a case involving the failure to pay a tax on time. In Baccei v. U.S., 632 F.3d 1140 (9th Cir. 2011), Ronald B. Baccei was appointed as the trustee for a revocable trust upon Eda Pucci's death on September 17, 2005. Baccei hired a CPA to prepare and file the Pucci's estate tax return. On June 16, 2006, the CPA mailed to the IRS a Form 4768, Application for Extension of Time to File a Return and/or Pay U.S. Estate Taxes, to extend the filing deadline. The accountant completed three of the four sections of Form 4768, but failed to complete Part II, entitled Extension of Time to Pay. The CPA's cover letter enclosing Form 4768 stated that the Pucci estate was seeking this extension of time to pay as well as asking that no penalty be asserted. Because the Pucci estate did not pay its tax by the June 2006 deadline, the IRS assessed a penalty plus interest against the estate. The Baccei court explained its' rational for applying Boyle in the context of a failure to timely pay a tax as follows:

We extend these determinations of reasonable cause under Sec. 6651(a)(1) to determinations of reasonable cause under Sec. 6651(a)(2). There is no reason to distinguish between reasonable cause for a failure to timely file an estate tax return and reasonable cause for a failure to timely pay an estate tax, and we refuse to do so. Accordingly, we affirm the district court's finding that [the taxpayer's] reliance upon [a professional] to competently file a payment extension request does not constitute reasonable cause excusing [the taxpayer's] failure to timely pay the estate taxes owed.

The district court agreed with the reasoning in Baccei that the holding in Boyle applies with equal force to a failure to pay a tax because the reasonable cause excuse for failing to file a return or pay a tax timely is under the same Code section. Further, the court noted, the statutes place an identical burden on executors to file returns and pay taxes by the prescribed deadlines. The retention of a professional does not negate a taxpayer's responsibility to identify the payment deadline and ensure payment was made prior thereto. The difference in occupation of a professional is not material either because an accountant and a tax attorney are professionals hired for their estate tax expertise. The district court thus concluded that the advice given by Smith regarding the statutory deadline to pay the tax did not constitute reasonable cause and the estate was liable for the penalties and interest assessed.

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IRS Continues Hurricane Sandy Tax Relief

The IRS said it is supporting leave-based donation programs to aid victims who have suffered from the extraordinary destruction caused by Hurricane Sandy. Notice 2012-69; IR-2012-88 (11/6/12).

The IRS announced more special relief for victims of Hurricane Sandy. In IR-2012-88 and Notice 2012-69, the IRS said it is supporting leave-based donation programs to aid victims who have suffered from the extraordinary destruction caused by Hurricane Sandy. Under these programs, employees may donate their vacation, sick, or personal leave in exchange for employer cash payments to qualified tax-exempt organizations providing relief for the victims of Hurricane Sandy.

Employees can forgo leave in exchange for employer cash payments made before January 1, 2014. Under this special relief, the donated leave will not be included in the income or wages of the employees. Employers will be permitted to deduct the amount of the cash payment.

In RI-12-30, the IRS stated that parts of Rhode Island may qualify for tax relief also. The President has declared Newport and Washington counties a federal disaster area. Individuals who live or have a business in these counties may qualify for tax relief. The declaration permits the IRS to postpone certain deadlines for taxpayers who reside or have a business in the disaster area. For instance, certain deadlines falling on or after October 26, and on or before February 1, have been postponed to February 1, 2013. In addition, the IRS is waiving the failure-to-deposit penalties for employment and excise tax deposits due on or after October 26, and on or before November 26, as long as the deposits are made by November 26, 2012.

In NY-12-47, the IRS stated that parts of New York also may qualify for tax relief. The President declared Bronx, Kings, Nassau, New York, Orange, Putnam, Queens, Richmond, Rockland, Sullivan, Suffolk, Ulster, and Westchester counties a federal disaster area. Individuals who live or have a business in these counties may qualify for tax relief. The declaration permits the IRS to postpone certain deadlines for taxpayers who reside or have a business in the disaster area. For instance, certain deadlines falling on or after October 27, and on or before February 1, have been postponed to February 1, 2013. In addition, the IRS is waiving the failure-to-deposit penalties for employment and excise tax deposits due on or after October 27, and on or before November 26, as long as the deposits are made by November 26, 2012.

In Announcement 2012-44, the IRS provided additional relief with respect to retirement plans. Under the announcement, a qualified employer plan will not be treated as failing to satisfy any requirement under the Code or regulations merely because the plan makes a loan, or a hardship distribution for a need arising from Hurricane Sandy, to an employee or former employee whose principal residence on October 26, 2012, was located in one of the counties or Tribal Nations that have been identified as covered disaster areas because of the devastation caused by Hurricane Sandy or whose place of employment was located in one of these counties or Tribal Nations on that date or whose lineal ascendant or descendant, dependent or spouse had a principal residence or place of employment in one of these counties or Tribal Nations on that date.

The amount available for hardship distribution is limited to the maximum amount that would be permitted to be available for a hardship distribution under the plan under the Code and regulations. However, the relief provided by Announcement 2012-44 applies to any hardship of the employee, not just the types enumerated in the regulations, and no post-distribution contribution restrictions are required. For example, regulations under Code Sec. 401(k) provide safe-harbor hardship distribution standards under which a hardship is deemed to exist only for certain enumerated events, and after receipt of the hardship amount, the employee is prohibited from making contributions for at least six months. Plans need not follow these rules with respect to hardship distributions for which relief is provided under Announcement 2012-44.

PRACTICE TIP: To make a loan or hardship distribution, a qualified employer plan that does not provide for them must be amended to provide for loans or hardship distributions no later than the end of the first plan year beginning after December 31, 2012. To qualify for the relief, a hardship distribution must be made on account of a hardship resulting from Hurricane Sandy and be made on or after October 26, 2012, and no later than February 1, 2013.

Plan loans made pursuant to Announcement 2012-44 must satisfy the requirements of Code Sec. 72(p).

In IR-2012-91, the IRS warned of scams relating to Hurricane Sandy, including bogus charities contacting people by phone to solicit money or financial information. According to the IRS, taxpayers should watch out for bogus websites that frequently mimic the sites of, or use names similar to, legitimate charities, or claim to be affiliated with legitimate charities, in order to obtain personal financial information that can be used to steal identities or financial resources. Taxpayers suspecting disaster-related frauds should go to IRS.gov and search for the keywords Report Phishing.

For a discussion of Hurricane Sandy relief, see Parker Tax ¶79,320.

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Thirty-Percent Rule Causes Recharacterization of Income to Nonpassive, but Losses Stay Passive

Because less than 30 percent of the unadjusted basis of the property leased by customers in the taxpayer's rental activity was subject to depreciation, the income from that activity was nonpassive and could not be offset against passive activity losses from other related rentals. Dirico v. Comm'r, 139 T.C. No. 16 (11/13/12).

Francis Dirico leased land and telecommunication towers to his wholly owned S corporation, Industrial Communications & Electronics, Inc. (ICE), in exchange for a percentage of ICE's revenues from its leases of tower access to third parties. Francis also leased three parcels of land to ICE that were without towers. Besides leasing tower access to third parties, ICE also sold and serviced radios and provided specialized mobile radio (SMR) services to customers for a monthly subscriber fee. Four of the towers leased to ICE housed antennas in free (unused) space for the rent-free use of ICE's SMR customers.

Francis's returns for the years at issue reported the income and loss from the leasing of towers and land to ICE as passive activity income and loss for purposes of Code Sec. 469. Those returns listed each of the individual land and tower rentals as a separate activity. ICE's returns for the years at issue did not separately report the income or loss from its various activities. Rather, ICE reported its total net income as ordinary business income. On the Form 1120S Schedule K-1, Shareholder's Share of Income, Deductions, Credits, etc., issued to Francis for each of the years at issue, ICE included Francis's entire 100 percent distributive share of its income for the year in Box 1, Ordinary business income (loss). Consistent with those Schedules K-1, Francis reported his distributive share of ICE's income as ordinary, nonpassive-activity income on Schedule E, Supplemental Income and Loss.

The IRS assessed a deficiency alleging that Francis's rental income from his tower and land rentals to ICE was income from property used in a trade or business in which Francis materially participated and, therefore, was nonpassive activity income under Reg. Sec. 1.469-2(f)(6). However, the IRS said this provision applied only to Francis's profitable tower and land leases to ICE so that his losses from unprofitable tower and land leases to ICE remained passive activity losses and could not offset the nonpassive activity income. Finally, according to the IRS, Francis's income from the three land-only leases to ICE was nonpassive-activity income under Reg. Sec. 1.469-2T(f)(3) because less than 30 percent of the leased property's unadjusted basis was subject to depreciation.

Under Code Sec. 469(c)(2) and (4), rental activities are generally automatically passive, regardless of whether the taxpayer materially participates in the activity, and thus are subject to the passive activity loss limitation rules. Reg. Sec. 1.469-4(d)(2) prohibits grouping the rental of real property and the rental of personal property as a single activity unless the personal property is provided in connection with the real property or vice versa. Reg. Sec. 1.469-2T(f)(3) recharacterizes rental income from passive to nonpassive where less than 30 percent of the unadjusted basis of the property used or held for use by customers in the rental activity (within the meaning of Reg. Sec. 1.469-1T(e)(3)) during the tax year is subject to depreciation. In that case, the taxpayer's gross income from the activity equal to the taxpayer's net passive income from the activity is treated as not from a passive activity.

The Tax Court held that ICE used the towers and associated land leased from Francis in a rental (not a trade-or-business) activity, with the result that his income from those leases constituted passive activity income (or loss), regardless of Francis's material participation in that activity. However, the court concluded that, because the land included in the land-only leases was not "provided in connection with" any of the towers Francis leased to ICE, those leases could not be grouped with Francis's tower and land leases to ICE and, therefore, because less than 30 percent of the property covered by those leases was depreciable, Francis's income therefrom was nonpassive-activity income under Reg. Sec. 1.469-2T(f)(3).

Observation: During the trial, the question of the extent of Francis's involvement with ICE during the years in issue arose. The court said that, assuming ICE used the towers and land leased from Francis or a nominee trust in a "trade or business activity" as defined in Reg. Sec.1.469-4(b)(1), the question was whether Francis's involvement in that activity rose to the level of material participation, thereby triggering the application of Reg. Sec. 1.469-2(f)(6) to convert his tower and land rental income from passive-activity to nonpassive-activity income. The court found that ICE did not use the towers and land leased from Francis or a nominee trust in a trade or business activity, which rendered moot the issue of whether Francis materially participated in ICE's tower access leasing activity during the years at issue. Therefore, the court did not address or attempt to resolve conflicting evidence in the record regarding Francis's involvement in the day-to-day operations of ICE.

For a discussion of passive versus nonpassive income and the 30-percent recharacterization rule relating to rental income, see Parker Tax ¶247,145.

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Income from Medical Study Includible in Income; Doesn't Qualify as Gift

A payment received for participating in a gout study was not excludible from income as compensation received on account of physical illness; nor was it excludible as a gift. O'Connor v. Comm'r, T.C. Memo. 2012-317 (11/14/12).

Daniel O'Conner has suffered from gout since 1983. In 2008, Covance Research Clinic advertised that it was conducting a gout study in Honolulu, Hawaii. Daniel was living in Honolulu at the time and entered into a contract with Covance to participate in the study. For 10 days and nine nights, Daniel was confined to the Covance medical facility. He was required to adhere to a strict schedule during the study, which included blood tests, urine tests, EKGs, and vital screenings. During the study, Covance gave Daniel and the other participants meals and lodging. Daniel was also required to participate in outpatient visits after the completion of the study. Daniel received a payment of $5,550 from Covance and Covance issued a Form 1099-MISC, Miscellaneous Income, to Daniel. He timely filed a Form 1040 for 2008 but did not report the $5,550. During an audit, the IRS requested a copy of the contract Daniel had with Covance but he failed to produce it. The IRS assessed a deficiency based on Daniel's excluding the Covance payment from income.

Daniel argued that the Covance payment was not includable in gross income because it was (1) excluded under Code Sec. 104 as compensation received on account of physical illness or physical sickness, and (2) excludible under Code Sec. 102 as property received by gift.

The Tax Court sided with the IRS and held that the $5,550 was includible in income. Daniel, the court noted, has been suffering from gout since roughly 1983, and he did not allege that he suffered from physical injury or sickness on account of the gout study. He did not prove a direct causal link between the payment he received from Covance and the gout that he has suffered from since 1983. The court noted that Daniel entered into a written contract with Covance but failed to produce it at trial. Without the contract, the Tax Court stated, it could not determine that the payment was compensation for anything except Daniel's participation in the study. Merely participating in the study, the court said, does not result in compensation for damages received on account of physical injury or physical sickness. In addition, the court concluded that the fact that Covance issued a Form 1099-MISC demonstrated that Covance did not have donative intent when it paid $5,550 to Daniel. Thus, Daniel could not exclude the amount from income as a gift.

For a discussion of payments excludible from income because they were received on account of physical illness or because they were received as a gift, see Parker Tax ¶75,910 and ¶75,501, respectively.

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Taxpayer Erred in Not Taking Losses in Year Sustained; Court Rejects Theft Loss Argument Involving Sitcom Star

A taxpayer could not use alleged promises of reimbursement from a former TV sitcom star to take a deduction for expenses years incurred years earlier. Alioto v. Comm'r, 2012 PTC 290 (6th Cir. 11/7/12).

From 1995 to 2000, David Alioto founded and developed his own company, which was in the business of transporting unusual items that other commercial carriers would not transport. In early 2000, David hired John Ratzenberger, an actor famous for his role as a postman on the television show Cheers, to speak at a conference relating to David's business. Ratzenberger approached Alioto about a new business venture, called Big Red Tent (BRT), which was to involve using celebrity talent to create short form media that would be sold to corporations as internet advertisements. David agreed to join the venture as a CEO and agreed to provide services including setting up the office operations and meeting with investment and venture firms to raise capital for the business.

During 2000 and 2001, David spent approximately $200,000 of his own money on expenses related to BRT. David said he believed he would be reimbursed by Ratzenberger for all of the BRT-related expenses. While he did receive $52,000 from Ratzenberger for BRT-related expenses in 2001, he decided to remove himself from BRT because it was a financial drain. By early 2002, David came to believe that some of Ratzenberger's representations regarding his financial condition had been false. Alioto testified that after he ended his involvement with BRT, he continued to seek reimbursement from Ratzenberger throughout 2002, 2003, and 2004, through emails, phone calls, and discussions with Ratzenberger. David asserted that he received a very specific email in 2005 from Ratzenberger's agent from which he inferred that no further reimbursement was forthcoming, and it was at this time that David concluded that he would not receive any repayment. The emails referenced by David were never produced at trial. In 2005, David filed for bankruptcy and listed $341,363 as outstanding business expenses or loans owed to him from BRT.

David argued that, before 2005, it could not be ascertained with reasonable certainty whether or not he would receive reimbursement from Ratzenberger for his BRT-related expenses. He contended that in 2005, he abandoned his claim for reimbursement, and thus the losses were sustained and deductible in that year because there was no longer a reasonable prospect of recovery. Alternately, David argued that the BRT-related losses were deductible as theft losses because Ratzenberger allegedly stole money from David using false pretenses. According to David, Massachusetts law applied and, under such law, a person is guilty of larceny if, with intent to defraud and by a false pretence, the person induces another person to part with property of any kind.

The Tax Court concluded there was no objective evidence that Alioto abandoned his claim for reimbursement in 2005, and further found that the weight of the evidence indicated that it was in 2001 and early 2002 when David could ascertain with reasonable certainty that the BRT-related expenses would not be reimbursed. Further, the Tax Court found that there was nothing in the record that proved that Ratzenberger committed any wrongdoing. David appealed.

On appeal, David pointed to two pieces of evidence to support his theory of abandonment. First, he cited his own testimony that he received an email in 2005 from Ratzenberger's agent notifying him that no further reimbursement was forthcoming. David did not produce the email at trial, nor otherwise prove that the communication occurred. Second, he pointed to his bankruptcy, saying that the fact that he was forced to file for bankruptcy was evidence of the uncollectibility of the reimbursement claim at that time. He also argued that the evidence he presented at trial established the elements of larceny under Massachusetts law.

The Sixth Circuit affirmed the Tax Court and held that David was not entitled to any deduction. Citing Reg. Sec. 1.165-1(d)(2)(i), the court stated that David's testimony concerning the email did not meet the requirement of objective evidence to prove abandonment. With respect to the bankruptcy, the court said that David's decision to file for bankruptcy could have been motivated by a variety of considerations. If anything, the court said, that David filed for bankruptcy in 2005 might lend weight to his argument that he subjectively believed there was no longer a prospect of recovery in 2005but even that did not necessitate a finding, using an objective standard, that a reasonable certainty regarding the reimbursement did not exist until that year.

With respect to David's argument that the BRT-related losses were deductible as theft losses, the Sixth Circuit agreed with the Tax Court that David did not present any evidence demonstrating that Ratzenberger or his agents did anything illegal and David failed to show any specific promises or agreements made by Ratzenberger and his agents.

For a discussion of the correct year to deduct losses, see Parker Tax ¶97,115.

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Payment of Adult Children's Living Expenses Negates Finding of Economic Hardship

Where a taxpayer spent a large portion of her monthly income on her adult children's living expenses, she could not prove economic hardship and thus was not eligible for innocent spouse relief. Karam v. Comm'r, 2012 PTC 289 (6th Cir. 11/5/12).

Theresa and James Karam have been married since 1980. Theresa is the director of special education for a public school district and has worked there since 1981. She holds a Ph.D. in educational psychology and her current gross income is about $8,000 per month. James is a self-employed dentist who has operated his own practice since 1985. The Karams have four adult sons, each of whom received their primary and secondary education in parochial schools. Theresa regularly sends her adult children money for living expenses after she pays for utilities, groceries, clothing, healthcare premiums for the entire family, and car insurance premiums for the family's four vehicles.

In 1997, following the death of their long-time accountant, James hired Theodore Schumann, P.C., C.P.A., doing business as Dental Business Services, Inc., to take over the family's accounting and taxes. Although James provided the Schumann firm with tax documentation necessary to timely prepare their tax returns, the firm was delinquent in preparing the Karams' tax returns for 1998 through 2001. The Karams later discovered that the accountant assigned to their file was ill, and the firm never had another accountant prepare their returns. Subsequently, late returns were prepared by the firm and filed by the Karams.

Exclusive of penalties and interest, the Karams owed a total of $197,302 in unpaid income taxes for those three years. The deficiency resulted from the Karams' failure to pay estimated tax on the dental business income earned between 1999 and 2001. Theresa sued the Schumann firm, alleging that the firm's negligence and breach of contract resulted in her joint and several liability for federal income taxes. The case was ultimately settled, with the CPA firm paying Theresa $150,000. After paying attorney's fees and costs, Theresa offered the IRS the remaining balance of $99,186 to settle her outstanding tax liability. The IRS rejected her offer.

Theresa subsequently submitted a Form 8857, Request for Innocent Spouse Relief, and, after analyzing her eligibility for relief under Code Sec. 6015(b), (c), and (f), the IRS denied her request. She challenged the denial in Tax Court, but only on the ground that she was entitled to equitable relief under Code Sec. 6015(f). The Tax Court sided with the IRS and rejected Theresa's argument that her reasonable basic living expenses included the payment of her adult children's living expenses. Thus, Theresa could not establish economic hardship, one of the requirements for obtaining relief, because she failed to demonstrate that her entire monthly salary was spent on reasonable basic living expenses. Theresa appealed.

The Sixth Circuit affirmed the Tax Court and held that Theresa was not entitled to innocent spouse relief. The Sixth Circuit said that nothing in the applicable procedures or regulations suggests that spending a large portion of monthly income on adult children's health and car insurance and living expenses should be included as part of a taxpayer's own reasonable basic living expenses. As a result, she did not meet the criteria for innocent spouse relief.

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

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Hiding Assets Overseas Leads to Large FBAR Penalties on Company Co-Founder

The fact that a taxpayer's failure to comply with FBAR was the result of his belief that he did not have a reportable financial interest in the foreign accounts was irrelevant, and the fact that he did not disclose his interests in the accounts was willful and the taxpayer was subject to a $100,000 fine for each year. U.S. v. McBride, 2012 PTC 295 (D. Utah 11/8/12).

Jon McBride and Scott Newell were equal partners in The Clip Company, LLC, a company that sold belt clip accessories for cell phones. The Clip Company was in continuous operation from 1994 to 2008. Jon was responsible for the financial operations of the Clip Company, including keeping accounting records, and preparing quarterly and yearly reports for the Clip Company.

In 1999, after seeing an advertisement for Merrill Scott and Associates, a financial firm, Jon contacted the firm to see if Merrill Scott could provide financial services that would result in avoiding or deferring the recognition of $2 million in income that Jon expected to receive as a result of the Clip Company signing several lucrative contracts for the sale of its products.

Merrill Scott held itself out as a financial management firm that employed strategies that would allow its clients to avoid or defer the recognition of income for tax purposes and to shield their assets from the reach of creditors by utilizing, among other financial strategies and instruments, foreign variable annuities and foreign financial accounts. In reality, Merrill Scott's strategies were designed to allow its clients to avoid reporting income and their ownership of assets by having the clients' assets held by nominees holding the legal title of shell corporations and foreign bank accounts. Among other strategies, Merrill Scott and its clients purchased foreign variable annuities, set up international business corporations (IBCs) that were incorporated in foreign countries for the benefit of individual clients, established bank and securities accounts in foreign countries, and created foreign trusts and other vehicles that would hold assets for the benefit of Merrill Scott's clients. McBride never obtained an outside legal opinion from an attorney about the legality of Merrill Scott's financial strategies, nor did he seek advice from his accountant at the time, who expressed concern about the transactions with Merrill Scott.

Upon auditing Jon, the IRS determined that he had worked with Merrill Scott to set up an offshore business structure to move domestic profits of the Clip Company offshore by inflating the costs of inventory paid to a supplier and retaining the excess funds in foreign financial accounts. Over the course of the examination, the IRS repeatedly requested that Jon produce various documents related to his participation in Merrill Scott programs. Initially, Jon did not produce anything and denied he had used Merrill's programs. He also lied to the IRS, and claimed that the money funneled from his inventory supplier through various entities to the Clip Company constituted a valid loan from the supplier, as opposed to the profits of the Clip Company. The IRS also concluded that Jon had not filed a foreign bank account report (FBAR), Form TD F 90-22.1, for the tax years 2000 and 2001 and requested that he do so. However, Jon did not file the reports and the IRS assessed a civil penalty in the amount of $200,000 (i.e., $100,000 for each year). Jon filed for relief in a district court.

The district court upheld the $200,000 assessment, in addition to additional interest and penalties in the amount of $75,000. The court noted that the IRS did not dispute that Jon's failure to comply with FBAR was the result of his belief that he did not have a reportable financial interest in the foreign accounts. However, the court said, that was irrelevant and the only question that remained was whether the law required its disclosure. The court concluded that the FBAR requirements did require that Jon disclose his interests in the foreign accounts during both the 2000 and the 2001 tax years. As a result, the court found Jon's failure to do so willful.

For a discussion of the FBAR requirements, see Parker Tax ¶203,170.

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Recomputation of Minimum Tax Credit Carryover Required when Taxpayers Carry Back ATNOL

Because an alternative tax net operating loss (ATNOL) carryback to a prior tax year can reduce the alternative minimum tax imposed in that prior year and affect the amount of minimum tax credit available for use by the taxpayer in a later year, a taxpayer's minimum tax credit carryover must be recomputed when a taxpayer carries back an ATNOL. CCA 201246034.

In CCA 201246034, the Office of Chief Counsel was asked about the effect of a carryback of an alternative tax net operating loss (ATNOL) on the minimum tax credit carryover of a corporate taxpayer.

Under Code Sec. 53(d)(1), the adjusted net minimum tax for any tax year is the amount of net minimum tax for the year. The net minimum tax is the alternative minimum tax (AMT). The AMT is the excess of the tentative minimum tax for the tax year, over the regular tax for the year. The tentative minimum tax is a percentage of so much of a taxpayer's alternative minimum taxable income (AMTI) as exceeds an exemption amount. AMTI is taxable income of a taxpayer for the tax year, determined with the adjustments and preferences. Among the adjustments is the adjustment under Code Sec. 56(a)(4) for the alternative tax net operating loss (ATNOL) deduction. The ATNOL deduction is allowed in computing AMTI in lieu of the net operating loss deduction allowed under Code Sec. 172. The ATNOL deduction is defined in Code Sec. 56(d) as the NOL deduction allowable under Code Sec. 172 with certain adjustments.

The Chief Counsel's Office noted that an NOL deduction under Code Sec. 172 includes NOL carrybacks to such tax year and there is nothing in the AMT provisions that treats the effect of an ATNOL deduction in computing AMTI any different than the effect of an NOL deduction in computing taxable income. In other words, the ATNOL deduction (including an ATNOL carryback) reduces AMTI. The AMT liability is based on a percentage of a taxpayer's AMTI (through the tentative minimum tax). Consequently, anything that reduces AMTI (such as an ATNOL deduction) will reduce a taxpayer's AMT. A reduction in a taxpayer's AMT will also be a reduction of the taxpayer's adjusted net minimum tax, which determines the amount of a taxpayer's minimum tax credit. Thus, a recomputation of the minimum tax credit carryover is required since an ATNOL carryback to a prior tax year can reduce AMT imposed in that prior year and, as a result, the amount of minimum tax credit available for use by the taxpayer in a later year.

For a discussion of the minimum tax credit, see Parker Tax ¶12,170.

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