IRS Operations During The Government Shutdown - No Refunds and No Audits

Due to the current lapse in appropriations and resulting government shutdown, IRS operations are limited. Taxpayers should not expect to receive any refunds during the shutdown, nor should they expect any audits. However, the underlying tax law remains in effect, and the IRS stated that all taxpayers should continue to meet their tax obligations as normal. Thus, individuals and businesses should keep filing their tax returns and making deposits with the IRS as required by law. The IRS will accept and process all tax returns with payments but will be unable to issue refunds during this time.

While no live telephone customer service assistance is available during the shutdown, most automated toll-free telephone applications will remain operational. IRS walk-in taxpayer assistance centers are closed.

According to the IRS, people with appointments related to examinations (audits), collection, Appeals, or Taxpayer Advocate cases should assume their meetings are cancelled. IRS personnel will reschedule those meetings at a later date.

Automated IRS notices will continue to be mailed but the IRS will not be sending any paper correspondence during the shutdown.

IRS Services Still Available

The following IRS services remain open during the government shutdown:

(1) For taxpayers seeking assistance, the automated applications on the regular 800-829-1040 telephone line will remain open.

(2) The IRS website, www.IRS.gov, will remain available, although some interactive features may not be available.

(3) The IRS Free File partners will continue to accept and file tax returns.

Effect of Shutdown on the October 15 Due Date for Filing Returns on Extension

According to the IRS, taxpayers should continue to file and pay taxes during the government shutdown as they would under normal government operations. Individuals who requested an extension of time to October 15 to file should file their returns by October 15, 2013. Taxpayers can file their tax return electronically or on paper, though the processing of paper returns will be delayed until full government operations resume. Payments accompanying paper tax returns will still be accepted as the IRS receives them. Tax refunds will not be issued until normal government operations resume.

All other tax deadlines remain in effect, including those covering individuals, corporations, partnerships, and employers. The regular payroll tax deadlines remain in effect as well. Penalties and interest still apply for all late filings not received by the regular deadlines.

Electronically Filed Returns Will be Automatically Processed but Processing of Paper Returns Will be Delayed

As noted above, during the government shutdown, individuals and businesses must continue to file their tax returns and make deposits with the IRS as they are required to do so by law. The IRS is urging taxpayers to file electronically because most of these returns will be processed automatically. Payments accompanying electronic tax returns will be accepted as the IRS receives them, although the IRS will be unable to issue refunds during this time. However, the IRS said, the processing of paper returns will be delayed until full government operations resume. Payments accompanying paper tax returns will still be accepted as the IRS receives them, though, as with electronically filed returns, the IRS will be unable to issue refunds during this time.

Observation: Because the U.S. Postal Service is operating during the shutdown, the USPS will postmark and deliver mail to the IRS. Any return postmarked by the due date is considered timely filed, even though processing of the return may not occur until after the return due date depending on when the IRS goes back to work.

Transcripts of Personal Tax Records Are Available During the Shutdown

Taxpayers can still use automated tools, including IRS.gov, to request that a transcript of their personal tax records be sent to their address of record. Transcripts should be received in the mail within five to 10 calendar days.

However, transcript requests from third parties require actions by IRS employees, who are not available due to the government shutdown. Thus, transcript requests by third parties, such as financial institutions, cannot be processed through the Return and Income Verification Services and Income Verification Express Service, as these processes are not automated.

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Tax Court Reverses Course; Donee's Assumption of Estate Tax Liability May Reduce Gift Value

In a recent case, the Tax Court determined that it would no longer follow its decision in McCord v. Comm'r, 120 T.C. 358 (2003), a case in which it held that a couple had improperly reduced their gross gift value by the actuarial value of the donees' obligation to pay any potential estate taxes that might result under Code Sec. 2035(b) if the couple was to die within three years of the gift.

In Steinberg v. Comm'r, 141 T.C. No. 8 (9/30/13), the taxpayer gifted securities and cash to her daughters and, in exchange, the daughters agreed to assume and pay, among other things, any estate tax liability imposed under Code Sec. 2035(b) as a result of the gifts. The Tax Court rejected the IRS's request for summary judgment and held that, because the value of the obligation assumed by the daughters was not barred as a matter of law from being consideration in money or money's worth, the fair market value of mother's taxable gift could possibly be reduced by the daughters' assumption of the potential Code Sec. 2035(b) estate tax liability.

Facts

At age 89, Jean Steinberg entered into a binding net gift agreement with her four adult daughters. In the net gift agreement, she agreed to make gifts of cash and securities to the daughters. In exchange, the daughters agreed to assume and to pay any federal gift tax liability imposed as a result of the gifts. They also agreed, in the event their mother passed away within three years of the gifts, to assume and to pay any federal or state estate tax liability imposed under Code Sec. 2035(b) as a result of the gifts. The agreements were the result of months of negotiations and the mother and daughters had separate attorneys.

Ms. Steinberg retained an appraiser to calculate the gross fair market value of the property transferred to her daughters. The appraiser also calculated the aggregate fair market value of the net gift. The appraiser determined the value of the net gift by reducing the fair market value of the cash and securities by both (1) the gift tax the donees paid, and (2) the actuarial value of the donees' assumption of potential Code Sec. 2035(b) estate tax. The appraiser determined the actuarial value of the donees' assumption of the potential Code Sec. 2035(b) estate tax by calculating Ms. Steinberg's annual mortality rate for the three years after the gift (i.e., the probability that she would pass away within one year, two years, or three years of the gift), among other things. The appraiser determined that the aggregate fair market value of the net gift was almost $72 million, as of the date of the gift.

On her gift tax return, Ms. Steinberg reported the appraiser's value as the taxable gift amount and calculated a total gift tax of $32 million. She attached a summary of the net gift agreement, which included a description of the appraiser's determination of the value of the net gifts, to the Form 709. Upon auditing the gift tax return, the IRS disallowed the discount for the assumption of the potential Code Sec. 2035(b) estate tax liability and assessed an additional $1.8 million of gift taxes.

The IRS did not dispute (1) the value of the cash and securities transferred; (2) whether Ms. Steinberg properly reduced her gift tax liability by the amount of gift tax her daughters assumed; or (3) whether the daughters' assumption of the Code Sec. 2035(b) estate tax liability was enforceable under local law. The IRS's sole claim was that the assumption of the potential Code Sec. 2035(b) estate tax liability by the daughters did not increase the value of Ms. Steinberg's estate and therefore did not constitute consideration in money or money's worth within the meaning of Code Sec. 2512(b).

Before the Tax Court, the IRS asked for summary judgment. It argued that the daughters' assumption provided no benefit (monetary or otherwise) to Ms. Steinberg other than some peace of mind. The IRS thus claimed that the daughters' assumption failed to replenish Ms. Steinberg's estate and therefore failed as consideration for a gift under the estate depletion theory of the gift tax. The IRS relied, in part, on the Tax Court's holding in McCord v. Comm'r, 120 T.C. 358 (2003), which was reversed and remanded in Succession of McCord v. Comm'r, 461 F.3d 614 (5th Cir. 2006).

The IRS also argued that the daughters' assumption of the potential Code Sec. 2035(b) estate tax liability was itself a gift because (1) the net gift agreement was between family members, and (2) the net gift agreement was not in the ordinary course of business. Further, it claimed that no part of the net gift agreement was bona fide, at arm's length, and free from any donative intent.

Determining the Tax Value of a Gift

The aggregate value of taxable gifts made during the year, among other things, determines the amount of gift tax on those gifts. Under Code Sec. 2512(a), the amount of a gift of property is generally the value of the property on the date the gift is complete. The gift is complete when the property has left the donor's dominion and control. Under Reg. Sec. 25.2512-1, the value of the property is the price at which it would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of the relevant facts. If consideration is received for the gift, the amount of the gift is the amount by which the value of the property transferred exceeds the value of consideration received in money or money's worth. Thus, if a donor makes a gift subject to the condition that the donee pay the resulting gift tax, the amount of the gift is reduced by the amount of the gift tax. This is referred to as a net gift.

Observation: The net gift rationale flows from the basic premise that the gift tax applies to transfers of property only to the extent the value of the property transferred exceeds the value in money or money's worth of any consideration received in exchange. When a net gift occurs, the donor calculates his or her gift tax liability by reducing the amount of the gift by the amount of the gift tax. The rationale is that because the donee incurred the obligation to pay the tax as a condition of the gift, the donor did not have the intent to make other than a net gift. In other words, the donor reduces the value of the gift by the amount of the tax because the donor has received consideration for a part of the gift equal to the amount of the applicable gift tax.

Under Reg. Sec. 25.2512-8, to qualify as consideration in money or money's worth, the consideration received must be reducible to value in money or money's worth; consideration consisting of something unquantifiable, such as love and affection or the promise of marriage, is wholly disregarded. The estate depletion theory of gift tax has been applied to determine what constitutes consideration in money or money's worth. Under the estate depletion theory, which the Supreme Court cited in Comm'r v. Wemyss, 324 U.S. 303 (1945), a donor receives consideration in money or money's worth only to the extent the donor's estate has been replenished. Thus, the benefit to the donor in money or money's worth, rather than the detriment to the donee, determines the existence and amount of any consideration offset in the context of an otherwise gratuitous transfer.

Code Section 2035(b)

Under Code Sec. 2035(b), a decedent's gross estate is increased by the amount of any gift tax paid by the decedent or the decedent's estate on any gift made by the decedent during the three-year period preceding the decedent's death. For purposes of this gross-up provision, the phrase gift tax paid by the decedent or the decedent's estate includes gift tax attributable to a net gift the decedent made during that period (despite the fact that the donee is responsible for paying the gift tax in such situation).

Observation: Congress enacted Code Sec. 2035(b) as part of an effort to mitigate the disparity in treatment between the taxation of lifetime transfers and transfers at death. Congress imposed the gross-up provision on gift tax paid within three years of death because the gift tax paid on a lifetime transfer that is included in a decedent's gross estate is taken into account both as a credit against the estate tax and also as a reduction in the estate tax base, so substantial tax savings could be achieved under prior law by making so-called deathbed gifts, even though the transfer was subject to both taxes. Congress intended the gross-up rule to eliminate any incentive to make deathbed transfers to remove an amount equal to the gift taxes from the transfer tax base.

The McCord Decision

In McCord, a husband and wife made gifts to their sons and the sons agreed to be liable for all transfer taxes (federal gift, estate, and generation-skipping transfer taxes and any resulting state taxes) imposed on the couple as a result of the gifts. The couple reduced the gross value amounts of their respective shares of the gifts by the amount of federal and state gift tax generated by the transfer, which the four sons had agreed to pay as a condition of the gifts. The couple further reduced that gross value amount by the actuarially determined value of the four sons' contingent obligation to pay any estate tax that would result from the transaction if the couple were to pass away within three years of the valuation date. The IRS determined, among other things, that the couple had improperly reduced the gross value of the gifts by the actuarial value of the four sons' obligation to pay any potential estate taxes arising from the transactions.

The Tax Court agreed and held that in advance of the death of a person, no recognized method existed for approximating the burden of the estate tax with a sufficient degree of certitude to be effective for federal gift tax purposes. The court reasoned that the taxpayers' computation of the mortality-adjusted present value of the sons' obligation merely demonstrated that if one assumes a fixed dollar amount to be paid, contingent on a person of an assumed age not surviving a three-year period, one can use mortality tables and interest assumptions to calculate the amount that an insurance company might demand to bear the risk that the assumed amount has to be paid. The court further noted that the dollar amount of a potential liability to pay the Code Sec. 2035 tax was by no means fixed; rather, such amount depended on factors that were subject to change, including estate tax rates and exemption amounts (not to mention the continued existence of the estate tax itself). The Tax Court thus concluded that the taxpayers were not entitled to treat the mortality-adjusted present values as consideration received for the gifts.

Additionally, the Tax Court suggested that the taxpayers' reduction of the value of their gift failed under the estate depletion theory. The court pointed out that a donee's assumption of gift tax liability resulting from a gift provides a benefit to the donor in money or money's worth that is readily apparent and ascertainable, since the donor is relieved of an immediate and definite liability to pay such tax. According to the court, if that donee further agrees to pay the potential Code Sec. 2035(b) tax that may result from the gift, then any benefit in money or money's worth from the arrangement arguably would accrue to the benefit of the donor's estate (and the beneficiaries thereof) rather than the donor, and that the donor in that situation might receive peace of mind, but that is not the type of tangible benefit required to invoke net gift principles.

The Fifth Circuit reversed and remanded McCord, holding, among other things, that there was nothing too speculative about the McCord sons' legally binding assumption of the potential Code Sec. 2035(b) estate tax at the time of the gift. The court noted that it was axiomatic contract law that a present obligation may be, and frequently is, performable at a future date. It was also axiomatic, the court noted, that responsibility for the future performance of such a present obligation may be either firmly fixed or conditional, i.e., either absolute or contingent on the occurrence of a future event, i.e., a condition subsequent. And, the court said, it was axiomatic that any conditional liability for the future performance of a present obligation is to a greater or lesser degree speculative. The issue in McCord, the Fifth Circuit said, was not whether Code Sec. 2035's condition subsequent was speculative, but whether it was too speculative to apply.

According to the Fifth Circuit, there are three major types of conditions subsequent along the speculative continuum: (1) a future event that is absolutely certain to occur, such as the passage of time; (2) a future event that is not absolutely certain to occur but nevertheless may be a more certain prophecy; and (3) a possible, but low-odds, future event, which is undeniably a less certain prophecy.

Tax Court's Analysis

The Tax Court began its analysis by noting that the fundamental question posed was the fair market value of the property rights transferred under the net gift agreement. The court observed that all relevant facts and elements of valuing a gift at the time the gift is made had to be considered and that the willing buyer/willing seller test required the court to determine what property rights were being transferred and on what price a willing buyer and a willing seller would agree for those property rights.

The Tax Court agreed with the conclusion of the Fifth Circuit in Succession of McCord that a willing buyer and a willing seller in appropriate circumstances would take into consideration a donee's assumption of potential Code Sec. 2035(b) estate tax liability in arriving at a sale price and, thus, the value of a gift. Saying that it would no longer follow its prior holding in McCord v. Comm'r, 120 T.C. 358 (2003), the Tax Court held that, because the value of the tax obligations assumed by the donees is not barred as a matter of law from being consideration in money or money's worth within the meaning of Code Sec. 2512(b), the fair market value of donor's taxable gift could be determined with reference to the donees' assumption of the potential Code Sec. 2035(b) estate tax liability.

The court noted that the issue at hand was whether Ms. Steinberg would survive three years after the date of the gift. According to the court, this is a simple contingency based on the possibility of survivorship, rather than a complex contingency based on multiple occurrences. So the court had to determine whether Ms. Steinberg's survival three years after the date of the gift was speculative and, if so, whether it was too speculative or too highly remote to place a value on. The court held that the IRS failed to show as a matter of law that the daughters' assumption of Ms. Steinberg's potential Code Sec. 2035(b) estate tax liability could not be consideration in money or money's worth within the meaning of Code Sec. 2512(b). As a result, the court determined that the daughters' assumption of potential Code Sec. 2035(b) estate tax liability could possibly be quantifiable and reducible to monetary value.

With respect to the estate depletion theory, the court noted that in McCord it suggested that the sons' assumption of the potential Code Sec. 2035(b) estate tax failed as consideration for a gift under the estate depletion theory. In particular, the court pointed out in McCord that any benefit in money or money's worth that might arise from a donee's assumption of potential Code Sec. 2035(b) estate tax arguably would accrue to the benefit of the donor's estate (and the beneficiaries thereof) rather than the donor. The Tax Court said that its distinction in McCord between a benefit to the donor's estate and a benefit to the donor was incorrect. For purposes of the estate depletion theory, the court said, the donor and the donor's estate are inextricably bound. According to the estate depletion theory, whether a donor receives consideration is measured by the extent to which the donor's estate is replenished by the consideration. A donee's assumption of potential Code Sec. 2035(b) estate tax liability, the court said, may provide a tangible benefit to the donor's estate, and therefore as a matter of law it could meet the requirements of the estate depletion theory.

Finally, the Tax Court found the IRS's claim that a transfer between family members is necessarily a gift unless it is in the ordinary course of business to be erroneous. A transfer between family members that is not in the ordinary course of business may still avoid gift tax to the extent it is made for consideration in money or money's worth, the court said. Thus, a transfer not in the ordinary course of business may still avoid gift tax to the extent it is made for full and adequate consideration, regardless of whether the transfer was between family members. Further, the court noted, there was nothing in the record to indicate that the net gift agreement was not bona fide or made at arm's length. Ms. Steinberg and her daughters, the court observed, were represented by separate counsel, and the net gift agreement was the culmination of months of negotiation.

As a result of the above, the Tax Court held that there were genuine disputes of material fact as to whether the daughters' assumption of Ms. Steinberg's potential Code Sec. 2035(b) estate tax liability constituted consideration in money or money's worth. The court thus rejected the IRS's request for summary judgment on this issue.

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Annual Per Diem Rate Guidance Changes "Incidental Expenses" Definition

In a notice announcing the 2013-2014 special per diem rates used for substantiating the amount of ordinary and necessary business expenses incurred while traveling away from home, the IRS also notes changes made in the Federal Travel Regulations to the definition of incidental expenses. Notice 2013-65.

In Notice 2013-65, the IRS provides the annual update of the special per diem rates used in substantiating the amount of ordinary and necessary business expenses incurred while traveling away from home. Specifically, the notice provides: (1) the special transportation industry meal and incidental expenses rates (M&IE rates), (2) the rate for the incidental expenses only deduction, and (3) the rates and list of high-cost localities for purposes of the high-low substantiation method.

Taxpayers using the rates and the list of high-cost localities provided in Notice 2013-65 must comply with Rev. Proc. 2011-47. In Rev. Proc. 2011-47, the IRS provides rules for using a per diem rate to substantiate, under Code Sec. 274(d) and Reg. Sec. 1.274-5, the amount of ordinary and necessary business expenses paid or incurred while traveling away from home.

In Rev. Proc. 2011-47, the IRS provides that the term incidental expenses has the same meaning as in the Federal Travel Regulations, 41 C.F.R. 300-3.1. In Notice 2013-65, the IRS notes that the definition of incidental expenses was revised by the Federal Travel Regulations in October of 2012, to provide that incidental expenses include only fees and tips given to porters, baggage carriers, hotel staff, and staff on ships.

Before the change in the definition of incidental expenses, incidental expenses included transportation between places of lodging or business and places where meals are eaten and the mailing cost associated with filing travel vouchers and paying employer-sponsored charge card billings.

Practice Tip: The effect of this change in the definition of incidental expenses means that taxpayers using per diem rates may separately deduct or be reimbursed for transportation and mailing expenses.

For a discussion of the substantiation rules for expenses incurred while traveling away from home, see Parker Tax ¶91,130.

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Baseball Player's Signing Bonus Must Be Amortized Over Life of Contract

A minor league baseball player's signing bonus should be amortized over the useful life of the player's contract. CCM 20133901F.

Under the facts in CCM 20133901F, the taxpayer operates a professional baseball team under a franchise agreement and is affiliated with several minor league baseball teams. The taxpayer operates under an agreement whereby it incurs and pays the payroll expense and certain operating costs as defined under Major League Baseball rules for all of its affiliates. When a player signs a contract to play on the taxpayer's team, a signing bonus may be paid. The taxpayer capitalizes and amortizes the signing bonuses of its major league players over the life of the players' contracts. The taxpayer capitalizes and amortizes the signing bonuses of the players that sign with the minor league teams over a one-year life. The taxpayer chooses to use a year life based on the average of the actual life of the contracts disposed of during the year.

The players that agreed to play for the taxpayer's minor league teams signed the Minor League Uniform Player Contract, Article IV, which provides that the player is required to provide services to the team for seven separate championship playing seasons. Unless the player contract is terminated under the contract, the agreement continues until the player has played for the taxpayer for seven championship seasons. Under Article XIX, the player can apply to the Commissioner of Major League Baseball to have the contract terminated only if the taxpayer is in arrears to the player for any payments due for more than 15 days or if the taxpayer fails to perform any other obligations required of it for more than 15 days. The Baseball Commissioner will terminate the agreement only if the taxpayer fails to remedy the situation by a fixed date. The taxpayer may terminate the player contract by written notice if the player at any time (1) fails, refuses, or neglects to conform his personal conduct to high standards of good citizenship and good sportsmanship; (2) fails, refuses, or neglects to keep himself in first-class physical condition; (3) fails, refuses, or neglects to obey the club's requirements respecting the player's conduct and service; (4) fails, in the judgment of the club, to exhibit sufficient skill or competitive ability to qualify or to continue as a professional baseball player as a member of the club's teams; or (5) fails, refuses, or neglects to render the player's services under the agreement, or in any other manner to materially breach the Minor League Uniform Player Contract. Under the contract, the taxpayer may also terminate the player's contract if the player becomes disabled. After the player has completed seven championship seasons for the taxpayer, the player becomes a minor league free agent.

The Office of Chief Counsel advised that the signing bonus of the minor league players should be amortized over the useful life of the player's contract, which is the seven-year term of the player's contract. The Chief Counsel's Office noted that Reg. Sec. 1.167(a)-3(a) provides a safe harbor rule under which an intangible asset may be the subject of a depreciation allowance if it is known from experience or other factors to be of use in the business or in the production of income for only a limited period, the length of which can be estimated with reasonable accuracy.

In Rev. Rul. 67-379, the IRS ruled that the useful life for a baseball player's contract generally is the period over which the team controls the player's ability to sign a contract with another team. Under Reg. Sec. 1.167(a)-14(c)(1)(ii), the cost or other basis of a taxpayer's right to receive an unspecified amount of tangible property or services over a fixed period is amortizable ratably over the period of that right.

In this situation, the taxpayer has control over the player until the player has played seven championship seasons with the taxpayer, and the player cannot unilaterally terminate the contract with the taxpayer. Even if the player opts to not play for the taxpayer, the Chief Counsel's Office noted, he cannot play with another team until he is released by the taxpayer or finishes playing the required seven championship seasons for the taxpayer. The player cannot choose to play for a different team after entering into a contract with the taxpayer. Although a player's contract may be terminated if he signs a major league contract or if he is released or traded by the taxpayer, the useful life is determined by how long the player contract would have been useful to the taxpayer if the contract was not terminated. It appeared to the Office of Chief Counsel that if the player contract is not terminated, then it is useful to the taxpayer for the seven-year term of the contract because during that time, the taxpayer has control over the player and the player is prevented from playing for a competitor of the taxpayer. Thus, the useful life of the player contract is seven years.

For a discussion of the safe harbor amortization rule, see Parker Tax ¶95,107.

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Couple Can't Discharge Tax Debt in Bankruptcy; Untimely Filings after IRS Assessments Were Not Returns

Late individual tax returns filed by a debtor couple after the IRS assessed tax liabilities and issued notices of deficiency were not returns within the meaning of Bankruptcy Code Section 523(a), and therefore the couple's tax liabilities were not dischargeable in bankruptcy. In re Mallo, 2013 PTC 278 (D.C. Col. 9/11/13).

Edson and Liana Mallo did not file their Form 1040, Individual Income Tax Return, on time for 2000 and 2001. As a result, in 2006, the IRS made assessments against the couple and issued deficiency notices. After the couple failed to pay the assessed income taxes, the IRS started collection efforts by issuing a Notice of Intent to Levy. In 2007, Edson and Liana jointly filed their 2000 and 2001 Form 1040s. Subsequently, in 2010, the couple filed a Chapter 7 bankruptcy petition and, at the time of filing, owed tax liabilities from 2000 through 2009.

Following the issuance of a bankruptcy discharge order in 2011, Edson and Liana filed an adversary proceeding against the IRS seeking a determination that their income tax debt was discharged by the bankruptcy order. In response, the IRS filed a motion for summary judgment and sought a determination that the couple's income tax liabilities were excepted from discharge because they were debt for which a return was not filed under Bankruptcy Code Section 523.

A debtor who files a bankruptcy petition is discharged from personal liability for all debts incurred before the filing of the petition, including those debts related to unpaid taxes. Bankruptcy Code Section 523(a) provides exceptions to the general rule of the discharge of unpaid tax debt and precludes the discharge of tax debt under certain circumstances, including if a related return was filed within two years of the bankruptcy petition filing or if a return was not filed. A return is defined as a return that satisfies the filing requirements of the Internal Revenue Code but does not include a return prepared by the IRS under Code Sec. 6020(b).

Edson and Liana argued that their income tax debts for 2000 and 2001 were discharged in bankruptcy by the discharge order. The IRS contended that the exception in Bankruptcy Code Section 523(a) applied because the returns filed by Edson and Liana after they had been contacted by the IRS did not meet the definition of a return. Thus, no return had been filed, and the tax liabilities were not dischargeable.

The bankruptcy court ruled in favor of the IRS. In reaching its decision, the bankruptcy court adopted the analysis of In re Wogoman, 475 B.R. 239 (B.A.P. 10th Cir. 2012), which utilized a four-prong test to determine whether a filing constituted a return for purposes of Bankruptcy Code Section 523(a). The test was whether the filing: (1) purported to be a return; (2) was executed under penalty of perjury; (3) contained sufficient data to allow computation of tax; and (4) represented an honest and reasonable attempt to satisfy the requirements of the tax law. Under this test, the bankruptcy court found that the 2007 returns filed by Edson and Liana did not represent an honest and reasonable attempt to comply with the tax law and were instead a belated attempt to create a record of compliance after the IRS filed substitute returns and issued notices of deficiency. Edson and Liana appealed.

A district court affirmed the bankruptcy court and held that Edson and Liana's filings in 2007 after the IRS assessments did not constitute returns and, as such, their income tax liabilities were excepted from discharge under Bankruptcy Code Section 523(a).

The district court declined to adopt a per se rule that any untimely filed return is not a return for purposes of assessing the dischargeability of the related tax liability in bankruptcy. But the court also rejected Edson and Liana's argument that whether their 2007 filing constituted a return should be determined on the face of the document and not on the timeliness of its filing. The court noted that the prior assessment of the debtors' delinquency was relevant in determining whether the debtors filed a return. The untimely returns filed by the couple negated an honest and reasonable attempt to comply with the tax law under the fourth prong of the Wogoman test, the court said. Because it was undisputed that the couple filed their Form 1040 after the IRS determined their tax liability, issued notices of deficiency and began collection action, the court concluded that the couple's filings did not constitute returns and the subject taxes were excepted from discharge.

For a discussion of the requirements to file a return, see Parker Tax ¶10,100.

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Remittance of Estate's Tax Liability Was a Payment, Not Deposit; Co-Executors' Refund Claim Was Subject to the Three-Year Statute of Limitations

An undesignated remittance of an estate's tax liability was a payment and not a deposit and, thus, the co-executors' claim for refund was subject to the three-year statute of limitations. Winford v. U.S., 2013 PTC 275 (W.D. La. 9/9/13).

Laura Bishop died in 2002 and left a will dated in 1994 which named Laura Winford and two other individuals as co-executors of her estate. Shortly after her death, Bishop's son and grandchild filed lawsuits contesting the validity of the 1994 will and the co-executors' actions. The Bishop estate was required to file Form 706, Estate Tax Return, within nine months after her death. The co-executors asserted that they were unable to determine the estate's total assets and liabilities due to the pending litigation and thus were prevented from gathering the necessary information to file an estate tax return by the filing deadline. Instead of filing a return in 2003, the co-executors filed Form 4768, Application for Extension of Time to File a Return, and sent $230,844 to the IRS. The co-executors did not indicate whether the amount sent was a payment or a deposit. The IRS posted the amount as a payment.

The litigation between the co-executors and the family members ended in 2008 at a cost of over $285,000. The co-executors retained control over the estate. The co-executors filed a federal estate tax return in 2009 and assessed the estate's total tax liability at $94,598 after deducting the litigation costs from the value of the estate. They claimed that the estate was due a credit of $136,268, which they calculated was the amount by which the 2003 remittance exceeded the estate's tax liability. The IRS disallowed the refund after determining the payment sent with the extension request was subject to the three-year statute of limitations and the time for filing for a refund had passed. After her administrative appeal was denied, Laura filed suit to recover the refund amount.

Code Sec. 6511(b)(1) provides that a taxpayer is not allowed a refund or credit for the overpayment of tax unless the taxpayer files a claim for refund or credit before the expiration of the statute of limitations. Code Sec. 6513(b)(2) states that a remittance is deemed paid on the last day for filing the return prescribed by Code Sec. 6012 for such tax year.

Observation: Practitioners should determine the correct characterization of tax as either a payment or deposit because that characterization will determine whether or not the statute of limitations has run on applying for a refund or credit and what procedures that must be followed to obtain the refund or credit.

Laura argued that the 2003 remittance was a deposit and therefore not subject to the three-year statute of limitations. The IRS contended that the court lacked jurisdiction because the refund claim was untimely filed and the 2003 extension amount was a payment under the facts-and-circumstances test utilized by various courts.

The district court held that the undesignated 2003 remittance was a payment and not a deposit; thus the co-executors' claim for refund was untimely filed under the three-year statute of limitations. The court rejected Laura's argument that Huskins v. U.S., 75 Fed. Cl. 659 (2007), which held that Rev. Proc. 84-58 required that an undesignated remittance should be treated like a deposit, should apply to her case. The court looked to Boensel v. U.S., 99 Fed. Cl. 607 (2011) and VanCanagan v. U.S., 231 F.3d 1349 (2000), which found that Rev. Proc. 84-58 provided a specific procedure by which a taxpayer could make a deposit and did not alter the facts and circumstances test set forth in Roseman v. U.S., 323 U.S. 658 (1945), in determining whether a remittance is a payment or deposit. The court found that, although the co-executors made the remittance before the IRS's assessment, the remittance was their good-faith approximation of the estate's tax liability and was not made to avoid late penalties and interest. In addition, the co-executors did not dispute the proposed tax liability or provide any evidence that they believed the 2003 remittance was a deposit. Finally, the IRS recorded the remittance as a payment, and it was tendered with the co-executors request for an extension at the time the tax was due. The court concluded that the facts and circumstances of the case demonstrated that the 2003 remittance was an amount paid as estimated income tax, not a deposit and, therefore, the co-executors' refund claim was barred as untimely filed.

For a discussion of the statute of limitations for refunds or credits for tax overpayments, see Parker Tax ¶261,180.

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All Empowerment Zone Designations Terminate at End of 2013

All empowerment zone designations remain in effect through the end of 2013 and will terminate on December 31, 2013. IR-2013-78 (9/27/13).

Empowerment zones are certain urban and rural areas where employers and other taxpayers qualify for special tax incentives. In May, the IRS issued Notice 2013-38 to address the relevant provision of the American Taxpayer Relief Act of 2012 that deal with empowerment zones. Notice 2013-38 provided that any nomination for an empowerment zone in effect on December 31, 2009, will have a new termination date of December 31, 2013, unless the governing state or municipality declined the extension in a notification to the IRS.

The deadline for notification was July 29, 2013, and no state or municipality contacted the IRS to decline the extension. Therefore, all empowerment zone designations in effect on December 31, 2009, remain in effect through December 31, 2013, at which time the designation terminates.

Empowerment zones were created by legislation enacted in 1993, and most zones had an expiration date of December 31, 2009. Subsequent legislation extended the expiration dates to December 31, 2011, and then December 31, 2013. The American Taxpayer Relief Act of 2012 did not provide for the extension of the designation for the District of Columbia enterprise zone, and therefore that designation ended on December 31, 2011.

For a discussion of empowerment zones, see Parker Tax ¶105,620.

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Custom Homebuilder Must Capitalize Costs Incurred in Building Homes

Custom homebuilders are no different from speculation homebuilders and, thus, must capitalize costs under the UNICAP rules. Frontier Custom Builders, Inc. v. Comm'r, T.C. Memo. 2013-231 (9/30/13).

Frontier Custom Builders (Frontier) is a custom homebuilder that sells custom and speculative homes. It did not capitalize many of the costs it incurred in building its custom homes but rather deducted those costs. According to Frontier, custom homebuilding is different from speculative homebuilding and this difference kept its custom homebuilding activities out of the reach of the uniform capitalization (UNICAP) rules of Code Sec. 263A. The UNICAP rules of Code Sec. 263A do not apply, Frontier said, because it does not employ the tradesmen--e.g., carpenters, welders, and plumbers--who actually build the homes. All of those activities are subcontracted out. It therefore claimed that its actual employees' services, and the related costs incurred, are more reflective of a sales and marketing company that manages the creation of a custom product rather than a construction company producing streamlined goods.

Under Reg. Sec. 1.263A-1, direct costs that must be capitalized under the UNICAP rules include direct material and direct labor costs. Indirect costs that must be capitalized are all indirect costs properly allocable to property produced. Indirect costs are properly allocable to property produced when the costs directly benefit or are incurred by reason of the performance of production activities. Thus, indirect costs must be allocated between production and nonproduction activities. In addition to production costs, indirect costs include service costs. Service costs must be allocated among capitalizable, deductible, and mixed service costs.

Frontier argued that custom homebuilding is different from speculative homebuilding and that this difference keeps its activities out of the reach of Code Sec. 263A. Before Frontier sells a home, it builds it; before Frontier builds a home, it designs it. After Frontier creates the design for each custom home, it subcontracts out the physical labor to the tradesmen who actually build the home.

The Tax Court held that Frontier's use of subcontractors for the physical home construction is not enough to exempt Frontier from capitalizing costs under the UNICAP rules. The creative design of custom homes, the court stated, is ancillary to the actual physical work on the land and is as much a part of a development project as digging a foundation or completing a structure's frame. The construction of a home cannot move forward if the design step is not taken. Therefore, the court rejected Frontier's argument and found Frontier to be a producer of real property subject to Code Sec. 263A. As a result, the court held that Frontier has to capitalize all direct and certain indirect costs of production; capitalize a portion of the cost of its officer's compensation; capitalize a portion of the cost of its nonofficer employees' compensation; and capitalize a portion of its other expenses incurred.

Practice Tip: However, the parties agreed that the following expenses were fully deductible: salaries and bonuses for sales and marketing employees; state franchise tax; corporate income tax; employment tax; depreciation; legal fees for warranty claims; Web page maintenance; decorating models; bank charges; dues and subscriptions; meals; charitable contributions; and advertising.

For a discussion of the UNICAP rules, see Parker Tax ¶242,380.

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IRS Can't Be Compelled to Reopen OIC Returned Years Before CDP Hearing

The IRS cannot be required to reopen an offer-in-compromise, based on doubt as to collectability, which the IRS returned to the taxpayer years before a collection hearing began; thus, the IRS did not abuse its discretion in sustaining the final notice of intent to levy. Reed v. Comm'r, 141 T.C. No. 7 (9/23/13).

Tom Reed failed to timely file federal income tax returns for years 1987 through 2001. He subsequently submitted delinquent returns but failed to fully satisfy the outstanding tax liabilities. Tom submitted two separate offers-in-compromise (OICs) to settle the outstanding tax liabilities. The IRS rejected the first OIC, returned the second OIC, and issued a final notice of intent to levy. Tom requested a collection due process (CDP) hearing and raised issues during the collection hearing regarding the IRS's handling of the two OICs. Tom requested that the returned OIC be reopened. The IRS concluded that he did not have the authority to reopen the returned OIC and sustained the final notice of intent to levy.

Tom argued that the IRS abused its discretion in sustaining the final notice of intent to levy. According to Tom, the IRS abused its discretion by concluding that it lacked the authority to reopen an OIC based on doubt as to collectibility that the IRS returned to Tom years before the collection hearing began. The IRS argued that the Tax Court lacked jurisdiction to determine whether the IRS abused its discretion because Tom proposed no new OIC during the collection hearing. The IRS further argued that the Tax Court lacked jurisdiction because Tom had no judicial review rights relating to the IRS's rejecting or returning an OIC.

The Tax Court held that it had jurisdiction to determine whether the IRS abused its discretion in sustaining the final notice of intent to levy. Further, the court said that the IRS cannot be required to reopen an OIC, based on doubt as to collectability, which the IRS returned to Tom years before the collection hearing began. Finally, the Tax Court concluded that the IRS did not abuse its discretion in sustaining the final notice of intent to levy.

For a discussion of OICs, see Parker Tax ¶263,165.