Parker's Federal Tax Bulletin - November 21, 2014 Archived

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Issue 76

November 21, 2014

Tax Briefs

Final Regs Clarify Rules for E&P Allocations in Tax-Free Transfers; IRS Issues Final Regs on Allocation of Basis in All Cash D Reorganizations; Property Received from Executor Not Eligible for First-Time Homebuyer Credit ...

S Corp's AAA Resets to Zero Following Post-Termination Transition Period

The IRS's Office of Chief Counsel has advised that the AAA balance of a corporation that terminated its S status was reset to zero when its post-termination transition period (PTTP) ended, and thus remained zero when the corporation re-elected S status after an intervening C corporation period. CCA 201446021 (11/14/14).

Supreme Court to Review Obamacare Insurance Subsidy Case in Wake of Circuit Split

The Supreme Court has granted review of a Fourth Circuit decision that upheld IRS regulations extending tax-credit subsidies to health insurance purchased through federally run Exchanges, bringing to a head the latest challenge to the Affordable Care Act (ACA). King v. Burwell, No. 14-114 (S. Ct. 11/10/14)

Expert Trainer's Involvement in Thoroughbred Venture Helps Taxpayers Avoid Hobby Classification

The Tax Court gave considerable weight to the involvement of a professional trainer as a co-owner in a thoroughbred racing venture in holding that heavy losses incurred in 2009 and 2010 by the taxpayers were not hobby losses. Annuzzi v. Comm'r, T.C. Memo 2014-233 (11/13/14).

IRS Clarifies Application of One-Per-Year Limit on IRA Rollovers; Provides Transition Rule

The IRS has issued guidance clarifying the application of the one-per-year limit on tax-free rollovers between IRAs and provided a transition rule. Announcement 2014-32 (11/10/14).

Software Licensing Arrangement Qualifies for Domestic Production Activities Deduction

A taxpayer's revenue from licensing software to contracting parties who use the software to perform services for end users qualified as gross receipts for purposes of the Code Sec. 199 domestic production activities deduction. The taxpayer's license to end users did not mean the taxpayer was providing services to the end users. TAM 201445010 (11/07/14).

Net-Worth Method Used to Support Fraud Determination Against Surf Shop Owners

The Tax Court upheld the IRS's use of the "net worth and personal expenditures" method (net-worth method) of income reconstruction; finding a family running a chain of surf and skateboard shops was liable for taxes on underreported income and civil fraud penalties. Worth v. Comm'r, T.C. Memo 2014-232 (11/13/14).

Ninth Circuit Reverses Tax Court: Partners Cannot Selectively Opt Out of TEFRA Proceedings

The Ninth Circuit Court of Appeals has reversed the Tax Court, holding that a partner with both direct and indirect partnership interests cannot make separate elections to opt out of TEFRA proceeding with respect to each type of interest. JT USA v. Comm'r, 2014 PTC 570 (9th Cir. 11/14/14).

Proprietor of a Residential Glass Business Failed to Establish He Was a Real Estate Professional

The rental real estate activities of a taxpayer who failed to properly document that he was a real estate professional were treated as passive activities. The taxpayer's failure to keep records of time spent on specific activities that could be considered "construction" or "reconstruction" in his residential glass business proved fatal to his bid to claim real estate professional status. Cantor v. Comm'r, T.C. Summary Opinion 2014-103 (11/06/14).

IRS Issues Regs on Failure to File Gain Recognition Agreements; Relaxes Standards for Penalty Relief

The IRS has issued final and temporary regulations relaxing the existing reasonable cause standard for obtaining relief from penalties for failure to timely file an initial gain recognition agreement (GRA), or to satisfy other reporting obligations associated with certain transfers of property to foreign corporations in nonrecognition exchanges. The regulations, which finalize proposed regulations issued last year, affect U.S. persons that transfer property to foreign corporations. T.D. 9704 (11/19/14).

C Corporations

Final Regs Clarify Rules for E&P Allocations in Tax-Free Transfers: In T.D. 9700 (11/10/14), the IRS issued final regulations under Code Sec. 312 clarifying current regulations on allocation of earnings and profits in tax-free transfers from one corporation to another. The IRS also issued final regulations under Code Sec. 381 that modify the definition of an acquiring corporation with regard to certain acquisitions of assets.

IRS Issues Final Regs on Allocation of Basis in All Cash D Reorganizations: In T.D. 9702 (11/12/14), the IRS issued final regulations on the determination of the basis of stock or securities in certain reorganizations where no stock or securities of the issuing corporation is issued and distributed in the transaction. The final regulations clarify that only a shareholder that owns actual shares in the issuing corporation in such a reorganization can designate the actual share of stock of the issuing corporation to which the basis, if any, of the stock or securities surrendered will attach.

Credits

Property Received from Executor Not Eligible for First-Time Homebuyer Credit: In Est. of Menges v. Miller, 2014 PTC 563 (M.D. Pa. 11/04/14), the district court held that the taxpayer was not eligible for the first-time homebuyer tax credit with respect to property she had received from the executor of her grandmother's estate. As the taxpayer was a beneficiary and acquired the property from a "related person" (the executor of the grandmother's estate), she did not "purchase" the property within the meaning of Code Sec. 36(c)(3) and thus was not entitled to the credit.

Deductions

Theft Loss Deduction Allowed under "Qualified Investor" Safe Harbor: In CCA 201445009 (11/07/14), the taxpayer transferred to third parties money that was to be used to purchase investments, but that was not so used. The Office of Chief Counsel concluded that the taxpayer was a "qualified investor" under the Rev. Proc. 2009-20 Ponzi scheme safe harbor and was thus able to deduct theft losses for amounts invested in a fraudulent scheme.

Individual Taxpayers' NOL Deductions Denied for Insufficient Substantiation: In Boring v. Comm'r, T.C. Summary 2014-105 (11/10/14), the Tax Court decided the taxpayers were not entitled to claim an $87,787 NOL carryover due to a lack of substantiation. The taxpayers' only support for the NOLs were their prior-year tax returns, which the court determined was not sufficient to establish that the losses were actually incurred.

Exempt Organizations

Surviving Entity Still Exempt after Merger of Two Exempt Organizations: In PLR 201446026 (11/14/14), the IRS ruled that the merger of two tax-exempt entities would not adversely affect the surviving entity's exempt status under Code Sec. 501(c)(6). Although the target entity was previously recognized as exempt under Code Sec. 501(c)(4), it worked collaboratively with the surviving entity on issues of common concern and was effectively operating in a manner similar to an organization exempt under Code Sec. 501(c)(6). Because the surviving entity was expected to continue operating in a manner consistent with Code Sec. 501(c)(6), the IRS ruled that its exemption would not be jeopardized by the merger.

Healthcare Taxes

IRS Releases Guidance on Eligibility for Minimum Essential Coverage under Pregnancy-Based Medicaid and CHIP Programs: In Notice 2014-71 (11/07/14), the IRS provides guidance on eligibility for minimum essential coverage for purposes of the Code Sec. 36B premium tax credit for pregnancy-related Medicaid and Children's Health Insurance Program (CHIP) programs. An individual enrolled in a qualified health plan who becomes eligible for Medicaid coverage for pregnancy-related services that is minimum essential coverage, or for CHIP coverage based on pregnancy, is treated as eligible for minimum essential coverage under the Medicaid or CHIP coverage for purposes of the premium tax credit only if the individual enrolls in the coverage.

Liens and Levies

Transfer of Apartment to Trust Deemed Fraudulent; Challenge to Tax Liens Dismissed: In U.S. v. Nassar, 2014 PTC 565 (S.D.N.Y. 11/10/14), the district court denied the taxpayer's motion to dismiss a lien on an apartment held in trust. The IRS had attached the lien under the independent theories that the trust was merely the taxpayer's nominee, and that the transfer of the apartment to the trust was a fraudulent conveyance under New York law. Because the taxpayer transferred the apartment for $10 consideration at a time when he was facing significant financial liabilities (thus making it difficult for creditors to reach), yet still continued personal enjoyment of the premises, the court found the the IRS had adequately plead that the taxpayer had, at the very least, a general intent to defraud his subsequent creditors and denied the taxpayer's motion to dismiss the lien.

Procedure

Tax Preparer Permanently Barred from Preparing Taxes after Fraud Conviction: In U.S. v. Majette, 2014 PTC 568 (D.N.J. 11/12/14), the IRS sought a permanent injunction to prohibit a tax preparer from preparing income tax returns for others. The preparer had prepared and filed false federal income tax returns on behalf of his customers, and is currently incarcerated after pleading guilty to two tax fraud offences. The court determined such an injunction was necessary to prevent further fraud.

Taxpayer's Bankruptcy Petition Didn't Bar Petition with Tax Court: In Perry v. Comm'r, T.C. Memo. 2014-231 (11/10/14), the taxpayer filed a petition for redetermination with the Tax Court, and 3-1/2 hours later filed a petition for bankruptcy with a California U.S. Bankruptcy Court. The IRS sought to dismiss the case in the Tax Court on the grounds that an automatic stay barred the case. The court held that as the taxpayer had filed with the Tax Court before she filed with the Bankruptcy Court, and thus before the automatic stay took effect, the court still had jurisdiction to hear the case.

Retirement Plans

IRA's Purchase of Shares in a Trust Owning Gold is Not an Acquisition of Collectibles: In PLR 201446030 (11/14/14), the IRS ruled that the acquisition of shares in a trust, whose assets are principally gold bullion, by the trustee of an IRA is not the acquisition of a collectible within the meaning of Code Sec. 408(m). Thus, an IRA owning shares of the trust will not be treated as making a deemed distribution under Code Sec. 408(m)(1) solely by virtue of owning such shares. However, an exchange of those shares for the underlying gold would constitute the acquisition of a collectible and would trigger a deemed distribution.

Taxpayer's Default on 401(k) Loan Triggers Deemed Distribution: In Scroggins v. Comm'r, T.C. Summary 2014-106 (11/13/14), the Tax Court determined that a taxable distribution from the taxpayer's 401(k) retirement plan occurred when he stopped making payments on a loan from the plan in late 2010. The taxpayer argued that the default should be treated as occurring in 2011, but the court concluded that the default happened when he stopped making payments in 2010, and in accordance with Reg. Sec. 1.72(p)-1, Q&A-10, the deemed distribution should be included in income for that year.

S Corp's AAA Resets to Zero Following Post-Termination Transition Period

Facts

The taxpayer was incorporated as a C corporation and operated as such until it made its first election to be treated as an S corporation. At that time, the taxpayer had accumulated earnings and profits (E&P) and after its S election, continued to generate annual profits.

When its majority shareholders later revoked its S election, the taxpayer had a positive balance in its accumulated adjustments account (AAA). During the post-termination transition period (PTTP), the taxpayer distributed a portion of its AAA to its shareholders pursuant to Code Sec. 1371(e), but left a positive balance at the end of the PTTP.

Observation: An S corporation's AAA is an account of the S corporation not apportioned among the shareholders. For S corporations with E&P from a prior period as a C corporation or a merger with a C corporation, the AAA tracks the corporation's ability to make tax-free distributions to shareholders. To the extent a corporation has a positive AAA, and the distribution does not exceed a shareholder's basis in the stock, the S corporation can make tax-free distributions to that shareholder.

After an intervening C corporation period, the taxpayer made another S election, and continues to operate as an S corporation today. The taxpayer represents that it converted from C to S to C and back to S to take advantage of individual and corporation tax rates available at the time of each conversion.

The taxpayer requested a ruling regarding whether its AAA balance from its first S period survived the period between the end of the PTTP and the time it once again became an S Corporation.

Analysis

Code Sec. 1368(e)(1) provides that an AAA is adjusted for the S period in a manner similar to the adjustments under Code Sec. 1367 and that no adjustment will be made for federal taxes attributable to any tax year in which the corporation was a C corporation. Code Sec. 1368(e)(2) defines the term "S period" as the most recent continuous period during which the corporation has been an S corporation. Reg. Sec. 1.1368-2(a)(1) provides that on the first day of the first year for which the corporation is an S corporation, the balance of the AAA is zero.
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Supreme Court to Review Obamacare Insurance Subsidy Case in Wake of Circuit Split

Observation: If the Supreme Court follows a similar time table to the one that played out in the landmark 2012 Obamacare decision, the court may issue a ruling on King v. Burwell toward the end of its spring term next June.
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Expert Trainer's Involvement in Thoroughbred Venture Helps Taxpayers Avoid Hobby Classification

Mel and Jean Annuzzi, operate Annuzzi Concrete Services, Inc. (ACS), in San Francisco. Mel has been the president of ACS for more than two decades. Jean works at ACS part time and has principal responsibility for the company's finances, including bookkeeping and accounting. In the early 1980s the Annuzzis began to buy race horses, hoping to make money by winning purses at horse races, selling race horses at a profit, and breeding foals that could be raced successfully or sold. They do not own or ride horses for pleasure; they do not allow anyone other than qualified professionals to ride their horses; they do not show their horses; they own no farm; and they do not keep horses as pets.
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IRS Clarifies Application of One-Per-Year Limit on IRA Rollovers; Provides Transition Rule

The IRS has issued guidance clarifying the application of the one-per-year limit on tax-free rollovers between IRAs and provided a transition rule. Announcement 2014-32 (11/10/14).

Background

Generally, under Code Sec. 408(d)(3)(A)(i), an amount distributed from an IRA is not included in the recipient's gross income to the extent the amount is rolled over into an IRA for the recipient's benefit within 60 days after the recipient receives the distribution. This is generally referred to as a "60-day rollover." Code Sec. 408(d)(3)(B) provides that an individual may make only one nontaxable 60-day rollover between IRAs in any one-year period.
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Software Licensing Arrangement Qualifies for Domestic Production Activities Deduction

The taxpayer designs, develops, and licenses unique computer software for certain contracting parties. End users subscribe to a product or service by entering into a subscriber agreement with both the taxpayer and the respective contracting party. Under such an agreement, an end user submits a service request to the contracting party, who then uses the licensed computer software and their own data to perform the requested service, providing the end user with the results. In some cases, the taxpayer grants the end user a license to use the results. Under the subscriber agreement, the contracting party collects fees from the end users, and pays the taxpayer an amount as provided under the respective master agreement. From time to time, a contracting party will ask the taxpayer to waive the fees relating to the services performed for certain end user projects. The taxpayer's agreement to waive its fees is documented in a letter addressed to the contracting party and is described as a "royalty waiver."
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Net-Worth Method Used to Support Fraud Determination Against Surf Shop Owners

The Worth family, Donald, Marie, and their son, Frank, operated a chain of seven surf and skateboard shops across California, called White Sands. Frank was responsible for about half of the stores and Donald and Marie operated the other half. Marie also managed the books and prepared tax returns. As manager of the heavily cash-based business, Frank had the authority to write checks on certain White Sands bank accounts, wrote checks or used cash to pay vendors for merchandise as it came in, and wrote checks to reimburse himself for business expenses he paid. Frank also supervised inventory and receipts from store branches. There were no formal ownership arrangements; however, Donald and Frank held themselves out as joint owners, and Frank testified in previous cases that he was a part-owner. Frank reported income from the business on his Form 1040 Schedule C and never received a Form W-2 from White Sands.
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Ninth Circuit Reverses Tax Court: Partners Cannot Selectively Opt Out of TEFRA Proceedings

In the 1970s, off-road motorcycle enthusiast John Gregory and his wife, Rita, founded a business that became very successful at selling accessories to enthusiasts of motocross and paintball. In 2000, the Gregorys decided to sell the assets of their company (JT USA, LP) to a large paintball equipment manufacturer for $32 million. Faced with the problem of having to pay tax on a very large capital gain, their solution was to use an alleged Son-of-BOSS transaction to create losses large enough to offset their gain. To effectuate the tax shelter, the Gregorys implemented a complex ownership structure in which they held both direct and indirect interests in JT USA.
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Proprietor of a Residential Glass Business Failed to Establish He Was a Real Estate Professional

Howard Cantor was the owner of ABS Glass, a sole proprietorship in the business of providing glazing services involving repairs and/or installation of automobile windshields and windows and repairs and/or installation of glass and glass products in buildings. ABS Glass was divided into an "automotive" division and a "residential" division.
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IRS Issues Regs on Failure to File Gain Recognition Agreements; Relaxes Standards for Penalty Relief

According to the IRS, the existing reasonable cause standard may not be satisfied by U.S. transferors in many common situations even though the failure was not intentional and not due to willful neglect. The IRS believes that full gain recognition under Code Sec. 367(a)(1) should apply only if a failure to timely file an initial GRA or a failure to comply with the Code Sec. 367(a) GRA regulations with respect to an existing GRA is willful. The IRS further believes that the penalty imposed by Code Sec. 6038B generally should be sufficient to encourage proper reporting and compliance.
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Federal Tax Bulletin - Issue 76 - November 21, 2014