Parker's Federal Tax Bulletin - February 13, 2018 Archived

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Issue 163

February 13, 2018

Tax Briefs

IRS Provides Withholding Tax Guidance Relating to New Tax Law; Excess State Tax Credit Is Taxable and Not a Recovery of Capital; IRS Expands Hurricane Maria Disaster Relief; Corporation Can't Deduct Rent Paid to Corporation's Sole Owner and Employee ...

Budget Bill Includes Tax Extenders, California Wildfire Disaster Relief, and a Grab Bag of Tax Reform Provisions

On Friday, February 9, 2018, the House and the Senate passed, and the President signed, the Bipartisan Budget Act of 2018 (BBA). The two-year budget bill incorporated numerous tax provisions, including retroactive extensions of more than 30 expired tax breaks for 2017, tax relief for victims of California wildfires, and several minor tax reform measures and adjustments to provisions in last year's tax overhaul. Pub. L. 115-123 (2/9/2018).

Third Circuit Affirms Tax Court; $10 Million in Transfers Were Equity Investments, Not Debt

The Third Circuit affirmed a Tax Court decision that a taxpayer's transfers of over $10 million from a wholly owned business to other companies in which he had an equity interest were equity investments, not loans, because the transfers bore no indicia of debt. The Third Circuit also rejected the taxpayer's treatment of the debt as worthless because no evidence was presented regarding the financial condition of the transferee companies and the taxpayer continued to transfer money to them after the year at issue. Sensenig v. Comm'r, 2018 PTC 16 (3d Cir. 2018).

Federal Circuit Reverses Lower Court; Supports Hospital's Bid for FICA Reimbursement

The Federal Circuit reversed the Federal Claims Court's dismissal of a hospital's reimbursement claim against the federal government for a $6.6 million settlement it paid to medical residents for Federal Insurance Contributions Act (FICA) taxes it incorrectly withheld. The Federal Circuit found that the phrase "shall be indemnified" in Code Sec. 3102(b) is not merely an immunity provision but mandates a right of recovery in damages from the government. New York and Presbyterian Hospital v. U.S., 2018 PTC 19 (Fed. Cir. 2018).

Virgin Islands Tax Return Triggered Statute of Limitations When Forwarded to the IRS

The Tax Court held that a nonresident of the Virgin Islands (VI) who filed a VI tax return but did not file a return with the IRS was protected by the statute of limitations from assessment by the IRS because the VI forwarded the first two pages of the VI returns to the IRS under an information sharing agreement. According to the Tax Court, the portion of the return the IRS received qualified as a return and started the running of the statute of limitations period, notwithstanding that the taxpayer filed nothing with the IRS and was not aware that the partial VI return was forwarded to the IRS. Coffey v. Comm'r, 150 T.C. No. 4 (2018).

2018 Pension Plan Limitations Not Affected by Tax Cut and Jobs Act of 2017

The IRS announced that the Tax Cut and Jobs Act of 2017 does not affect the tax year 2018 dollar limitations for retirement plans previously announced in Notice 2017-64. Although the new law made changes to how these cost of living adjustments are made, no changes take effect in 2018. IR-2018-19 (2/6/18).

Taxpayer's Self-Serving Affidavit Was Sufficient to Defeat Summary Judgment

The Eleventh Circuit Court held that self-serving and uncorroborated statements in a taxpayer's affidavit can create an issue of material fact with respect to the correctness of an IRS assessment of taxes and penalties provided the affidavit is made on personal knowledge, sets out facts that would be admissible in court, and the person making the statements is competent to testify. The Eleventh Circuit overruled the portion of Mays v. U.S., 763 F.2d 1295 (11th Cir. 1985) holding that a taxpayer's general and self-serving assertions failed to rebut an assessments' legal presumption of correctness. U.S. v. Stein, 2018 PTC 24 (11th Cir. 2018).

Taxpayer Entitled to Innocent Spouse Relief for Tax on Former Spouse's Income, but Not for Tax on Early 401(k) Withdrawal

The Tax Court held that a taxpayer was entitled to innocent spouse relief from the taxes on her ex-husband's business income because she reasonably believed they would be paid out of the proceeds of a business contract that never materialized. However, the taxpayer was not eligible for relief with respect to an early withdrawal of her retirement savings that that her husband used to invest in an ultimately worthless venture because, although her husband misled her about the quality of the investment, she freely withdrew the funds and should have known they could be lost. Minton v. Comm'r, T.C. Memo. 2018-15.

Compensation

IRS Provides Withholding Tax Guidance Relating to New Tax Law: In Notice 2018-14, as a result of the enactment of the Tax Cuts and Jobs Act of 2017, the IRS issued guidance which: (1) extends the effective period of Forms W-4, Employee's Withholding Allowance Certificate, furnished to claim exemption from income tax withholding under Code Sec. 3402(n) for 2017 until February 28, 2018, and temporarily permits employees to claim exemption from withholding under Code Sec. 3402(n) for 2018 by using 2017 Form W-4; (2) suspends the requirement that employees must furnish their employers new Forms W-4 within 10 days of changes of status resulting in fewer withholding allowances; (3) provides that the optional withholding rate on supplemental wage payments is 22 percent for tax years 2018 through 2025; and (4) provides that, for 2018, withholding on annuities or similar periodic payments where no withholding certificate is in effect is based on treating the payee as a married individual claiming three withholding allowances under Code Sec. 3405(a)(4). The IRS said it is currently working on revising Form W-4 to reflect the changes made by the Tax Cuts and Jobs Act of 2017 and, as a result, the 2018 Form W-4 may not be released until after February 15, 2018.

Credits

Excess State Tax Credit Is Taxable and Not a Recovery of Capital: In Ginsburg v. U.S., 2018 PTC 22 (Fed. Cl. 2018), the Court of Federal Claims held that an excess amount of a New York state tax credit paid to the taxpayer by the state of New York is subject to federal income tax and is not, as the taxpayer argued, a nontaxable recovery of capital. According to the court, the $1,864,618 payment from the state of New York to the taxpayer constituted a gain that does not qualify for any exclusion or exception from the federal definition of income.

IRS Expands Hurricane Maria Disaster Relief: In Notice 2018-17, as a result of the devastation caused by Hurricane Maria to the Commonwealth of Puerto Rico, the IRS expanded the low-income housing relief that is provided in Rev. Proc. 2014-49 and Rev. Proc. 2014-50. The expanded relief is limited to the Hurricane Maria PR Major Disaster and, except as expressly provided in the notice, all provisions of Rev. Proc. 2014-49 and Rev. Proc. 2014-50 apply to the Hurricane Maria PR Major Disaster without modification.

Deductions

Corporation Can't Deduct Rent Paid to Corporation's Sole Owner and Employee: In Christopher C.L. NG MD, Inc. APC v. Comm'r, T.C. Memo. 2018-14, the Tax Court held that a corporation, solely owned by a doctor who was also the corporation's sole employee, could not deduct expenses relating to the purported rental of part of the doctor's home. In reaching its decision, the court relied on the fact that the corporation did not produce any evidence of a written rental agreement or other documentation to support its position that the amounts claimed were actually rent and the fact that the doctor also did not treat the arrangement with the corporation as a bona fide rental arrangement because he did not report any reciprocal rental income on his Schedules E for the years at issue.

Court Rejects Alimony Deduction; Says Intent of Parties Doesn't Count: In Devaleria v. Comm'r, T.C. Summary 2018-5, the Tax Court held that a taxpayer was not entitled to a deduction for alimony paid to his former spouse in excess of the amount the IRS had allowed because the disputed payments were voluntary and, therefore, did not qualify as alimony under Code Sec. 71(a) and Code Sec. 215(a). With respect to the taxpayer's assertion that he and his former spouse had intended that the payments would be treated as alimony, the court noted that Congress eliminated any consideration of intent in determining the deductibility of a payment as alimony in favor of a more straightforward, objective test that relies entirely on the fulfillment of explicit requirements set forth in Code Sec. 71.

Miscellaneous

IRS Withdraws Solicitations for Applications for Clean Renewable Energy Bonds: In Notice 2018-15, the IRS withdrew the solicitations in Notice 2015-12 and Notice 2017-66 for applications for the remaining unused national limitation of authority to issue new clean renewable energy bonds under Code Sec. 54C. Code Sec. 54C was repealed by the Tax Cuts and Jobs Act of 2017.

IRS Updates Rules on Designating Census Tracts as Opportunity Zones: In Rev. Proc. 2018-16, the IRS provides guidance to the Chief Executive Officers (CEOs) of any state, about how certain population census tracts may be designated as Qualified Opportunity Zones for purposes of Code Sec. 1400Z-1 and Code Sec. 1400Z-2. Specifically, the revenue procedure clarifies the nomination process under Code Sec. 1400Z-1 by informing the CEOs of each state which census tracts in their jurisdictions are eligible to be nominated to be Qualified Opportunity Zones and by providing the requirements and due dates for the nomination, certification, and designation of the zones.

Partnerships

IRS Issues Proposed Regulations on the Centralized Partnership Audit Regime: In REG-118067-17, the IRS issued proposed regulations which give further guidance on the centralized partnership audit regime rules that are effective for partnership with tax years beginning after 2017. These proposed regulations provide rules that were reserved in earlier proposed regulations and specifically address how and when partnerships and their partners adjust tax attributes to take into account partnership adjustments under both Code Sec. 6225 and Code Sec. 6226. For an in-depth article on the new partnership audit regime, see the February 26, 2018 issue of Parker's Federal Tax Bulletin.

Penalties

Taxpayer Is Liable for Penalties By Preparing Reports Mischaracterizing the Life of Client's Property: In CCA 201805001, the Office of Chief Counsel advised that a taxpayer is liable for the Code Sec. 6701 penalty for aiding and abetting understatements of tax liability for returns on which his clients claimed incorrect depreciation deductions in reliance on a report furnished by the taxpayer which mischaracterized the life of certain property. By furnishing a report to clients that mischaracterized components of 39-year depreciable property as property with a shorter useful life (e.g. 5-year property), the Chief Counsel's Office concluded that the taxpayer aided in the preparation or presentation of the returns of clients who understated tax liability through claiming excessive deductions for depreciation and the taxpayer knew that the report would be used in connection with a material matter under the internal revenue laws.

Procedure

Court Rejects IRS Attempt to Extend Statute in Refund Case: In Starr International Company, Inc. v. U.S., 2018 PTC 22 (D. D.C. 2018), a district court granted a corporation's motion for summary judgment after finding that the corporation did not make the misrepresentations the IRS claimed that it made when the corporation filed a refund claim with the IRS. As a result, the court concluded that the IRS was limited to a two-year statute of limitations period, rather than a four-year period, in which to reclaim what it argued was an erroneously issued a $21 million refund to the taxpayer.

Eighth Circuit Enforces Summons After Couple's Failure to Answer Innocuous Questions: In U.S. v. Pate, 2018 PTC 28 (8th Cir. 2018), the Eighth Circuit affirmed a district court and a magistrate judge's recommendation that a summons against a couple, which directed the couple to provide testimony regarding alleged tax deficiencies, be enforced. The Eighth Circuit reached its decision after noting that the couple appeared before an IRS Officer and invoked the Fifth Amendment privilege in response to every question, including ones innocuous on their face, such as questions about their names, telephone numbers, and dates of birth.

Tax Act Didn't Constitute an Intervening Change That Necessitated Tax Recalculation: In Sonoma Apartment Associates v. U.S., 2018 PTC 26 (Fed. Cl. 2018), the Court of Federal Claims denied an IRS motion for reconsideration of a December 1, 2017, judgment in favor of a partnership, after the government argued that the Tax Cuts and Jobs Act of 2017 constituted an intervening change in controlling law that necessitated a recalculation of the tax neutralization payment that had been awarded to the partnership. The court noted that, in calculating the tax neutralization payment, it was reasonable to use the federal and state income tax rates for 2015 to project the partners' tax liabilities for each year from 2016 through 2035 because it was impossible to predict how Congress might change the income tax rates in the future and requiring a methodology to account for every possible event that might affect the partners' future tax liabilities risked making the necessary calculations so complex and unwieldy that the amount of a tax neutralization payment could never be determined.

Tax Accounting

Activities Conducted Thru Three S Corps and a Partnership Aren't a Single Activity: In CCA 201805013, the Office of Chief Counsel was asked whether business activities conducted through a partnership and three separate S corporations could be aggregated and treated as a single activity for purposes of the at-risk rules of Code Sec. 465. The Chief Counsel's Office advised that the organization of the four activities into separate legal entities that limit the liability of their owners weighed heavily against treating the four activities as a single trade or business that would allow them to be aggregated and treated as a single activity for purposes of Code Sec. 465.

Tax-Exempt Entities

Exempt Status Denied Where Founder Was Focused on Preventing Home's Foreclosure: In David Muresan Scientific Research Foundation v. Comm'r, T.C. Memo. 2018-13, the Tax Court held that an entity was not exempt from federal income tax under Code Sec. 501(a) because it was not an organization described in Code Sec. 501(c)(3). The court said that the evidence suggested that the reason for the nonprofit's existence was to prevent the foreclosure of the mortgage on the founder's personal residence, which was listed as an asset in the entity's application despite the lack of any evidence in the record that he had transferred title to the property to the entity.

Nonprofits Don't Need a New Exemption Application When Changing Form or Place of Organization: In Rev. Proc. 2018-15, the IRS announced that it generally will not require a new exemption application from a domestic Code Sec. 501(c) organization that changes its form or place of organization. As a result, Rev. Proc. 2018-15 obsoletes Rev. Rul. 67-390 and Rev. Rul. 77-469.

Budget Bill Includes Tax Extenders, California Wildfire Disaster Relief, and a Grab Bag of Tax Reform Provisions

I. Tax Extenders

Business Tax Breaks

Classification of Certain Race Horses as 3-Year Property. BBA extends the 3-year recovery period for race horses to property placed in service during 2017.

7-Year Recovery Period for Motorsports Entertainment Complexes. BBA extends the 7-year recovery period for motorsport entertainment complexes to property placed in service during 2017.

Special Expensing Rules for Certain Film and Television Productions. BBA extends through 2017 the special expensing provision for qualified film, television, and live theater productions. In general, only the first $15 million of costs may be expensed.

Accelerated Depreciation for Business Property on an Indian Reservation. BBA extends accelerated depreciation for qualified Indian reservation property to property placed in service during 2017. It also modifies the deduction to permit taxpayers to elect out of the accelerated depreciation rules.

Miscellaneous Business Tax Provisions Extended Through 2017. BBA also extends through 2017 the following business tax breaks:

Indian employment tax credit.
Railroad track maintenance credit.
Mine rescue team training credit.
Election to expense mine safety equipment.
Deduction allowable with respect to income attributable to domestic production activities in Puerto Rico.
Empowerment zone tax incentives.
Temporary increase in limit on cover over of rum excise taxes to Puerto Rico and the Virgin Islands.
American Samoa economic development credit.
Extension of special rule relating to qualified timber gain.

Tax Breaks for Individuals

Exclusion from Gross Income of Discharge of Qualified Principal Residence Indebtedness. BBA extends through 2017 the exclusion from gross income of a discharge of qualified principal residence indebtedness. It also modifies the exclusion to apply to qualified principal residence indebtedness that is discharged in 2018, if the discharge is pursuant to a written agreement entered into in 2017.

Mortgage Insurance Premiums Treated as Qualified Residence Interest. BBA extends through 2017 the treatment of qualified mortgage insurance premiums as interest for purposes of the mortgage interest deduction. This deduction phases out ratably for a taxpayer with AGI of $100,000 to $110,000.

Above-the-Line Deduction for Qualified Tuition and Related Expenses. The bill extends through 2017 the above-the-line deduction for qualified tuition and related expenses for higher education. The deduction is capped at $4,000 for an individual whose AGI does not exceed $65,000 ($130,000 for joint filers) or $2,000 for an individual whose AGI does not exceed $80,000 ($160,000 for joint filers).

Energy Incentives

Residential Energy Efficient Property Credit. Code Sec. 25D provides a tax credit for five categories of qualified property: (1) solar electric property, (2) solar water heating property, (3) fuel cell property, (4) small wind energy property, and (5) geothermal heat pump property. Under pre-BBA law, the credit for qualifying property in the last three categories expired on December 31, 2016, whereas that credit for qualified solar electric property and qualified solar water heating property wasn't set to expire until December 31, 2021. Under BBA, the credit will be available for property in all five categories until December 31, 2021. The amount of the credit is determined by applying a specified percentage to expenditures for qualifying property based on the date it's placed in service as follows: 30 percent for property placed in service in 2017 through 2019; 26 percent for property placed in service in 2020; and 22 percent for property placed in service in 2021.

Extension and phaseout of energy credit. (Sec. 40411 - looks like 5-year extension + modifications). Code Sec. 48 provides an energy credit for various types of energy property, including property which uses solar energy, property used to produce energy derived from a geothermal deposits, qualified fuel cell or microturbine property, heat and power system property, wind energy property, and equipment which uses ground or ground water as a thermal energy source. Under pre-BBA law, such property qualified as property eligible for the energy credit only with respect to periods ending before January 1, 2017. Under BBA, such property continues to be eligible for the energy credit for periods ending before January 1, 2022. Under pre-BBA the term "qualified fuel cell property" was scheduled to exclude any property for any period after December 31, 2016. The BBA changed the termination date to property for which construction does not begin before 2022. The BBA also extended application of the credit to combined heat and power system property the construction of which begins before 2022, whereas pre-BBA had it scheduled to terminate for property placed in service before 2017. The BBA also provides special rules for the phaseout of the credit for fiber-optic solar, qualified fuel cell, and qualified small wind energy property.

BBA also extends the following energy tax incentives for alternative and renewable energy sources through December 31, 2017:

Extension of credit for nonbusiness energy property.
Extension of credit for new qualified fuel cell motor vehicles.
Extension of credit for alternative fuel vehicle refueling property.
Extension of credit for 2-wheeled plug-in electric vehicles.
Extension of second generation biofuel producer credit.
Extension of biodiesel and renewable diesel incentives.
Extension of production credit for Indian coal facilities.
Extension of credits with respect to facilities producing energy from certain renewable resources.
Extension of credit for energy-efficient new homes.
Extension of special allowance for second generation biofuel plant property.
Extension of energy efficient commercial buildings deduction.
Extension of special rule for sales or dispositions to implement FERC or state electric restructuring policy for qualified electric utilities.
Extension of excise tax credits relating to alternative fuels.
Enhancement of carbon dioxide sequestration credit.
Modifications of credit for production from advanced nuclear power facilities.

II. California Wildfire Disaster Relief

BBA provides several forms of tax relief to victims of California wildfires: (1) enhancements to casualty loss deduction rules, (2) relaxation of retirement plan distribution rules, (3) modification of the earned income definition for purposes of the earned income credit and child tax credit, (4) suspension of limitations on charitable contributions, and (5) the modification of the employee retention tax credit available to businesses.

BBA's disaster relief provisions revolve around two definitions used to determine whether a taxpayer qualifies for relief. BBA defines "California wildfire disaster area" as an area with respect to which, between January 1, 2017 through January 18, 2018, a major disaster has been declared by the President under section 401 of the Robert T. Stafford Disaster Relief and Emergency Assistance Act ("Stafford Act") by reason of wildfires in California. It defines "California wildfire disaster zone" to mean the portion of the California wildfire disaster area determined by the President to warrant assistance from the Federal Government under the Robert T. Stafford Disaster Relief and Emergency Assistance Act by reason of wildfires in California.

Enhancements to Casualty Loss Deduction Rules

Generally, the deduction for a casualty loss of personal-use property is subject to a $100 reduction rule (only losses above $100 are counted) and the loss is limited to the extent it exceeds 10 percent of the taxpayer's adjusted gross income. For victims of California wildfires, BBA removes the 10 percent of adjusted gross income limitation, but increases the $100 floor to $500. It also allows individuals to claim a casualty loss even if they do not itemize their deductions by adding the amount of the loss to their standard deduction.

To qualify, a loss must arise in the California wildfire disaster area on or after October 8, 2017, and be attributable to the wildfires to which the disaster for such area declaration relates. The deduction is limited to the "net disaster loss" which consists of the excess of personal casualty losses attributable to a federally declared disaster over personal casualty gains.

Retirement Plan Rules Relaxed

BBA contains the following relief provisions regarding retirement plans:

(1) The 10 percent early withdrawal penalty tax in Code Sec. 72(t) will not apply to any qualified wildfire distribution made from a taxpayer's qualified retirement plan.

(2) The aggregate amount of distributions from a qualified retirement plan received by an individual which may be treated as qualified wildfire distributions for any tax year cannot exceed the excess (if any) of (i) $100,000, over (ii) the aggregate amounts treated as qualified wildfire distributions received by such individual for all prior tax years.

(3) If a distribution to an individual would (without regard to (2), above) be a qualified wildfire distribution, a plan will not be treated as violating any requirement of the Code merely because the plan treats such distribution as a qualified wildfire distribution, unless the aggregate amount of such distributions from all plans maintained by the employer (and any member of any controlled group which includes the employer) to such individual exceeds $100,000.

(4) Any individual who receives a qualified wildfire distribution may, at any time during the three-year period beginning on the day after the date on which such distribution was received, make one or more contributions in an aggregate amount not to exceed the amount of such distribution to an eligible retirement plan of which such individual is a beneficiary and to which a rollover contribution of such distribution could be made under Code Secs. 402(c), 403(a)(4), 403(b)(8), 408(d)(3), or Code Sec. 457(e)(16). If such contributions are made with respect to a qualified wildfire distribution from an eligible retirement plan other than an individual retirement plan, then the taxpayer will, to the extent of the amount of the contribution, be treated as having received the qualified wildfire distribution in an eligible rollover distribution and as having transferred the amount to the eligible retirement plan in a direct trustee-to-trustee transfer within 60 days of the distribution. If such contributions are made with respect to a qualified wildfire distribution from an individual retirement plan, then, to the extent of the amount of the contribution, the qualified wildfire distribution will be treated as a distribution described in Code Sec. 408(d)(3) and as having been transferred to the eligible retirement plan in a direct trustee-to-trustee transfer within 60 days of the distribution.

(5) In the case of any qualified wildfire distribution, any amount required to be included in gross income for such tax year will be includible ratably over the three-tax-year period beginning with such tax year, unless the taxpayer elects not to have this rule apply for any tax year. For purposes of this provision, rules similar to Code Sec. 408A(d)(3)(E), relating to an acceleration of the inclusion of such amounts in income, apply.

(6) Any individual who received a qualified distribution may, during the period beginning on October 8, 2017, and ending on June 30, 2018, make one or more contributions in an aggregate amount not to exceed the amount of such qualified distribution to an eligible retirement plan of which such individual is a beneficiary and to which a rollover contribution of such distribution could be made under Code Secs. 402(c), 403(a)(4), 403(b)(8), or Code Sec. 408(d)(3), as the case may be.

(7) The limit on loans from a qualified employer plan to a qualified individual that are not treated as taxable distributions is increased from $50,000 to $100,000, and the repayment of such loan may be delayed from the regular repayment term by an additional year.

BBA defines the term "qualified wildfire distribution" as any distribution from an eligible retirement plan made on or after October 8, 2017, and before January 1, 2019, to an individual whose principal place of abode during any portion of the period from October 8, 2017, to December 31, 2017, is located in the California wildfire disaster area and who has sustained an economic loss by reason of the wildfires to which the disaster declaration for such area relates.

Modification of Earned Income for Purposes of the Earned Income Credit and Child Tax Credit

If a qualified individual is eligible for the earned income credit and the child tax credit for 2017, and the taxpayer's earned income for the 2017 tax year is less than the taxpayer's earned income for 2016, the earned income credit and child tax credit may, at the taxpayer's election, be determined by substituting 2016 earned income for 2017 earned income.

A qualified individual is an individual whose principal place of abode during any portion of the period from October 8, 2017, to December 31, 2017, was located (1) in the California wildfire disaster zone, or (2) in the California wildfire disaster area (but outside the California wildfire disaster zone) and such individual was displaced from such principal place of abode by reason of the wildfires to which the disaster declaration for such area relates.

Suspension of Limitations on Charitable Contributions

A temporary suspension of the limitations on charitable contributions applies with respect to qualified contributions, which are defined as those made between October 8, 2017, and December 31, 2018, to a charitable organization and made for relief efforts with respect to the wildfire disaster area. The taxpayer must make an election to apply these rules. In the case of a partnership or S corporation, the election is made separately by each partner or shareholder.

Employee Retention Tax Credit Available to Businesses

BBA provides eligible employers with an employee retention credit of 40 percent of qualified wages with respect to each eligible employee. The amount of qualified wages which may be taken into account cannot exceed $6,000 paid to an eligible individual (making the maximum credit $2,400 per eligible employee).

A taxpayer is considered an eligible employer if it conducted an active trade or business on October 8, 2017, in the California wildfire disaster zone, and the trade or business was inoperable on any day after October 8, 2017 and before January 1, 2018, as a result of damage sustained by reason of wildfires to which the disaster declaration for such area relates.

III. Additional Hurricane Disaster Relief

Modification of Hurricanes Harvey and Irma Disaster Areas

BBA modifies the definition in Section 501 of the Disaster Tax Relief and Airport and Airway Extension Act of 2017 relating to the date to which the Hurricane Harvey and Hurricane Irma disaster areas were declared a disaster by striking "September 21, 2017" and inserting "October 17, 2017." In addition, the BBA provides that the rules under Code Sec. 280C also apply to any employers affected by those hurricanes and who are taking the employee retention credit.

IV. Tax Reforms and Other Provisions

Extension of Waiver of Limitations with Respect to Excluding from Gross Income Amounts Received by Wrongfully Incarcerated Individuals

Pre-BBA, Code Sec. 139F provided a special onewindow during which an eligible wrongfullyincarcerated individual could file a refund claim based on any civil damages, restitution, or other monetary award received and reported in a prior tax year, even if the normal statute of limitations had already expired for that year. If the credit or refund of any overpayment of tax resulting from the application of Code Sec. 139F to a period before December 18, 2015 (i.e., the date of enactment of Code Sec. 139F) was prevented as of such date by the operation of any law or rule of law (including res judicata), such credit or refund was nevertheless allowed if the claim was filed before the close of the one-year period beginning on December 18, 2015. Under the BBA, the wrongfully incarcerated individual has until December 18, 2018, to file a claim.

Individuals Held Harmless on Improper Levy on Retirement Plans

The BBA enacted Code Sec. 6343(f), which provides that, if the Treasury Secretary determines that an individual's account or benefit under an eligible retirement plan has been levied upon in a case where the property has been returned to the taxpayer or the levy was premature or otherwise not in accordance with administrative procedures, the individual can contribute such property or an amount equal to the sum of (1) the amount of money so returned, and (2) interest paid on such amount into an eligible retirement plan if such contribution is permitted by the plan, or into an individual retirement plan (other than an endowment contract) to which a rollover contribution of a distribution from such eligible retirement plan is permitted, but only if such contribution is made not later than the due date (not including extensions) for filing the return of tax for the tax year in which such property or amount of money is returned. The IRS must, at the time such property or amount of money is returned, notify such individual that such a contribution may be made.

The distribution on account of the levy and any contribution with respect to the return of such distribution are treated as if such distribution and contribution were described in Code Secs. 402(c), 402A(c)(3), 403(a)(4), 403(b)(8), 408(d)(3), 408A(d)(3), or 457(e)(16), whichever is applicable, except that (1) the contribution will be treated as having been made for the tax year in which the distribution on account of the levy occurred, (2) the interest paid under this provision will be treated as earnings within the plan after the contribution and will not be included in gross income, and (3) such contribution shall not be taken into account under Code Sec. 408(d)(3)(B).

Form 1040SR for Seniors

Under the BBA, the IRS is required to make available a form, to be known as ''Form 1040SR'', for use by individuals to file their income tax return. Such form is to be as similar as practicable to Form 1040EZ, except that (1) the form will be available only to individuals who have attained age 65 as of the close of the taxable year, (2) the form may be used even if income for the taxable year includes (i) social security benefits, (ii) distributions from qualified retirement plans, annuities or other such deferred payment arrangements, (iii) interest and dividends, or (iv) capital gains and losses taken into account in determining adjusted net capital gain, and (3) the form must be available without regard to the amount of any item of taxable income or the total amount of taxable income for the tax year.

Modification of User Fee Requirements for Installment Agreements

Under the BBA, the amount of any fee imposed on an installment agreement for certain individuals is capped and, for certain low-income taxpayers, no fee is imposed for automated payments and, for those who can't make automated payments, the fees may be refundable.

Other Miscellaneous Provisions

Miscellaneous other provisions in the BBA include the following:

(1) Provision relating to the deduction of attorney's fees relating to awards to whistleblowers;

(2) Clarification to the term "proceeds" as it relates to whistleblower awards;

(3) Clarification regarding excise tax based on investment income of private colleges and universities;

(4) Exception from private foundation excess business holding tax for independently-operated philanthropic business holdings;

(5) Simplification of rules regarding records, statements, and returns;

(6) Modification of rules governing certain hardship distributions and hardship withdrawals;

(7) Opportunity Zones rule for Puerto Rico;

(8) Modification to the rule of tax homes of certain citizens or residents of the United States living abroad;

(9) Treatment of foreign persons for returns relating to payments made in settlement of payment card and third party network transactions; and

(10) Repeal of shift in time of payment of corporate estimated taxes.

[Return to Table of Contents]

Third Circuit Affirms Tax Court; $10 Million in Transfers Were Equity Investments, Not Debt

John Sensenig is a CPA with years of experience preparing tax returns for himself and for businesses in which he has an equity interest. Sensenig has also engaged in business transactions totaling many millions of dollars. In 2005, Sensenig transferred $10.7 million through his wholly owned business, Conestoga Log Cabins Leasing, Inc. (CLCL), to three other companies in which he had an equity interest. Sensenig characterized the transfers as loans and deducted the full amount as wholly worthless debt in 2005. The deduction left Sensenig without income and thus without tax liability for that year.

The IRS determined that the transactions were not loans but equity investments. It disallowed the worthless debt deduction and determined that Sensenig owed approximately $1.5 million in taxes. A notice of deficiency was issued requiring payment of that amount plus a penalty of around $300,000. Sensenig petitioned the Tax Court. The Tax Court sustained the IRS's determination of the deficiency and the penalty. It agreed that the transfers were equity investments because, although Sensenig had identified a handful of the transactions as loans in his CLCL journal entries, the transactions bore no other indicia of debt. The Tax Court found that the transfers were not made pursuant to any written agreements providing for repayment of the principal or payment of interest, Sensenig never demanded repayment, and the transfers were designed to benefit Sensenig's equity interests in the companies. The Tax Court also concluded that even if the transfers were loans, they were not deductible as wholly worthless in 2005 because Sensenig produced no evidence regarding the financial conditions of the transferee companies and continued to transfer money to them after 2005.

Sensenig appeal to the Third Circuit. He pointed out that the transfers were accounted for in book entries by both the lender and the borrowing entities, that interest was calculated and booked, and that borrowing and repayments were also consistently booked over the years as loans and not as equity. Sensenig argued that he used book entries instead of promissory notes and that there was no law requiring a certain form of recordkeeping to prove a loan. Sensenig further contended that, as a Mennonite, he obtained the funds in question from a pool of Mennonite and Amish clients and that those clients orally instructed him to forward the funds as loans rather than as equity investments so that the funds would not be commingled with those of nonbelievers.

The Third Circuit affirmed the Tax Court's decision. Addressing the issues Sensenig raised on appeal, the court found that Sensenig cited no evidence of the purported book entries recording the transfers as loans. Sensenig's argument that he was not required to use promissory notes was rejected; as the Tax Court noted, aside from a handful of journal entries, there were no other objective indicia of loans and the economic realities of the transactions suggested that they were intended as equity investments. The Third Circuit determined that the Tax Court had applied the proper framework and that Sensenig had raised nothing to call its decision into question.

Finally, the Third Circuit found that Sensenig provided no evidence that the transfers were structured as loans at the instruction of his Mennonite and Amish clients. The Third Circuit reasoned that this argument undercut Sensenig's position. It noted that other transactions between Sensenig and his Mennonite and Amish clients were structured as loans and evidenced by notes providing for an interest rate. The transactions at issue, by contrast, were not. The Third Circuit concluded that even if Sensenig subjectively intended for the transactions at issue to be loans, he introduced no evidence regarding the intent of the transferee companies, and the evidence as a whole overwhelmingly suggested that the transactions were equity investments.

For a discussion of the characterization of a corporate instrument as stock or debt, see Parker Tax ¶45,310. For a discussion of the deduction for a worthless debt, see Parker Tax ¶ 98,410.

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Federal Circuit Reverses Lower Court; Supports Hospital's Bid for FICA Reimbursement

The Federal Insurance Contributions Act (FICA) requires employers to withhold and pay taxes on wages paid to employees. Under Code Sec. 3102(b), employers that are required to withhold are liable for any unpaid FICA taxes, and are indemnified against claims of any person for the withholding taxes they pay.

One exception to FICA withholding applies to students employed by universities. Medical residents were initially determined to be ineligible for the student exception, but the issue became the subject of litigation. While the lawsuits were pending, the IRS allowed either employers or medical residents to file protective refund claims to preserve their claims for a refund of the FICA taxes withheld.

A 2004 regulation excluded medical residents from the student exception and required withholding on their wages beginning after April 1, 2005. However, the IRS determined that medical residents qualified for the student exception on wages paid before that date, and hospitals and medical residents who had filed protective refund claims would be entitled to refunds.

In 2013, former medical residents sued New York and Presbyterian Hospital, alleging that the hospital had not filed protective refund claims between 1995 and 2001 and asserting various claims including fraud and breach of fiduciary duty. The hospital eventually settled with the residents for approximately $6.6 million. The settlement agreement provided that the award could be characterized as a refund for the amount of FICA taxes previously withheld by the hospital.

The hospital sued the federal government in the Court of Federal Claims for reimbursement of the settlement award on the basis that it was indemnified under Code Sec. 3102(b). The Court of Federal Claims dismissed for lack of jurisdiction, finding that Code Sec. 3102(b) is merely an immunity provision and does not entitle an employer to seek damages against the government. The hospital appealed to the Federal Circuit.

The Federal Claims Court has jurisdiction over a damages claim against the government only if a substantive law creates a right to money damages (money mandating). A law is money mandating if it can be fairly interpreted as requiring compensation from the government. This standard is met if the statute in question is reasonably amenable to the reading that it mandates a recovery in money damages.

On appeal, the hospital argued that Code Sec. 3102(b) is money mandating because the phrase "shall be indemnified" can be fairly interpreted to require the government to pay monetary compensation. The government, on the other hand, argued that the primary dictionary definition of indemnification at the time Code Sec. 3102(b) was enacted was immunity from liability and not a right to reimbursement. The government also reasoned that the statute would not make sense if employers who have withheld and paid FICA taxes could, at their own whim, pay the claims of their employees and then be entitled to full reimbursement from the government.

The Federal Circuit reversed the Federal Claims Court's dismissal and remanded the case. It held that the Court of Federal Claims did have jurisdiction because Code Sec. 3102(b) can be fairly interpreted as mandating recovery from the government.

The court rejected the government's argument that the primary meaning of indemnification is immunity for three reasons. First, the court found that reimbursement did not need to be the first definition of indemnify; the court had only to find that the statute was reasonably amenable to that interpretation. Second, the court found that the order of the definitions in dictionaries did not necessarily reflect the most widely accepting meaning of the terms as understood at the time. To the contrary, at least one dictionary stated that the first definition was the earliest usage of the term. Third, the court found that even if the meaning of "indemnify" was limited to the first definitions, those definitions still contemplated monetary compensation. The Federal Circuit went on to find that the definition of "indemnification" contemplated reimbursement because three contemporaneous dictionaries included "to compensate" in their definitions of the term, and two specifically discussed reimbursement.

The Federal Circuit also did not agree that Code Sec. 3102(b) would be internally inconsistent if it gave employers a right to reimbursement. The court reasoned that it had to defer to the statute's plain language as an expression of Congressional intent, and that the plain language was reasonably amenable to an interpretation that mandated reimbursement. The court concluded that even if it agreed with the hospital's position, it was for Congress, not the court, to rewrite the law.

The Federal Circuit also found that other Code provisions supported its interpretation. Code Sec. 3202(b), which applies to railroad employers, and Code Sec. 3403, which concerns the withholding of taxes by an employer, provide that an employer "shall not be liable" to any person for the amount of any payment for taxes deducted. The fact that these similar provisions explicitly state that employers are not liable, rather than that they are indemnified, shows that Congress understood these terms to have different meanings. Code Sec. 7422 provides that taxpayers cannot sue for any wrongfully collected tax without first filing a refund claim. This provision, which gives employers immunity from employee claims for wrongfully collected taxes, showed to the court that Congress knew how to craft an immunity provision when it wanted to do so.

Finally, the Federal Circuit found that the legislative history also supported its conclusion. A House Report contained language that Code Sec. 3202(b) was intended to protect employers by indemnifying them up to the "correct amount." This showed that Congress understood indemnification to contemplate the payment of money.

Observation: In a dissenting opinion, one judge contended that the majority's conclusion conflicted with the refund procedure under Code Sec. 7422. The dissenting judge reasoned that taxpayers seeking refunds must first file a refund claim with the IRS before filing suit against the government (and only the government) for the taxes paid. It was implausible to the dissenter that Congress meant to give employers a reimbursement right when it explicitly excluded them from the procedure for claiming a refund.

For a discussion of FICA withholding, see Parker Tax ¶213,101.

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Virgin Islands Tax Return Triggered Statute of Limitations When Forwarded to the IRS

Judith Coffey had a successful career in scholastic publishing. In 1985, she and her husband formed Rainbow Educational Concepts, Inc., a publisher's development company that focused on editorial design and production of textbooks. Coffey was president of Rainbow until 2003 and had income of over $1 million in 2003 and 2004.

In 2003, Coffey learned of the advantages of the Virgin Islands (VI) tax system, which offers incentives to bring companies to the VI. Coffey ended her relationship with Rainbow and became a partner in a VI partnership called StoneTree. She bought a house and two cars in the VI, got a VI driver's license and became a VI registered voter.

Coffey thought she was a bona fide VI resident and believed she was required to file a return only with the VI Bureau of Internal Revenue (VIBIR) and not with the IRS. VI residents and nonresidents use the same Form 1040 that is filed with the IRS. Coffey timely filed Forms 1040 with the VIBIR for 2003 and 2004, the years at issue. The returns were complete and accepted by the VIBIR. Coffey's returns were complex and she filed numerous schedules in addition to the Form 1040.

Under an information sharing agreement, the VIBIR sends copies of VI returns to the IRS in some instances. For example, when the VIBIR receives a return from a bona fide VI resident who had taxes withheld in the U.S., the VIBIR sends a copy of the return (or parts of it) to the IRS in order to collect the withheld funds. In this case, the VIBIR electronically sent photocopies of the first two pages of Coffey's Forms 1040 to the IRS along with copies of her Forms W-2. The VIBIR did not send any of the schedules that Coffey filed with her returns.

The IRS extracted some information from the returns. Its records reflected that Coffey claimed two exemptions and showed withholding credits from non-VI sources. The IRS initially recorded Coffey's adjusted gross income as zero for both years. Her VIBIR returns were later selected for audit and a notice of deficiency was sent in September 2009. Coffey challenged the notice in the Tax Court and the VI intervened.

Under Beard v. Comm'r, 82 T.C. 766 (1984), a filing is treated as a return and starts the running of the statute of limitations period if it (1) contains enough information to calculate the tax, (2) purports to be a return, (3) is an honest and reasonable attempt to comply with the law, and (4) is signed under penalties of perjury.

Coffey argued in a motion for summary judgment that what the IRS received from the VIBIR constituted returns under Beard. Coffey argued that the IRS got enough information from the VIBIR and that it could have requested any missing data under the information sharing agreement. She reasoned that her VIBIR filing purported to be a return because it was the same Form 1040 that would have been filed with the IRS. Coffey said that because she believed she was required to file only in the VI, her VI returns were therefore an honest and reasonable attempt to comply with the tax laws. Finally, Coffey contended that although the returns the IRS received did not have original signatures, a return need not be perfect to start the statute of the limitations, and the IRS routinely accepts nonoriginal signatures.

The IRS argued that what it received from the VIBIR did not disclose information in such a way that the returns could be readily verified. The IRS said that the returns did not purport to be returns because they were territorial filings, not federal filings. Nor were the returns an honest and reasonable attempt to comply with the law, in the IRS's view; if Coffey believed she had no U.S. taxable income, the only return consistent with her position would have been a protective all zero return. Finally, the IRS said the returns it received did not contain original signatures, so they were not executed under penalties of perjury.

Observation: IRS Notice 2007-31 states that, if a taxpayer claims to be bona fide resident of VI and files a tax return there, the VI return starts the statute of limitations in the U.S. Regulations issued under Code Sec. 932 in 2008 mirror the position taken in the notice. Neither the notice nor the regulations applied retroactively, so the Tax Court looked to the common law rules in this case.

The Tax Court found that the information the IRS received qualified as returns under Beard. First, the Tax Court reasoned that the IRS had enough information to create a transcript of account, albeit one with zeroes on almost every line. But that was precisely what the IRS said Coffey should have filed if she was unsure whether she was a U.S. resident. The Tax Court pointed out that the IRS actually received more information than it would have from a zero return. The missing schedules, in the court's view, did not prevent the computation of Coffey's tax liability. The court added that the computation need not be accurate for purposes of the statute of limitations.

Coffey's returns purported to be returns because Coffey filed the same Forms 1040 used by the IRS. The Tax Court reasoned that the filing of a VI return is part of the federal filing obligation for a taxpayer with VI source income. The court further reasoned that, in the criminal context, a person who files a fraudulent VI return is charged with filing a fraudulent federal return. The facts showed, in the court's view, that the IRS stamped Coffey's returns as received, summarized the contents in its files and opened an audit, but ultimately failed to issue the notice of deficiency in time.

The court also found that Coffey made an honest and reasonable attempt to satisfy the law. It rejected the IRS's argument that Coffey should have filed a protective zero return because it found this argument was based on Coffey's subjective beliefs about her obligations, which were irrelevant under Beard. The court reasoned that this element of the test was intended to distinguish tax protester returns from honest attempts to comply and saw Coffey's returns as the latter rather than the former.

Finally, the Tax Court held that the signed returns Coffey filed with the VIBIR satisfied the signature requirement under Beard. The court reasoned that nothing in the Code or regulations explicitly calls for an original signature. Moreover, the IRS accepts some returns with facsimile signatures. The court acknowledged that the IRS usually requires authenticating safeguards when nonoriginal signatures are accepted, but reasoned that the IRS received the forms from the VIBIR, the official revenue agency of a U.S. possession and one with which the IRS has a longstanding information sharing agreement. The Tax Court was careful not to hold that a photocopied signature is always sufficient to make a return valid, but found that Coffey's signature was valid under the circumstances.

A concurring opinion contended that the limitations period began not with what the VIBIR sent to the IRS but with the returns Coffey filed with the VIBIR. A dissenting opinion reasoned that, for purposes of the limitations period, the filing of a valid federal income tax return requires an intentional act by the taxpayer, and there was none here.

For a discussion of the return filing requirements and the statute of limitations, see Parker Tax ¶260,130. For a discussion of the return filing requirements for taxpayers with income from U.S. possessions, see Parker Tax ¶10,125.

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2018 Pension Plan Limitations Not Affected by Tax Cut and Jobs Act of 2017

The Internal Revenue Code provides dollar limitations on benefits and contributions under qualified retirement plans, and it requires the Treasury Department to annually adjust these limits for cost of living increases. Those adjustments are to be made using procedures that are similar to those used to adjust benefit amounts under the Social Security Act.

The IRS has announced that, since the Tax Cuts and Jobs Act of 2017 made no changes to the section of the tax law limiting benefits and contributions for retirement plans, the qualified retirement plan limitations for tax year 2018, which were previously announced in Notice 2017-64, remain unchanged.

The tax law also specifies that contribution limits for IRAs, as well as the income thresholds related to IRAs and the saver's credit, are to be adjusted for changes in the cost of living using procedures that are used to make cost-of-living adjustments that apply to many of the basic income tax parameters.

The IRS observed that, although the new law made changes to how these cost of living adjustments are made, after taking the applicable rounding rules into account, the amounts for 2018 detailed in Notice 2017-64 remain unchanged.

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Taxpayer's Self-Serving Affidavit Was Sufficient to Defeat Summary Judgment

In 2015, the IRS sued Estelle Stein for outstanding tax assessments, late penalties, and interest owed for five previous years. The IRS alleged that Stein owed approximately $220,000 plus fees and additions to tax. In a motion for summary judgment, the IRS submitted copies of Stein's tax returns, transcripts of her accounts, and an affidavit from an IRS officer.

Stein responded with an affidavit of her own stating that, to the best of her recollection, she had paid the taxes and penalties owed for the years at issue. According to the affidavit, Stein had hired an accounting firm to file her returns after the death of her husband, who had been solely responsible for filing the couple's returns and paying taxes. Stein said in her affidavit that although she remembered paying the taxes and penalties, she no longer had bank statements to establish her payments to the IRS and could not obtain the bank statements to prove her payments. She also claimed that the IRS had acknowledged misapplying her tax payment for one year to an earlier year. Stein's affidavit said it was her unwavering contention that she paid the taxes and penalties when she filed her returns for the years at issue.

A district court granted summary judgment in favor of the IRS. According to the district court, the IRS's evidence created a presumption that its assessments were correct. Stein's affidavit, the court said, did not produce any evidence documenting her payments and therefore did not satisfy her burden to overcome the presumption of correctness. As a result, the district court held that there was no genuine issue of material fact and the IRS was entitled to judgment as a matter of law.

Stein appealed to the Eleventh Circuit Court. A panel of the court affirmed the district court's decision and found that Stein's affidavit failed to create a genuine factual dispute about the validity of the IRS's assessments. The Eleventh Circuit then vacated the panel's decision and reconsidered the case en banc.

Under Rule 56(c) of the Federal Rules of Civil Procedure, an affidavit that disputes a material fact precludes summary judgment if the affidavit is made on personal knowledge, sets out facts that would be admissible in evidence, and shows that the person submitting the affidavit is competent to testify in court. However, in Mays v. U.S., 763 F.2d 1295 (11th Cir. 1985), the Eleventh Circuit held that a taxpayer seeking a refund had to substantiate his or her claim by using something other than tax returns, uncorroborated testimony, or self-serving statements. The taxpayer's submissions of printouts showing business expenses and statements of net worth were insufficient to substantiate such claims, and therefore did not overcome the presumption of correctness afforded the IRS's determinations.

The Eleventh Circuit overruled the portion of Mays holding that self-serving and uncorroborated statements in a taxpayer's affidavit cannot create an issue of material fact with respect to the correctness of the IRS's assessments. It held that a nonconclusory affidavit which complies with Rule 56 can create a genuine dispute concerning an issue of material fact even if it is self-serving and/or uncorroborated.

The Eleventh Circuit found that, contrary to Mays, nothing in Rule 56 prohibits an affidavit from being self-serving. In fact, the Eleventh Circuit noted that in many of its decisions, self-serving statements based on personal knowledge or observation were sufficient to defeat summary judgment. The court further found that Mays incorrectly relied on Gibson v. U.S., 360 F.2d 457 (5th Cir. 1966), which, in the view of the Eleventh Circuit, held only that it was not clear error for a fact finder to disregard self-serving and unsupported trial testimony. The Eleventh Circuit reasoned that Gibson did not apply to summary judgment, where the court's function is not to weigh the evidence.

The Eleventh Circuit also rejected the panel's holding that an affidavit must be corroborated by independent evidence. The court pointed out that nothing in Rule 56 requires an otherwise permissible affidavit to be corroborated and it saw no basis for imposing a corroboration requirement. The Eleventh Circuit found that if corroboration is needed, that requirement must come from a source other than Rule 56, such as the substantive law that governs the dispute or the rules of evidence. The determination of whether substantive tax law required Stein to substantiate her tax and penalty payments was left to the panel to decide on remand.

For a discussion of the general rules of assessments, tax see Parker Tax ¶260,110.

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Taxpayer Entitled to Innocent Spouse Relief for Tax on Former Spouse's Income, but Not for Tax on Early 401(k) Withdrawal

Connie Minton moved from Ohio to Florida in 2008. She sold her house in Ohio after the sudden death of her first husband and used the proceeds to buy a house in Florida. There she met John Keeney and married him in 2009. Keeney operated an air conditioning business. Minton was listed as an agent of the business because Keeney claimed to have been a victim of identity theft, but her involvement in the business was minimal and Keeney did not want her working outside the home. Minton tried to pay bills for the business and the household and, therefore, was aware of Keeney's financial difficulties, which included insufficient funds to pay bills. However, Keeney repeatedly told Minton that a big contract was coming for his business. The contract never materialized.

In 2009, Keeney convinced Minton to withdraw $30,000 from her Code Sec. 401(k) account so he could invest it in a moneymaking venture that later turned out to be worthless. In 2010, the couple filed a joint tax return reporting the 401(k) withdrawal and other items of income, including business income, for a total of approximately $35,000 of taxable income. The tax liability came to approximately $5,300, which included $1,100 in self-employment tax and an early withdrawal tax of $3,000. The couple paid $480, leaving a balance due of around $4,800.

Minton knew that she and her husband could not pay their tax liability. However, she trusted Keeney's representations about the imminent contract his business would get and believed the proceeds would take care of their outstanding tax bill. The couple eventually declared bankruptcy but, after separating from Keeney, Minton could not afford to continue the process.

Keeney verbally abused Minton beginning early in the marriage and the abuse grew worse as time went on. Minton discovered that Keeney had lied about his prior employment and hid cash payments from his business from her. When the couple divorced in 2013, Keeney withdrew all the funds from their joint bank account and made threats which lead to Minton filing for a restraining order. Minton found a job and moved in with her mother in a house she bought after paying off a $20,000 lien on her old home so that she could sell it.

In 2014, Minton filed for relief from her and Keeney's unpaid taxes by filing a Form 8857, Request for Innocent Spouse Relief. The IRS denied her request. Minton sold her house in 2016 and paid the tax liability in full. She then sued for a refund in the Tax Court.

Under Code Sec. 6015(f), a spouse can obtain relief from liability for taxes owed on a joint return if imposing liability would be inequitable under the circumstances. Rev. Proc. 2013-34 provides guidance on when such relief will be granted. It sets forth seven threshold conditions that the taxpayer must establish before the IRS will consider the request. One is that at least part of the tax liability must be attributable to the nonrequesting spouse (the attribution rule). Certain exceptions apply to the attribution rule. For example, if the nonrequesting spouse misappropriated funds, then the requesting spouse need not show attribution. Likewise, the rule does not apply if abuse affected the requesting spouse's ability to challenge or question an item or balance due, or if the nonrequesting spouse's fraud is the reason for the erroneous item. Once the threshold conditions are met, Rev. Proc. 2013-34 further provides a list of nonexclusive factors that determine equitable relief is warranted. The Tax Court pointed out that, in this case, the only factor in question was whether Minton knew or had reason to know that Keeney would not pay the couple's tax liability.

The Tax Court held that Minton was entitled to relief with respect to the taxes on Keeney's business income but not the early withdrawal tax on her 401(k) distribution. First, the Tax Court found that not all of the threshold conditions were met because the tax on Minton's early 401(k) withdrawal could not be attributed to Keeney. The court also found that none of the relevant exceptions to the attribution rule applied. Although Minton claimed that Keeney withheld cash from household accounts, the court found that he did not misappropriate money intended to pay the taxes. Rather, Keeney convinced Minton that he had business prospects that would enable them to pay their taxes. The Tax Court noted that Keeney had made misleading statements and manipulated and verbally abused Minton throughout the marriage but found that these actions did not restrict Minton's ability to challenge how items were reported on their return. Minton freely withdrew funds from her retirement account knowing that Keeney intended to invest them, the court found, and Keeney's deceitfulness was not the type of abuse that warranted excusing Minton from the responsibility for tax on income from her own retirement account. The Tax Court further found that the fraud exception did not apply because, while Keeney misled Minton about business prospects, Minton freely withdrew the funds and should have known they could be lost.

The Tax Court found that the attribution rule applied to the liability attributable to Keeney's business because Minton's involvement in the business was nominal. The court went on to find that the equitable factors weighed in favor of granting relief with respect to Keeney's business income. Minton had a reasonable expectation that the tax on the business and self-employment income would be paid out of the proceeds from the big contract that Keeney promised was coming. The Tax Court also noted Minton's lack of sophistication and her position in the marriage as well as Keeney's duplicity and abuse and determined that under these circumstances, Minton's belief was reasonable. The Tax Court therefore concluded that it would be inequitable to require Minton to pay Keeney's tax liability and held that she was entitled to a refund for taxes paid on that amount.

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

Federal Tax Bulletin - Issue 163 - February 13, 2018