Federal Tax Bulletin - Issue 131 - January 4, 2017

Top Tax Developments of 2016

In 2016, the tax practitioners experienced the usual slew of important court decisions and major new IRS regulations, procedures, and rulings. But the biggest development was a seismic shift in the political terrain, expected to produce the most significant tax changes in a generation.

The following is a summary of 2016's most important tax developments.

Republican Victory in November Sets the Stage for Major Tax Changes in 2017

By winning the White House and holding on to their majorities in the House and Senate, Republicans put themselves in a position to fulfill campaign promises to reduce individual and corporate tax rates, repeal healthcare taxes, repeal the estate tax, and possibly implement broad, substantive tax reform.

With a Republican government seated for the first time in a decade, it's anticipated that 2017 will bring extensive tax changes. Among the most likely to pass:  

• reductions in most individual income tax rates;
• reduction in the top corporate income tax rate;
• repeal of healthcare taxes and credits enacted under the Affordable Care Act (Obamacare); and
• repeal of the estate tax.

A large increase in standard deduction amounts and a sharp curtailment of itemized deductions will also be on the table, along with broad corporate tax reform.

The proposed changes were centerpieces of the Trump campaign and were also featured in a tax reform plan put forward last summer by House Speaker Paul Ryan and Ways and Means Chairman Kevin Brady ("Ryan-Brady plan").

For a discussion of the various tax plans, see the November 18, 2016, issue of Parker's Federal Tax Bulletin (PFTB 2016-11-18).

Obama Administration Tries to Implement New Federal Overtime Rules; District Court Judge Shoots Them Down

Less than ten days before major updates to federal overtime rules were to take effect in December, a Texas district court judge issued a preliminary injunction blocking the new rules and effectively killing them.

The revised overtime rules were estimated to affect over 4.2 million workers. They would have doubled the salary threshold at which a white collar worker could be classified as an "exempt employee" not entitled to overtime pay. The regulations also would have increased the salary threshold for highly compensated employees, who are subject to looser exemption criteria.

Instead, on November 22, 2016, the judge granted an injunction blocking implementation indefinitely after concluding that the Department of Labor had overstepped its regulatory authority.

For a discussion of the overtime rules that had been scheduled to take effect in December 2016, see the October 21, 2016, issue of Parker's Federal Tax Bulletin (PFTB 2016-10-21).

Proposed Regs Would Disallow Valuation Discounts for Family Businesses; Draw Criticism from All Corners

The IRS issued controversial proposed regulations in REG-163113-02 (8/4/16) which seek to eliminate loopholes by reducing the availability of valuation discounts for transfers among family members of interests in family owned businesses. Citing concerns over certain transactions taxpayers have used to avoid the application of Code Sec. 2704, the regulations address deathbed transfers that result in the lapse of a liquidation right, refine the definition of the term "applicable restriction," add a new class of disregarded restrictions, and address restrictions on the liquidation of an individual interest in an entity and the effect of insubstantial interests held by persons who are not members of the family.

The regulations have received almost universal criticism from the AICPA, ABA, and family business tax planners because they would eliminate most valuation discounts on redemptions and transfers of family business interests among family members when a single family controls the business both before and after the transfer.

Observation: While President-elect Trump has vowed to eliminate the estate tax, these rules would still be applicable for gift tax purposes.

The regulations are proposed to be effective when finalized.

For a discussion of the proposed regulations, see the August 12, 2016, issue of Parker's Federal Tax Bulletin (PFTB 2016-08-12).

Self-Directed IRA Cases Highlight Potential Pitfalls

Self-directed individual retirement accounts (IRAs) have been gaining in popularity because they provide more flexibility to taxpayers as far as investments that can be held in the IRA. A self-directed IRA is simply an IRA under which the IRA owner has control over the type of investments held in the IRA. Thus, the owner of a self-directed IRA may choose from the complete range of investments permitted for IRAs - including real estate, limited partnerships, mortgages, notes, franchise businesses, etc. - rather than being limited to the typical investments offered by IRA custodians and trustees (stocks, bonds, mutual funds, etc.). While this higher degree of flexibility in choosing IRA investments allows the IRA owner to invest in assets with greater wealth-building potential, there are potential pitfalls. In 2016, two Tax Court cases involving self-directed IRAs highlighted some issues that can arise.

In McGaugh v. Comm'r, T.C. Memo. 2016-28, the IRS tried argue that a taxpayer missed the 60-day tax-free rollover period when he requested that Merrill Lynch initiate a wire transfer directly from his IRA account to a corporation whose stock the taxpayer wanted to add to his IRA. The stock was delivered to the taxpayer's IRA more than 60 days after the wire transfer. The IRS determined that the wire transfer issued by Merrill Lynch to the corporation was constructively received by the taxpayer and was includible in his gross income because it was not rolled over within the mandatory 60-day period. In addition, because he had not yet reached age 59 1/2, it was an early distribution subject to the 10 percent penalty tax of Code Sec. 72(t). The Tax Court rejected the IRS's "constructive receipt" reasoning and held that an owner of an IRA is entitled to direct the investment of the funds without forfeiting the tax benefits of the IRA. The court concluded there was no distribution to the taxpayer and thus the 60-day rule did not apply.

However, the taxpayers in Thiessen v. Comm'r, 146 T.C. No. 7 (2016), weren't so lucky. In that case, a couple made loan guarantees with respect to transactions involving their self-directed IRAs. The Tax Court held that they had engaged in prohibited transactions and thus received deemed distributions from their IRA, which were subject to tax as well as the 10 percent penalty tax under Code Sec. 72(t).

For a full discussion of the McGaugh case, see the February 26, 2016, issue of Parker's Federal Tax Bulletin (PFTB 2016-02-26). For a discussion of the Thiessen case, see the April 8, 2016, issue of Parker's Federal Tax Bulletin (PFTB 2016-04-08).

Income from Forfeited Deposit Is Ordinary Income, Not Capital Gain

In a case of first impression, the Tax Court held that where a partnership received as income a $9.7 million deposit forfeited by a prospective buyer of its hotel, the deposit was taxable as ordinary income. The Tax Court rejected the partnership's argument that, under Code Sec. 1234A, the income was capital gain because the sale of the hotel would have been treated as capital gain under Code Sec. 1231.

In CRI-Leslie, LLC v. Comm'r, 147 T.C. No. 8 (2016), the Tax Court noted that while Code Sec. 1234A extends to rights or obligations relating to capital assets, Code Sec. 1221(a)(2) excludes depreciable property used in the taxpayer's trade or business, as well as real property used in his trade or business, from the definition of a capital asset.

For a discussion of the CRI-Leslie, LLC case, see the September 9, 2016, issue of Parker's Federal Tax Bulletin (PFTB 2016-09-09).

Final Regs Overhaul Partnership Disguised Sale and Partnership Liability Rules

In October, the IRS issued final, temporary, and proposed regulations (T.D. 9787, T.D. 9788, REG-122855-15 (10/5/16)) that substantially alter the partnership disguised sale rules, as well as the rules relating to the treatment of partnership liabilities. To a large extent, the rules eliminate the ability to engage in tax-deferred leveraged partnership transactions and to defer taxable gain by using bottom-dollar payment obligations when allocating partnership liabilities.

For an in depth discussion of the final, temporary, and proposed regulations, see the October 7, 2016, issue of Parker's Federal Tax Bulletin (PFTB 2016-10-07).

New IRS Procedure Lets Taxpayers Self-Certify Eligibility for Waiver of 60-Day Rollover Requirement

Taxpayers are eligible to rollover distributions from an IRA if certain requirements are met one being that the rollover must be completed within a 60-day period. If the requirement is not met, the distribution is treated as taxable and may be subject to the 10 percent penalty tax of Code Sec. 72(t), depending on the taxpayer's age. The IRS receives numerous letter ruling requests each year from taxpayers asking for waivers of this rule due to the deadline being missed because of circumstances beyond a taxpayer's control. Submitting a letter ruling request to the IRS can be costly because of the CPA and/or lawyer's time required in preparing the request, as well as the IRS user fees involved.

In August, the IRS issued Rev. Proc. 2016-47, which provides a self-certification procedure for taxpayers to claim eligibility for a waiver of the 60-day rollover requirement in certain circumstances. A plan administrator or an IRA trustee can rely on such certification in accepting and reporting receipt of a rollover contribution where the untimely rollover is due to an error on the part of a financial institution. There is no IRS fee for using the self-certification procedure.

For a discussion of Rev. Proc. 2016-47, see the August 26, 2016, issue of Parker's Federal Tax Bulletin (PFTB 2016-08-26).

Blue Book Addresses Issues Involving New Partnership Audit Regime

In March, The Joint Committee on Taxation released the General Explanation of Tax Legislation Enacted in 2015 (JCS-1-16), otherwise referred to as the "Blue Book." The Blue Book provides insight into the overhaul of the partnership audit rules and addresses some of the questions that had been posed by practitioners on various aspects of how the new rules might apply.

While the new partnership audit rules are generally effective for partnership tax years beginning after December 31, 2017, partnerships may elect to apply them to any partnership returns for partnership tax years beginning after November 2, 2015, and before January 1, 2018.

For a discussion of the partnership audit issues as highlighted in the Blue Book, see the March 25, 2016, issue of Parker's Federal Tax Bulletin (PFTB 2016-03-25).

Sharply Increased Form 1099 Penalties Take Effect

Starting in 2017, hefty increases in the penalties imposed under Code Sec. 6721 and Code Sec. 6722 apply if a payer fails to timely file an information return, fails to include all information required to be shown on an information return, or includes incorrect information on an information return (including all variations of Form 1099). The new penalties run as high as $250 per information return, with maximum total penalties of $1,000,000 for certain small businesses and $3,000,000 for all others.

For a full discussion of the increased information return penalties, see the January 15, 2016, issue of Parker's Federal Tax Bulletin (PFTB 2016-01-15).

IRS Releases Form 8971 for Reporting Estate Distributions

In 2015, Congress enacted Code Sec. 1014(f) and Code Sec. 6035, imposing two new estate tax reporting requirements. Under Code Sec. 1014(f), the basis of certain property acquired from a decedent may not exceed the value of that property as finally determined for federal estate tax purposes, or if not finally determined, the value of that property as reported on a statement made under Code Sec. 6035. Code Sec. 6035 imposes reporting requirements with respect to the value of property included in a decedent's gross estate for federal estate tax purposes.

Early in 2016, the IRS finalized Form 8971, Information Regarding Beneficiaries Acquiring Property From a Decedent, which is used to fulfill these new reporting requirements.

For a full discussion of the requirements for filing Form 8971, see the February 12, 2016, issue of Parker's Federal Tax Bulletin (PFTB 2016-02-12).

IRS Revises List of Automatic Accounting Method Changes

Under Code Sec. 446(e), once a taxpayer has used an accounting method and filed a first return, the taxpayer must receive approval from the IRS before making any change to that accounting method. In general, a taxpayer must file Form 3115, Application for Change in Accounting Method, to request a change in either an overall accounting method or the accounting treatment of any item. Rev. Proc. 2015-13 contains the general procedures for changing methods of accounting, either with IRS consent or automatically.

In Rev. Proc. 2016-29, the IRS issued a revised list of automatic changes to which the automatic accounting method change procedures of Rev. Proc. 2015-13 apply. It covers a wide variety of accounting method changes, such as changes involving depreciation methods, certain trade or business expenses, capital expenditures, and uniform capitalization methods.

For a discussion of Rev. Proc. 2016-29, see the May 6, 2016, issue of Parker's Federal Tax Bulletin (PFTB 2016-05-06).

IRS Weighs In on Tax Treatment of Cash Rewards and Premium Reimbursements under Wellness Programs

Business wellness programs have taken off in the past several years as employers realize the benefits of a healthy workforce. In CCA 201622031, the IRS weighed in on the tax treatment of incentives to get employees to join wellness programs.

According to the IRS, employers may not exclude from an employee's income cash rewards for participating in a wellness program, nor may they exclude reimbursements of premiums for participating in such programs made by salary reduction through a cafeteria plan. Such amounts are includible in income and subject to employment taxes.

For a discussion of CCA 201622031, see the June 3, 2016, issue of Parker's Federal Tax Bulletin (PFTB 2016-06-03).

Passive Participation in Oil and Gas Venture Leads to Self-Employment Tax

An individual's self-employment income is subject to self-employment tax. Disagreements between taxpayers and the IRS often involve the question of whether earnings are from self-employment. Under Code Sec. 1402(a), net earnings from self-employment are generally defined as the gross income derived by an individual from any trade or business carried on by the individual, less allowed deductions attributable to such trade or business, plus the individual's distributable share of income or loss from any trade or business carried on by a partnership of which he is a member.

In Methvin v. Comm'r, 2016 PTC 231 (10th Cir. 2016), the issue was whether or not income from a passive investor's working interests in several oil and gas ventures, where the parties elected under Code Sec. 761(a) to be excluded from the application of the partnership rules under subchapter K, constituted self-employment income. The Tax Court and Tenth Circuit concluded that the working interest owners and the well operator created a pool or joint venture for the operation of the wells and the taxpayer's income from the working interests was income from a partnership of which he was a member under the broad definition of "partnership" found in Code Sec. 7701(a)(2).

For a discussion of the Methvin case, see the July 5, 2016, issue of Parker's Federal Tax Bulletin (PFTB 2016-07-05).

Two Cases Illustrate Importance of Material Participation for Real Estate Professionals

In 2016, two tax cases highlighted the challenges taxpayers face when attempting to use the real estate professional exception to deduct rental losses. In one, Gragg v. U.S., 2016 PTC 288 (9th Cir. 2016), the Ninth Circuit affirmed a district court and held that Code Sec. 469(c)(7) does not automatically render a licensed real estate professional's rental losses nonpassive and deductible where the taxpayer did not materially participate in the real estate endeavors. In the other, Hailstock v. Comm'r, T.C. Memo. 2016-146, the Tax Court found that because of her credible testimony and the substantial amount of money and time devoted to her rental properties, a woman who quit her job to go into the real estate business met the material participation requirements in Reg. Sec. 1.469-5T(a)(7) and could deduct her rental losses.

For a discussion of these cases, see the August 12, 2016, issue of Parker's Federal Tax Bulletin (PFTB 2016-08-12).

Ninth Circuit Green Lights Homebuilder's Use of Completed Contract Method

In 2014, a real estate developer scored a big victory against the IRS when it successfully argued before the Tax Court that it could defer millions in profits under the completed contract method. The IRS challenged the result and, in Shea Homes, Inc. and Subsidiaries v. Comm'r, 2016 PTC 323 (9th Cir. 2016), the Ninth Circuit affirmed the Tax Court's holding. As a result, the developer was able to defer income on home sales in a planned community until 95 percent of that community, including common improvements and amenities, was completed and accepted.

Before the Ninth Circuit, the IRS had argued that the developer should report income from its long-term contracts for the years in which the contracts closed in escrow because the subject matter of the contract was the home and the lot upon which it sat. The Ninth Circuit rejected that argument, noting that it was clear that the primary subject matter of the contracts included the improvements to the lot as well as the common improvements and thus the improvements were an essential element of the home purchase and sale contract.

For a discussion of the Shea Homes case, see the September 9, 2016, issue of Parker's Federal Tax Bulletin (PFTB 2016-09-09).

Estate Could Deduct Theft Loss Decedent's LLC Suffered in Madoff Ponzi Scheme

Under Code Sec. 2054, estates are generally entitled to deductions relating to losses incurred during the settlement of the estate "arising" from theft. In Est. of Heller v. Comm'r, 147 T.C. No. 11 (2016), the Tax Court was asked to decide an issue of first impression: whether or not an estate could take a theft loss deduction for a loss the decedent's LLC incurred when its account with Madoff Investment Securities became worthless.

The Tax Court held that the decedent's estate was entitled to the theft loss deduction. The estate lost value, the court pointed out, because its interest in the LLC had been reduced to zero as a result of the Madoff Ponzi scheme.

For a discussion of Est. of Heller v. Comm'r, see the October 7, 2016, issue of Parker's Federal Tax Bulletin (PFTB 2016-10-07).

Former Tax Court Judge and Husband Indicted on Tax-Related Charges

Diane Kroupa, a long-serving U.S. Tax Court judge, and her husband were indicted in April on various tax-related charges. Kroupa's husband, Robert Fackler, worked as a lobbyist and political consultant. The indictment in U.S. v. Fackler, 2016 PTC 134 (D. Minn. 2016) charged that numerous personal expenses, including vacations to China, Australia and Thailand, were deducted on the business tax return of Fackler's lobbying firm. The couple subsequently pled guilty to understating income by approximately $1 million.

For a discussion of the case, see the April 8, 2016, issue of Parker's Federal Tax Bulletin (PFTB 2016-04-08).

New Law Enacts HRAs for Small Businesses

On December 13, 2016, President Obama signed into law the 21st Century Cures Act (Pub. L. 114-255). The law exempts qualified small employer health reimbursement arrangements (QSEHRAs) from certain requirements that apply to group health plans. As a result, such plans can now be offered to employees of small businesses.

For a discussion of the requirements that must be met for an arrangement to qualify as a QSEHRA, see the December 19, 2016, issue of Parker's Federal Tax Bulletin (PFTB 2016-12-19).

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IRS Extends Time to Request Automatic Consent for Changes Relating to Tangible Property Regs

The IRS has extended the time for requesting automatic IRS consent to make automatic accounting method changes relating to the (1) tangible property regulations, and (2) the MACRS depreciation and disposition regulations. Specifically, the IRS waives for one year the rule which limits automatic consent requests where the taxpayer has made or requested a change for the same item during any of the five tax years ending with the year of change. Notice 2017-6.

Background

Between 2011 and 2014, the IRS implemented revamped tangible property regulations providing rules on the tax treatment of amounts paid to acquire, produce, or improve tangible personal property (referred to as "the final tangible property regulations"). The rules generally apply to tax years beginning on or after January 1, 2014, or, at the option of the taxpayer, to tax years beginning on or after January 1, 2012.

In August 2014, the IRS issued final regulations under Reg. Secs. 1.168(i)-1, 1.168(i)-7, and 1.168(i)-8. These regulations provide guidance on accounting for property depreciated under the Modified Accelerated Cost Recovery System (MACRS) provisions of Code Sec. 168, and for dispositions of MACRS property (i.e., referred to collectively as "the final depreciation and disposition regulations"). These rules also generally apply to tax years beginning on or after January 1, 2014, or, at the option of the taxpayer, to tax years beginning on or after January 1, 2012.

Accounting Method Changes to Comply with Final Tangible Property Regs

A change to comply with the final tangible property regulations and the final depreciation and disposition regulations is a change in method of accounting to which the provisions of Code Sec. 446(e) and Code Sec. 481 and the accompanying regulations apply. A taxpayer seeking to change its method of accounting under these regulations must obtain IRS consent in accordance with Reg. Sec. 1.446-1(e), and must follow the administrative procedures under Reg. Sec. 1.446-1(e)(3)(ii).

Rev. Proc. 2015-13 provides the general procedures under Code Sec. 446(e) for a taxpayer to obtain the automatic or non-automatic consent of the IRS to change a method of accounting. Rev. Proc. 2016-29 provides the list of automatic accounting method changes to which the automatic change procedures of Rev. Proc. 2015-13 apply.

Rev. Proc. 2016-29 provides for certain automatic changes to use the final tangible property regulations. Section 6.14 of Rev. Proc. 2016-29 provides for automatic changes to permissible methods of accounting for depreciation of MACRS property under the final depreciation and disposition regulations. Sections 6.15 through 6.17 of Rev. Proc. 2016-29 provide for automatic changes related to dispositions of certain MACRS property under Reg. Sec. 1.168(i)-1 and Reg. Sec. 1.168(i)-8.

Section 5 of Rev. Proc. 2015-13 provides certain eligibility rules for a taxpayer applying for automatic IRS consent to change a method of accounting. It provides that a taxpayer is not eligible for the automatic change procedures if the taxpayer has made or requested a change for the same item during any of the five tax years ending with the year of change (i.e., the eligibility rule).

However, in order to facilitate the transition to the final tangible property regulations and the final depreciation and disposition regulations, Rev. Proc. 2016-29 waived this eligibility rule for taxpayers changing methods to conform to the tangible property regulations and the depreciation and disposition regulations. Under Rev. Proc. 2016-29, the eligibility rule does not apply to such taxpayers for changes for any tax year beginning before January 1, 2016.

One Year Extension of Waiver of Eligibility Rule

According to the IRS, taxpayers are continuing to request consent to change their methods of accounting to use the final tangible property regulations and the final depreciation and disposition regulations. To ease taxpayers' transition to the final regulations and to reduce the administrative burden that would result from requiring taxpayers to apply for non-automatic changes of accounting methods for such changes, the IRS has issued Notice 2017-6 which modifies Rev. Proc. 2016-29 to extend the waiver of the eligibility rule in Rev. Proc. 2015-13 to obtain automatic consent to change to the final regulations for one year to any tax year beginning before January 1, 2017.

Specifically, the sections of Rev. Proc. 2016-29 that waive the eligibility rules for making automatic changes under the final tangible property regulations and the final depreciation and disposition regulations are modified by replacing the references to the date "January 1, 2016," with the date, January 1, 2017." These modifications also apply for purposes of the concurrent automatic changes that are specifically referenced in those sections.

Procedures to Follow If Form 3115 Requesting a Non-automatic Change Has Already Been Filed

If, before December 20, 2016, a taxpayer properly filed a Form 3115 under the non-automatic change procedures in Rev. Proc. 2015-13 requesting the IRS's consent for a change in method of accounting relating to the tangible property regulations and tangible depreciation and disposition regulations discussed above, and the Form 3115 is pending with the IRS National Office on December 20, 2016, the taxpayer may choose to make the change of accounting method under the automatic change procedures in Rev. Proc. 2015-13 by following the requirements and procedures in Subsection .02(1) of the EFFECTIVE DATE section in Rev. Proc. 2016-29 with the following modifications:

(1) the references to the date, "May 5, 2016," are replaced with the date "December 20, 2016"; and

(2) the references to the date, "June 6, 2016," are replaced with the date, "January 19, 2017."

For a discussion of the accounting method change rules for changing accounting methods to conform to the tangible property regulations and the depreciation and disposition regulations, see Parker Tax ¶99,525.

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Wharton M.B.A. Expenses Deducible as Unreimbursed Employee Expenses

The Tax Court held that a taxpayer could deduct the cost of a Wharton M.B.A. degree as an unreimbursed employee expense because his studies improved on preexisting skills and did not, as the IRS argued, qualify him for a new trade or business. Thus, the taxpayer could deduct the education expenses as miscellaneous itemized deductions on Schedule A, Itemized Deductions, to the extent the expenses exceeded 2 percent of his adjusted gross income. Long v. Comm'r, T.C. Summary 2016-88.

Background

From March 2005 to May 2011, Tao Long worked for Broadcom Corp., a semiconductor company in Silicon Valley that makes computer chips. He started as a design engineer and was promoted to the positions of product marketing manager, senior product marketing manager, and product line manager. While he was working at Broadcom, Long passed levels I, II, and III of the Chartered Financial Analyst (CFA) Institute exam. At Broadcom, Long's responsibilities in the product marketing department included market, product, and trend analysis, creating proposals about products for upper management that included financial analysis, and managing teams that developed and introduced products to the market.

In May 2010, Long enrolled in the M.B.A. program at the Wharton School, University of Pennsylvania (Wharton M.B.A. program). He graduated with honors in April 2012. His coursework for the program was finance and management-related; he took courses such as financial accounting, new product management, and corporate valuation.

Broadcom had an educational assistance policy providing financial reimbursement, up to $5,250 per employee per calendar year, for tuition, fees, books, supplies, and equipment. To be eligible for reimbursement an employee had to be active (not on an unpaid leave of absence), working full time, and have preapproval of each course. Employees had to request the reimbursement within 60 days after the completion of the course. An employee who terminated his employment within one year of receiving reimbursement was required to repay the reimbursement in full at the time of termination.

In May 2011, Long resigned from Broadcom and, in June 2011, Long began a full-time summer internship in the investment division of Barclays Capital, an investment bank. He worked for Barclays Capital from June through August 2011. Long did not work again until January 2012 when he began working at Connective Capital Management, LLC (Connective Capital), as a senior research analyst in nearby Palo Alto, California. The job posting under which Long applied stated that the senior research analyst would "lead research activities in technology and industrial sectors, with responsibility for all aspects including idea generation, technology/product review, business model and competitive analysis, primary research utilizing Connective's industry network, valuation modeling, and risk management." Requirements listed for the senior investment analyst position included technology-related industry experience, a financial and/or engineering background, and "[t]echnical undergraduate and MBA from top university preferred."

Deductions Taken for Wharton M.B.A. Costs on 2010 and 2011 Tax Returns

Long reported salary income of $527,860 and $117,888 for 2010 and 2011, respectively. He claimed deductions for tuition expenses for attending the Wharton M.B.A. program. Long sought to deduct $86,100 and $84,450 for amounts paid to Wharton for tuition, fees, books, supplies, and room and board for tax years 2010 and 2011, respectively. While Long initially tried to tie the Wharton M.B.A. expenses to a real estate activity in which he was engaged, he subsequently sought to deduct the costs as unreimbursed employee expenses.

Education Expenses as Unreimbursed Employee Expenses

Generally, Code Sec. 162(a) allows a deduction for ordinary and necessary expenses paid or incurred in carrying on any trade or business. Under Reg. Sec. 1.162-5(a), an individual's expenditures for education are deductible as ordinary and necessary business expenses if the education maintains or improves skills required in his employment or other trade or business. Generally, the performance of services as an employee constitutes a trade or business. A taxpayer may deduct unreimbursed employee expenses only as miscellaneous itemized

deductions on Schedule A, Itemized Deductions, and then only to the extent such expenses exceed 2 percent of the individual's adjusted gross income. Itemized deductions may be limited under the overall limitations on itemized deductions under Code Sec. 68 and may have an alternative minimum tax implication under Code Sec. 56(b)(1)(A)(i).

Under Reg. Sec. 1.162-5(b)(2) and (3), no deduction for the following education expenses are allowed:

(1) those incurred to meet the minimum educational requirement for qualification in a taxpayer's trade or business; and

(2) those which qualify a taxpayer for a new trade or business.

IRS's Position

The IRS did not question whether Long's M.B.A. degree was incurred to meet the minimum educational requirement of his trade or business. Instead, the IRS argued that the Wharton M.B.A. qualified Long for a new trade or business because it qualified him for the senior research analyst position with Connective Capital. The IRS highlighted the fact that the Connective Capital job description said that someone with an M.B.A. was preferred as evidence that the M.B.A. qualified Long for a new trade or business.

Tax Court's Analysis

The Tax Court began its analysis by observing that an education that merely refines a taxpayer's existing skills does not qualify him for a new trade or business. Citing its decisions in Allemeier v. Comm'r, T.C. Memo. 2005-207, and Sherman v. Comm'r, T.C. Memo. 1977-301, the court noted that a taxpayer may deduct the cost of an M.B.A. degree as an unreimbursed employee expense if the taxpayer's studies improve on preexisting skills, such as management skills. A taxpayer is in the same trade or business, the court said, if he is still in the same general field and still using the same skills; for example, moving from one position to another that also uses management, administrative, and planning skills.

The court was satisfied that Long was qualified in the same trade or business both before and after the M.B.A. program. He was qualified in financial analysis, the court said, through his studies and personal investment experience before enrolling in the M.B.A. program in May 2010. The court also noted that Long had passed all three levels of the CFA exam by June 2009, spending an estimated 900 hours learning about investment tools and portfolio management to prepare for the exam. Long also acquired managerial and financial analysis skills through his employment and continued to develop those skills during the years in issue, the court said. Long developed managerial skills in his role at Broadcom by managing teams that would bring a product to market. The court concluded that Long's management and finance courses in the Wharton M.B.A. program did not qualify him for a new trade or business, but rather developed skills he was already using in his current trade or business.

With respect to Connective Capital's job description saying that an M.B.A. was preferred, the court said this was a mere preference, and Long had other qualifications listed in the job description, including personal and professional investment experience and a technical undergraduate degree.

With respect to Long's unemployment for four months in 2011, the court said that it was clear that he intended to find another position and continue his professional career. Those four months, the court noted, were a transition period during which Long was actively seeking employment while pursuing a defined graduate degree program. As a result, the court concluded that Long was still carrying on his trade or business during this time.

The court then considered whether Long could deduct his educational expenses as an unreimbursed employee expense. In order to deduct employee expenses, the court noted that a taxpayer must not have received reimbursement or been eligible to receive reimbursement. The court observed that Long met the requirements of Broadcom's educational assistance policy and thus may have been eligible for reimbursement of up to $5,250 per year for his Wharton M.B.A. expenses. However, the court said, since Long terminated his employment in May 2011, less than a year from the periods in which he was eligible for reimbursement, he would have had to immediately repay any reimbursement the day he resigned. Thus, the Tax Court concluded that Long's decision to not seek reimbursement from Broadcom for his education expenses incurred during January 2010 through June 2011 was reasonable.

The court held that Long was entitled to deduct the costs of his Wharton M.B.A. program for 2010 and 2011 as unreimbursed employee expenses on Schedule A, subject to the applicable limitations on such expenses.

For a discussion of the requirements to deduct unreimbursed employee business expenses, see Parker Tax ¶85,105.

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IRS Failure to Issue Regs Precludes Donor's Use of Alternative Method of Substantiating Contribution

The Tax Court held that the method under Code Sec. 170(f)(8)(D) for substantiating a charitable contribution through reporting by the donee organization was not applicable because the IRS had not yet issued regulations effectuating the provision. Several judges dissented, noting that the IRS's failure to provide regulations should not render the provision inoperative. 15th West 17th Street LLC v. Comm'r, 147 T.C. No. 19 (2016).

Background

In September 2005, 15th West 17th Street LLC (LLC) purchased for $10 million two parcels of property in New York City. The LLC is taxed as a partnership for federal tax purposes. On one parcel was the Van Tassell & Kearney Auction Mart (VTK Building). The VTK Building was built in 1903 1904 for staging horse auctions. LLC originally planned on demolishing the VTK Building but an historic preservation society successfully lobbied to have the building placed on the National Register of Historic Places, and it thus became a "certified historic structure."

On December 20, 2007, LLC executed in favor of the Trust for Architectural Easements (Trust) a historic preservation deed of easement. This deed granted the Trust a perpetual conservation easement over one parcel of the property, including the VTK Building. The Trust is a Code Sec. 501(c)(3) organization and, on May 14, 2008, the Trust sent LLC a letter acknowledging receipt of the easement. This letter did not state whether the Trust had provided any goods or services to LLC, or whether the Trust had otherwise given LLC anything of value, in exchange for the easement.

The LLC secured an appraisal concluding that, as of February 8, 2008, the property had a fair market value of $69,230,000 before placement of the easement. The appraisal thus opined that the property acquired for $10 million in September 2005 had risen in value by almost 600 percent in 2-1/2 years. Opining that the property was worth only $4,740,000 after the donation, the appraisal concluded that the easement had reduced the property's value by $64,490,000. On its 2007 partnership return, LLC claimed a charitable contribution deduction of $64,490,000 with respect to the easement contribution. LLC included with its tax return a copy of the appraisal report, a copy of the Trust's May 14, 2008, letter, and Form 8283, Noncash Charitable Contributions, executed by the appraiser and by a representative of the Trust.

On August 19, 2008, the Trust filed Form 990, Return of Organization Exempt From Income Tax, for calendar year 2007. On that return, the Trust did not report the receipt of a charitable contribution from the LLC. Nor did it report whether it had provided any goods or services to LLC in exchange for the easement. Upon auditing LLC's 2007 tax return, the IRS disallowed the charitable contribution deduction in full because LLC had not met the applicable substantiation requirements of Code Sec. 170 and the related regulations for noncash charitable contributions.

On November 2, 2011, the LLC petitioned the Tax Court for a review of the IRS's disallowance of the charitable deduction. On June 16, 2014, the Trust prepared an amended Form 990 for 2007, which summarized the easement donations it had received during 2007. On the amended Form 990 filed in 2014, the Trust added the following two sentences to that description: "One of the New York donations received during 2007 included the donation by 15 West 17th Street LLC of an Historic Preservation Deed of Easement ***. The Trust provided no goods or services to 15 West 17 Street LLC in consideration for its donation of the Historic Preservation Deed of Easement."

Analysis

Code Sec. 170(f)(8)(A) provides that no deduction is allowed for any charitable contribution of $250 or more unless the taxpayer substantiates the gift by a contemporaneous written acknowledgment (CWA) from the donee organization. The CWA must state (among other things) whether the donee provided the donor with any goods or services in exchange for the gift. Code Sec. 170(f)(8)(B) provides that the CWA must state (among other things) whether the donee supplied the donor with any goods or services in consideration for the gift and (if so) must furnish a description and good-faith estimate of the value of such goods or services. However, Code Sec. 170(f)(8)(D) provides that this substantiation requirement does not apply to a contribution if the donee organization files a return, on "such form and in accordance with such regulations as the Secretary may prescribe," that includes the information specified in Code Sec. 170(f)(8)(B). To date, no regulations have been issued to implement the donee-reporting regime referred to in Code Sec. 170(f)(8)(D).

LLC filed a motion with the Tax Court for partial summary judgment. Before the Tax Court, the IRS advanced two arguments in opposition to LLC's motion. First, the IRS argued that Code Sec. 170(f)(8)(D) is not "self-executing," i.e., it will become operative only when the IRS publishes the regulations to which the statute refers. Since no regulations have been issued, the IRS contended that Code Sec. 170(f)(8)(A) remains applicable and that a proper CWA was necessary to substantiate LLC's contribution. Alternatively, the IRS argued, if the Tax Court determined that Code Sec. 170(f)(8)(D) is operative in the absence of regulations, then the term "return" as used in Code Sec. 170(f)(8)(D) referred to the donee organization's original return for the period in question and cannot include an amended return.

The Tax Court held that the authority delegated in Code Sec. 170(f)(8)(D) is discretionary, not mandatory, and that Code Sec. 170(f)(8)(D) is not self-executing in the absence of regulations. The court thus concluded that the general rule set forth in Code Sec. 170(f)(8)(A), requiring a CWA meeting the requirements of Code Sec. 170(f)(8)(B), was fully applicable for the easement contribution. The court denied LLC's motion for summary judgment.

Several judges dissented from the majority opinion, observing that while the IRS has not issued regulations to implement the donee-reporting regime referred to in Code Sec. 170(f)(8)(D), the statute makes no mention of regulations to implement such a regime. According to the dissent, the first clause of Code Sec. 170(f)(8)(D) establishes whether Code Sec. 170(f)(8)(A) applies when the donee organization files a return, and the second clause merely establishes that the IRS may provide alternative rules detailing how a donee organization may file such a return.

Citing the Tax Court's decision in Francisco v. Comm'r, 119 T.C. 317 (2002), the dissent noted that the IRS's failure to create such rules and issue new forms does not render Code Sec. 170(f)(8)(D) inoperative. Indeed, the dissent said, "we have frequently held that the Secretary may not prevent implementation of a tax benefit provision simply by failing to issue regulations." In the absence of regulations from the IRS, the dissent concluded, a donee filing a return that contains the information described in Code Sec. 170(f)(8)(B) satisfies the requirements of Code Sec. 170(f)(8)(D).

For a discussion of the charitable contribution substantiation rules, see Parker Tax ¶84,190.

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Distribution from Decedent's IRA to Wife to Settle Suit with Stepson Is Subject to Tax and Penalties

The Tax Court held that the distributions from a taxpayer's IRA to effect a settlement agreement with her stepson were taxable to her and subject to the 10 percent early distribution penalty tax as well. The court also held that the taxpayer was liable for the failure to timely file penalty under Code Sec. 6651(a)(1), but was liable for only a portion of the accuracy-related penalty under Code Sec. 6662(a). Ozimkoski v. Comm'r, T.C. Memo. 2016-228.

Background

Suzanne Ozimkoski's husband, Thomas, died in August 2006. Approximately six months before his death, Thomas had executed a simple, two-page last will and testament that left all of his property, with the exception of some tangible personal property, to Suzanne and named her as personal representative of his estate. At the time of his death, Thomas owned a traditional IRA with Wachovia Securities.

In 2006, during the probate proceedings for Thomas's estate, one of his adult children and Suzanne's stepson, filed two petitions with the probate court - one for revocation of Thomas's will and one for declaratory relief. Wachovia froze Thomas's traditional IRA pending the outcome of the probate litigation. On March 7, 2008, Suzanne and her stepson reached the following settlement agreement:

"Respondent [Mrs. Ozimkoski] shall pay to petitioner [Mr. Ozimkoski, Jr.] the sum of $110,000 and shall transfer title to petitioner [Mr. Ozimkoski, Jr.] to that certain 1967 Harley Davidson motorcycle in full and final settlement of all claims raised or which could have been raised in this action. Payment shall be made within 30 days of the date on which decedent's IRA is unfrozen by Wachovia Securities. All payments shall be net payments free of any tax."

Notes from a Wachovia employee journal stated that Suzanne's probate attorney understood that someone would have to pay income tax on the $110,000 allocated to the stepson under the settlement agreement.

On July 2, 2008, after unfreezing the IRA assets, Wachovia transferred $235,495 from Thomas's IRA to Suzanne's traditional IRA, which was also with Wachovia. On July 14, 2008, Suzanne received a distribution of $141,997 from her IRA. On July 15, 2008, Suzanne wrote a personal check for $110,000 to her stepson to make the payment required under the settlement agreement. Suzanne also received approximately $174,600 of distributions from her IRA in 2008.

In 2009, Wachovia issued a Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., with respect to the distributions from Suzanne's IRA for 2008. The distribution code 1 on the Form 1099-R represented that the distributions were early distributions with no known exception because Suzanne had not reached the age of 59-1/2 in 2008. On May 9, 2009, Suzanne untimely filed her 2008 Form 1040 and did not report any of the IRA distributions as income for 2008.

The IRS determined that the distributions were includible in Suzanne's income and issued a deficiency notice, assessing additional taxes, a 10 percent early withdrawal penalty under Code Sec. 72(t), a Code Sec. 6651(a)(1) penalty for late filing, and an accuracy related penalty under Code Sec. 6662(a).

Analysis

At trial, Suzanne argued that the distributions should not be included in her income because her stepson was entitled to $110,000 of his father's IRA through the probate litigation and the ensuing settlement agreement. The IRS argued that the distributions were taxable to Suzanne because they were from her own IRA.

An IRA owner can designate beneficiaries to inherit his IRAs in the event that the owner dies before receiving all of the IRA distributions, but there is no exception from inclusion in gross income for distributions to a beneficiary following the death of the account owner. Therefore, distributions to beneficiaries of a decedent are includible in the gross income of the beneficiaries.

Under Code Sec. 401(a)(9)(B) and Code Sec. 408(a)(6), if an IRA owner dies before distributions were required to begin, the owner's interest in the IRA generally must be distributed to the beneficiary within five years of the decedent's death. Additionally, if an IRA owner dies before distributions were required to begin and the named beneficiary is the decedent's estate, the assets must be distributed within five years of the decedent's death. If an IRA owner dies after distributions were required to begin, the IRA assets generally must be distributed to the beneficiary of the IRA at least as rapidly as under the method of distribution to the owner.

The Tax Court held that the distributions from Suzanne's IRA were taxable to her and that she was liable for the 10 percent early distribution penalty tax. The court also held that she was liable for the failure to timely file penalty under Code Sec. 6651(a)(1) and was liable for a portion of the accuracy-related penalty under Code Sec. 6662(a), but not the portion relating to the $110,000 payment to her stepson.

Generally, the Tax Court said, an IRA payable to a specific beneficiary, other than the decedent's estate, is not a probate asset and is not included in the decedent's probate estate. The court noted that under Florida law there appeared to be only two scenarios in which Wachovia could properly freeze Thomas's IRA assets during the pendency of probate litigation. If there had been a named beneficiary for his IRA, the funds would have been paid to the trustee of the account and then distributed according to the terms of the IRA. If no proper claim was made on the IRA proceeds within six months of Thomas's death, the proceeds would have been paid to his personal representative. The court noted that, under Florida law, the only two scenarios in which Wachovia could have correctly frozen Thomas's IRA pending the outcome of the probate litigation were that: (1) his estate was the named beneficiary of the IRA, or (2) there was no named beneficiary of the IRA. Under either scenario, the court said, Wachovia incorrectly rolled over the entirety of Thomas's IRA to Suzanne's IRA.

Under Florida law, the court observed, Wachovia should have distributed the IRA assets to Thomas's estate because either it was named as the beneficiary or there was no named beneficiary and because the settlement agreement made no direction as to the disposition of the IRA. Although the court found that Wachovia incorrectly rolled over Thomas's IRA to Suzanne's IRA, it said it had no jurisdiction to unwind that transaction and had to decide Suzanne's tax liability on the basis of Wachovia's erroneous transfer of Thomas's IRA assets to her IRA and the subsequent distributions from her IRA.

The court said it was clear from the record that Suzanne's probate attorney failed to counsel her on the full tax ramifications of paying her stepson $110,000 from her own IRA. While the court was sympathetic to Suzanne's argument, the distributions she received were from her own IRA and therefore were taxable income to her.

For a discussion of distributions from traditional individual retirement arrangements, see Parker Tax ¶134,500.

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Chief Counsel Questions Use of Electronic Signatures Where Not Specifically Authorized

According to the Office of Chief Counsel, an electronic signature should only be accepted by the IRS when there is published guidance or Internal Revenue Manual (IRM) provisions that specifically authorize use of an electronic signature for the specific form involved. With respect to Form 2678, Employer/Payer Appointment of Agent, because there is no guidance or IRM provisions authorizing the use of an electronic signature on Forms 2678, the Chief Counsel's Office recommended that the IRS not accept Forms 2678 signed electronically. CCA 201650019.

Code Sec. 6061(a) generally provides that any return, statement, or other document required to be made under any provision of the Code or regulations must be signed in accordance with forms or regulations prescribed by the IRS. Although the Internal Revenue Code does not define the term "signature," 1 U.S.C. Section 1 provides that a "signature" includes a mark when the person declaring the same intended it as such, and Code Sec. 6061(b)(1) provides that the IRS must establish procedures for accepting signatures in digital or other electronic form. That provision states that, until such time as such procedures are in place, the IRS may waive the requirement of a signature for, or provide for alternative methods of signing or subscribing, a particular type or class of return, declaration, statement, or other document required or permitted to be made or written under the Code and regulations. The Code does not provide detailed rules for the use of electronic signatures beyond authorizing their use in Code Sec. 6061.

In CCA 201650019, the Office of Chief Counsel was asked by the IRS Examination Division whether the IRS could accept a Form 2678, Employer/Payer Appointment of Agent, which displays an electronic signature. Under the proposed electronic signing procedure, an enrollee would fill out the Form 2678 online and sign it with a mouse or stylus. The signature would created by the person with a live signature, but it would be a digital image of the actual signature. The form would be mailed to the IRS, and the vendor would maintain a digital image of the completed form.

The Chief Counsel's Office recommended that an electronic signature only be accepted by the IRS when there are published guidance or Internal Revenue Manual (IRM) provisions that specifically authorize use of an electronic signature for the specific form involved. Since there is no guidance or IRM provisions authorizing the use of an electronic signature on Forms 2678, the Chief Counsel's Office said, it recommended that the IRS not accept Forms 2678 signed electronically until the IRS authorizes its use for Forms 2678 either in published guidance or in the IRM.

The Chief Counsel's Office noted that it is a business decision whether to accept the use of electronic signatures on any specific form and, although electronic signatures are legally valid, the utility of using electronic signatures on specific documents or forms must be balanced against the risk of disavowal by the signer.

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Prison Time Considered an "Absence Due to Special Circumstances" in Determining Dependency Exemption

The Tax Court held that a taxpayer's incarceration for more than 10 months during the tax year did not prevent him from satisfying the residency requirement of Code Sec. 152(c)(1)(B) and claiming a dependency exemption deduction, earned income credit, and child tax credit for his child. The court cited Reg. Sec. 1.152-1(b) in concluding that the taxpayer's incarceration was a temporary absence due to special circumstances that was not counted for purposes of determining whether he lived with the child in the same home for more than half of the tax year. Binns v. Comm'r, T.C. Summary 2016-90.

Facts

In March 2012, Daniel Binns and Lisa Hinkle, two unmarried taxpayers, rented an apartment in Columbus, Ohio, which served as a home for them and their child, C.B. In 2013, Binns was incarcerated at an Ohio prison from January 16 to November 6, and thus was not living with Hinkle. Except for Binns's confinement period when he was absent from the home, the couple remained at the Columbus apartment throughout 2013.

Binns worked for an event rental business starting in March 2011 until he was incarcerated. He paid January rent for his and Hinkle's apartment and then pre-paid the $555 monthly rent for the next six months (through July 2013) as he expected to be released from prison at the end of July. After he filed his 2012 federal income tax return, Binns had his refund of $4,511 issued to a checking account controlled by Hinkle's uncle. The tax refund was then dispersed to Hinkle by her uncle for bills, food, clothing, etc. for herself and C.B. Binns also set up a budget plan with Columbia Gas of Ohio, under which he paid a set amount of $40 per month for gas regardless of use. At the end of the year Columbia Gas of Ohio billed Binns an accrued balance to reflect actual use or issued a credit for any overpayment. The electric bill for the apartment was approximately $1,470 for the entire year. Hinkle used funds that Binns provided to pay $480 to the gas company and $1,470 to the electric company during 2013. During this period, Hinkle stayed home with the child and did not work.

Neither Binns nor Hinkle incurred any school or significant child care expenses in 2013. When Binns realized he would not be released in July as he had previously thought, he contacted his landlord, Ms. Chan. She agreed to allow Hinkle (and C.B.) to remain in the apartment until Binns was released from prison when he would pay off or work off any unpaid balance. Upon his release, Binns worked as a handyman in some of Ms. Chan's other apartment units. She credited an agreed amount for his work against the rent owed. From his release on November 6, 2013, to the end of 2013, he earned $11,000 from Ms. Chan which he reported on Schedule C, Profit or Loss from Business, of his 2013 Form 1040. In addition, Hinkle received benefits from the Supplemental Nutrition Assistance Program (SNAP), commonly referred to as food stamps, for most or all of 2013. For a household of two people, the maximum monthly SNAP benefits were $367 per month for most of 2013. C.B. received medical care in December 2013, but there was no indication that such costs were significant; nor was there any indication how these visits were paid for.

Binns filed his 2013 federal income tax return with the filing status of head of household and claimed (1) a dependency exemption deduction for Hinkle and C.B., (2) an earned income tax credit, and (3) a child tax credit. The IRS disallowed the head of household filing status, the dependency exemption deduction, the earned income credit, the child tax credit, and assessed a tax deficiency. Binns filed suit in Tax Court.

Tax Court's Analysis

Before the Tax Court, Binns' testimony indicated that Hinkle's parents likely provided some additional financial assistance to C.B. and Hinkle for 2013 and that Hinkle's parents may have claimed C.B. and Hinkle as dependents on their 2013 tax return. The Tax Court found that the transcripts of Binns' prior years returns reflected a course of conduct showing that Binns provided for C.B.'s support during these years. While Binns did not provide any evidence with respect to the amount of support Hinkle's parents provided or, by extension, the total amount of support received by Hinkle during 2013, the court found that Binns paid the rent and utilities related to the apartment where he, Hinkle, and C.B. lived in 2013, and that these amounts represented more than one-half of the expenses incurred to maintain the household for the year.

The court held that Binns was not entitled to a dependency exemption deduction for Hinkle because he failed to carry his burden of showing that he provided more than half of Hinkle's support during 2013. However, the court held that Binns was entitled to head of household filing status, the dependency exemption deduction for C.B., the earned income credit, and the child tax credit.

Under Code Sec. 152(c)(1)(B), the court said, a residency test must be satisfied in order for a taxpayer to take a dependency exemption deduction for a dependent. That test is satisfied if the taxpayer has the same principal place of abode as the dependent for more than one-half of the tax year. With respect to Binns' incarceration and the fact that he did not live with C.B. in the same home for more than one-half of the tax year, the court noted that Reg. Sec. 1.152-1(b) provides that temporary absences due to special circumstances are not treated as absences for purposes of determining whether the residency test is satisfied. The court concluded that Binns' incarceration did not prevent him from satisfying the residency requirement of Code Sec. 152(c)(1)(B) and thus he was entitled to the dependency exemption deduction for C.B.

The court noted that because C.B. satisfied the four tests under Code Sec. 152(c)(1) to be a qualifying child and could be a dependent of either Binns or Hinkle, the tie-breaker rules of Code Sec. 152(c)(4) had to be applied to determine which of them could claim a dependency exemption deduction for C.B. Because Binns had the higher adjusted gross income for 2013, the court concluded that Binns was entitled to the dependency exemption deduction.

With respect to filing as head of household, the court found that Binns established that he paid more than one-half of the expenses associated with the household, even considering the government assistance for food expenses, and thus was entitled to head of household filing status.

With respect to the child tax credit and earned income credit, the court concluded that because C.B. was a qualifying child for purposes of the dependency exemption deduction, he was a qualifying child for purposes of the two credits.

For a discussion of the exceptions to the residency test for taking a dependency exemption deduction, see Parker Tax ¶10,720.