Federal Tax Bulletin - Issue 105 - January 5, 2016

Top 15 Tax Developments of 2015

Last year saw some major developments on the federal tax front, many of them quite positive. In particular, 2015 ended on a high note with the permanent extension of increased Section 179 expensing limits and several other perennial "extender" tax breaks, along with the temporary extensions of many more.

Earlier in the year, practitioners were happy to see the IRS waive the requirements to file Form 3115 for many small businesses adopting the new tangible property regulations, although many were furious that the IRS had not done so sooner. And the entire nation was treated to yet another tax-centric battle over the existence of Obamacare last summer when the Supreme Court upheld the sweeping healthcare law for a second time.

A recap of these key developments and a dozen others follows.

IRS Ends Confusion Over Form 3115 Requirements for Repair Regs, Provides Relief to Small Businesses

As tax professionals focused on the implementation of the IRS's new tangible property regulations ("repair regs") in early 2015, many became concerned that nearly every business with depreciable property would have to file a Form 3115, Application for Change in Accounting Method, to adopt any applicable method of accounting changed by the regulations. Some practitioners found this prospect daunting, as Form 3115 is notoriously difficult and time-consuming.

Relief came in February via Rev. Proc. 2015-20. The revenue procedure waived the requirement for small businesses to file Form 3115, providing instead a simplified procedure for changing accounting methods under the repair regs.

Eligible taxpayers were permitted to apply the new regs on a prospective basis to tax years beginning in 2014. Applying the rules prospectively eliminated the requirement to file Form 3115, as well as the need to make a Code Sec. 481(a) adjustment related to prior tax years.

Year-end Legislation Extends Popular Business and Individual Tax Breaks

In mid-December, the President signed into law the Protecting Americans from Tax Hikes Act of 2015 (PATH) (Pub. L. 114-74). PATH permanently extends many tax breaks and temporarily extends dozens of others for periods ranging from two to five years.

For businesses, the main highlight of the new law is the permanent extension of the Code Sec. 179 election. Under PATH, the Code Sec. 179 expensing limitation and phase-out amounts have been permanently increased to the amounts available in years 2010 through 2014: $500,000 and $2 million, respectively. Both the $500,000 and $2 million limits are indexed for inflation beginning in 2016. In addition, the law modifies the expensing limitation by treating air conditioning and heating units placed in service in tax years beginning after 2015 as eligible for expensing. The provision further modifies the expensing limitation with respect to qualified real property by eliminating the $250,000 cap beginning in 2016. The special rules that allow expensing for computer software and qualified real property (qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property) also are permanently extended.

PATH also permanently extended the ever popular research and development (R&D) tax credit. Additionally, beginning in 2016, businesses with $50 million or less in gross receipts may claim the R&D credit against alternative minimum tax (AMT) liability. Also beginning in 2016, qualified small businesses ($5 million or less in gross receipts and no gross receipts for any tax year preceding the five-tax-year period ending with such tax year) may claim the R&D credit against their payroll tax liability.

Another big highlight for businesses under the new law is the temporary extension of the bonus depreciation rules. Bonus depreciation is available for property acquired and placed in service during 2015 through 2019 (with an additional year for certain property with a longer production period). The bonus depreciation percentage is 50 percent for property placed in service during 2015, 2016, and 2017, and phases down with 40 percent in 2018, and 30 percent in 2019.

One of the biggest wins for lower income individuals is the permanent extension of the enhanced child tax credit (CTC). The CTC is a $1,000 credit. To the extent the CTC exceeds the taxpayer's tax liability, the taxpayer is eligible for a refundable credit (the additional child tax credit) equal to 15 percent of earned income in excess of a threshold dollar amount (the "earned income" formula). Until 2009, the threshold dollar amount was $10,000 indexed for inflation from 2001 (which would be roughly $14,000 in 2015). Since 2009, however, this threshold amount has been set at an unindexed $3,000 and was scheduled to expire at the end of 2017, returning to the $10,000 (indexed for inflation) amount. The law permanently sets the threshold amount at an unindexed $3,000.

PATH also made favorable changes to the earned income tax credit (EITC) that had previously been temporary. For 2009 through 2017, the EITC amount had been temporarily increased for those with three (or more) children and the EITC marriage penalty had been reduced by increasing the income phase-out range by $5,000 (indexed for inflation) for married couples filing jointly. The law makes these provisions permanent.

New Tax Return Due Dates and Extension Deadlines Take Effect Beginning for 2016 Tax Years

In July, as part of the Surface Transportation and Veterans Health Care Choice Improvement Act of 2015, Congress made significant changes to the due dates of C corporation and partnership tax returns. The changes are generally effective for tax years beginning after 2015. Along with those changes came modifications to the extension deadlines for numerous entity returns.

For tax years beginning after 2015, partnerships will be required to file their returns by the 15th day of the third month following the close of a tax year. For calendar year partnerships, the due date will be March 15, instead of April 15.

Observation: The filing deadlines for S corporation returns remain unchanged, meaning that partnership and S corporation returns will now share the same due dates.

In general, for tax years beginning after 2015, C corporations will have until the 15th day of the fourth month following the close of the tax year to file their returns. For calendar year C corporations, this means the due date will be April 15, instead of March 15.

A special rule exempts C corporations with fiscal years ending on June 30 from this change until tax years beginning after Dec. 31, 2025. Thus, the filing deadline for such corporations will remain September 15 until 2026 (when it will change to October 15).

The legislation also changed many of the automatic extension periods. For calendar year C corporations, the new rules provide a five-month automatic extension for returns for tax years beginning after December 31, 2015, and ending before January 1, 2026. The extension period is a month shorter, but results in the same September 15 extended deadline because of the new due date for C corporation returns (i.e., April 15).

For fiscal year C corps with tax years ending on dates other than June 30, the length of automatic extensions remains unchanged at six months. For fiscal year C corps with tax years ending on June 30, a special seven month automatic extension applies for tax years beginning after December 31, 2015 and ending before January 1, 2026.

For tax years ending after December 31, 2025, automatic extensions for all C corporations will be six months. The new law also requires the IRS to appropriately modify regulations to provide maximum extensions for certain other returns of calendar year taxpayers for tax years beginning after December 31, 2015, including:  

• a six month extension ending on September 15 for partnerships filing Form 1065;
• a 5-1/2 month extension ending on September 30 for trusts filing Form 1041;
• a 3-1/2 month extension ending on November 15 for employee benefit plans filing Form 5500;
• and a six month extension ending on November 15 for exempt organizations filing Form 990.

Bipartisan Budget Act Substantially Changes Partnership Audit Rules

The Bipartisan Budget Act of 2015 (Pub. L. 114-74) repealed the voluntary centralized audit procedures for electing large partnerships (ELPs), as well as the TEFRA procedures (i.e., rules adopted as part of the Tax Equity and Fiscal Responsibility Act of 1982) for auditing most other partnerships. Those rules have been replaced with a new system in which audits and adjustments of all partnership items are generally determined at the partnership level, although an opt-out provision to the new rules is available for certain partnerships. Under the new rules, distinctions among partnership items, non-partnership items, and affected items no longer exist.

The changes relating to the partnership audit provisions generally apply to returns filed for partnership tax years beginning after December 31, 2017. However, a partnership may elect to apply the new partnership audit rules to any return of the partnership filed for partnership tax years beginning after November 2, 2015, and before January 1, 2018.

Practice Tip: In deciding whether to adopt the new rules early, practitioners should consider that TEFRA is a tough audit process for the IRS. For partnerships that have 100 or fewer partners, the IRS is required to notify each partner at the beginning and at the end of the partnership audit and recalculate each partner's liability. Additionally, the IRS has run into significant statutes of limitation issues as a result of failing to properly identify a TEFRA partnership. Thus, there are generally less partnership audits. Congress saw getting rid of TEFRA as a revenue raiser because they believe that, without TEFRA, there will be more partnership audits and, thus, more money flowing into the Treasury. By making an early election into the non-TEFRA rules, a partnership may be increasing its chances of being audited.

For a full discussion of the partnership audit changes in the Bipartisan Budget Act of 2015, see the November 6, 2015, issue of Parker's Federal Tax Bulletin (PFTB 2015-11-06).

Tax Preparer Due Diligence Requirements Extended to Child Tax Credit and American Opportunity Tax Credit

Under Code Sec. 6695(g), a penalty of $500 may be imposed on a tax return preparer who prepares a tax return or refund request claiming the earned income tax credit (EITC), unless the tax return preparer exercises due diligence with respect to that claim. The due diligence requirements extend to both the determination of eligibility for the credit and the amount of the credit. Reg. Sec. 1.6695-2 details how to document compliance with those due diligence requirements. The position taken with respect to the EITC must be based on current and reasonable information that the paid preparer develops, either directly from the taxpayer or by other reasonable means. The preparer may not ignore implications of information provided by a taxpayer, and is expected to make reasonable inquiries about incorrect, inconsistent, or incomplete information. The conclusions about eligibility and computation, as well as the steps taken to develop those conclusions, must be documented using Form 8867, Paid Preparer's Earned Income Credit Checklist, which is filed with the return.

Effective for tax years beginning after December 31, 2015, The Protecting Americans from Tax Hike Act of 2015 requires tax return preparers to meet due diligence requirements similar to those applicable to returns claiming an EITC if they prepare federal income tax returns on which a child (or additional child) tax credit is claimed or on which the American opportunity tax credit is claimed.

For a full discussion of changes made by The Protecting Americans from Tax Hike Act of 2015, see the December 18, 2015, issue of Parker's Federal Tax Bulletin (PFTB 2015-12-18).

Ninth Circuit Overturns Tax Court: Unmarried Co-owners Apply Mortgage Interest Limitation on Per-Taxpayer Basis

Under Code Sec. 163(h)(3), a taxpayer can deduct the interest paid on home acquisition indebtedness and/or a home equity line of credit for a principal residence and a second home. Specifically, the statute provides that the aggregate amount that a taxpayer may treat as acquisition debt for any year cannot exceed $1,000,000 ($500,000 in the case of a married individual filing a separate return). The aggregate amount that a taxpayer may treat as home equity debt for any year cannot exceed $100,000 ($50,000 in the case of a separate return by a married individual). Although the statute is specific with respect to a married taxpayer filing a separate return, it does not specify whether, in the case of co-owners who are not married, the debt limits apply on a per-residence or per-taxpayer basis.

In 2012, the Tax Court was asked to decide whether the statutory limitations that apply to deductible interest on acquisition and home equity indebtedness are applied on a per-residence or per-taxpayer basis where residence co-owners are not married to each other. As the number of heterosexual and same-sex couples living together has skyrocketed, the decision had major implications for thousands of taxpayers. Unfortunately for taxpayers, in Sophy v. Comm'r, 138 T.C. 204 (2012), the Tax Court sided with the IRS and concluded that the limitations of Code Sec. 163(h) apply to the aggregate indebtedness on up to two residences, and co-owners who are not married to each other may not deduct more than a proportionate share of interest on $1.1 million.

In August, however, in Voss v. Comm'r, 2015 PTC 275 (9th Cir. 2015), the Ninth Circuit reversed the Tax Court's decision in Sophy and held that, when unmarried taxpayers co-own a qualifying residence, the limitation on the qualified residence interest deduction applies on a per-taxpayer, rather than on a per-residence, basis.

Observation: The decision means that unmarried taxpayers who co-own their home are not limited to deducting the same amount as married taxpayers filing jointly. Instead, they can deduct up to twice the amount of interest as married taxpayers.

While Federal Prosecutors May Overlook State Marijuana Distribution Crimes, the IRS Will Not

As more states legalize the sale and use of marijuana, it has become a thriving billion-dollar business. Although such state laws violate federal criminal drug statutes, the Justice Department has turned a blind eye to enforcing those laws in states approving the use and sale of marijuana.

But the IRS hasn't. As a result, while operating marijuana dispensaries and selling marijuana may be legal businesses in California, Colorado, and other states, that doesn't mean the expenses of operating those businesses are deductible for federal income tax purposes. This was made clear by the Ninth Circuit in Olive v. Comm'r, 2015 PTC 229 (2015), which affirmed a Tax Court holding that, while a taxpayer's marijuana business was legal under California law, Code Sec. 280E precluded him from deducting any amount of ordinary or necessary business expenses associated with the business, other than cost of goods sold, because it was a trade or business consisting of trafficking in controlled substances prohibited by federal law.

IRS Combats Identity Theft by Eliminating Automatic Extensions of Forms W-2 and Other Information Returns

Currently, Reg. Sec. 1.6081-8T allows an automatic 30-day extension of time to file information returns on forms in the W-2 series (including Forms W-2, W-2AS, W-2G, W-2GU, and W-2VI), 1095 series, 1098 series, 1099 series, and 5498 series, and on Forms 1042-S and 8027. An additional 30-day non-automatic extension of time to file those information returns is available in certain cases.

Effective July 1, 2016, in an effort to fight identity theft, the IRS will end the automatic extension of time to file information returns on forms in the W-2 series (except Form W-2G). The IRS also plans to end automatic filing extensions for all other information returns included under Reg. Sec. 1.6081-8T at a date no earlier than January 1, 2018.

For information returns on the Form W-2 series (except Form W-2G) due after December 31, 2016, a single non-automatic extension of time is available (Reg. Sec. 1.6081-8T(b)). For information returns on Forms W-2G, 1042-S, 1094-C, 1095-B, 1095-C, 1097 series, 1098 series, 1099 series, 3921, 3922, 5498 series, or 8027 due after December 31, 2016, one automatic 30-day extension of time to file the information return beyond the due date for filing it is available if the filer or the person transmitting the information return for the filer (i.e., the transmitter) files an application in accordance with Reg. Sec. 1.6081-8T(c)(1). One additional 30-day extension of time to file these forms may be allowed if the filer or transmitter submits an extension request before the expiration of the automatic 30-day extension of time to file. No extension of time to file will be granted unless the filer or transmitter has first obtained an automatic extension of time (Reg. Sec. 1.6081-8T(c)(2)).

Proposed Regulations Take Aim at Pro-Taxpayer Decision Involving Code Sec. 199 Deduction

Under Code Sec. 199(a)(1), a taxpayer can deduct a portion of its qualified production activities income, which is determined from the taxpayer's domestic production gross receipts. Domestic production gross receipts are defined, in part, as proceeds from the sale of qualifying production property (QPP) which was manufactured, produced, grown, or extracted (MPGE) by the taxpayer in whole or in significant part within the United States.

Under Reg. Sec. 1.199-3(e)(2), if a taxpayer packages, repackages, labels, or performs minor assembly of QPP and the taxpayer engages in no other manufacturing, producing, growing, or extracting (MPGE) activities with respect to that QPP, the taxpayer's packaging, repackaging, labeling, or minor assembly does not qualify as MPGE with respect to that QPP. Thus, no Code Sec. 199 deduction is available.

In U.S. v. Dean, 945 F. Supp. 2d 1110 (C.D. Cal. 2013), a district court concluded that an S corporation's activity of preparing gift baskets was a manufacturing activity and not solely packaging or repackaging for purposes of Code Sec. 199. Thus, the S corporation was eligible for a Code Sec. 199 deduction. Subsequently, in Precision Dose, Inc. v. U.S., 2015 PTC 345 (W.D. Ill. 2015), another district court cited the decision in Dean and held that a company's business of selling unit doses of medicines involved the sale of QPP which was MPGE and the company thus qualified for the Code Sec. 199 deduction.

The IRS disagreed with the Dean decision and issued proposed regulations which add an example (Example 9) to Reg. Sec. 1.199-3(e)(2). While the example is based on the facts in Dean, it reaches the opposite conclusion as the Dean court and concludes that the taxpayer is not considered to have engaged in the MPGE of QPP. Thus, no Code Sec. 199 deduction is available.

Steep Increases in Information Reporting Penalties Take Effect in January

Generally, any person, including a corporation, partnership, individual, estate, and trust, which has reportable transactions involving information returns and payee statements during the calendar year, must report those transactions to the IRS. Persons required to file information returns to the IRS must also furnish statements to the recipients of the income. A failure to file a required information return or payee statement, or a failure to include all necessary information, will subject taxpayers to penalties under Code Sec. 6721 or Code Sec. 6722.

In June, the President signed into law the Trade Preferences Extension Act of 2015 (Pub. L. 114-27). The new law enacted hefty increases in the penalties imposed under Code Sec. 6721 and Code Sec. 6722. For each information return or payee statement with respect to which a failure occurs, the penalty has been increased from $100 to $250, and the maximum penalty that may be imposed has increased from $1,500,000 to $3,000,000. These penalties are effective for returns or statements taxpayers are required to file after Dec. 31, 2015.

Final Rules on Changes in Partnership Ownership Interests Allow Different Methods to Be Used for Different Ownership Changes in the Same Year

In August, the IRS issued final regulations (T.D. 9728) on determining a partner's distributive share of partnership items of income, gain, loss, deduction, and credit when a partner's interest changes. The final rules provide a step-by-step process for making allocations and are important because the correct determination of a partner's distributive share of partnership income is critical to determining that partner's ultimate tax liability.

The final regulations make several favorable changes to the proposed regulations that had preceded them. Most notable is the ability of a partnership to use different methods for different ownership changes. Under the proposed regulations, a partnership had to take into account any variation in the partners' interests in the partnership during the tax year in determining the distributive share of partnership items by using either the interim closing method or the proration method. Unless the partners agreed to use the proration method, the partnership was required to use the interim closing method and allocate its items among the partners in accordance with their respective partnership interests during each segment of the taxable year. The final regulations allow a partnership to use different methods for different variations within the partnership's taxable year. Accordingly, a partnership may use the interim closing method with respect to one variation and may choose to use the proration method for another variation in the same year.

In addition, the proposed regulations had required partnerships applying the interim closing method to perform the interim closing at the time a variation in ownership was deemed to occur, and did not permit a partnership to perform an interim closings of its books except at the time of any variation. Because most partnerships lack the resources to close their books at other than month end, the final regulations allow a partnership, by agreement of the partners, to perform regular interim closings of its books on a monthly or semi-monthly basis, regardless of whether any variation occurs.

Supreme Court Upholds Obamacare for a Second Time

On June 25, in King v. Burwell, 2015 PTC 210 (S. Ct. 2015), the Supreme Court upheld the use of tax credits for health insurance purchased on any Exchange created under The Patient Protection and Affordable Care Act (ACA), be it federal or state. Of the 380,000+ words that comprise the ACA, its fate under this case hinged on just six:  

"an Exchange established by the State."

The case involved Reg. Sec. 1.36B-2, which provides that a taxpayer is eligible for a premium tax credit if the taxpayer is enrolled in an insurance plan through "an Exchange," which the regulation defines as an Exchange serving the individual market regardless of whether the Exchange was established and operated by a state or by the federal government through Health and Human Services.

Hearing the appeal of four Virginia taxpayers who had challenged the validity of the regulation, the Supreme Court concluded that the ACA's context and structure compelled the conclusion that Code Sec. 36B allows tax credits for insurance purchased on any Exchange created under the statute.

Having survived what may be its last major challenge in the courts, the ACA's next existential challenge will likely come in the political arena, as numerous Republican presidential candidates and party leaders have vowed to make repeal of the ACA a central issue in the 2016 elections.

IRS Provides Transition Relief from Staggering $36,500 per Employee Healthcare Penalty

In February, the IRS issued Notice 2015-17, which provided transition relief though 6/30/2015 from the assessment of penalties under Code Sec. 4980D for small employers who reimburse or pay a premium for individual health insurance for an employee. The notice also stated that such penalties will not be assessed any earlier than 2016 against S corporations that have similar arrangements with 2-percent shareholder-employees (and then only if future guidance holds that the penalty applies in those situations).

The potential penalties are the result of an aspect of the Affordable Care Act (ACA) known as "market reforms." In order to bring about the larger goals of healthcare reform, the ACA added Code Sec. 4980D, which applies a penalty to group health plans that fail to meet reform requirements such as providing certain preventative services without imposing cost-sharing arrangements and eliminating annual limits of benefits.

Under Notice 2013-54, employee payment plans (i.e., plans where employees choose their own insurance plans and employers reimburse the costs) are considered to be group health plans that fail to meet these market reforms. Employers who reimburse the health insurance premiums of their employees under such plans are subject to a $100 per day, per employee penalty under Code Sec. 4980D (reaching up to $36,500 per employee, per year).

Notice 2015-17 gave employers, other than applicable large employers with employee payment plans, an extra six months to comply with the ACA's market reform requirements before incurring these staggering penalties.

Congress Reverses Supreme Court's Home Concrete Decision

In U.S. v. Home Concrete & Supply, LLC, 2012 PTC 94 (S. Ct. 4/25/12), the Supreme Court held that taxpayer misstatements that overstate the basis in property do not fall within the scope of the Code Sec. 6501(e)(1) extended statute of limitations. That section extends the normal three year limitation period for assessments to six years where a taxpayer omits from gross income an amount in excess of 25 percent of the amount stated on the return.

The Court determined that an "understatement" of basis was not an "omission" for purposes of the statute. In reaching this decision, the Court looked at the legislative history of the provision and concluded that Congress intended an exception to the usual three-year statute of limitations only in a restricted type of situation - a situation that did not include overstatements of basis. As a result of the decision, the taxpayers were allowed to avoid certain taxes from their participation in a Son-of-BOSS transaction because the IRS didn't discover their overstated basis until after the normal three year period.

IRS Chief Counsel William J Wilkins had lamented that the decision would mean taxpayers in other unsettled Son-of-BOSS cases would likely prevail, given the difficulty of untangling such transactions within the three year limit.

In July, Congress effectively reversed the Supreme Court's holding. In the Surface Transportation and Veterans Health Care Choice Improvement Act of 2015 (Pub. L. 114-41), Congress amended Code Sec. 6501 to clarify that an understatement of gross income by reason of an overstatement of unrecovered cost or other basis is an omission from gross income for purposes of the six year statute of limitations.

IRS Delays Reporting of 2015 Health Insurance Information

Under Code Secs. 6055 and 6056, every person that provides minimum essential coverage to an individual during a calendar year must file Form 1095-B, Health Coverage, reporting the coverage. However, employers subject to the employer shared responsibility provisions sponsoring self-insured group health plans generally report information about the coverage on Form 1095-C, Employer-Provided Health Insurance Offer and Coverage, instead of Form 1095-B. The information on those forms is transmitted to the IRS on Form 1094-B, Transmittal of Health Coverage Information Returns, and Form 1094-C, Transmittal of Employer-Provided Health Insurance Offer and Coverage Information Returns. For the 2015 calendar tax year, these returns were required to be filed by February 1, 2016.

In Notice 2016-4, the IRS extended the due dates for the 2015 information reporting requirements (both furnishing such reports to individuals and filing them with the IRS) on these returns. Specifically, Notice 2016-4 extends the due date (1) for furnishing to individuals the 2015 Form 1095-B and the 2015 Form 1095-C from February 1, 2016, to March 31, 2016, and (2) for filing with the IRS the 2015 Form 1094-B, the 2015 Form 1095-B, the 2015 Form 1094-C, and the 2015 Form 1095-C, from February 29, 2016, to May 31, 2016, if not filing electronically, and from March 31, 2016, to June 30, 2016 if filing electronically. Notice 2016-4 also provides guidance to individuals who might not receive a Form 1095-B or Form 1095-C by the time they file their 2015 tax returns.

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IRS Extends Deadline for Applicable Large Employers to Report Health Coverage Information

The IRS has extended the due dates, for the 2015 tax year only, for applicable large employers to file Form 1095-B and Form 1095-C from February 1, 2016, to March 31, 2016. For taxpayers required to file Form 1094-B and Form 1094-C (generally insurers or self-insuring employers), the due dates have also been extended for 2015. Notice 2016-4.

Information Reporting Requirements under the Affordable Care Act

The Affordable Care Act added (1) Code Sec. 6055, which requires health insurance issuers, self-insuring employers, government agencies, and other providers of minimum essential coverage to file and furnish annual information returns and statements regarding coverage provided, and (2) Code Sec. 6056, which requires applicable large employers (ALEs) to file information returns with the IRS and provide statements to their full-time employees about the health insurance coverage offered. This information is used by the IRS to administer the employer shared responsibility provisions of Code Sec. 4980H and the premium tax credit under Code Sec. 36B.

An ALE is an employer that employed an average of at least 50 full-time employees during the preceding calendar year. A full-time employee generally includes any employee who was employed, on average, at least 30 hours per week and any full-time equivalents. For example, 40 full-time employees employed 30 or more hours per week on average plus 20 employees employed 15 hours per week on average are equivalent to 50 full-time employees.

The Code Sec. 6055 and Code Sec. 6056 information reporting requirements are first effective for coverage offered (or not offered) in 2015. Beginning in 2016, an ALE must file information returns with the IRS and furnish statements to employees to report information about its offers of health coverage to its full-time employees for 2015.

ALEs are required to file Form 1095-C, Employer-Provided Health Insurance Offer and Coverage, and Form 1094-C, Transmittal of Employer-Provided Health Insurance Offer and Coverage Information Returns, with the IRS and must furnish a statement including the same information provided to the IRS to each full-time employee.

The information to be reported to the IRS includes identification of the ALE, identification of full-time employees to whom an offer of coverage is made, and duration of the offer.

The information contained in the employee statement includes identification of the employer and the same information required to be reported to the IRS for each full-time employee.

The regulations under Code Sec. 6056 impose similar requirements on providers of minimum essential coverage, to be reported on Form 1094-B, Transmittal of Health Coverage Information Returns, and Form 1095-B, Health Coverage.

Due Dates for ACA Information Returns Extended

Notice 2016-04 extends the due date for furnishing the 2015 Form 1095-B and the 2015 Form 1095-C from February 1, 2016, to March 31, 2016.

The notice also extends the due date for filing with the IRS the 2015 Form 1094-B and the 2015 Form 1094-C from February 29, 2016, to May 31, 2016, if not filing electronically, and from March 31, 2016, to June 30, 2016, if filing electronically.

According to the IRS, the provisions regarding automatic and permissive extensions of time for filing information returns and permissive extensions of time for furnishing statements do not apply to the extended due dates.

An ALE or other coverage provider that fails to comply with the information reporting requirements may be subject to the general reporting penalty provisions under Code Sec. 6721 (failure to file correct information returns) and Code Sec. 6722 (failure to furnish correct payee statement).

Caution: The information reporting penalties under Code Secs. 6721 and 6722 have increased from $100 to $250 per Form 1094-B, Form 1094-C, Form 1095-B, or Form 1095-C with respect to which a failure occurs. The maximum penalty that may be imposed has increased from $1,500,000 to $3,000,000.

The IRS notes that employers may be eligible for short-term relief from reporting penalties in certain circumstances. Specifically, under Code Sec. 6724, relief is provided from penalties under Code Secs. 6721 and 6722 for incorrect or incomplete information returns and statements filed and furnished in 2016 to report offers of coverage in 2015, provided the ALE can show that it made a good faith effort to comply with the requirements.

Transition Relief for Taxpayers Affected by Delayed Forms 1095

The IRS notes that some employees (and related individuals) who enrolled in coverage through the Marketplace but did not receive a determination from the Marketplace that the offer of employer-sponsored coverage was not affordable could be affected by the extension if they do not receive their Forms 1095-C before they file their income tax returns. As a result, for 2015 only, individuals who rely upon other information received from employers about their offers of coverage for purposes of determining eligibility for the premium tax credit when filing their income tax returns need not amend their returns once they receive their Forms 1095-C or any corrected Forms 1095-C. Individuals need not send this information to the IRS when filing their returns but should keep it with their tax records.

Similarly, some individual taxpayers may be affected by the extension of the due date for providers of minimum essential coverage to furnish information under Code Sec. 6055 on either Form 1095-B or Form 1095-C. Individuals generally use this information to confirm that they had minimum essential coverage for purposes of Code Secs. 36B and 5000A. Because, as a result of the extension, individuals may not have received this information before they file their income tax returns, for 2015 only, individuals who rely upon other information received from their coverage providers about their coverage for purposes of filing their returns need not amend their returns once they receive the Form 1095-B or Form 1095-C or any corrections. Individuals need not send this information to the IRS when filing their returns but should keep it with their tax records.

For a discussion of the information reporting requirements under the ACA for applicable large employers, see Parker Tax ¶191,160.

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Decedent Had Non-Tax Reasons to Transfer Assets to Family Company; Value Not Included in Estate

The value of assets transferred by a decedent to a family limited liability company (LLC) were not includible in the value of her gross estate and her gifts of interests in the family LLC to a family trust were present interest gifts that qualified for the gift tax exclusion. In addition, the decedent's estate was entitled to deduct interest on loans used to pay estate tax liabilities. Est. of Purdue, T.C. Memo. 2015-249.

Background

Barbara Purdue died in 2007. Her husband was an attorney and a founding partner of Montgomery Purdue Blankinship & Austin (MPBA). In 1995, the decedent and her husband hired an attorney from MPBA for estate and gift tax planning and advice. Among other suggestions, the attorney suggested that the couple form a family limited partnership to hold their stock interests and their interest in a building in order to centralize management and take advantage of valuation discounts.

In August of 2000, the decedent and her husband formed the Purdue Family LLC (PFLLC). The couple had five children all of whom were individual members of the PFLLC. The decedent retained the right to income and distributions from the property she transferred to the PFLLC in proportion to her PFLLC ownership percentage. From 2001 until 2007, the decedent generally made an annual exclusion gift of PFLLC interests to the Purdue Family Trust (PFT).

After their mother's death, the attorney from MPBA sent a letter to the Purdue children explaining the options for paying the estate tax liabilities, including a $6.2 million loan from the PFLLC and a QTIP Trust established under Mr. Purdue's will or a $9.9 million dividend from the PFLLC. Unanimous consent of all the decedent's children was necessary, but one of the children refused to approve a PFLLC dividend sufficient for the estate and QTIP Trust to pay the estate tax liabilities. The remaining children aggregated their distributions and made loans totaling $1.2 million to the estate and the QTIP Trust. In return, the estate paid the distributees interest on the loans.

At the time of her death, decedent individually owned approximately $3.2 million of assets outside of the QTIP Trust and the PFLLC. Her estate timely filed its Form 706, United States Estate (and Generation- Skipping Transfer) Tax Return, on March 1, 2009. The IRS issued an estate tax notice of deficiency on February 21, 2012, and the gift tax notice of deficiency on September 12, 2012.

IRS and Estate's Arguments

Code Sec. 2036(a) generally provides that if, before death, a decedent transfers property other than in a bona fide sale for adequate and full consideration and retains certain enumerated rights or interests in the property which are not relinquished until death, the full value of the transferred property is included in the value of the decedent's gross estate. Code Sec. 2035(a) generally provides that if the decedent transferred an interest in property, or relinquished a power over property, during the three-year period ending on the date of his or her death, and the value of that property would have been included in the decedent's estate on the date of his or her death, then the property is included in the decedent's estate. This rule does not apply, however, to any bona fide sale for an adequate and full consideration in money or money's worth.

The IRS argued that (1) the value of the assets transferred by the decedent to the PFLLC were includible in the value of her gross estate under Code Sec. 2036(a) and Code Sec. 2035(a); (2) the decedent's gifts of PFLLC interests from 2001 through 2007 to the PFT were not present interest gifts and thus did not qualify for the annual gift tax exclusion under Code Sec. 2503(b); and (3) the estate was not entitled to deduct interest on the loans made to the estate that were used to pay the estate tax liabilities. According to the IRS, Code Sec. 2036(a) applied because: (1) the decedent made an inter vivos transfer of property; (2) the transfer was not a bona fide sale for adequate and full consideration; and (3) the decedent retained an interest or right in the transferred property which she did not relinquish before death. The estate argued that the last two conditions were not satisfied.

With respect to the issue of whether the transfer of assets to the PFLLC was a bona fide sale, the estate argued that the decedent had seven nontax motives for transferring such property: (1) to relieve her and her husband from the burdens of managing their investments; (2) to consolidate investments with a single adviser to reduce volatility according to a written investment plan; (3) to educate the Purdue children to jointly manage a family investment company; (4) to avoid repetitive asset transfers among multiple generations; (5) to create a common ownership of assets for efficient management and meeting minimum investment requirements; (6) to provide voting and dispute resolution rules and transfer restrictions appropriate for joint ownership and management by a large number of family members; and (7) to provide the Purdue children with a minimum annual cash flow. The IRS countered that the PFLLC was a testamentary substitute and that transfer tax savings were the primary motivation for the formation and funding of the PFLLC and the nontax reasons were purely hypothetical.

Tax Court Holds Transferred Assets Were Not Part of the Estate; Gifts Qualified for Annual Exclusion

The Tax Court rejected all of the IRS's argument and held that (1) the value of the assets transferred by the decedent were not includible in the value of her gross estate; (2) the decedent's gifts of PFLLC interests to the PFT were present interest gifts that qualified for the gift tax exclusion; and (3) the estate was entitled to deduct interest on loans used to pay the estate tax liabilities.

The court noted that the decedent's desire to have marketable securities and a building interest held and managed as a family asset constituted a legitimate nontax motive for her transfer of property to the PFLLC. With respect to whether the gifts of PFLLC interests were present interest gifts eligible for the gift tax exclusion, the court observed that to ascertain whether rights to income satisfy the criteria for a present interest under Code Sec. 2503(b), the estate had to prove that: (1) the PFLLC would generate income, (2) some portion of that income would flow steadily to the donees, and (3) that portion of income could be readily ascertained. The court concluded that the estate proved all three conditions.

Finally, with respect to the deductibility of the loan interest, the court noted that, for an interest expense to be deductible, the loan obligation must be bona fide and actually and necessarily incurred in the administration of the decedent's estate and essential to the proper settlement of the estate. The court said the estate had met the burden of showing that the interest was deductible under Code Sec. 2053, noting that the IRS never contended that the loan was not a bona fide loan and the facts proved that the loan was bona fide.

For a discussion of the rules for including property in a decedent's estate, see Parker Tax ¶225,500. For a discussion of interest deductions allowed against a decedent's gross estate, see Parker Tax ¶227,530.

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S Corporation Can't Convert QSub's Losses to Ordinary Losses Using Worthless Security Rules

The IRS has advised that an S corporation's acquisition of its QSub's stock after terminating its status as a QSub was exactly the type of acquisition of stock with the intent to convert a capital loss into an ordinary loss that Reg. Sec. 1.165-5(d)(2)(ii) was designed to prevent. Thus, the shareholders were not entitled to an ordinary loss deduction under Code Sec. 165(g)(3). CCA 201552026.

Background

Under the facts in CCA 201552026, an S corporation holding company (the taxpayer) owns a qualified subchapter S subsidiary (QSub) that operates a regulated business. The QSub's operations were found to be unsafe and unsound. The taxpayer and its shareholders wanted to maximize the pass through of ordinary income losses from the QSub before it was placed in receivership. Under the taxpayer's initial structure, shareholders primarily had three ways to recognize a loss, none of which resulted in an ordinary loss:

(1) have the shareholders take a worthless stock deduction on their S corporation shares, resulting in a capital loss (assuming the loss qualified under Code Sec. 165(g)(1));

(2) have the shareholders sell their shares to a third-party for a nominal arm's length price, resulting in a capital loss (assuming someone would buy a "worthless" S corporation); or

(3) have the S corporation sell the QSub stock (treated as a deemed asset sale) or assets to a third-party for an arm's length price which could result in a mix of ordinary and capital loss (depending on the character of the assets held by the QSub).

In an attempt to qualify its shareholders for ordinary loss treatment for the full amount of their investment, the taxpayer affirmatively terminated its S corporation status. As a result, the QSub's status also terminated. Under Reg. Sec. 1.1361-5(b)(1)(i), if a QSub election terminates, the former QSub is treated as a new C corporation acquiring all of its assets (and assuming all of its liabilities) immediately before the termination from the S corporation parent in an exchange for stock of the new corporation. If the deemed creation of a new corporation qualifies under Code Sec. 351, the transaction is tax-free.

In this case, the taxpayer argued that on the date when it was still an S corporation but after the QSub became a C corporation, a moment of worthlessness occurred. Thus, the taxpayer said, it was entitled to an ordinary deduction under Code Sec. 165(g)(3) provided its subsidiary C corporation was affiliated and worthless.

Analysis

Code Sec. 165(g)(3) provides that, for purposes of Code Sec. 165(g)(1) (which treats a loss on a security as a loss on a capital asset), a security in a corporation affiliated with a taxpayer that is a domestic corporation is not treated as a capital asset. As a result, an ordinary loss may be generated from the worthlessness of the stock, notwithstanding that the stock otherwise is a capital asset, if certain affiliation and gross receipts tests are satisfied.

Under Code Sec. 165(g)(3), a corporation is treated as affiliated with the taxpayer if (1) the taxpayer owns directly stock in that corporation meeting the requirements of Code Sec. 1504(a)(2), and (2) generally, more than 90 percent of the aggregate of its gross receipts for all tax years have been from sources other than royalties, rents, dividends, interest, annuities, and gains from sales or exchanges of stock and securities.

Reg. Sec. 1.165-5(d)(2)(ii) limits the application of Code Sec. 165(g)(3) by providing that a corporation is treated as affiliated only if none of the stock of the corporation was acquired by the taxpayer solely for the purpose of converting a capital loss sustained by reason of the worthlessness of any such stock into an ordinary loss under Code Sec. 165(g)(3).

The IRS Office of Chief Counsel (IRS) advised that the taxpayer was not entitled to an ordinary loss deduction under Code Sec. 165(g)(3).

The IRS concluded that the taxpayer's acquisition of its QSub's stock after terminating its status as a QSub was exactly the type of acquisition of stock with the intent to convert a capital loss into an ordinary loss that Reg. Sec. 1.165-5(d)(2)(ii) was designed to prevent. Under that regulation, the IRS said, the newly created C corporation is not treated as affiliated with the taxpayer for purposes of Code Sec. 165(g)(3). Thus, the ordinary loss deduction under Code Sec. 165(g)(3) is not available to the taxpayer; instead, the taxpayer may claim a Code Sec. 165(g)(1) capital loss deduction.

The IRS also noted that the termination of the subsidiary's QSub status resulted in a failed Code Sec. 351 transaction because worthless assets aren't Code Sec. 351 property.

For a discussion of the tax treatment of the termination of QSub status, see Parker Tax ¶31,540.

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Tax Court Rejects IRS Attempt to Apply Single-Trip Rule to Expenses Incurred to Move Household Goods

A taxpayer was entitled to deduct the majority of expenses incurred in making 20 round trips to personally move his belongings to a new residence before starting a new job. The Tax Court determined that the IRS's interpretation of the Code Sec. 217 regulations limiting a taxpayer's expenses to just one trip would ignore the actual cost incurred by individuals who move their own property. Parmeter v. Comm'r, T.C. Summary 2015-75.

Background

During 2012 Matthew Parmeter, an information technology engineer for the U.S. Army working in Pennsylvania, accepted a new position in a different state. In an effort to save money, he decided to move his belongings himself to his new home in Maryland. Parmeter had obtained three estimates from moving companies of the cost to pack and move his household goods. The estimates ranged from $22,000 to $30,000. The distance from his old to his new residence was 182 miles, and his moving expenses were not reimbursed by his employer.

Parmeter moved his belongings by making 20 round trips with his pickup truck. During each trip he placed the belongings in a storage facility in the vicinity of his new job. The facility charged him $178 per month, and he stored his belongings for nine months during 2012. During four of the round trips, he rented a trailer to move larger items, including vehicles. The trailer rental expense was $250 on each occasion. Before being able to use his new residence, Parmeter rented a hotel room for $139 per night for two nights.

On his 2012 income tax return Parmeter deducted $29,527 for unreimbursed moving expenses, which the IRS disallowed in its entirety.

Analysis

Under Code Sec. 217 a taxpayer may deduct moving expenses paid or incurred in connection with the commencement of work at a new principal place of work if certain conditions are met.

Reg. Sec. 1.217-2(b)(3) provides the requirements for deducting expenses incurred in moving household goods:

"Expenses of moving household goods and personal effects include expenses of transporting such goods and effects from the taxpayer's former residence to his new residence, and expenses of packing, crating, and in-transit storage and insurance for such goods and effects."

The IRS did not question the reasonableness or number of trips that Parmeter made to move his property and agreed that he met the Code Sec. 217 conditions to deduct his moving expenses, but challenged the amount of deductions to which he was entitled. The IRS argued that Parmeter was entitled to deduct only the cost of one trip to his new residence under Reg. Sec. 1.217-2(b)(4),which provides that:

"Expenses of traveling from the former residence to the new place of residence include the cost of transportation and lodging en route (including the date of arrival) from the taxpayer's former residence to his new place of residence. [deduction for traveling expenses from the former residence to the new place of residence is allowable for only one trip made by the taxpayer and members of his household

The IRS argued that the one-trip limitation of Reg. Sec. 1.217-2(b)(4) applied to the transportation of personal property under Reg. Sec. 1.217-2(b)(3).

The Tax Court disagreed, finding the IRS's interpretation would ignore the actual cost incurred by individuals who move their own personal property and would effectively limit the purpose of Reg. Sec. 1.217-2(b)(3) to instances where taxpayers paid to have their personal property commercially moved or moved by someone not a member of the family. The court also noted the IRS cited no cases for its interpretation, and held that Parmeter was entitled to deductions for his moving expenses.

Tax Court's Calculation of Parmeter's Moving Expenses

Although the Tax Court determined Parmeter was entitled to moving expenses, it did not believe he was entitled to the $29,527 claimed on his 2012 return. Parmeter stated he had used tax preparation software to prepare his return and did not understand how the $29,527 was computed.

The Tax Court noted that under Rev. Proc. 2010-51, Parmeter would be entitled to use the optional standard mileage rate to calculate his expenses (23 cents per mile for 2012). The court noted Parmeter's new residence was 182 miles away from his old and he drove 20 round trips, totaling 7,280 miles.

The court stated that the final of the 20 trips to the new residence must be counted as Parmeter's travel to his new residence, and accordingly he would not be entitled to deduct the cost of a round trip on that occasion. The effect of the one-trip rule, the court said, would be to reduce his costs by $41.86 so that his total mileage expense deduction was $1,632.54.

After totaling the allowable expenses, which included mileage expenses, trailer rental, and storage fees, the Tax Court held that Parmeter was entitled to a $2,810.54 moving expense deduction under Code Sec. 217.

For a discussion of moving expenses, see Parker Tax ¶80,500.

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Wages Resulting from Deployment to NATO Units in Afghanistan Aren't Foreign Earned Income

A taxpayer was not entitled to exclude from gross income, as foreign earned income under Code Sec. 911(a), the wages he earned while deployed to a NATO mission in Afghanistan. Because the taxpayer was an employee of the United States when performing his NATO services, his compensation was not characterized as foreign earned income under Code Sec. 911(b)(1)(B)(ii). Striker v. Comm'r, T.C. Memo. 2015-248.

Background

Samuel Striker, a U.S. citizen, is a social scientist with a Ph.D. in his field. During 2010 and 2011, he performed services as a civilian during two deployments to Afghanistan. The first deployment ran from October 2009 to November 2010, the second from November 2010 to October 2011. During both deployments he served in units led by North Atlantic Treaty Organization (NATO) commanders. NATO currently has 48 members, including the United States, and is funded by direct and indirect contributions from its members. Direct contributions cover the expenses of NATO command structures, alliance-wide communications systems, NATO-wide air defense, and similar fixed costs. Members contribute to NATO indirectly by participating in NATO-led missions and operations. Whenever a member country volunteers military forces or civilian consultants to perform in a NATO-led operation, that member country typically pays the costs of deploying its personnel.

Striker wanted to use his social science skills to assist the NATO mission in Iraq or Afghanistan and applied to the U.S. Army. He received training, security clearances, and travel orders that took him to Afghanistan. Striker wore a NATO-ISAF civilian name tag and a NATO badge when rendering his services, which he performed as part of a Human Terrain Team (HTT). The HTT was composed of citizens from various NATO countries, and the team's composition changed as personnel came and went. Each HTT had a team leader whose main role was to ensure that requests for information from NATO military officers were properly addressed. The team leader conducted Striker's performance evaluations but had no authority to discipline him or discharge him from his post.

The Army paid Striker on the basis of standard U.S. Government pay scales. He had a GS-13 grade during his first deployment and a GS-14 grade during his second. The Army provided him with standard fringe benefits, including health and retirement benefits. The Army furnished him with a biweekly "Civilian Leave and Earnings Statement" showing his gross pay and deductions. The Army reported Striker's wages to the IRS on Forms W-2, Wage and Tax Statement, and withheld from his paychecks the required federal income and employment taxes.

Striker did not maintain a permanent residence in the United States in 2010 and 2011. His 2010 and 2011 Forms 1040 listed his mother's residence as his address and both returns were prepared by a qualified income tax return preparer. Striker attached to his returns Forms 2555, Foreign Earned Income, on which he claimed under Code Sec. 911 exclusions of $91,500 and $92,900 for 2010 and 2011, respectively. Those were the maximum amounts allowed under Code Sec. 911 for those years. On the Forms 2555, Striker listed his occupation as "Defense Contractor"; listed his employer as "Defense Finance & Accounting Services"; stated that his employer was a "U.S. company"; listed his employer's U.S. address as a location in Cleveland, Ohio; and listed his employer's foreign address as a location in Kabul, Afghanistan. The IRS disallowed the foreign earned income exclusions on the ground that Striker was, during both deployments, an employee of the U.S. Government.

Analysis

Under Code Sec. 911(a), a qualified individual may elect to exclude from gross income, subject to certain limitations, his or her foreign earned income. To be entitled to this exclusion, a taxpayer must satisfy two distinct requirements:

(1) the taxpayer must be an individual whose tax home is in a foreign country, and

(2) the taxpayer must either be a bona fide resident of one or more foreign countries or be physically present in such countries during at least 330 days in a 12-month period.

The IRS agreed that Striker met these requirements.

In addition, Code Sec. 911(b)(1)(B)(ii) excludes from foreign earned income amounts paid by the United States or an agency thereof to an employee of the United States or an agency thereof. The question of whether Striker was entitled to the foreign earned income exclusion turned on whether he worked for the United States during 2010 and 2011.

The Tax Court held that Striker was an employee of the United States when performing his NATO services and, thus, Code Sec. 911(b)(1)(B)(ii) prevented his compensation from being characterized as foreign earned income. In so holding, the court cited its decision in Gillis v. Comm'r, T.C. Memo. 1986-576, in which wages earned by a U.S. Air Force lieutenant colonel, who was assigned to NATO in Germany and worked under the supervision of a German general, were found not to be excludible from income under Code Sec. 911. In Gillis, the Tax Court held that because the U.S. Air Force hired the taxpayer, paid his salary, assigned him to the NATO post, and had the exclusive authority to discharge him from military service, he was controlled by the U.S. Air Force and his wages were not excludible from income under Code Sec. 911.

The Tax Court noted that the purpose of Code Sec. 911(b)(1)(B)(ii) is to prevent a windfall to U.S. government employees in foreign countries. A taxpayer should not be allowed a windfall, the court said, merely because the taxpayer is stationed overseas in an allied command. According to the Tax Court, a taxpayer whom the U.S. military has assigned to a NATO command should not be treated any differently from any other military personnel serving overseas. The court concluded that Striker did not show that his position upon deployment to Afghanistan differed in any material way from the position occupied by hundreds of thousands of other Army military and civilian employees who have been deployed to NATO and other allied commands worldwide.

For a discussion of wages eligible for the foreign earned income exclusion, see Parker Tax ¶78,620.

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IRS Expands Scope of Identity Protection Services Excludable from Gross Income

In August, the IRS stated that it would not require an individual whose personal information may have been compromised in a data breach to include in gross income the value of identity protection services provided by the organization that experienced the breach. The IRS has extended this exclusion from income to include identity protection services provided to employees or other individuals before a data breach occurs. Announcement 2016-2.

Background

Identity theft, also known as identity fraud, occurs when a person wrongfully obtains and uses another person's personal information (for example, name, social security number, or banking or credit account numbers) in a way that involves fraud or deception, typically for economic gain.

In response to a data breach of an organization's recordkeeping systems, organizations often provide credit reporting and monitoring services, identity theft insurance policies, identity restoration services, or other similar services (collectively "identity protection services") to the customers, employees, or other individuals whose personal information may have been compromised as a result of the data breach. These identity protection services are intended to prevent and mitigate losses due to identity theft resulting from the data breach.

In Announcement 2015-22, the IRS announced it would not require an individual whose personal information may have been compromised in a data breach to include in gross income the value of the identity protection services provided by the organization that experienced the data breach.

Income Exclusion Expanded to Include Protection Services Offered Before a Data Breach Occurs

In Announcement 2016-2, the IRS announced that it is extending the scope of Announcement 2015-22 to include identity protection services provided to employees or other individuals before a data breach occurs.

Accordingly, the IRS will not require an individual to include in gross income the value of identity protection services provided by the individual's employer or by another organization to which the individual provided personal information (for example, name, social security number, or banking or credit account numbers).

Additionally, the IRS will not require an employer providing identity protection services to its employees to include the value of the identity protection services in the employees' gross income and wages, nor require these amounts to be reported on Form W-2.

The IRS stated that the announcements do not apply to cash received in lieu of identity protection services, or to proceeds received under an identity theft insurance policy.

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Amounts Paid to Settle Fraudulent Conveyance Claims Must be Capitalized

Amounts paid by a taxpayer in settlement of fraudulent conveyance claims were required to be capitalized as amounts paid to defend or perfect title to real or personal property, and thus were not deductible under Code Sec. 162 and did not qualify as specified liability losses under Code Sec. 172(f). CCA 201552028.

Background

A corporation (OldCo) entered into a reorganization with the intention of separating two of its businesses and merging one with a taxpayer. A subsidiary of OldCo, which produced an unspecified substance, created a new, wholly owned subsidiary (Taxpayer Sub), transferred all of its assets and liabilities relating to one business to Taxpayer Sub in exchange for stock in Taxpayer Sub, in a transaction intended to qualify under Code Sec. 351. Old Co then formed a new, wholly owned subsidiary (NewCo), and transferred the stock of the original subsidiary to NewCo. Old Co then spun off NewCo to its shareholders in a transaction intended to qualify under Code Sec. 355 and Code Sec. 368. OldCo was left with the stock of Taxpayer Sub as its primary or sole asset, at which point OldCo merged with the taxpayer.

At the time of the merger, OldCo and its original subsidiary were defendants in numerous lawsuits for both personal injury and property damages stemming from the unspecified substance contained in products the subsidiary sold. After the merger, the taxpayer was also a defendant in a number of lawsuits alleging that, as a result of the reorganization, it was responsible for the substance liabilities, based on the theory that the transfer of the business to the taxpayer was a fraudulent transfer or that the transaction resulted in successor liability.

While the litigation was pending, NewCo and its domestic subsidiaries, including the original subsidiary, filed for Chapter 11 bankruptcy. The bankruptcy court established two creditor committees to represent individuals pursuing personal injury or property damage claims relating to the unspecified substance, and authorized the two committees to pursue litigation against the taxpayer with respect to any claims arising from the transfers leading to the merger. The creditor committees brought a complaint on behalf of the bankruptcy estate for the purpose of avoiding the transfers, recovering the property transferred or the value of such property, and subjecting the taxpayer and Taxpayer Sub to liability for substance-related claims against NewCo. The complaint listed nine counts, four of which included claims for intentional or constructive fraudulent transfer.

The committee settled with the taxpayer, and the taxpayer transferred cash and shares of its common stock to trusts qualifying as qualified settlement funds under Code Sec. 468B in exchange for a release from all claims.

The taxpayer requested a Pre-Filing Agreement from the IRS for the tax year in which the settlement payments were made. Specifically, the taxpayer requested approval of its intention to deduct the amounts transferred to the qualified settlement funds pursuant to the settlement (the cash and the fair market value of the stock) as a Code Sec. 162 expense, and to carryback the loss to the preceding tax years as a specified liability loss under Code Sec. 172(f).

Analysis

The IRS Office of Chief Counsel (IRS) advised that the amounts paid by the taxpayer in settlement of the fraudulent conveyance claim were capitalizable under Reg. Sec. 1.263-2(e)(1) as amounts paid to defend or perfect title to real or personal property, and thus did not qualify as specified liability losses under Code Sec. 172(f) because they were not deductible under Code Sec. 162.

The IRS stated the tax treatment of the fraudulent conveyance claims was determined under the origin of the claim test established in U.S. v. Gilmore, 372 U.S. 39 (1963). Under that test, the substance of the underlying claim or transaction out of which an expenditure in controversy arose governs whether the item is a deductible expense or a capital expenditure, regardless of the motives of the payor or the consequences that may result from the failure to defeat the claim.

The IRS noted that while amounts paid by a business in connection with business-related litigation generally are deductible as ordinary and necessary expenses under Code Sec. 162, amounts with their origin in a capital transaction are required to be capitalized under the origin of the claim test. Thus, the IRS said, payments made in settlement of a lawsuit or potential lawsuits are generally deductible under Code Sec. 162 if the acts that gave rise to the litigation were performed in the ordinary conduct of the taxpayer's business. However, pursuant to Reg. Sec. 1.263-2(e)(1), litigation costs incurred to defend or perfect title to property are capital expenditures that are not deductible as ordinary and necessary business expenses.

Fraudulent conveyance claims, the IRS said, have their origin in a defense of title to real or personal property under Reg. Sec. 1.263-2(e)(1) because they seek to restore improperly transferred property back to the bankruptcy estate. Although the settlement agreement did not allocate the amounts amongst the various claims, the IRS advised that to the extent the amounts were attributable to the four fraudulent conveyance claims, they were not deductible under Code Sec. 162.

In addition, the IRS noted that, pursuant to Code Sec. 172(f)(1)(A), an amount can only qualify as a specified liability loss if it is deductible under Code Sec. 162 or Code Sec. 165. Because the amounts attributable to the fraudulent conveyance claims were not deductible under either section, the IRS advised that they would not qualify as specified liability losses.

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IRS Announces 2015 Filing Season to Begin on January 19, 2015

The IRS announced plans to open the 2015 filing season as scheduled on January 19, 2015. No tax returns will be processed prior to that date. IR-2015-139 (12/21/14).

The announcement comes in the wake of Congress's last minute passage of the tax extenders bill, which had cast some doubt on whether tax season would begin on time. The extenders bill permanently extends many of the 50+ tax provisions that previously had been up for renewal for one or two years at a time and temporarily extends dozens of others for periods ranging from two to five years. The final legislation, the Protecting Americans from Tax Hikes Act of 2015, was signed into law on Dec. 18, 2015.

The IRS reminded taxpayers that filing electronically is the most accurate way to file a tax return and the fastest way to get a refund. The IRS stated that there is no advantage to filing paper returns in early January instead of waiting for e-file to begin, because it will begin processing both electronic and paper returns on January 19.

The filing deadline to submit 2015 tax returns is Monday, April 18, 2016, rather than the traditional April 15 date. Washington, D.C., will celebrate Emancipation Day on that Friday, which pushes the deadline to the following Monday for most of the nation. (Due to Patriots Day, the deadline will be Tuesday, April 19, in Maine and Massachusetts.)