Federal Tax Bulletin - Issue 103 - December 4, 2015

2015 Saw Significant Tax Law Changes, But Tax Extenders Remain up in the Air

Congress made significant changes to the Tax Code in 2015, including a restructuring of Partnership and C corporation return due dates, sharp increases to information reporting penalties, and a repeal of TEFRA partnership audit procedures. But a permanent or multi-year extension of dozens of tax breaks, known not-so-affectionately as the "tax extenders," remains up in the air with just two weeks left before Congress recesses for the year.

A recap of the 2015's most important tax law changes and this year's version of the tax extenders debacle follows.

Status of Tax Extenders Remains Uncertain

Last year, on December 19, the President signed into law the Tax Increase Prevention Act of 2014, retroactively extending enhanced Section 179 expensing and dozens of other tax breaks for one year. On January 1, 2015, just thirteen days later, the provisions expired, starting the tax extenders cycle anew.

In July, the Senate Finance Committee voted 23 to 3 to approve a package of tax extenders provided for in the Tax Relief Extension Act of 2015 (S. 1946). The bill proposed to extend for two years 52 tax breaks that expired at the end of 2014, including the increased small business expensing limitation and phase-out amounts under Code Sec. 179 ($500,000 and $2 million respectively), the 50 percent bonus depreciation, the deduction for state and local sales taxes, and the Code Sec. 41 research credit.

Senate Finance Committee Chairman Orrin Hatch, commenting on the bill, said that legislators should be working to make a number of the tax extender provisions permanent, but in order to make the process less contentious and to ensure that much needed relief to taxpayers could be more quickly provided, he agreed to defer the issue of permanence until a later time.

Despite strong bipartisan support from the Finance Committee, the Senate extenders bill has since languished, as have two House bills that would make permanent the research tax credit (H.R. 880) and Code Sec. 179 expensing for small businesses (H.R. 636).

With the end of the legislative year drawing near, negotiations are currently focused on which, if any, extenders are to be made permanent. Republicans are looking to make several business tax breaks permanent, primarily Code Sec. 179 expensing and the research credit. Democrats wish to make permanent provisions for tax credits benefitting low income taxpayers, such as the Earned Income Tax Credit and the Child Tax Credit (both set to expire in 2018), along with various clean energy credits.

On November 30, House Majority Leader Kevin McCarthy said he expected the legislation would be finished by December 18. On the same day, Hatch also sounded an optimistic note, saying, "We're working on it and we'll get it done."

Steep Increases in Information Reporting Penalties Set to Take Effect in January

On June 29, President Obama signed into law the Trade Preferences Extension Act of 2015 (Pub. L. 114-27). The law significantly increases, for the second time in five years, the penalties imposed under Code Secs. 6721 and 6722 for failures relating to information returns and payee statements. These increases take effect on January 1, 2016.

Practice Aid: See ¶320,690 for a client letter that explains the requirement to file Form 1099 and alerts clients to the increased penalties for failing to comply.

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.

The lower maximum penalties for taxpayers with gross receipts of $5,000,000 or less has also been increased. For such taxpayers, the maximum penalty is now $1,000,000, up from $500,000.

For taxpayers who intentionally disregard the filing requirements for information returns and payee statements, the per failure penalty increased from $250 to $500.

Common forms subject to these penalties include: Schedule K-1 (Forms 1041, 1065, and 1120S); Form 1098, Mortgage Interest Statement; Form 1098-E, Student Loan Interest Statement, Form 1099-C, Cancellation of Debt; Form 1099-INT, Interest Income; Form 5498, IRA Contribution Information; and Form W-2, Wage and Tax Statement.

Congress Swaps Partnership and C Corp Deadlines

On July 31, President Obama signed into law the Surface Transportation and Veterans Health Care Choice Improvement Act of 2015 (Pub. L. 114-41), which restructures the due dates for Partnership and C corporation tax returns beginning with the 2016 tax year, with a goal of reducing the need for extended and amended tax returns.

Once the new rules take effect, 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 corp returns remain unchanged, meaning that partnership and S corp returns will now share the same due dates.

In general, 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 corps, this means the due date will be April 15, instead of March 15.

A special rule exempts C corps 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 bill also modifies the automatic extension periods for C corporations. Calendar year C corps are provided a five month automatic extension for returns for tax years beginning after December 31, 2015 and ending before January 1, 2026. 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.

Bipartisan Budget Act Replaces TEFRA Partnership Audit Procedures

On November 2, President Obama signed into law the Bipartisan Budget Act of 2015 (Pub. L. 114-74) (2015 BBA), which repealed TEFRA partnership audit procedures and replaced them with a single centralized audit system.

With respect to partnership audit rules, the 2015 BBA repeals the voluntary centralized audit procedures for electing large partnerships, as well as the TEFRA procedures (i.e., rules adopted as part of the Tax Equity and Fiscal Responsibility Act of 1982). Under the new system, the audit 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.

Observation: 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, except for the election relating to the opt-out provision, 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.

In addition, the new law revises the "family partnership" rules in Code Sec. 704(e) to clarify that Congress intended the rules to merely explain that a family member who received, via gift, a capital interest in a partnership where capital is a material income-producing factor (as opposed to services), should be respected as a partner in the partnership and should be taxed on the income from that partnership. The changes relating to family partnerships and partnership interests created by gift apply to partnership taxable years beginning after December 31, 2015.

Transportation Bill Allows IRS to Use Private Debt Collectors

On December 3, Congress passed the Fixing America's Surface Transportation (FAST) Act (H.R. 22). The President is expected to sign the bill into law.

The FAST act funds federal surface transportation programs for the next five years (through fiscal year 2020), paid for in part by tax provisions.

The act amends Code Sec. 6306 to allow the IRS to use private debt collection agencies to locate and contact delinquent taxpayers, and to arrange for payment of those taxes.

In addition, the IRS is required to use amounts marked for collection enforcement activities under Code Sec. 6306 to fund a "special compliance personnel program" under new Code Sec. 6307 in order to hire, train, and employ individuals to use automated collection systems or as field collection officers.

The act also adds new Code Sec. 7345, which calls for the denial, revocation, or limitation of a passport for any individual with a delinquent tax debt in excess of $50,000.

Additional Changes Made to the Tax Code in 2015

In addition to the major changes to the Code described above, the laws passed this year made several other significant changes to the tax code:

The Bipartisan Budget Act of 2015 (Pub. L. 114-74) repeals the automatic enrollment provisions added by the ACA, effective November 2, 2015.

The Surface Transportation and Veterans Health Care Choice Improvement Act of 2015 (Pub. L. 114-41) amended Code Sec. 6501, effectively overruling the Supreme Court's holding in U.S. v. Home Concrete & Supply, LLC, 2012 PTC 94 (S. Ct. 4/25/12), 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 under Code Sec. 6501(e).

In addition, that law also provides a new consistency standard for reporting basis in property received by reason of death under Code Sec. 1014, new information reporting requirements for inherited property, additional details taxpayers will need to disclose on mortgage information returns, and an extension for transfers of excess pension assets to retiree health accounts. For taxpayers with foreign bank accounts, the law directs the IRS to change the due date for FinCEN Report 114, relating to Report of Foreign Bank and Financial Accounts (FBAR), from June 30 to April 15, with a maximum extension for a six month period ending on Oct. 15.

The Trade Preferences Extension Act of 2015 (Pub. L. 114-27) extended and modified the Health Coverage Tax Credit to allow those eligible to claim the credit against the premiums they paid for certain health insurance coverage through 2019. That law also added a provision which limits the refundable portion of the child tax credit for taxpayers who elect to exclude foreign earned income from tax.

Lastly, the Protecting Affordable Coverage for Employees Act (Pub. L. 114-60 ) (PACE Act) amended the Affordable Care Act's (ACA) non-tax definition of a "small business." Although not designed as a tax measure, the PACE Act does have an indirect effect on cafeteria plan benefits. Under Code Sec. 125(f)(3), certain qualified health plans may be offered through cafeteria plans if the employee's employer is a qualified employer under the ACA. Because a "qualified employer" in this context is defined as certain small employers, the PACE Act's modification of the definition of "small employers" will affect qualified benefits under Code Sec. 125.

[Return to Table of Contents]

IRS Increases Tangible Property De Minimis Safe Harbor Threshold for Taxpayers Without an Applicable Financial Statement

For tax years beginning in 2016, the IRS has increased the threshold for applying the Reg. Sec. 1.263(a)-1(f) de minimis safe harbor for taxpayers without an applicable financial statement from $500 to $2,500 per invoice or item. Notice 2015-82.

The IRS has increased the threshold for applying the Reg. Sec. 1.263(a)-1(f) de minimis safe harbor to deduct the costs of certain tangible property acquired or produced by taxpayers without an applicable financial statement (AFS) from $500 to $2,500 per item or invoice. The increase is effective for costs incurred during tax years beginning on or after January 1, 2016.

Practice Aid: Taxpayers are required to make an affirmative election in order to avail themselves of the de minimis safe harbor under Reg. Sec. 1.263(a)-1(f). The election is made by attaching a statement to the taxpayer's timely filed original federal tax return (including extensions) for the tax year in which these amounts are paid. See Parker Tax ¶ 320,216 for a sample election statement.

Background

The 2013 tangible property regulations added a de minimis safe harbor election under Reg. Sec. 1.263(a)-1(f) that permits a taxpayer to not capitalize, or treat as a material or supply, certain amounts paid for tangible property that it acquires or produces during the tax year, provided the taxpayer meets certain requirements and the property does not exceed certain dollar limitations. If such requirements are met, amounts paid for the qualifying property generally may be deducted under Code Sec. 162, provided the amount otherwise constitutes an ordinary and necessary business expense in carrying on a trade or business.

Under the 2013 regulations, a taxpayer without an AFS may elect to apply the de minimis safe harbor if, in addition to other requirements, the amount paid for the property subject to the de minimis safe harbor does not exceed $500 per invoice (or per item as substantiated by the invoice). In contrast, a taxpayer with an AFS may elect to apply the de minimis safe harbor if, in addition to other requirements, the amount paid for the property does not exceed $5,000 and the taxpayer treats the amount paid as an expense on its AFS in accordance with its written accounting procedures.

An AFS includes a financial statement required to be filed with the SEC, as well as other types of certified audited financial statements accompanied by a CPA report, including a financial statement provided for a loan, reporting to shareholders, or for other non-tax purposes. An AFS also includes a financial statement required to be provided to a federal or state government or agency other than the IRS or the SEC.

Safe Harbor Threshold Increased for Taxpayers Without an Applicable Financial Statement

The IRS notes that the de minimis safe harbor was intended as an administrative convenience to allow taxpayers to deduct small dollar expenditures for the acquisition or production of new property or for the improvement of existing property rather than having to capitalize such amounts. After issuing the tangible property regulations, the IRS said it received numerous letters from representatives of small business taxpayers requesting that the de minimis safe harbor limit be increased for taxpayers that do not have an AFS.

Generally, the IRS stated, commenters wrote that the $500 limitation was too low to effectively reduce the administrative burden of complying with the capitalization requirement for small business taxpayers that frequently purchase tangible property in their trades and businesses. Commenters noted that the cost of many commonly expensed items (for example, tablet-style personal computers, smart phones, and machinery and equipment parts) typically surpassed the $500 per item or invoice threshold. Commenters also stated that the $500 threshold did not correspond to the financial accounting policies of many small businesses, which frequently permit the deduction of amounts in excess of $500 as immaterial.

Commenters additionally noted that without an increase in the de minimis safe harbor limit for taxpayers without an AFS, a capitalization threshold in excess of $500 can only be substantiated by establishing that a taxpayer's policy results in the clear reflection of income for federal income tax purposes, resulting in additional burden and uncertainty for taxpayers. Finally, many commenters expressed concern regarding the disparate treatment of taxpayers with an AFS compared to those without an AFS under the safe harbor requirements, stating that obtaining an AFS is cost prohibitive for many small businesses and did not adequately justify the substantially lower de minimis ceiling for those taxpayers.

In response to these concerns, the IRS has, effective for costs incurred during tax years beginning on or after January 1, 2016, increased the Reg. Sec. 1.263(a)-1(f) de minimis safe harbor limitation for a taxpayer without an AFS from $500 to $2,500.

For taxpayers with an AFS, the limitation remains $5,000.

Audit Protection for Years Prior to 2016

The IRS states that for tax years beginning before 2016, it will not raise on examination the issue of whether a taxpayer without an AFS can utilize the de minimis safe harbor for an amount not to exceed $2,500 per invoice or item if the taxpayer otherwise satisfies the requirements of the safe harbor. Moreover, if the taxpayer's use of the de minimis safe harbor is an issue under consideration in examination, appeals, or before the Tax Court in a tax year that begins after December 31, 2011, and ends before January 1, 2016, the issue relates to the qualification under the safe harbor of an amount that does not exceed $2,500 per invoice or item, and the taxpayer otherwise satisfies the requirements of the safe harbor, the IRS said it will not further pursue the issue.

For a discussion of the de minimis safe harbor, see Parker Tax ¶99,550.

[Return to Table of Contents]

Taxpayer's Care of Terminally Ill Wife Is Reasonable Cause for Failure to File Return and Pay Tax

A taxpayer had reasonable cause for failing to timely file his tax return and pay the tax due where he was busy caring for his dying wife. However, because the penalty for failing to make estimated payments is generally mandatory, the taxpayer was liable for that penalty. Ibarra v. Comm'r, T.C. Summary 2015-70.

Background

In early 2011, Baudelio Ibarra was laid off from work. At about the same time his wife, who was already in ill health from a stroke and other chronic medical conditions, was diagnosed with pancreatic cancer after complaining about a pain in her side for some time. She died later that year at the end of the summer. During the last months of her life, Ibarra's wife required round-the-clock care, which Ibarra, together with other immediate family members, provided full time in his home. Although Ibarra had some health insurance, it was inadequate given the medical care that his wife required, and the family's resources were depleted. At that point, Ibarra could no longer afford to pay for the oncologists and other medical specialists that his wife required, and her cancer treatment was relegated to naturopaths and other similar nonmedical providers who were willing to either reduce their fees or donate their services. Those methods proved to be ineffective in treating the cancer and, after a period of hospice care, also at home, Ibarra's wife died.

Ibarra was distraught after the death of his wife, to whom he had been married for over 40 years, and it took some time for him to come to terms with her passing. After some period had elapsed and to help deal with his grief, Ibarra trained to become a medical interpreter, and thereafter he both volunteered his time and worked for a company in that capacity.

During the course of his marriage, Ibarra's practice was to file joint returns with his wife. Specifically for 2009, he filed a joint return and reported tax of approximately $4,000. However, for 2010, Ibarra did not file any return, nor did he pay any tax other than through withholdings. He did file a return for 2011. The IRS assessed penalties for failing to timely file a return and pay the tax due for 2010. The IRS also assessed a penalty under Code Sec. 6654 for failure to make estimated tax payments for 2010. Ibarra argued that he should be excused from paying the penalties because he had reasonable cause for the failures to file his return and pay the tax and estimated tax payments.

Analysis

The Tax Court held that Ibarra's failure to timely file his return and pay the resulting tax was due to reasonable cause and, thus, he was not liable for the related penalties under Code Sec. 6651(a). However, because the imposition of the addition to tax for failing to pay estimated tax payments is generally mandatory whenever prepayments of tax do not equal the amount required by Code Sec. 6654(a), the court concluded that Ibarra was liable for that penalty.

In determining that Ibarra had reasonable cause for failing to file his return and pay the tax due, the court noted that it has held in the past that the illness of a taxpayer or a member of his or her immediate family may be reasonable cause for late filing if the taxpayer demonstrates that he or she could not file a timely return because of the illness. The court also noted that the rules of federal evidence generally acknowledge that the loss of a spouse, particularly one of long standing, has demonstrable emotional, mental, and physical affects. The court reviewed the circumstances surrounding Ibarra's failure to file his return and pay the tax due and concluded that he met the standard for reasonable cause due to his wife's illness.

For a discussion of the abatement of penalties due to reasonable cause, see Parker Tax ¶262,127.

[Return to Table of Contents]

Discharge of Corinthian College-Related Student Loans Won't Result in Taxable Income

Effective for tax years beginning on or after January 1, 2015, the IRS has stated that it will not require taxpayers who took out federal student loans to finance attendance at a school owned by Corinthian Colleges, Inc. to recognize gross income as a result of the discharge of such loans under the Department of Education's "Defense to Repayment" discharge process. Rev. Proc. 2015-57.

Background

In April, the Department of Education (ED) fined Corinthian Colleges Inc., a large for-profit post-secondary education company, $30 million for misrepresenting job placement rates to current and prospective students within its Heald College system. The company subsequently began selling or closing the for-profit colleges it owned, and filed for bankruptcy in May.

The Department of Education has estimated that over 50,000 students who took out federal student loans to finance attendance at schools owned by Corinthian Colleges, Inc. may be eligible for discharges under the Closed School discharge process or, as a result of misrepresentations by the colleges, under the Defense to Repayment discharge process.

In general, under the Higher Education Act of 1965 (HEA), the Closed School discharge process allows the ED to discharge a federal student loan obtained by a student, or by a parent on behalf of a student, who was attending a school at the time it closed or who withdrew from the school within a certain period before the closing date.

Under the HEA, the Defense to Repayment process requires the ED to discharge a Federal Direct Loan if a student loan borrower establishes, as a defense against repayment, that a school's actions would give rise to a cause of action against the school under applicable state law.

The HEA provides statutory exclusions from gross income for federal student loans discharged under the Closed School discharge process. Accordingly, a taxpayer whose federal student loan is discharged under the Closed School discharge process will not recognize gross income as a result of the discharge, and the taxpayer should not report the amount of the discharged loan in gross income on his or her federal income tax return.

In contrast, the HEA does not provide a statutory exclusion from gross income for federal student loans discharged under the Defense to Repayment discharge process, but provisions of the Code or other tax law authorities may allow a taxpayer to exclude amounts discharged under the process. For example, Code Sec. 108(a)(1)(B) provides that a taxpayer may exclude from gross income a discharge of indebtedness that occurs when the taxpayer is insolvent (the "insolvency exclusion").

IRS Won't Require Affected Students to Include Discharged Loans in Income

According to the IRS, most borrowers whose Corinthian student loans are discharged under the Defense to Repayment discharge process would be able to exclude from gross income all or substantially all of the discharged amounts based on fraudulent misrepresentations made by the colleges to the students, the insolvency exclusion, or another tax law authority. However, the IRS noted, determining whether one or more of these exceptions is available to each affected borrower would require a fact intensive analysis of the particular borrower's situation to determine the extent to which the discharged amount is eligible for exclusion under each of the potentially available exceptions.

Because such an analysis would impose a compliance burden on taxpayers, as well as an administrative burden on the IRS, that is excessive in relation to the amount of taxable income that would result, the IRS said that it will not require a taxpayer within the scope of Rev. Proc. 2015-57 to recognize gross income as a result of the Defense to Repayment discharge process.

The treatment provided Rev. Proc. 2015-57 applies to any taxpayer who took out federal student loans to finance attendance at a school owned by Corinthian Colleges, Inc. that are discharged under the Closed School discharge process or the Defense to Repayment discharge process.

In addition, the IRS said it will not require such taxpayers to increase his or her taxes owed in the year of a discharge, or in a prior year, as a result of either discharge process if in a prior year he or she received an education credit under Code Sec. 25A (Hope and Lifetime Learning Credits) attributable to payments made with proceeds of the discharged loan.

Finally, the IRS said it also will not require such taxpayers to increase his or her income in the year of the discharge if he or she took a deduction under Code Sec. 221 (interest on education loans) in a prior year attributable to interest paid on a discharged loan or a deduction under Code Sec. 222 (qualified tuition and related expenses) in a prior tax year attributable to payments of qualified tuition and related expenses made with proceeds of the discharged loan.

Rev. Proc. 2015-57 is effective for tax years beginning on or after January 1, 2015, for federal student loans discharged under the ED's Closed School and Defense to Repayment discharge processes.

[Return to Table of Contents]

Pending Federal Income Tax Refunds Are Includible in Gross Estate

A decedent had property interests in the values of his 2011 and 2012 federal income tax refunds that remained unpaid at the time of his death. Consequently, the refunds are includible in the decedent's gross estate for federal estate tax purposes. Est. of Badgett, Jr. v. Comm'r, T.C. Memo. 2015-226.

Background

Russell Badgett, Jr. died on March 8, 2012. The decedent's 2011 Form 1040 was filed a couple months later and reflected total tax of $495,096, total payments of $924,411, and an overpayment of $429,315. The return further reflected that $25,000 of the overpayment was to be applied to the decedent's 2012 estimated tax and $404,315 was to be refunded. The IRS applied the $25,000 estimated tax payment to the decedent's 2012 federal income tax on April 15, 2012, and refunded the rest on May 28, 2012.

On December 13, 2012, the estate filed a Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return. The decedent's 2011 federal income tax refund was not included in the value of the gross estate. The decedent's 2012 Form 1040 was filed on April 15, 2013. It reflected a total tax of $10,874, total payments of $25,000, and an overpayment of $14,126. A month later, the IRS issued a refund of $14,126 to the estate. The $14,126 refund for 2012 was not included in the value of decedent's gross estate as reflected on the Form 706.

Code Sec. 2031(a) provides that the value of a decedent's gross estate is generally determined by including the value of all of the decedent's property, real or personal, tangible or intangible, wherever situated, as of the date of death. Code Sec. 2033 provides that the value of the gross estate includes the value of all property to the extent of the interest therein of the decedent at the time of his death.

The IRS assessed a deficiency in the estate tax as a result of the estate not including the amounts of the 2011 and 2012 federal income tax refunds in the value of the decedent's gross estate. The estate argued that, under Kentucky law, property must be in existence on the tax assessment date to be subject to tax and cannot be a mere possibility or expectancy. While the estate acknowledged that the decedent overpaid his 2011 and 2012 income tax, it contended that an "overpayment" does not create a right to an income tax refund. According to the estate, there was no property interest until the refund was declared by the government and even if the decedent had an expectancy to receive the income tax refunds, Kentucky law provides that a mere expectancy is not the same as an interest in property.

Analysis

The Tax Court held that the decedent's federal tax refunds were includible in his gross estate. The court examined several cases involving tax refunds and their inclusion or exclusion in a decedent's gross estate. The court noted that in Est. of Bender v. Comm'r, 827 F.2d 884 (3d Cir. 1987), the decedent had unpaid federal tax liabilities for some years and tax overpayments in other years. The Third Circuit concluded that the decedent did not have a property interest in the tax overpayments for purposes of calculating his gross estate. According to the court, the IRS's discretionary power to offset the decedent's tax overpayments against his unpaid liabilities meant that the estate could not compel the IRS to issue a tax refund for the years for which the decedent overpaid his taxes; therefore, the tax overpayments never attained the status of independent assets for estate tax purposes.

However, the Tax Court noted, a different conclusion was reached in Est. of Chisolm v. Comm'r, 26 T.C. 253 (1956), a case where a deceased taxpayer had no tax liabilities to which a tax overpayment could be offset. In that case, the Tax Court concluded that the full value of the deceased taxpayer's viable but unasserted income tax refund claim was an asset of his estate. The Tax Court noted that, if no offsetting liability exists, Code Sec. 6402(a) is clear: The IRS must refund any balance to the taxpayer.

In the instant case, the court said, the decedent was not subject to any liability or obligation against which the IRS could offset his overpayments. Thus, the status of the decedent's tax refund was more than a mere expectancy; the estate had the right to compel the IRS to issue a refund for the years for which decedent overpaid his tax. As a result, the Tax Court concluded that the overpayments in question attained the status of independent assets for estate tax purposes and they constituted property of the decedent for estate tax purposes.

For a discussion of items includible in a decedent's gross estate, see Parker Tax ¶224,510.

[Return to Table of Contents]

IRS Finds Fault with Taxpayer's Statistical Sampling Study; Structural Component Disposition Loss Reduced

A taxpayer was not entitled to the full amount of a structural component disposition (SCD) loss estimated in its statistical sampling study. The proposed regulations under Code Sec. 168 that the taxpayer used were incorrectly applied, an incorrect method was used to calculate the SCD loss, and the taxpayer's records did not fully substantiate the estimated SCD loss. FAA 20154601F.

Background

Under Prop. Reg. Sec. 1.168(i)-8, a taxpayer can claim a loss on the disposition of a depreciable asset (or portion of a depreciable asset) that it has not fully depreciated at the time of the disposition. Under Rev. Proc. 2014-54, a taxpayer can make a late partial disposition election for tax years between January 1, 2012, and January 1, 2015, by filing a Form 3115, Application for Change in Accounting Method. The proposed regulations apply to property that a taxpayer depreciates under MACRS. A taxpayer that disposes of an asset (or a portion thereof) that is MACRS property can claim a loss in the amount of the adjusted depreciable basis of the asset or portion of the asset at the time of the disposition. Each building, including its structural components, is an asset. An improvement or addition that a taxpayer placed in service after it placed the asset in service is a separate asset.

Under the proposed regulations, when a taxpayer disposes of a complete asset, the adjusted depreciable basis of the asset at the time of its disposition determines the taxpayer's gain or loss on the disposition. A taxpayer that disposes of a portion of an asset can use any reasonable method to determine the unadjusted depreciable basis of the disposed of portion or portions. The taxpayer must then determine the adjusted depreciable basis of the asset by applying the depreciation method, recovery period, and convention applicable to the asset and accounting for the portion of additional first-year depreciation deduction claimed for the asset that is attributable to the disposed of portion.

Observation: Prop. Reg. Sec. 1.168(i)-8 was finalized by T.D. 9689 (8/14/14) as part of the final tangible property regulations. These final regulations were not in effect during the year at issue.

In an unidentified year, a taxpayer, who was eligible to use the proposed Code Sec. 168 regulations, sought to change its accounting method to recognize gain or loss on the disposition of building structural components in the year of disposition, in accordance with Prop. Reg. Sec. 1.168(i)-8. The taxpayer had a statistical sampling study prepared to identify assets (or portions of assets) that it had disposed of but that it was still depreciating. The study concluded that the taxpayer was entitled to a structural component disposition loss (SCD loss).

The preparer of the statistical sampling study relied on the taxpayer's schedule of all buildings it owned or leased at each of its locations. The preparer also relied on the taxpayer's fixed asset databases, which included building and personal property assets at the taxpayer's locations (i.e., cost histories). The cost histories included asset location, description, tax life, depreciable cost basis, bonus depreciation elections, accumulated depreciation, placed in service (PIS) date, and net tax value. The taxpayer did not use multiple asset accounts. The accuracy and detail of the cost histories varied.

Analysis

The IRS Office of Chief Counsel (IRS) advised that the taxpayer was not entitled to the full amount of the SCD loss estimated in its statistical sampling study. According to the IRS, the taxpayer incorrectly applied the proposed regulations by identifying SCD losses when the taxpayer installed new assets without establishing that the taxpayer:  

(1) had actually disposed of assets when it installed a new asset; or  

(2) had adjusted depreciable basis in a building, leasehold improvement, or single asset account at the time of the disposition that would give rise to a SCD loss.  

In addition, the IRS said, the taxpayer used an incorrect method to calculate the SCD loss when it compared the cost basis of new assets with the taxpayer's oldest assets because the assets were not of the same type and may not have been disposed of. Finally, the IRS noted, the taxpayer's records did not fully substantiate the estimated SCD loss.

The IRS advised that, under either the FIFO or modified FIFO method of identifying the partially disposed of asset, a taxpayer must treat the asset with the earliest PIS year that has the same recovery period as the partially disposed of asset. The preparer' study incorrectly relied on the FIFO method, the IRS said, by ignoring single asset accounts with no remaining adjusted basis. If a sample included pre-MACRS assets or ignored zero adjusted depreciable basis assets, the IRS noted, the taxpayer cannot claim a loss on the disposition or partial disposition of the asset.

Under Prop. Reg. Sec. 1.168(i)-8(f)(2), a taxpayer can use a reasonable method to determine the unadjusted depreciable basis of the disposed of portion of an asset or an asset in a multiple asset account. In the instant case, the IRS observed, the taxpayer did not account for its assets in multiple asset accounts and, therefore, in the case of a full disposition of an asset, the adjusted depreciable basis of that asset at the time of its disposition determines the SCD gain or loss. The use of a reasonable method to determine an asset's adjusted depreciable basis can only be used if the taxpayer partially disposed of an asset. According to the IRS, the taxpayer's various building and structural component assets cannot be treated as though the assets are in a multiple asset account for the purpose of determining the assets' adjusted depreciable basis. The study, the IRS noted, identified groups of the oldest assets as the disposed of assets by comparing a new asset's cost basis to the oldest assets' cost basis. The IRS advised that, to the extent this method was applied, the sample should be disallowed in calculating the taxpayer's SCD loss.

For a discussion of calculating gain or loss on a qualifying disposition of an asset, see Parker Tax ¶94,328.

[Return to Table of Contents]

No Loss Allowed for Expired Contract Where Business Continued as Normal

A business was not entitled to a Code Sec. 165 loss deduction for a towing contract that expired where it was clear that the business did not, in substance, suffer a loss during the year even if the contract expired in form. The business continued to enjoy the benefits of the towing contract even after it initially expired. Steinberg v. Comm'r, T.C. Memo. 2015-222.

Background

Randy Steinberg and Jon Nissley were partners in Kelmark Tow, LLC, a limited liability company taxed as a partnership. In 2005, Kelmark purchased a towing contract for $1.2 million. Upon the purchase of the towing contract, Kelmark obtained the sole and exclusive right to operate the Official Police Garages (OPG) for the Southeast Area of the Los Angeles Police Department (LAPD). OPGs in Los Angeles are regulated through a contract process. Los Angeles Municipal Code Sec. 80.77.4 limits the duration of OPG contracts to a five-year term. Kelmark's contract provided for a five-year term ending on June 27, 2009. At the end of the five-year term, the City of Los Angeles could, at its sole option, extend the contract for an additional five-year term.

In 2008, the Los Angeles City Council amended the city's Municipal Code to establish permanent OPG boundaries and, on February 12, 2010, adopted a recommendation that had the effect of retroactively changing the expiration date of Kelmark's towing contract from June 27, 2009, to December 27, 2009. New OPG contracts were drafted and Kelmark was notified in writing that (1) its first five-year term had expired, and (2) if Kelmark wished to be considered for a second five-year term, it needed to submit a written request for renewal no later than February 15, 2010. An amendment to the original contract was executed on June 8, 2010, which extended the original contract to June 26, 2014. Kelmark continued to operate the Southeast Area OPG during all of 2009 and was the only provider of towing services for the LAPD in that area. Kelmark submitted monthly summary reports to the Board of Police Commissioners for each month of 2009.

On its 2009 Form 1065, U.S. Return of Partnership Income, Kelmark deducted $880,000 of amortization expense. The IRS disallowed the deduction and the pass-through of the deduction to Steinberg and Nissley on their personal tax returns. The IRS also assessed an accuracy-related penalty under Code Sec. 6662.

Analysis

While the parties agreed that the towing contact was a Code Sec. 197 intangible amortizable over a 15-year period, they disagreed as to whether Steinberg and Nissley suffered passthrough losses under Code Sec. 165 in 2009 when the contract lapsed on either June 27 or December 27, 2009, and was not amended until June 8, 2010. Steinberg and Nissley argued that since the express terms of the contract stated that it must terminate on June 27, 2009, the contract became worthless in 2009 and they were therefore entitled to loss deductions under Code Sec. 165 for 2009 equal to the remaining basis in the contract. They contended that state or local law determines property rights and asked the Tax Court to take judicial notice of the Los Angeles Code provision which limits the duration of OPG contracts to a five-year term. Steinberg and Nissley argued that general rules of contract interpretation required the court to ascertain the intent of the parties from the plain language of the contract itself.

The IRS countered that the contract did not become worthless in 2009 because (1) Kelmark continued to enjoy the same benefits of towing for the Southwest Area OPG after the towing contract expired by its own terms on June 27, 2009, (2) the city delayed extending the towing contract to include details of the new OPG ordinance in all existing OPG contracts, and Kelmark was not at risk of losing its OPG contract, (3) the city was not required to exercise its option to extend the contract before the expiration of the initial term, (4) the city did in fact exercise its option to extend, first with a temporary extension and then with an amendment to the initial contract, and (5) the terms of the amendment reflected the intentions of Kelmark and the city to include the interim period as part of the towing contract. The IRS also noted that the amendment extended the terms of the contract until June 26, 2014, which was five years after the original term expired on June 27, 2009. According to the IRS, if the parties did not intend to include the interim period in the towing contract, the amendment would have provided for a five-year term beginning on the date the amendment was signed on June 8, 2010.

The Tax Court held that Steinberg and Nissley were not entitled to loss deductions based on the towing contract becoming worthless. The court disagreed that the original contract language was dispositive of whether Steinberg and Nissley sustained passthrough losses in 2009. According to the court, both the Code and case law required that the court consider all facts and circumstances surrounding Kelmark's towing contract with the City of Los Angeles. The court looked at Kelmark's conduct in conjunction with the original contract, the amendment to the contract, and the Los Angeles Municipal Code, and said it was clear that Kelmark did not, in substance, suffer a loss in 2009 even if the contract expired in form. Kelmark continued to enjoy the benefits of the towing contract, the court said, even after it initially expired on June 27, 2009, and subsequently expired after the 180-day extension on December 27, 2009. The court noted that Kelmark continued to operate the Southeast Area OPG, and no other party provided towing services for the LAPD in the Southeast Area during any part of 2009.

The court also commented on the fact that Kelmark continued to provide monthly summary reports to the LAPD for the Southeast Area OPG, thus further indicating that nothing material occurred in 2009 that changed the relationship Kelmark maintained with the LAPD in the Southeast Area or Los Angeles. This fact, the court said, favored a finding that the contract was neither subjectively worthless in Steinberg's and Nissley's eyes nor objectively worthless given the surrounding facts and circumstances.

The court also considered the original contract in conjunction with the amendment, saying that the plain language of the amendment evidenced an intent by Kelmark and the City of Los Angeles to include the interim period within the amendment's terms because, in part, it called for an additional five-year term that ended exactly five years after the expiration date of the original contract.

Finally, the court agreed with the IRS that Steinberg and Nissley were negligent and disregarded rules and regulations when they claimed the Code Sec. 165 loss deductions and thus upheld the assessment of the accuracy-related penalty under Code Sec. 6662.

For a discussion of the general requirements for deducting Code Sec. 165 losses, see Parker Tax ¶84,503.

[Return to Table of Contents]

IRS Addresses Employer Payment of Employee Coverage Provided Under a Spouse's Group Health Plan

An employer may exclude from an employee's gross income payments for the cost of health insurance coverage provided through the spouse's group health plan, but only to the extent the spouse has paid for all or part of the coverage on an after-tax basis. No exclusion from income is available where coverage is paid through salary-reduction under a Code Sec. 125 cafeteria plan. CCA 201547006.

Background

The IRS Office of Chief Counsel (IRS) was asked to address whether an employer may, under Code Sec. 105 or Code Sec. 106, exclude from an employee's income payments for the cost of health insurance coverage provided to the employee through his or her spouse's employer's group health plan.

Under Code Sec. 106(a), the gross income of an employee does not include employer-provided coverage under an accident or health plan. Reg. Sec. 1.106-1 provides that the gross income of an employee does not include contributions which the employee's employer makes to an accident or health plan for compensation (through insurance or otherwise) for personal injuries or sickness to the employee or the employee's spouse or dependents. To the extent amounts are excluded from gross income under Code Sec. 106(a), they are also excluded from wages subject to income tax withholding. In addition, amounts paid, under a plan or system established by an employer that makes provision for the employer's employees generally (or for the employees generally and their spouses and dependents) or for a class or classes of the employer's employees (or for a class or classes of the employer's employees and their spouses and dependents), to reimburse medical expenses are excluded from FICA and FUTA wages.

Under Code Sec. 105(e), amounts received under an accident or health plan for employees are treated as amounts received through accident or health insurance for purposes of Code Sec. 105. Reg. Sec. 1.105-5(a) provides that an accident or health plan is an arrangement for the payment of amounts to employees in the event of personal injuries or sickness.

Code Sec. 125 provides that an employer may establish a cafeteria plan that permits an employee to choose among two or more benefits, consisting of cash (generally, salary) and qualified benefits, including accident or health coverage. Pursuant to Code Sec. 125, the amount of an employee's salary reduction applied to purchase such coverage is not included in gross income, even though it was available to the employee and the employee could have chosen to receive cash instead.

Analysis

The IRS looked at seven situations and concluded that an employer may exclude from an employee's gross income payments for the cost of health insurance coverage provided through the spouse's group health plan but only to the extent the spouse has paid for all or part of the coverage on an after-tax basis and not through salary-reduction under a Code Sec. 125 cafeteria plan.

One situation involved a married couple working for separate employers. The wife's employer offers a group health plan that she declines. Her employer also provides an arrangement under which it will reimburse her for the cost of coverage incurred by her husband, who participates in his employer's group health plan. Under the husband's employer's plan, an employee participating in the plan must make either an after-tax contribution of $100 per month for self-only insured coverage or an after-tax contribution of $175 per month for other than self-only insured coverage. The husband elects other than self-only coverage to cover both himself and his wife under his employer's group health plan. The wife substantiates to her employer that her spouse has $175 per month deducted from his pay on an after-tax basis, $75 of which represents the cost of her insured coverage. The wife's employer pays her $75 per month in addition to her other compensation.

In this situation, the IRS advised that the amounts paid to the wife by her employer for the health insurance coverage are excluded from her gross income under Code Sec. 106 and are also excluded from FICA taxes, FUTA taxes, and federal income tax withholding. The fact that the insured group health plan is provided by her husband's employer and not her employer does not change the result under these facts.

Another situation involved the same facts except that the husband elects self-only insured coverage under the group health plan of his employer and makes the $100 per month employee contribution by salary reduction through his employer's Code Sec. 125 cafeteria plan. The wife substantiates to her employer that her husband contributes $100 per month on a pretax basis through salary-reduction for self-only insured coverage under his employer's group health plan. The wife's employer pays her $100 per month in addition to her other compensation.

In this situation, the IRS advised, the amount paid for the insured health coverage by the husband through salary-reduction under a Code Sec. 125 cafeteria plan has been excluded from the husband's gross income. Accordingly, the arrangement under which the wife's employer makes payments to her fails to be a health plan and no amounts paid under the arrangement to any participant are excluded from the gross income under Code Sec. 105. The amounts paid under the arrangement to the wife and other participants, the IRS said, are also subject to FICA taxes, FUTA taxes, and federal income tax withholding.

For a discussion of the taxation of employer-provided accident and health benefits, see Parker Tax ¶120,101.

[Return to Table of Contents]

No Plug-in Electric Vehicle Credit Where Golf-Cart Wasn't Delivered in Appropriate Tax Year

Because a plug-in electric vehicle purchased by the taxpayers in 2009 was not ready and available for full service to the taxpayers until 2010, they were not entitled to the plug-in electric vehicle credit in 2009. Trout v. Comm'r, T.C. Summary 2015-66.

Background

In 2009, Zone Electric Car, LLC, manufactured electric vehicles. On October 1, pursuant to Notice 2009-54, Zone Electric submitted a request to the IRS to certify that its Spark NEV-48 EX golf-carts were qualified plug-in electric vehicles for purposes of Code Sec. 30D, which as of the date of the notice allowed a tax credit for qualified plug-in electric vehicles placed in service from January 1 to December 31, 2009. On October 7, 2009, the IRS issued a letter to Zone Electric stating that the Spark NEV-48 EX model "meets the requirements of the Qualified Plug-in Electric Vehicle Credit as a Qualified Plug-in Vehicle. This acknowledgment is valid only through December 31, 2009, at which time the vehicle will need to be re-submitted under the revised provisions of IRC 30D and any subsequent Notice covering that period." The letter went on to state that purchasers of the Spark NEV-48 EX could rely on the certification concerning the vehicle's qualification for the qualified plug-in vehicle credit (PEVC).

On December 29, 2009, John and Barbara Trout ordered a Spark NEV-48 EX online and paid approximately $7,200 (including shipping) for the vehicle. They received an email confirmation of the order and a certificate of origin and a bill of sale, both of which were dated December 29, 2009. The bill of sale described a conveyance of the Spark NEV-48 EX model electric vehicle which has a unique vehicle identification number (VIN). The bill of sale also purported to transfer title to the specifically identified vehicle "as evidenced by the accompanying Manufacturer's Statement of Origin." The certificate of origin also contained the date of the transaction and the VIN. The certificate of origin was signed by Zone Electric.

The Trouts were provided with the terms and conditions of sale when they ordered the vehicle. Under those terms and conditions, the seller would place the vehicle order with the appropriate manufacturer upon receipt of funds from the buyer. In pertinent part, the terms and conditions stated that the buyer and the seller agreed that title to the vehicle would pass to the buyer upon issuance of the Manufacturer's Statement of Origin (certificate of origin), notwithstanding later production, assembly or physical shipment of the vehicle to the buyer. The Trouts received their vehicle with a matching VIN on August 26, 2010. They subsequently submitted a golf cart permit application to their local authorities, who issued a permit.

The PEVC was originally enacted in 2008, effective for tax years beginning after 2008. Under Code Sec. 30D(a)(1), as in effect at that time, a taxpayer was allowed a one-time credit against income tax with respect to each new qualified plug-in electric drive motor vehicle placed in service during the tax year. The definition of a "new qualified plug-in electric drive motor vehicle" was amended for tax years after December 31, 2009, to exclude low-speed vehicles, such as those primarily for use on golf courses. Code Sec. 30D(a)(1), as in effect on the date of the Trouts' purchase, provided that low-speed vehicles could qualify for the PEVC if the vehicle was: (1) placed in service by the taxpayer in a tax year beginning after December 31, 2008; (2) acquired by the taxpayer on or before December 31, 2009; and (3) generally in compliance with the requirements of Code Sec. 30D.

The Trouts timely filed their 2009 federal income tax return and claimed a PEVC of $6,497. The IRS disallowed the credit and the Trouts took their case to the Tax Court.

Analysis

The parties did not dispute that the Spark NEV-48 EX was a low-speed electric vehicle and, for purposes of Code Sec. 30D, would not qualify for the PEVC under the more narrow definition of eligible vehicles to be applied after December 31, 2009. The IRS argued that the Trouts were not eligible for a PEVC for 2009 because the qualified vehicle was not placed in service on or before December 31, 2009. According to the IRS, the vehicle was placed in service when it was delivered in 2010. The Trouts countered that they paid for, and acquired title to, a qualified electric vehicle on December 29, 2009. They asserted that legal title passed to them on the date they entered into the purchase agreement and therefore they were entitled to a PEVC for 2009 because the vehicle was acquired before December 31, 2009.

The Tax Court sided with the IRS and held that the Trouts did not qualify for the PEVC for 2009. The statute effective on the date of purchase, the court stated, not only required that a qualified vehicle be purchased before 2010, it also required that the vehicle be placed in service on or before December 31, 2009. Thus, the court noted, the requirements for the Trouts to take the PVEC were twofold: (1) title to the vehicle had to be acquired after December 31, 2008, and (2) the vehicle had to be placed in service on or before December 31, 2009.

While noting that the term "placed in service" is not defined in Code Sec. 30D, there are other provisions that provide guidance, the court said. Specifically, the court looked to Code Sec. 38(a) and Reg. Sec. 1.46-3(d)(4)(i) in noting that property is considered placed in service when it is in a condition or state of readiness and available for a specifically assigned function. In addition, the court observed, case law required it to determine more specifically whether the asset in question was ready and available for full operation on a regular basis for its specifically assigned function. The court concluded that the vehicle purchased by the Trouts was not ready and available for full service to the Trouts until August 26, 2010, and thus they were not entitled to the PVEC.

For a discussion of the PVEC, see Parker Tax ¶101,705.