September AFRs Issued; IRS Updates Guidance on Requesting Advance Pricing Agreements; IRS Issues Guidance on Obtaining Tax Treaty Assistance from U.S. Competent Authority; IRS Relaxes Residency Test for Taxpayers in U.S. Territories ...
The IRS has issued proposed regulations on the domestic production activities deduction under Code Sec. 199 to reflect amendments made in 2008 to rules relating to oil-related qualified production activities income and qualified films. The proposed regs also remove the "benefits and burdens" test and clarify several other rules. Temporary regulations issued simultaneously address the calculation of W-2 wages in a short tax year. REG-136459-09 (8/27/15); T.D. 9731 (8/27/15).
For the second time in five years, Congress has enacted hefty increases in the penalties imposed under Code Secs. 6721 and 6722 for failures relating to information returns and payee statements. The changes, which were included in the Trade Preferences Extension Act of 2015, take effect on January 1, 2016. Pub. L. 114-27 (6/29/15).
Donee's Liability for Donor's Unpaid Gift Tax Is Capped at Gift Amount, Fifth Circuit Holds
A donee's liability for a donor's unpaid gift tax and interest is capped by the amount of the gift; thus, to the extent a district court's judgment imposed liability on the donees beyond the value of the gifts received, that judgment was reversed. U.S. v. Marshall, 2015 PTC 292 (5th Cir. 2015).
Tax Court Denies Deductions for U.S. Legal Education of Attorney Licensed Abroad
The educational expenses incurred by an attorney licensed to practice law in Germany to obtain a U.S. law degree were not deductible because the education did not maintain or improve skills required in his trade or business. O'Connor v. Comm'r, T.C. Memo. 2015-155.
Although there was no formal partnership agreement between a partnership that managed oil and gas properties and the business that owned the properties, the eventual sale of the properties resulted in capital gain to the managing partnership because it invested "sweat equity" in the arrangement, increasing the value of the partnerships' capital. U.S. v. Stewart, 2015 PTC 294 (S.D. Tex. 2015).
Taxpayer's Statute of Limitations Isn't Extended by Third Party's "Intent to Evade Tax"
The suspension of the three-year statute of limitations in Code Sec. 6501(c)(1) is only triggered by the intent of the taxpayer to evade tax and not the intent of a third party who is remotely connected with the relevant tax return. BASR Partnership v. U.S., 2015 PTC 263 (Fed. Cir. 2015).
Ninth Circuit Denies Easement Deduction Where Mortgage on Property Was Not Subordinated to Easement
For a taxpayer to take a charitable deduction for the donation of a conservation easement, any mortgage on the property must be subordinated to the easement at the time of the donation. Minnick v. Comm'r, 2015 PTC 280 (9th Cir. 2015).
Abused Wife with Mental and Physical Health Issues Qualifies for Innocent Spouse Relief
Innocent spouse relief was appropriate where a taxpayer with mental and physical health issues suffered abuse at the hands of her husband and was afraid to question anything having to do with the tax return out of fear of retaliation. Hollimon v. Comm'r, T.C. Memo. 2015-157.
The IRS has stated that it will 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 will also not require these amounts to be reported on an information return filed with respect to such individuals. Announcement 2015-22.
IRS Issues Proposed and Temporary Regs on Domestic Production Activities
The IRS has issued proposed regulations on the domestic production activities deduction under Code Sec. 199 to reflect amendments made in 2008 to rules relating to oil-related qualified production activities income and qualified films. The proposed regs also remove the "benefits and burdens" test and clarify several other rules. Temporary regulations issued simultaneously address the calculation of W-2 wages in a short tax year. REG-136459-09 (8/27/15); T.D. 9731 (8/27/15).
The proposed regulations are effective when finalized, and the temporary regulations are effective as of August 27, 2015.
Background
Under Code Sec. 199, taxpayers can take a deduction for a percentage of their income attributable to certain production activities that take place within the United States (i.e., domestic production activities).
For 2010 and later years, the domestic production activities deduction is equal to 9 percent of the lesser of the taxpayer's qualified production activities income (QPAI) or its taxable income. Code Sec. 199(b)(1) limits this deduction to 50 percent of the W-2 wages paid by the taxpayer that are properly allocable to its domestic production gross receipts (DPGR).
Pursuant to Reg. Sec. 1.199-1(c), the QPAI of a taxpayer is equal to its domestic production gross receipts (DPGR) less certain expenses, losses, or deductions allocable to that DPGR. The amounts subtracted from DPGR include the cost of goods sold allocable to DPGR and any other expenses, losses, or deductions that are properly allocable to DPGR.
The term DPGR means the taxpayer's gross receipts that are derived from any lease, rental, license, sale, exchange, or other disposition of:
(1) qualifying production property (QPP) that was manufactured, produced, grown, or extracted (MPGE) by the taxpayer in whole or in significant part within the United States;
(2) any qualified film produced by the taxpayer; or
(3) electricity, natural gas, or potable water (utilities) produced by the taxpayer in the United States.
Proposed regulations issued in REG-136459-09 (8/27/15) provide guidance to taxpayers on the amendments made to Code Sec. 199 by the Energy Improvement and Extension Act of 2008 and the Tax Extenders and Alternative Minimum Tax Relief Act of 2008, involving oil related qualified production activities income and qualified films. The proposed regs also amend and clarify sever other rules under Code Sec. 199.
Regulations issued simultaneously in T.D. 9731 (8/27/15) provide guidance on the allocation of W-2 wages paid by two or more taxpayers that are employers of the same employees during a calendar year and the determination of W-2 wages if the taxpayer has a short tax year. To provide immediate effect, the IRS is issuing these regulations as temporary regulations.
Temporary Regulations
Allocation of W-2 Wages Following Acquisition or Disposition or a During Short Tax Year
Reg. Sec. 1.199-2(c) currently provides that if a taxpayer (a successor) acquires a trade or business from another taxpayer (a predecessor), then, for purposes of computing the respective Code Sec. 199 deduction of the successor and of the predecessor, the W-2 wages paid for that calendar year are allocated between the successor and the predecessor based on whether the wages are for employment by the successor or for employment by the predecessor.
Rev. Proc. 2006-47 provides that the amount of W-2 wages for a taxpayer with a short tax year includes only those wages subject to income tax withholding that are reported on Form W-2, Wage and Tax Statement, for the calendar year ending with or within that short tax year.
In certain situations, a short tax year may not include a calendar year ending within such short tax year, but current Reg. Sec. 1.199-2(c) does not address these situations. The IRS has thus issued temporary regulations that provide guidance on the application of Code Sec. 199(b)(3) to a short tax year that does not include a calendar year ending within the short tax year.
The temporary regulations provide that, if one or more taxpayers may be considered the employer of the employees of the acquired or disposed of trade or business during that calendar year, the W-2 wages paid during the calendar year to employees of the acquired or disposed of trade or business are allocated between each taxpayer based on the period during which the employees of the acquired or disposed of trade or business were employed by that taxpayer.
In the case of a short tax year in which there is no calendar year ending within such short tax year (short-tax-year rule), the temporary regulations provide that wages paid by a taxpayer during the short tax year to employees for employment by such taxpayer are treated as W-2 wages for such short tax year for purposes of Code Sec. 199(b)(1).
The temporary regulations provide that an acquisition or disposition includes an incorporation, a formation, a liquidation, a reorganization, or a purchase or sale of assets.
The temporary regulations also contain cross references to Reg. Secs. 1.199-2(a), (b), (d), and (e), because those regulations continue to apply to taxpayers. For example, the non-duplication rule of Reg. Sec. 1.199-2(d) applies such that a taxpayer that includes wages as W-2 wages based on the temporary regulations, including by filing an amended return for a short tax year, may not treat those wages as W-2 wages for any other tax year. Also, wages qualifying as W-2 wages of one taxpayer based on the temporary regulations cannot be treated as W-2 wages of another taxpayer.
Proposed Regulations
IRS Replaces "Benefits and Burdens" Test for Determining Taxpayer Engaged in Qualifying Activity
Current regulations provide that if one taxpayer performs a qualifying activity pursuant to a contract with another party, then only the taxpayer that has the benefits and burdens of ownership of the QPP, qualified film, or utilities is treated as engaging in the qualifying activity.
Taxpayers and the IRS have had difficulty determining which party to a contract manufacturing arrangement has the benefits and burdens of ownership of the property while the qualifying activity occurs. To resolve this confusion, the proposed regulations remove the benefits and burdens of ownership rule, and instead provide that if a qualifying activity is performed under a contract, then the party that performs the activity is the taxpayer for purposes of Code Sec. 199(c)(4)(A)(i).
Definition and Allocation of Oil Related Qualified Production Activities Income
The Energy Extension Act of 2008 added new Code Sec. 199(d)(9) which provides that, beginning in 2010, a taxpayer that has oil-related QPAI must reduce its domestic production activities deduction by 3 percent of the lesser of its oil-related QPAI, its QPAI, or its taxable income.
The proposed regulations define "oil-related QPAI" as an amount equal to the excess (if any) of the taxpayer's DPGR from the production, refining, or processing of oil, gas, or any primary product thereof (oil-related DPGR) over the sum of the cost of goods sold (CGS) that is allocable to such receipts and other expenses, losses, or deductions that are properly allocable to such receipts.
The proposed regulations provide that oil-related DPGR does not include gross receipts derived from the transportation or distribution of oil, gas, or any primary product thereof, subject to certain exceptions. To the extent a taxpayer treats gross receipts derived from the transportation or distribution of oil, gas, or any primary product thereof as DPGR, the proposed regulations require taxpayers to include those gross receipts in oil-related DPGR.
The proposed regulations provide guidance on how a taxpayer should allocate and apportion costs when determining oil-related QPAI, and require taxpayers to use the same cost allocation method to allocate and apportion costs to oil-related DPGR as the taxpayer uses to allocate and apportion costs to DPGR.
Qualified Films Include Certain Intangibles, Generally Excludes Promotional Films
Under Code Sec. 199(c)(6), gross receipts derived from the lease, rental, license, sale, exchange, or other disposition of a qualified film generally are treated as DPGR if a substantial amount of the film production activities are performed within the United States. The Tax Extenders Act of 2008 (2008 Act) amended the rules relating to qualified films, and the proposed regulations make conforming changes.
To address the changes made by the 2008 Act, the proposed regulations amend the definition of qualified film in Reg. Sec. 1.199-3(k)(1) to include copyrights, trademarks, or other intangibles with respect to such film. The proposed regulations define other intangibles with a nonexclusive list of intangibles that fall within the definition. The proposed regulations also modify the definition of W-2 wages to include compensation for services performed in the United States by actors, production personnel, directors, and producers.
Example: Xcite Co. produced a qualified film and licenses the trademark of Alfie, a character in the qualified film, to Youths Inc. for reproduction of the Alfie image onto t-shirts. Youths Inc. sells the t-shirts with Alfie's likeness to customers, and pays Xcite Co. a royalty based on sales of the t-shirts. Xcite Co.'s qualified film only includes intangibles with respect to the qualified film in tax years beginning after 2007, including the trademark of Alfie. Accordingly, any gross receipts derived from the license of the trademark of Alfie to Youths Inc. occurring in a tax year beginning before 2008 are non-DPGR, and any gross receipts derived from the license of the trademark of Alfie occurring in a tax year beginning after 2007 are DPGR (assuming all other requirements are met). The royalties Xcite Co. derives from Youths Inc. occurring in a tax year beginning before 2008 are non-DPGR because the royalties are derived from an intangible (which was not within the definition of a qualified film for tax years beginning before 2008).
The proposed regulations provide that gross receipts a taxpayer later derives from products or services promoted in a qualified film are not derived from a disposition of the qualified film (including any intangible with respect to such qualified film). The proposed regulations add an example to illustrate an exception to this rule in a situation where gross receipts from a promotional film can qualify as DPGR because the gross receipts are distinct from the disposition of the product or service.
Example: Xcite Co. produces a qualified film commercial in the United States that features the company's services (promoted services). The commercial includes the character "Alfie" developed to promote Xcite Co.'s services. Gross receipts that Xcite Co. derives from providing the promoted services are not derived from the disposition of Xcite Co.'s qualified film, including any copyrights, trademarks, or other intangibles with respect to the qualified film. Xcite Co. also licenses the right to reproduce Alfie to Youths Inc. so that Youths Inc. can produce t-shirts featuring Alfie. This license is distinct (separate and apart) from a disposition of the promoted services and the gross receipts are derived from the license of an intangible with respect to Xcite Co.'s qualified film. Thus Xcite Co.'s gross receipts derived from the license to reproduce Alfie are DPGR.
The proposed regulations amend a rule allowing a taxpayer to treat certain tangible personal property as a qualified film (for example, a DVD), to exclude tangible personal property affixed with a film intangible (such as a trademark). For example, total revenue from the sale of an imported t-shirt affixed with a film intangible should not be treated as gross receipts derived from the sale of a qualified film. The portion of the gross receipts attributable to the qualified film intangible separate from receipts attributable to the t-shirt may qualify as DPGR.
Limitations on the Attribution of the Production of a Qualified Film to Partnerships and S Corps
The 2008 Act also added an attribution rule under Code Sec. 199(d)(1)(A)(iv) for a qualified film for taxpayers who are partnerships or S corporations, or partners or shareholders of such entities. A partner of a partnership or shareholder of an S corporation who owns (directly or indirectly) at least 20 percent of the capital interests in such partnership or the stock of such S corporation is treated as having engaged directly in any film produced by such partnership or S corporation. Further, such partnership or S corporation is treated as having engaged directly in any film produced by such partner or shareholder.
The proposed regulations provide that in order for a partner or partnership to apply the attribution rule, the partnership must treat itself as a partnership for all purposes of the Code.
The proposed regulations generally prohibit attribution between partners of a partnership or shareholders of an S corporation, partnerships with a partner in common, or S corporations with a shareholder in common. Thus, when a partnership or S corporation is treated as having engaged directly in any film produced by a partner or shareholder, any other partners or shareholders who did not participate directly in the production of the film are treated as not having engaged directly in the production of the film at the partner or shareholder level.
The proposed regulations also describe the attribution period for a partner or partnership or shareholder or S corporation. A partner or shareholder is treated as having engaged directly in any qualified film produced by the partnership or S corporation, and a partnership or S corporation is treated as having engaged directly in any qualified film produced by the partner or shareholder, regardless of when the qualified film was produced, during the period in which the partner or shareholder owns (directly or indirectly) at least 20 percent of the capital interests in the partnership or the stock of the S corporation.
Example: In 2014, Studio A and Studio B form an S corporation in which each is a 50-percent shareholder to produce a qualified film. Studio A owns the rights to distribute the film domestically and Studio B owns the rights to distribute the film outside of the United States. The production activities of the S corporation are attributed to each shareholder, and thus each shareholder's revenue from the distribution of the qualified film is treated as DPGR during the attribution period because Studio A and Studio B are treated as having directly engaged in any film that was produced by the S corporation.
Testing and Minor Repackaging Activities Are Not MPGE Activities by Themselves
Generally, qualified production property (QPP) must be manufactured, produced, grown, or extracted (MPGE) in whole or in significant part by the taxpayer and in whole or in significant part within the United States to qualify for the domestic production activities deduction. The proposed regulations clarify that testing activities are not MPGE activities if they are not performed as part of the MPGE of QPP.
Current regulations provide that a taxpayer's packaging, repackaging, labeling, or minor assembly of QPP does not qualify as MPGE if the taxpayer engages in no other MPGE activities with respect to that QPP. The court in U.S. v. Dean, 945 F. Supp. 2d 1110 (C.D. Cal. 2013) concluded that the taxpayer's activity of preparing gift baskets was a manufacturing activity and not solely packaging or repackaging for purposes of Code Sec. 199.
The proposed regulations add an example based on the facts in U.S. v Dean, but reaches the opposite conclusion and illustrates that the taxpayer is not considered to have engaged in the MPGE of QPP.
Construction Activities Do Not Include Mere Approval of Payments
The proposed regulations clarify that a taxpayer must engage in construction activities that include more than the approval or authorization of payments or invoices for that taxpayer's activities to be considered as activities typically performed by a general contractor for purposes of including gross receipts from construction activity in DPGR.
The proposed regulations also revise the definition of substantial renovation to conform to the final regulations under Reg. Sec. 1.263(a)-3, which provide rules requiring capitalization of amounts paid for improvements to a unit of property owned by a taxpayer. Under the proposed regulations, in general, a substantial renovation of real property is a renovation the costs of which are required to be capitalized as an improvement.
Cost of Goods Sold Must be Allocated Between DPGR and non-DPGR
The proposed regulations provide that in the case of a long-term contract under the percentage-of-completion method (PCM) or the completed-contract method (CCM), the cost of goods sold (CGS) includes allocable contract costs.
In addition, the proposed regulations clarify that the CGS must be allocated between DPGR and non-DPGR, regardless of whether any component of the costs included in CGS can be associated with activities undertaken in an earlier taxable year.
Other Changes
In addition to the substantive changes discussed above, the proposed regulations modify the W-2 wage limitation to the extent provided by Code Sec. 199(d)(8), and modifies the term "United States" to include Puerto Rico, in order to conform to the rules involving domestic production activities in Puerto Rico made by the American Taxpayer Relief Act of 2008
The proposed regulations also make several administrative revisions to the hedging rules in Reg. Sec. 1.199-3(i)(3), and defines a hedging transaction to include transactions in which the risk being hedged relates to property described in Code Sec. 1221(a)(1) giving rise to DPGR.
Lastly, the proposed regulations provide a new example in Reg. Sec. 1.199-6(m) illustrating how QPAI is computed when an agricultural or horticultural cooperative's payments to members for corn qualify as per-unit retain allocations paid in money under Code Sec. 1388(f).
For a discussion of the domestic production activities deduction, see Parker Tax ¶96,100.
[Return to Table of Contents]
Steep Increases in Information Reporting Penalties Set to Take Effect in January
For the second time in five years, Congress has enacted hefty increases in the penalties imposed under Code Secs. 6721 and 6722 for failures relating to information returns and payee statements. The changes, which were included in the Trade Preferences Extension Act of 2015, take effect on January 1, 2016. Pub. L. 114-27 (6/29/15).
Generally, any person, including a corporation, partnership, individual, estate, and trust, which has reportable transactions during the calendar year, must file information returns to 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.
Increased Penalty Amounts
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.
Observation: This is the second time in the past five years that Congress has sharply increased these penalties. In 2010, the per-item penalty was doubled, from $50 to $100, and the maximum penalty was increased sixfold, from $250,000 to $1,500,000. With the latest changes, taxpayers now face a 500% increase in the per-item penalty compared with the pre-2010 amount, and a staggering 1,200% increase in the maximum penalty.
For failures corrected within thirty days, the penalty amounts have increased from $30 to $50, and the maximum penalty for corrected failures increased to $500,000, up from $250,000.
For failures corrected by August 1, the penalty amounts have increased from $60 to $100, and the maximum penalty for such corrected failures increased to $1,500,000, up from $500,000.
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 such taxpayers who correct within thirty days, the maximum penalty is $175,000, up from $75,000. And for such taxpayers who correct by August 1, the maximum penalty has been increased from $200,000 to $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. In such cases, the maximum penalty amount does not apply, nor can such taxpayers reduce the penalty by correcting the failures.
Information Returns and Statements Affected
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.
Observation: The penalties for failure to file Forms 1065 and 1120S remain unchanged. Those penalties were last increased in 2009 from $89 to $195 per month per partner (or shareholder).
The increased penalties are also imposed for failures related to information returns added by the Affordable Care Act: Form 1095-A, Health Insurance Marketplace Statement; Form 1095-B, Health Coverage, and Form 1095-C, Employer-Provided Health Insurance Offer and Coverage.
For a discussion of information reporting penalties, see Parker Tax ¶ 262,130.
[Return to Table of Contents]
Donee's Liability for Donor's Unpaid Gift Tax Is Capped at Gift Amount, Fifth Circuit Holds
A donee's liability for a donor's unpaid gift tax and interest is capped by the amount of the gift; thus, to the extent a district court's judgment imposed liability on the donees beyond the value of the gifts received, that judgment was reversed. U.S. v. Marshall, 2015 PTC 292 (5th Cir. 2015).
Background
In 1995, J. Howard Marshall, II sold his stock in Marshall Petroleum, Inc. (MPI) back to the company. Because he sold it back for a below-market price, the sale increased the value of the stock of the remaining five shareholders: (1) a Grantor Retained Income Trust (GRIT), which paid income to Marshall's former wife, Eleanor Stevens, and which was funded with MPI stock received by Stevens in her divorce from Marshall; (2) Marshall's son, E. Pierce Marshall; (3) E. Pierce's wife, Elaine; (4) the Preston Marshall Trust (formed for the benefit of J. Howard's grandson, Preston Marshall); and (5) the E. Pierce Marshall, Jr. Trust (formed for the benefit of J. Howard's grandson, E. Pierce Marshall, Jr.). At the time that he made the indirect gift, Marshall did not pay gift taxes. He passed away shortly after making the gift.
While the donor of a gift is primarily responsible for paying the gift tax on the gift, Code Sec. 6324(b) provides that the donee becomes personally liable for such tax to the extent of the value of such gift when the donor does not pay the gift tax. Because the term "tax" includes interest and penalties, the donee can be held liable for the interest and penalties for which the donor is liable. Donee liability is several, meaning that the donee can be held liable for the full amount of the gift tax that the donor owes, regardless of what portion of the gift the particular donee may have received of the total amount distributed, subject to the cap in Code Sec. 6324(b).
After several years of negotiations over Marshall's tax liability for his indirect stock gift, the IRS and Marshall's Estate entered into a stipulation that determined the value and recipients of the indirect gifts. Marshall's Estate still did not pay the gift tax and, under Code Sec. 6324(b), the IRS tried to collect the unpaid gift tax from the donees. E. Pierce and Eleanor Stevens had subsequently died and their estates became subject to the IRS's assessments. E. Pierce's Estate paid approximately $45 million toward the unpaid gift tax for the benefit of donees E. Pierce, Elaine, the Preston Trust, and the E. Pierce Jr. Trust. Stevens' Estate argued that Stevens was not the donee of Marshall's 1995 gift because she did not personally own any MPI stock at the time of the gift.
In 2010, the IRS brought suit against the donees, seeking to recover the unpaid gift taxes and to collect interest from the beneficiaries. The IRS argued that it could charge interest pursuant to Code Secs. 6601 and 6621 on the unpaid donee liability created by Code Sec. 6324(b). According to the IRS, there were two separate obligations: the obligation of the donor and the obligation of the donee. Code Sec. 6324(b), the IRS said, only limited the obligation of the donor, and so the donee's liability for the unpaid gift tax was not capped under Code Sec. 6324(b). The IRS also sought to recover from two individuals E. Pierce Marshall, Jr. and Finley L. Hilliard who, as representatives of various estates and trusts, allegedly paid other debts before paying those owed to the IRS.
The district court agreed with the IRS and found that (1) the donees had an independent liability under Code Sec. 6324(b) that was not capped at the value of the gift, and (2) this independent liability was subject to interest under Code Sec. 6601. The district court found that the donees were liable to the IRS for interest on their independent liability for the unpaid gift tax. The court also held that Stevens was a donee of Marshall's indirect gift and Hilliard and E. Pierce Jr. were individually liable for several of the debts they paid as executors and trustees. The court also held that E. Pierce Jr. breached his fiduciary duty under state law by failing to pay taxes on behalf of Stevens' Estate. The donees appealed to the Fifth Circuit.
Analysis
The Fifth Circuit held that a donee's liability for a donor's unpaid gift tax and interest is capped by the amount of the gift and thus reversed the district court's judgment to the extent it imposed liability on the donees beyond the value of the gifts. According to the court, the statute's text did not support the IRS's position. The court noted that its interpretation of Code Sec. 6324(b) was in accord with the Third Circuit's decision in Poinier v. Comm'r, 858 F.2d 917 (3d Cir. 1988) and the Eighth Circuit's decision in Baptiste v. Comm'r, 29 F.3d 433 (8th Cir. 1994). However, the court observed, the Eleventh Circuit has held otherwise and has disagreed with the Third and Eighth Circuits holdings on this issue, thus creating a split in the circuits.
The Fifth Circuit affirmed the district court's conclusion that Stevens was a donee of Marshall's stock gift. The court cited the Supreme Court's decision in Helvering v. Hutchings, 312 U.S. 393 (1941), where the Supreme Court held that gifts to a trust were gifts to the trust beneficiaries and that the trust beneficiaries were eligible for a gift tax exclusion under Code Sec. 2503(b). Based on that holding, the Fifth Circuit agreed with the district court which saw no reason why the definition of "donee" for purposes of the gift tax exclusion would be different than the definition of "donee" for the purposes of donee gift tax liability.
The Fifth Circuit also held that Hilliard and E. Pierce Jr. knew of the potential liability to the IRS, and thus, the Federal Priority Statute applied to hold them personally liable for various expenses, including accounting and legal fees, they paid out of the trusts and estates. However, the court reversed the district court as far as it held that E. Pierce Jr. breached his fiduciary duty under state law. According to the court, E. Pierce Jr. did not owe the Stevens Estate's creditors (i.e., the government) a fiduciary duty under Texas law.
For a discussion of donee gift tax liability, see Parker Tax ¶262,530.
[Return to Table of Contents]
Tax Court Denies Deductions for U.S. Legal Education of Attorney Licensed Abroad
The educational expenses incurred by an attorney licensed to practice law in Germany to obtain a U.S. law degree were not deductible because the education did not maintain or improve skills required in his trade or business. O'Connor v. Comm'r, T.C. Memo. 2015-155.
Background
From April 1998 to July 2004, Mark Tracy, a U.S. citizen, attended the University of Heidelberg in Germany as a law student. To practice law in Germany, an individual must complete various requirements, including passing two state exams. After completing the written section of these exams, Tracy moved to Salt Lake City, Utah, to complete a three-month elective station of his German legal training at a law firm. In June 2007, Tracy completed all of the necessary requirements and was licensed to practice law in Germany. Also in 2007, Tracy became a project manager of a multimillion-dollar residential building project in Salt Lake City.
In 2009, while still living in Utah, Tracy started law school at the University of San Diego. He traveled back and forth from Salt Lake City to San Diego, California, while completing his degree. Tracy did not work and did not receive any Forms W-2 during 2010 and 2011. He received his juris doctor (J.D.) in 2012. In February 2014, Tracy sat for, and passed, the bar exam in New York.
Tracy and his wife attached Forms 2106-EZ, Unreimbursed Employee Business Expenses, to their 2010 Form 1040X and 2011 Form 1040 and deducted travel, meals and entertainment, and other business expenses related to Tracy's legal education. The IRS disallowed those deductions and assessed accuracy-related penalties under Code Sec. 6662(a).
Analysis
Under Reg. Sec. 1.162-5(a), educational expenses are considered ordinary and necessary business expenses if the education:
(1) maintains or improves skills required by the individual in his employment or other trade or business, or
(2) meets the express requirements of the individual's employer, or the requirements of applicable law or regulations, imposed as a condition to the retention by the individual of an established employment relationship, status, or rate of compensation.
Such expenses are deductible only if the taxpayer is established in the trade or business at the time he or she pays or incurs the expense. The taxpayer must show that the educational expense is directly and proximately related to the skills required in his trade or business
The IRS argued that the facts in Tracy's case were similar to those in Horodysky v. Comm'r, 54 T.C. 490 (1970), where the Tax Court disallowed deductions for expenses related to the taxpayer receiving a law degree because the educational expenses were not required for the taxpayer to maintain his skills or to retain his position because he was not yet an admitted as an attorney at the time he incurred the expenses.
Tracy argued that his situation was different because New York, where he passed the bar exam in 2014, allows foreign-trained lawyers to sit for the bar exam without completing a legal education program in the United States. Therefore, he contended, he was not entering into a new trade or business. The IRS and Tracy stipulated that Tracy met the minimum requirements of the legal profession in Germany. According to Tracy, his educational expenses were deductible under Code Sec. 162 as long as he was active in any trade or business.
The Tax Court upheld the IRS assessment and denied the legal expense deductions. According to the Tax Court, the fact that Tracy met the minimum requirements of the legal profession in Germany did not mean that he automatically qualified to be a legal professional in the United States. In New York, the court noted, foreign trained applicants may sit for the bar exam only if certain requirements are fulfilled. Because Tracy did not receive an LL.M. from an American Bar Association approved law school, he would be required to prove that his legal studies program was substantially equivalent in duration to the legal education provided by an American Bar Association approved law school in the United States, and in substantial compliance with the instructional and academic calendar requirements provided by New York. Additionally, the court said, Tracy would have to show that the law of Germany is based on principles of English common law and that his legal studies program was the substantial equivalent of the legal education provided by an American Bar Association approved law school in the United States. Because Tracy did not provide any evidence to show that these requirements had been met and that he was entitled to sit for the New York bar exam before he completed his J.D., the court found that Tracy had not established himself in the legal profession in the United States, and his educational expenses were incurred in association with entering into a new trade or business.
The court then addressed Tracy's argument that the educational expenses were deductible under Code Sec. 162 as long as he was active in any trade or business. The court noted that, while Tracy was a law student in 2010 and 2011 and was also involved with managing a residential building project, and he may have been involved in bringing a legal action under the False Claims Act, the record was unclear regarding when Tracy undertook these activities. Even assuming that he was involved in these activities during 2010 and 2011, the court found that Tracy did not show any connection between these activities and his legal education.
Finally, the Tax Court concluded that Tracy failed to show that he had a reasonable basis for deducting the expenses associated with his legal education. Thus, the court sustained the assessment by the IRS of the penalties under Code Sec. 6662.
For a discussion of the requirements to deduct educational expenses, see Parker Tax ¶85,110.
[Return to Table of Contents]
Partners' "Sweat Equity" Translated into Capital Gain, Not Ordinary Income
Although there was no formal partnership agreement between a partnership that managed oil and gas properties and the business that owned the properties, the eventual sale of the properties resulted in capital gain to the managing partnership because it invested "sweat equity" in the arrangement, increasing the value of the partnerships' capital. U.S. v. Stewart, 2015 PTC 294 (S.D. Tex. 2015).
In March of 2003, Hydrocarbon Capital, LLC bought a portfolio of oil and gas properties from Mirant Corporation. Because it was new to the industry, Hydrocarbon asked the five executives at Mirant, who managed the operation of the properties, to manage its wells. Those five individuals then founded Odyssey Capital Energy I, LP. David Stewart and Richard Plato were two of those people. Odyssey agreed with Hydrocarbon to manage exploration and production of the old Mirant properties. Odyssey operated the wells or worked with other operators. Hydrocarbon had to approve expenses, but Odyssey fully controlled operations.
The deal was structured so that Hydrocarbon lent Odyssey $6 million without recourse for working capital. When the assets were eventually sold, Odyssey had a 20 percent interest in the sales revenue after Hydrocarbon recouped its expenses, its investment plus a 10 percent return, and the loan. The Odyssey partners also agreed to limit the salaries they paid themselves. If Hydrocarbon did not profit, the partners earned nothing from the sale.
A little more than a year later, Hydrocarbon sold the portfolio. It recovered its expenses, its initial investment, its return on investment, and the loan. The remaining revenue was split with Odyssey and Odyssey's 20 percent interest was worth about $20 million.
When Odyssey filed its 2004 federal partnership return, it reported the $20 million as ordinary income. Each partner received a Schedule K-1 and Stewart and Plato reported their respective shares of the $20 million as ordinary income. Two years later, Odyssey determined that its income from the 2004 sale was long-term capital gains, not ordinary income. In 2007, Odyssey amended its 2004 return to report that income as capital gain income and issued amended K-1s to its partners. Stewart and Plato amended their individual returns accordingly and requested refunds from the IRS.
The IRS reviewed Odyssey's amended return and formally approved it in 2008. Steward and Plato received their refunds, as did two of the other partners. However, the IRS denied a fifth partner a refund, concluding that Odyssey's 20 percent interest was compensation for services and the partner's earnings should be taxed as ordinary income. The IRS then decided it had erred in approving the refunds for Stewart and Plato and sued them, demanding a return of the refunds. It could not sue the other two partners who received refunds because it was too late.
The IRS argued that there was no tax partnership between Odyssey and Hydrocarbon because their agreement disclaimed a partnership. Further, the IRS said that Hydrocarbon contributed and controlled the money, owned the assets, and Odyssey had no money at risk. According to the IRS, Odyssey was a contract employee that could not spend money or sell the assets without Hydrocarbon's approval and the parties did not have a joint name, did not jointly file a tax return, and did not maintain a single accounting ledger.
Additionally, the IRS said that because Odyssey did not ask for a formal adjustment, the IRS did not approve the new return, and the original return, with ordinary income, still controlled. Since the partners' returns conflicted with the original return, the IRS argued, the refund was incorrect.
A district court rejected the IRS's arguments and held that the income in question was capital gain income, not ordinary income, and Stewart and Plato were entitled to keep their refunds. Citing Haley v. Comm'r, 203 F.2d 815 (5th Cir. 1953), the court stated that tax partnerships do not depend on contract language; instead, they arise from the reality of relationships. Hydrocarbon encumbered its real-property interests when it granted Odyssey an interest in them, the court said. Although it was not a fee interest, it was an equitable one. Stewart and Plato risked money for that interest by accepting salaries that were lower than the market rate for their work. Many partnerships, the court noted, have a financial partner and an operating partner. According to the court, the arrangement between Hydrocarbon and Odyssey was no different than flipping a house. The gain realized through sweat equity, the appreciation in the value of the house by fixing it up, is a capital gain. In the same way, Odyssey's sweat (i.e., their management) increased the value of the capital (i.e., the portfolio of properties), the court said.
The court also agreed with Stewart and Plato that Odyssey's amended return complied substantially with the applicable requirements. A request for adjustment of a partnership return need not be on Form 8082, Notice of Inconsistent Treatment or Administrative Adjustment Request, as long as it substantially complies with the regulations, the court said. The IRS investigated the amended return and approved the return without adjustment. Thus, the court concluded, Stewart's and Plato's amended returns were correct.
For a discussion of the sale or exchange requirement for recognizing capital gains, see Parker Tax ¶111,113.
[Return to Table of Contents]
Taxpayer's Statute of Limitations Isn't Extended by Third Party's "Intent to Evade Tax"
The suspension of the three-year statute of limitations in Code Sec. 6501(c)(1) is only triggered by the intent of the taxpayer to evade tax and not the intent of a third party who is remotely connected with the relevant tax return. BASR Partnership v. U.S., 2015 PTC 263 (Fed. Cir. 2015).
Background
In 1999, the members of the Pettinati family were about to realize a large capital gain from the sale of their printing business. Before they consummated the sale, Erwin Mayer, a lawyer in the Chicago office of the now defunct law firm of Jenkens & Gilchrist, contacted the family and proposed a tax advantaged investment opportunity. This opportunity involved numerous transactions which ended with all the stock in the printing business being owned by a family partnership, BASR. The Pettinatis could then sell the printing business by directing BASR to sell its shares to the buyer. In addition to recommending the transactions, three attorneys at Jenkens & Gilchrist signed a tax opinion document attesting to the legitimacy of the transactions. Mayer characterized the transactions as a "tax advantaged investment opportunity." Finally, the Pettinatis received guidance on reporting these transactions on their 1999 tax returns in a manner that was consistent with the opinion letters.
The Pettinatis hired Malone & Bailey PLLC to prepare their tax returns. While Malone & Bailey had a long-standing relationship with the Pettinatis, it had no prior connection with Jenkens & Gilchrist. Malone considered the legal opinions provided to the Pettinati family when preparing the BASR and Pettinati tax returns. Ultimately, by creating the BASR partnership, the Pettinatis greatly reduced the tax liability arising from the sale of their printing business.
In 2010, the IRS issued a final partnership administrative adjustment (FPAA) to BASR for the tax returns that reflected the sale of the printing business. In the FPAA, the IRS explained that BASR lacked economic substance because its principal purpose was to reduce substantially the present value of its purported partners' aggregate federal tax liability. The IRS adjusted the tax effect of the printing business sale accordingly, significantly increasing the Pettinatis' tax liability for the 1999 tax returns. BASR filed an action in the Court of Federal Claims (Claims Court), arguing that the adjustments and increased tax liability in the FPAA were untimely under the three-year statute of limitations in Code Sec. 6229(a) and Code Sec. 6501(a).
Arguments before the Court of Federal Claims
As a general rule, Code Sec. 6501(a) provides that the IRS must assess additional taxes and penalties with respect to a taxpayer's tax return within three years after the return was filed. Code Sec. 6229(a) provides a similar rule with respect to assessing tax attributable to any partnership item. However, there are certain exceptions that may extend or suspend the three-year limitations period. Code Sec. 6501(c)(1) provides that, in the case of a false or fraudulent return with the intent to evade tax, the tax may be assessed at any time. Similarly, in Code Sec. 6229(c)(1), the statute remains open in the case of a partner who signed or participated directly or indirectly in the preparation of a partnership return which includes a false or fraudulent item.
Before the Claims Court, the IRS acknowledged the general limitations periods, but asserted that the limitations period remained open under Code Sec. 6501(c)(1) and Code Sec. 6229(c)(1) because the case involved a false or fraudulent return with the intent to evade tax. The IRS conceded that the Pettinatis themselves lacked the intent to evade tax and did not allege that the return preparers acted with intent to evade taxes or to have the Pettinatis evade taxes. The IRS asserted only that Mayer acted with the intent to evade tax when he conceived of and marketed the tax-advantaged investment structure. Contrary to the opinion letters supplied to the Pettinatis by Jenkins & Gilchrist, the IRS argued, Mayer knew these transactions were fraudulently designed to generate large noneconomic tax losses for wealthy taxpayers.
In reply, BASR argued that the three-year statute of limitations is suspended only when the taxpayer intended to evade tax and, therefore, Mayer's admitted fraud was insufficient and too remote to extend the statute with respect to the Pettinatis. Ultimately, the Claims Court agreed with BASR and the IRS appealed to the Federal Circuit.
Federal Circuit's Analysis
In its appeal, the IRS relied on the Tax Court's decision in Allen v. Comm'r, 128 T.C. 37 (2007) and the Second Circuit's decision in City Wide Transit, Inc. v. Comm'r, 2013 PTC 27 (2d Cir. 2013). In Allen, the court concluded that a tax preparer could supply the necessary intent to evade tax. In City Wide Transit, the court held that an accountant that filed fraudulent tax returns on behalf of a company, in order to embezzle money that the company otherwise owed the IRS, intentionally evaded that company's taxes, with the effect that the statute of limitations was indefinitely extended for the company. The IRS also stressed the Supreme Court's recognition, in Badaracco v. Comm'r, 464 U.S. 386 (1984), that "statutes of limitation sought to be applied to bar rights of the Government, must receive a strict construction in favor of the Government."
The Federal Circuit was asked to determine whether Code Sec. 6501(c)(1)'s suspension of the three-year statute of limitations is only triggered by the intent of the taxpayer, as urged by BASR, or whether, as the IRS maintained, the requisite intent can be that of a third-party who is more remotely connected with the relevant tax return.
The Federal Circuit affirmed the Claims Court and held that Code Sec. 6501(c)(1) suspends the three-year limitations period only when the IRS establishes that the taxpayer, and not a third party, acted with the intent to evade tax.
The court noted that Code Sec. 6501(c)(1) is not the only Code provision that deals with the consequences of intentional tax evasion. A survey by the court of Code sections dealing fraud-related provisions revealed, the court said, that those provisions contemplate fraud by the taxpayer, as opposed to by a person who merely contributed, albeit in a fraudulent way, to the filing of an inaccurate tax return.
Additionally, the court found the IRS's reliance on the cases cited to be misplaced. The Federal Circuit did not find the reasoning of the Tax Court in Allen to be persuasive, noting that the Tax Court conducted only a limited analysis of the text of Code Sec. 6501(c)(1). In City Wide, the court observed, the Second Circuit confronted only the issue of whether the person who prepared the tax returns acted with the intent to evade taxes. Contrary to the IRS's assertions, the court said, City Wide did not actually address the question of whether the tax preparer's intent was sufficient to trigger Code Sec. 6501(c)(1) and thus was not relevant to the instant inquiry. Finally, the court said that it did not read the Supreme Court's statement in Badaracco as requiring it to adopt the IRS's interpretation of the statute of limitations. In contrast to the present case, the court observed, there was no indication in Badaracco that the Court's interpretation was inconsistent or incoherent in the greater statutory scheme.
For a discussion of when the statute of limitations may be extended, see Parker Tax ¶260,130.
[Return to Table of Contents]
Ninth Circuit Denies Easement Deduction Where Mortgage on Property Was Not Subordinated to Easement
For a taxpayer to take a charitable deduction for the donation of a conservation easement, any mortgage on the property must be subordinated to the easement at the time of the donation. Minnick v. Comm'r, 2015 PTC 280 (9th Cir. 2015).
In 2005, Walter Minnick took out a $400,000 loan from a bank, secured by an undeveloped plot of land Minnick already owned in Idaho. Minnick intended to use the funds to develop that land. After Minnick received preliminary approval to develop parts of the land, the loan amount was increased to $1.5 million. Subsequently, in September 2006, Minnick received final approval of the development plans. Two days later, he donated to the Land Trust of Treasure Valley, a qualified organization, a conservation easement on parts of the land that would not be developed.
Minnick did not inform the bank of the easement. An appraiser hired by Minnick valued the easement at $941,000, and Minnick and his wife claimed a charitable deduction of approximately $390,000 on their 2006 tax return and carried over the remainder to their 2007 and 2008 returns. The IRS issued a notice of deficiency, disallowing the charitable contribution carryovers to 2007 and 2008. According to the IRS, the couple could not deduct the conservation easement as a gift because Minnick did not subordinate his rights in the property to the rights of the Land Trust of Treasure Valley to enforce the conservation purposes of the gift in perpetuity.
Under Code Sec. 170(h)(5)(A), a deduction for the donation of a conservation easement is allowed only if the easement's conservation purpose is protected in perpetuity. Reg. Sec. 1.170A-14(g)(2) interprets this provision to mean that, that when a piece of property is subject to a mortgage, no deduction is allowed unless the mortgagee subordinates its rights in the property to the right of the qualified organization to enforce the conservation purposes of the gift in perpetuity.
Minnick and his wife contested the IRS deficiency in Tax Court. In December 2012, the Tax Court, citing its recent decision in Mitchell v. Comm'r, 138 T.C. No. 16 (2012), affirmed the IRS's disallowance of the charitable deduction for 2007 and 2008 because of the couple's failure to ensure the subordination of the mortgage held by the bank at the time of the gift. Minnick and his wife appealed to the Ninth Circuit, arguing that the requirement to subordinate a mortgage need not be met at the time of the gift. While the appeal was pending, the Tenth Circuit affirmed the Tax Court's earlier decision on the issue in Mitchell v. Comm'r, 2015 PTC 1 (10th Cir. 2015).
The Ninth Circuit affirmed the Tax Court and held that Reg. Sec. 1.170A-14(g)(2) requires that a mortgage be subordinated at the time of the gift of an easement for the gift to be deductible. The court looked at whether the plain language of the regulation supported the Tax Court's interpretation. When the meaning of a regulation is clear, the court said, the regulation is enforced according to its plain meaning. The court found that the plain language of the regulation supported the Tax Court's interpretation because the regulation specifies that "no deduction will be permitted under this section for an interest in property which is subject to a mortgage unless the mortgagee subordinates its rights in the property." Strictly construed, the court said, this language makes clear that subordination is a prerequisite to allowing a deduction.
The Ninth Circuit noted that, in 2006, when Minnick and his wife made the donation and requested a deduction, there was no dispute that the bank had not subordinated its rights in the property. Thus, under the plain meaning of the regulation, the court said, no deduction is allowed. Further, the court found that the IRS's interpretation was reasonable and not plainly erroneous or inconsistent with the regulation.
The Ninth Circuit cited the Tenth Circuit's holding in Mitchell and said that, because a conservation easement subject to a prior mortgage obligation is at risk of extinguishment upon foreclosure, requiring subordination at the time of the donation is consistent with the Code's requirement that the conservation purpose be protected in perpetuity. An easement can hardly be said to be protected in perpetuity, the court observed, if it is subject to extinguishment at essentially any time by a mortgage holder who was not a party to, and indeed (as in the instant case) may not even have been aware of, the agreement between the taxpayers and a conservation trust.
For a discussion of the rules for deducting a conservation easement, see Parker Tax ¶84,155.
[Return to Table of Contents]
Abused Wife with Mental and Physical Health Issues Qualifies for Innocent Spouse Relief
Innocent spouse relief was appropriate where a taxpayer with mental and physical health issues suffered abuse at the hands of her husband and was afraid to question anything having to do with the tax return out of fear of retaliation. Hollimon v. Comm'r, T.C. Memo. 2015-157.
Candice Hollimon married Fadil Al Bakari in 2000. Hollimon is a respiratory care practitioner and struggles with bipolar disorder and diabetes. During their marriage. Hollimon and Al Bakari established Bay Area Staffing, which provided temporary staff to hospitals.
According to court records, Hollimon and Al Bakari's relationship has been rife with abuse perpetrated by both parties, and each of them has requested restraining orders against the other at various times. After one particular incident, Hollimon requested a restraining order against Al Bakari. That request was granted and, in 2010, the spouses separated and began living apart. Hollimon filed for divorce in August 2011.
In June 2011, while living apart, Hollimon and Al Bakari filed their 2009 joint income tax return. The return included a Schedule C, Profit or Loss From Business, related to Bay Area Staffing. Although the return showed a balance due, Hollimon and Al Bakari did not pay the amount and the IRS assessed a deficiency. Hollimon and Al Bakari agreed to the adjustments and signed the Form 870, Waiver of Restrictions on Assessment and Collection of Deficiency in Tax and Acceptance of Overassessment, consenting to the assessment of tax and additions to tax. Subsequently, Hollimon filed a Form 8857, Request for Innocent Spouse Relief, for 2009. Al Bakari later filed a notice of intervention, and the case went to the Tax Court. Before trial, the IRS conceded that Hollimon was entitled to innocent spouse relief under Code Sec. 6015(f), but Al Bakari continued to oppose relief.
According to Hollimon, she provided Al Bakari with her tax information and he prepared the return. She testified that because the restraining order was still in effect, she did not review the return. Instead, she gave Al Bakari permission to sign the return on her behalf. Hollimon also stated that she feared that questioning Al Bakari about the return could lead to additional abuse. Additionally, she said that she did not know that Al Bakari did not pay the full tax liability when the return was filed.
After considering the various factors for innocent spouse relief in Rev. Proc. 2013-34, the Tax Court found that Hollimon was entitled to relief under Code Sec. 6015(f). The record was clear, the court said, that the taxpayer suffered abuse at the hands of her husband and was afraid to question anything having to do with the tax return out of fear of retaliation. Additionally, the court noted that Hollimon was struggling with mental and physical health problems for many years, including the period when the return was filed and when the relief was requested, and this factor weighed in favor of relief. Of the other factors considered by the court, the factors were either neutral or weighed in Hollimon's favor.
For a discussion of innocent spouse relief, see Parker Tax ¶260,560.
[Return to Table of Contents]
Value of Identity Protection Services Excludable from Gross Income
The IRS has stated that it will 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 will also not require these amounts to be reported on an information return filed with respect to such individuals. Announcement 2015-22.
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.
The IRS notes that identity theft is a growing problem in the U.S. and has been the number one consumer complaint to the Federal Trade Commission for fifteen consecutive years. The Bureau of Justice Statistics estimates that 16.6 million people were victims of identity theft in 2012, the latest year for which data is available.
In response to a data breach of an organization's recordkeeping systems, the IRS said, 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.
The IRS has announced it will 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.
Additionally, the IRS will not require an employer providing identity protection services to employees whose personal information may have been compromised in a data breach of the employer's (or employer's agent or service provider's) recordkeeping system to include the value of the identity protection services in the employees' gross income and wages.
The IRS will also not require these amounts to be reported on an information return (such as Form W-2 or Form 1099-MISC) filed with respect to such individuals.
The IRS stated that the announcement does not apply to cash received in lieu of identity protection services, or to identity protection services received for reasons other than as a result of a data breach, such as identity protection services received in connection with an employee's compensation benefit package. The announcement also does not apply to proceeds received under an identity theft insurance policy, because such treatment is governed by existing law.
