Federal Tax Bulletin - Issue 78 - December 18, 2014

Tax Extenders Bill Passes Congress, President Expected to Sign into Law

On December 16, the Senate brought to an end this year's tax extenders drama, passing a bill that extends all but a few tax provisions that expired at the end of 2013 through the end the current year. The President is expected to sign the Tax Increase Prevention Act of 2014 (TIPA) into law later this week. H.R. 5771 (12/16/2014).

Tax Extender CLIENT LETTERS are available on Parker Tax Pro Library site ...  

Practice Aid: See ¶320,132 for a sample client letter explaining how TIPA applies to businesses, and ¶320,133 for a letter explaining how the law applies to individuals. Note that Parker's year-end tax planning letters have also been updated to reflect the new law. See ¶320,134 for the updated year-end letter for businesses, and ¶320,135 for updated letter for individuals.

TIPA extends retroactively for one year, through the end of 2014, virtually all of the tax breaks that had previously been temporarily extended by the American Taxpayer Relief Act of 2012 (ATRA). In addition to the extensions, TIPA corrects numerous technical and clerical errors in the tax code, as well as eliminating many superfluous provisions (known as "deadwood").

The following is an overview of the key provisions and extensions taxpayers should be aware of when filing their 2014 tax returns.

Individual Tax Extenders

TIPPA extends the following tax breaks for individuals through the end of 2014:

State and Local General Sales Taxes Deduction: Taxpayers can elect to deduct state and local general sales taxes, instead of state and local income taxes, as an itemized deduction on Schedule A (Form 1040), Itemized Deductions. The taxpayer may either deduct the actual amount of sales tax paid in the tax year, or, alternatively, an amount prescribed by the IRS. TIPA extends the availability of that election to tax years beginning before January 1, 2015. See Parker Tax ¶83,130.

Mortgage Insurance Premiums Treated as Qualified Residence Interest: Taxpayers can treat amounts paid during the year for qualified mortgage insurance as qualified residence interest. To qualify for this treatment, the insurance must be in connection with acquisition debt for a qualified residence, and the insurance contract must have been issued after 2006. This deduction phases out ratably for taxpayers with adjusted gross income of $100,000 to $110,000 (half those amounts for married taxpayers filing separately). TIPA extends this treatment to amounts paid or accrued before January 1, 2015. See Parker Tax ¶83,515.

Exclusion for Discharge of Qualified Principal Residence Indebtedness: Income from the discharge of qualified principal residence indebtedness is generally excludable from gross income. TIPA extends the exclusion to debt that is discharged before January 1, 2015. See Parker Tax ¶76,125.

Above-the-Line Deduction for Qualified Tuition and Related Expenses: Taxpayers with modified adjusted gross income within certain limits may deduct up to $4,000 of qualified education expenses paid during the year for themselves, their spouses, or their dependents. The maximum deduction is $4,000 for an individual whose adjusted gross income for the tax year does not exceed $65,000 ($130,000 in the case of a joint return), or $2,000 for other individuals whose adjusted gross income does not exceed $80,000 ($160,000 in the case of a joint return). For those with incomes above the maximum threshold, no deduction is allowed. TIPA extends the availability of the deduction to tax years beginning before January 1, 2015. See Parker Tax ¶80,145.

Tax-Free Distributions from IRA Plans for Charitable Purposes: A qualified charitable distribution from an individual's IRA is excluded from the individual's gross income. TIPA extends the exclusion from IRAs of individuals at least 70 1/2 years of age, up to $100,000 per taxpayer per year. TIPA extends the exclusion for qualifying distributions made before January 1, 2015. See Parker Tax ¶134,560.

Deduction for Certain Expenses of Elementary and Secondary School Teachers: Elementary and secondary school teachers can deduct from gross income up to $250 of qualified expenses they paid during the year. If spouses are filing jointly and both were eligible educators, the maximum deduction on the joint return is $500. However, neither spouse can deduct more than $250 of his or her qualified expenses. TIPA extends the deduction through tax years beginning before 2015. See Parker Tax ¶80,135.

Parity for Employer-Provided Mass Transit and Parking Benefits: The value of the qualified transportation benefits provided by an employer to an employee is excludable from the employee's gross income to the extent the value does not exceed certain dollar limitations. TIPA extends through 2014 the maximum monthly exclusion amount for transit passes and van pool benefits to $250 per month so that these transportation benefits match the exclusion for qualified parking benefits. See Parker Tax ¶76,125.

Contributions of Capital Gain Real Property Made for Conservation Purposes: An individual taxpayer's deduction for qualified conservation contributions is generally limited to 50 percent of the taxpayer's adjusted gross income (AGI), minus the taxpayer's deduction for all other charitable contributions. TIPA extends this deduction, and also extends the enhanced 100 percent deduction for certain individual and corporate farmers and ranchers for contributions of property used in agriculture or livestock production. These deductions are availabe for qualifying contributions made before January 1, 2015. A qualified conservation contribution is a contribution of a real property interest to a qualified organization, exclusively for conservation purposes. See Parker Tax ¶84,180.

Business Tax Extenders

TIPA extends forty-one tax relief provisions for businesses, including the research and development tax credit, bonus depreciation, and increased expensing limitations and the treatment of certain real property as Code Sec. 179 property. A rundown of the more important provision follows.

50 Percent Bonus Depreciation: Businesses can recover the cost of capital expenditures over time through depreciation. In 2012 and 2013, taxpayers were entitled to take 50 percent bonus depreciation for investments placed in service during those years. TIPA extends the 50 percent bonus depreciation provision for qualifying property purchased and placed in service before January 1, 2015 (before January 1, 2016, for certain longer-lived and transportation assets) and also allows taxpayers to elect to accelerate some AMT credits in lieu of taking the bonus depreciation.. The provision also continues a special accounting rule involving long-term contracts and a special rule for regulated utilities. See Parker Tax ¶94,120.

Increased Section 179 Expensing Limitations: TIPA extends the increased small business expensing limitation and phase-out amounts ($500,000 and $2 million respectively; without the extension the amounts would be $25,000 and $200,000, respectively). The special rules that allow expensing for computer software, qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property are also extended to purchases made prior to January 1, 2015. See Parker Tax ¶94,701.

Research Tax Credit: Taxpayers are allowed a credit for certain research expenses paid or incurred in a trade or business. The research tax credit, generally allows taxpayers a 20 percent credit for qualified research expenses or a 14 percent alternative simplified credit. TIPA extends this credit for research and experimental expenses incurred before January 1, 2015. See Parker Tax ¶104,900.

15-year Straight-Line Cost Recovery for Qualified Improvements: Qualified leasehold improvement, qualified restaurant buildings and improvements, and qualified retail improvements placed in service before January 1, 2012, were subject to special rules. Taxpayers could recover the cost of such assets over a 15-year period rather than the longer 39-year period they would otherwise be required to use. TIPA extends the 15-year recovery period for qualified leasehold improvements, qualified restaurant property, and qualified retail improvement property to property placed in service during 2014. See Parker Tax ¶94,315.

Exclusion of 100 Percent of Gain on Certain Small Business Stock: Generally, a taxpayer other than a corporation may exclude 50 of the gain from the sale of certain small business stock acquired at original issue and held for at least five years. However, TIPA extends a temporary exclusion, introduced by ATRA, of 100 percent of the gain on certain small business stock for non-corporate taxpayers to stock acquired before January 1, 2015, and held for more than five years. This provision also would extend the rule that eliminates such gain as an AMT preference item. See Parker Tax ¶116,165.

Reduction in S-corporation Built-In Gains Recognition Period: Generally, under Code Sec. 1374, a corporate-level tax, at the highest marginal rate applicable to corporations is imposed on an S corporation's net recognized built-in gain that arose before the conversion of the C corporation to an S corporation and is recognized by the S corporation during the recognition period, i.e., the 10-year period beginning with the first day of the first tax year for which the S election is in effect. However, TIPA extends, to sales of assets occurring prior to January 1, 2015, the rule reducing to five years (rather than ten years) the period for which an S corporation must hold its assets following conversion from a C corporation to avoid the tax on built-in gains. See Parker Tax ¶31,785

New Markets Tax Credit: TIPA authorizes the allocation of an additional $3.5 billion of new markets tax credits for 2014. The credit encourages taxpayers to make loans to, or invest in, businesses in low-income communities. See Parker Tax ¶106,201.

Work Opportunity Tax Credit: The work opportunity credit allows employers a 40 percent credit for qualified first-year wages paid or incurred during the tax year to individuals who are members of a targeted group of employees. TIPA extends through 2014 the work opportunity tax credit. See Parker Tax ¶104,501.

Basis Adjustment to Stock of S Corps Making Charitable Contributions of Property: The Pension Protection Act of 2006 amended Code Sec. 1367(a)(2) to provide that the decrease in shareholder basis under Code Sec. 1367(a)(2)(B) by reason of a charitable contribution of property is equal to the shareholder's pro rata share of the adjusted basis of such property. TIPA extends this rule for charitable contributions made before 2015. See Parker Tax ¶31,960.

TIPA also extends the following tax provisions through the end of 2014:

• Look-through treatment of payments between related controlled foreign corporations under foreign personal holding company rules.
• Temporary minimum low-income housing tax credit rate for non-Federally subsidized buildings.
• Military housing allowance exclusion for determining whether a tenant in certain counties is low-income.
• Indian employment tax credit.
• Railroad track maintenance credit.
• Mine rescue team training credit.
• Employer wage credit for employees who are active duty members of the uniformed services.
• Qualified zone academy bonds.
• Classification of certain race horses as 3-year property.
• 7-year recovery period for motorsports entertainment complexes.
• Accelerated depreciation for business property on an Indian reservation.
• Enhanced charitable deduction for contributions of food inventory.
• Election to expense mine safety equipment.
• Special expensing rules for certain film and television productions.
• Deduction allowable with respect to income attributable to domestic production activities in Puerto Rico.
• Modification of tax treatment of certain payments to controlling exempt organizations.
• Treatment of certain dividends of regulated investment companies.
• RIC qualified investment entity treatment under FIRPTA.
• Subpart F exception for active financing income.
• Look-through treatment of payments between related controlled foreign corporations under foreign personal holding company rules.
• Empowerment zone tax incentives.
• Temporary increase in limit on cover over of rum excise taxes to Puerto Rico and the Virgin Islands.
• American Samoa economic development credit.

Energy Tax Extenders

TIPA extends multiple tax incentives for alternative and renewable energy sources.

Credit for Nonbusiness Energy Property: Taxpayers can receive credits for purchases of nonbusiness energy property (a.k.a. residential energy credits). The provision allows a credit of 10 percent of the amount paid or incurred by the taxpayer for qualified energy improvements, up to $500. TIPA extends this credit to purchases made before January 1, 2015. See Parker Tax ¶101,505.

Credit for Energy-Efficient New Homes: Certain contractors are allowed a credit for constructed or manufactured qualifying energy efficient homes in the year such homes are sold or leased to other persons for use as a residence. The amount of this energy efficient home credit is $2,000 or $1,000, depending on whether the home is constructed or manufactured and on the energy saving standards satisfied. TIPA extends the tax credit through 2014for manufacturers of energy-efficient residential homes. See Parker Tax ¶107,801.

Incentives for Biodiesel and Renewable Diesel: The provision would extend through 2014 the $1.00 per gallon production tax credit for biodiesel, and the small agri-biodiesel producer credit of 10 cents per gallon. The provision also extends through 2014 the $1.00 per gallon production tax credit for diesel fuel created from biomass. See Parker Tax ¶104,725.

TIPA also extends the following energy tax provisions through the end of 2014:

• Second generation biofuel producer credit.
• Production credit for Indian coal facilities placed in service before 2009.
• Credits with respect to facilities producing energy from certain renewable resources.
• Special allowance for second generation biofuel plant property.
• Special rule for sales or dispositions to implement FERC or State electric restructuring policy for qualified electric utilities.
• Excise tax credits relating to certain fuels.

Extenders Relating to Multiemployer Defined Benefit Pension Plans

Automatic Extension of Amortization Periods: TIPA extends through 2015 the ability of multiemployer pension (ME) plans to take an additional five years to amortize funding shortfalls. The proposal was enacted in the Pension Protection Act of 2006 (PPA), but expires at the end of 2014. ME plans generally have 15 years to amortize shortfalls and can seek Treasury approval for an additional ten years. A plan receiving such Treasury approval may not combine the two extensions.

Shortfall Funding Method and Endangered and Critical Rules: TIPA extends through 2015 the special rules for three categories of severely underfunded ME plans. It also would extend through 2015 the ability of ME plans to generally start or stop using the shortfall funding method without obtaining approval from Treasury.

Technical Corrections and Deadwood Provisions

In addition to the tax extenders provisions, TIPA contains numerous corrections to various technical and clerical errors. These technical and clerical errors create confusion for taxpayers and complicate administration of the tax laws. Title II of TIPA the Tax Technical Corrections Act of 2014 would make technical and clerical corrections to recently enacted tax legislation, including the American Taxpayer Relief Act of 2012, the Creating Small Business Jobs Act of 2010, and the Economic Stimulus Act of 2008. Notably absent from the list of technical corrections is the Affordable Care Act (i.e., Obamacare). In general, the amendments made by these technical and clerical corrections would take effect as if included in the original legislation to which each amendment relates.

Under current law, there are numerous provisions that relate to past tax years (and generally are no longer applied in computing taxes for open tax years), involve situations that were narrowly defined and unlikely to recur, or otherwise have outlived their usefulness. These types of provisions are often referred to as "deadwood" provisions and TIPA would repeal these current-law deadwood provisions. This repeal generally would be effective on the date of enactment, although the tax treatment of any transaction occurring before that date, of any property acquired before that date, or of any item taken into account before that date, would not be affected.

Tax Breaks That Weren't Extended

While TIPA came close to providing a blanket extension of expiring tax breaks, not all expiring provisions were extended. Of the sixty tax preferences up for extension for the 2014 tax year, five failed to make the cut: (1) the health coverage tax credit for displaced workers and retirees, (2) the plug-in motorcycle tax credit, (3) the energy-efficient appliance credit, (4) New York Liberty Zone tax-exempt bond financing, and (5) partial expensing of refinery equipment.

Looking Ahead

Because TIPA only extends tax breaks through the end of 2014, the recently renewed provisions will expire again in two weeks. As it did a year ago, the White House is signaling that any extension of the tax breaks into 2015 will have to come within the context of broader tax reform. For his part, incoming Senate Finance Committee Chairman Orrin Hatch (R-Utah) has released an analysis by the Finance Committee Republican staff titled "Comprehensive Tax Reform for 2015 and Beyond."

Regardless of the legislative context, the one certainty is that Congress will have to revisit the extenders again next year, and taxpayers will spend much of 2015 guessing whether scores of credits, deductions, and exclusions will be available when the time come to file their returns.

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New Section 529A Provides Tax-Advantaged Savings Plans for Disabled Individuals

With strong bipartisan support, Congress passed the Achieving a Better Life Experience Act (ABLE) on December 16, providing a new type of tax-advantaged savings plan for disabled individuals. Dubbed "ABLE" plans, the new Code Sec. 529A plans are modeled off Code Sec. 529 Qualified Tuition Plans. H.R. 5771 (12/16/2014).

Contributions to 529A plans are not deductible, but qualified distributions (including distributions of earnings) are tax free. In addition to offering tax benefits, Code Sec. 529A plans provide a way for disabled individuals to accumulate and earn income on assets, within statutory limits, that otherwise might disqualify them from programs such as Supplemental Security Income and Medicaid.

The new rules go into effect for tax years beginning in 2015.

Background

An early version of the ABLE Act was introduced in 2006 by Representative Ander Crenshaw (R-Fl). Since that time, there have been several attempts to pass the bill amidst debate over the cost of the program. During the 112th Congress, ABLE was redrafted to mirror the rules for Code Sec. 529 qualified tuition plans. However, the session concluded early January 2013 with no action.

The bill was reintroduced in February of 2013 containing a series of offsets and compromises to encourage passage. Apparently the bill's backers finally found the right mix. ABLE passed the House as H.R. 647 on December 3, 2014 with overwhelming bipartisan support, and easily won passage in the Senate two weeks later after being tacked on to the tax extenders bill (H.R. 5771). President Obama is expected to sign it into law later this week, nearly eight years after its initial introduction.

Under the ABLE program, a 529A plan may be set up for any eligible state resident, who will generally be the only person allowed to take distributions from the account. 529A plans are established and maintained by the designated beneficiary's home state. A designated beneficiary is allowed limited control over investments, and may direct the investments of any contributions or earnings no more than twice per year.

Eligible Individuals

A 529A plan is established for the exclusive benefit of a designated beneficiary, who must be an "eligible individual". To qualify, an individual must have become blind or disabled before attaining age 26. Such blindness or disability must be evidenced by the individual having become entitled to receive Supplemental Security Income (SSI) or Social Security Disability Insurance (SSDI), or by providing a disability certification (including a signed diagnosis by a physician), establishing that "the individual has a medically determinable physical or mental impairment, which results in marked and severe functional limitations, and which can be expected to result in death or which has lasted or can be expected to last for a continuous period of not less than 12 months, or is blind."

In contrast to qualified tuition plans, only one 529A plan is permitted per beneficiary. Any accounts subsequently established for that beneficiary will not be treated as a 529A plan (Code Sec. 529A(c)(4)). Additionally, the beneficiary must be a resident of the state that established the account.

Tax Treatment of Contributions

The contributions made to a 529A plans are not deductible. The only limit on contributions is that plans are not permitted to accept additional contributions after the account value reaches the limit set by the state for Section 529 Qualified Tuition Plans (Code. Sec. 529A(b)(6)). These limits presently range from a low of $260,000 for the District of Columbia to high of $452,210 for Pennsylvania. There is no limit on the amount of an individual contribution to a 529A plan, other than that a contribution cannot push the account value above the state maximum.

Observation: In contrast to 529 plans which are marketed across state lines, states can only offer 529A plans to individuals who reside in the state. Thus, contribution limits will be tied to the limits imposed by the designated beneficiary's home state.

Practice Tip: Any contribution to a 529A plan is treated as a completed gift to the plan's designated beneficiary. In some situations, a taxpayer's desire to stay within the gift tax annual exclusion amount may effectively limit the amount of a contribution. See the section on "Estate and Gift Tax Treatment" below.

The 529A plan itself is generally exempt from tax. However, like other tax-exempt organizations, a 529A plan is subject to the taxes imposed by Code Sec. 511 on its unrelated business income (Code Sec. 529A(a)).

Tax Treatment of Distributions

Generally, a distribution from a 529A plan to a designated beneficiary is not includible in the gross income of either the beneficiary or the taxpayer(s) who made contributions. However, if the total 529A plan distributions to a designated beneficiary exceed the beneficiary's qualified disability expenses for the year, a portion of those distributions is taxable to the beneficiary (Code Sec. 529A(c)(1)(B)). An additional 10 percent penalty tax also generally applies to a taxable distribution from a 529A plan (Code Sec. 529A(c)(3)(A); see exceptions below).

"Qualified disability expenses" means any expenses related to the eligible individual's blindness or disability, including:

(1) education,

(2) housing,

(3) transportation,

(4) employment training and support,

(5) assistive technology and personal support services,

(6) health, prevention and wellness,

(7) financial management and administrative services,

(8) legal fees,

(9) expenses for oversight and monitoring,

(10) funeral and burial expenses, and

(11) other expenses as may be provided in IRS regulations

To determine the taxable part of the total 529A distributions for a year, the portion of those distributions attributable to earnings is multiplied by a fraction, the numerator of which is the amount by which the total 529A plan distributions exceed the disability expenses and the denominator of which is the amount of the total 529A plan distributions (Code Sec. 529A(c)(1)(B)(ii)).

Ten Percent Penalty Tax: In addition to income tax, a 10 percent penalty tax generally applies to taxable distributions from a 529A plan. Exceptions apply to: (1) distributions made to upon the death of the designated beneficiary, and (2) distributions made to reverse excess contributions, provided the distribution is made by the due date of the return for the tax year to which the excess contribution relates.

Rollovers and Beneficiary Changes

An amount that is distributed from a 529A plan is not taxable if, within 60 days of the distribution, it is rolled over to another 529A plan for the benefit of the same designated beneficiary or for the benefit of a member of the beneficiary's family who is an eligible individual. In the case of a rollover for the benefit of the same designated beneficiary, only one such tax-free rollover is allowed during any 12-month period (Code Sec. 529A(c)(1)(C)(i)).

There are no tax consequences when the designated beneficiary of a 529A is changed from one family member to another family member who is an eligible individual. For this purpose, a family member of a designated beneficiary includes a brother, sister, stepbrother, or stepsister.

Observation: The definition of a "family member" under Code Sec. 529A is considerably narrower than the definition under Code Sec. 529 plans. When combined with the requirement that a newly designated beneficiary must also be an eligible individual (i.e. someone who was disabled or blind by age 26), many families may find that making a tax-free rollover to a new designated beneficiary is not an option.

Estate and Gift Tax Treatment

Any contribution to a 529A plan on behalf of any designated beneficiary is treated as a completed gift to the beneficiary that is not a future interest in property. Thus, contributions to a 529A plan qualify for the Code Sec. 2503(b)(1) gift tax annual exclusion (Code Sec. 529A((c)(2)).

Even if funds contributed to a 529A plan are intended to be eventually be used to pay medical or educational expenses, such contributions are not treated as qualified transfers under Code Sec. 2503(e) (which excludes transfers for educational expenses or medical expenses from gift taxation). Code Sec. 529A(c)(2).

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Tax Extender Bill Leaves Five Tax Breaks in the Dust

While the Tax Increase Prevention Act of 2014 (TIPA) is widely seen as a blanket one-year extension of expiring tax breaks, not all expiring provisions were extended. Of the sixty tax preferences up for extension for the 2014 tax year, five failed to make the cut: (1) the health coverage tax credit for displaced workers and retirees, (2) the plug-in motorcycle tax credit, (3) the energy-efficient appliance credit, (4) New York Liberty Zone tax-exempt bond financing, and (5) partial expensing of refinery equipment. H.R. 5771 (12/16/2014).

The following is a recap of the five forlorn provisions, all of which expired on December 31, 2013.

Health coverage tax credit (HCTC) for displaced workers and retirees: The Code Sec. 35 health coverage tax credit permitted certain displaced workers and retirees to pay only a portion of their qualified health insurance. Eligible workers included those receiving trade readjustment allowances under the Trade Adjustment Assistance program. Retirees (age 55 or older) receiving benefits from the Pension Benefit Guaranty Corporation were also eligible. Unlike the other four expiring provisions, this one was actually targeted for extinction. The 2013 expiration date was appended in 2011 by Pub. L. 112-40; the health coverage tax credit was originally enacted by the Trade Act of 2002 without a sunset provision.

Plug-in motorcycle tax credit: Often referred to as the "plug-in motorcycle credit", the Code Sec. 30D(g) credit applied to highway-capable plug-in two-wheeled and three-wheeled vehicles. The plug-in motorcycle credit bears the distinction of being the only entirely new tax break introduced by American Taxpayer Relief Act of 2012 (ATRA). The omission of the popular new credit from TIPA was a shock to many. House Ways and Means Chairman Dave Camp, (R-Mich) has indicated that the omission was an accidental oversight as a result of the last minute push to finalize the legislation.

Energy-efficient appliance tax credit: This credit under Code Sec.45M allowed U.S.-based manufacturers of energy efficient dishwashers, clothes washers, and refrigerators a credit equal to the sum of the credit amounts figured separately for each type of appliance produced during the calendar year ending with or within its tax year. Originally enacted as part of the Energy Policy Act of 2005, the tax break had previously been extended three times, most recently by ATRA.

New York Liberty Zone tax-exempt bond financing: In the wake of the 9/11 tragedy, the Job Creation and Worker Assistance Act of 2002 provided for the treatment of qualified New York Liberty Zone bonds as tax-exempt facility bonds. The deadline for issuing these tax-preferred bonds had been extended three times, most recently by ATRA.

Partial expensing of refinery equipment: This provision under Code Sec. 179C allowed taxpayers to elect to expense 50 percent of the cost of certain refinery equipment placed in service prior to January 1, 2014. To qualify for this incentive, a binding construction contract must have been in place by January 1, 2010. Originally enacted as part of the Energy Policy Act of 2005, the tax break had previously been extended by the Emergency Economic Stabilization Act of 2008.

Because these five provisions were not extended by TIPA, the tax breaks will not be available for taxpayers filing their 2014 tax returns. Whether Congress resuscitates the Code Sec. 30A(g) plug-in motorcycle credit, which appears to have expired because of an error, remains to be seen.

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Ninth Circuit Rejects Valuation of Partnership Interest Based on Hypothetical Asset Sale

The Ninth Circuit rejected the Tax Court's valuation, based on a hypothetical sale of the partnership's assets, of a decedent's interest in a limited partnership. The court concluded that such a sale was based on imaginary scenarios that were not reasonably probable to occur. Est. of Giustina v. Comm'r, 2014 PTC 587 (9th Cir. 12/5/14).

Natale Giustina was the trustee of the N.B. Giustina Revocable Trust. The trust owned a 41.128 percent limited partner interest in Giustina Land & Timber Co. Limited Partnership. Giustina died in August of 2005, survived by his spouse and his three children. The limited partnership interest was subject to a buy-sell agreement which greatly restricted the ability of the estate or the heirs to sell the interest to anyone outside of a small family ownership group.

On the estate tax return, the value of his limited partner interest was reported to be $12,678,117. In April of 2009, the IRS issued a notice of deficiency determining the value of the limited partner interest to be $35,710,000, and assessed a multi-million dollar deficiency. The estate challenged the IRS' valuation in the Tax Court.

The Tax Court examined the methods employed by each party's expert witnesses. After ruling out several valuation methods as inappropriate, the court decided to give full weight to two methods: (1) the cashflow method and (2) the asset method. The cashflow method was based upon how much cash the partnership would be expected to earn if it had continued its ongoing forestry operations. The asset method was based upon the value of the partnership's assets if they were sold. Application of the asset method resulted in a valuation roughly 50% greater than the one determined by the cashflow method.

The Tax Court concluded that there was a 25 percent likelihood of liquidation of the partnership and therefore gave a 25 percent weight to the asset method valuation and a 75 percent weight to the cashflow method valuation. Applying these factors, the court arrived at a weighted valuation of the limited partnership interest of $27,454,115.

Dissatisfied with the Tax Court's valuation, the executor appealed to the Ninth Circuit, which reviewed the Tax Court's valuation for clear error.

Generally, the value of all property included in a decedent's gross estate is the property's fair market value on the date of the decedent's death (Code Sec. 2031(a)). The fair market value of any interest of a decedent in a business is the net amount that a willing buyer would pay for the interest to a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts (Reg. Sec. 20.2031-3).

Appraisers rely on several different approaches in valuing partnership interests including the cash flow method, based upon how much cash the partnership would be expected to earn if it had continued its ongoing operations, and the asset value method, based upon the value of the partnership's assets if they were sold.

The Ninth Circuit concluded that the Tax Court had clearly erred in assigning any weight to the asset method valuation methods. The Circuit Court noted that, although the Tax Court recognized that the owner of the limited interest could not unilaterally force liquidation, it had concluded that the owner of that interest could form a voting bloc with other limited partners to force liquidation. The Tax Court proceeded to assign a 25 percent probability to this occurrence and weighted its valuation accordingly.

The Ninth Circuit determined the Tax Court's conclusion was contrary to the evidence in the record. In order for liquidation to occur, the court noted, it must be assumed that (1) a hypothetical buyer would somehow obtain admission as a limited partner from the general partners, who had repeatedly emphasized the importance they placed upon continued operation of the partnership; (2) the buyer would then turn around and seek dissolution of the partnership or removal of the general partners who just approved his admission to the partnership; and (3) the buyer would manage to convince at least two other limited partners to go along, despite the fact that no limited partner ever asked or ever discussed the sale of an interest. Alternatively, the court said, for liquidation to be probable, it must be assumed that the existing limited partners, or their heirs or assigns, owning two-thirds of the partnership, would seek dissolution.

Referencing a similar situation in Estate of Simplot v. Commissioner, 249 F.3d 1191 (9th Cir. 2001), the Circuit Court stated the Tax Court had engaged in "imaginary scenarios as to who a purchaser might be, how long the purchaser would be willing to wait without any return on his investment, and what combinations the purchaser might be able to effect" with the existing partners. The court also applied Olson v. United States, 292 U.S. 246 (1934), which states that elements affecting value that depend upon events or combinations of occurrences which, while within the realm of possibility, are not shown to be reasonably probable, should be excluded from consideration when estimating market value.

The Ninth Circuit therefore concluded that it was clear error to assign any weight to a valuation based on a hypothetical sale of the partnership's assets, and remanded the case for recalculation of the estate's value based on the partnership's value as a going concern.

For a discussion of estate tax valuation, see Parker Tax ¶ 224,700.

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IRS: Reflective Roof Installed in Connection with Solar Panels Qualifies for Energy Credit

The IRS ruled that a reflective roof, when installed in connection with a bifacial paneled solar power system, constituted energy property under Code Sec. 48 to the extent that the cost of the reflective roofing exceeded the cost of reroofing the Taxpayer's building with a non-reflective roof. PLR 201450013 (12/12/14).

Background

Taxpayer, a privately held limited liability company, considered purchasing a rooftop solar photovoltaic generation system (the system) to help defray energy costs. The system included bifacial panels, able to generate electrical energy using not only direct sunlight that strikes the panels from above, but also sunlight that is reflected from the surface on which the panels are installed. It was recommended that the panels be installed over highly reflective roof membranes in order to generate a significant amount of electrical energy through reflected sunlight.

In connection with the installation of the solar panel system, Taxpayer anticipated installing a reflective membrane over the portion of the roof located beneath the system and requested a ruling that the reflective roof, when installed in connection with the system, constitutes energy property under Code Sec. 48.

Analysis  

 

Code Sec. 48(a)(3)(A)(i) provides that energy property includes any equipment which uses solar energy to generate electricity.

Reg. Sec. 1.48-9(d)(1) provides that energy property includes solar energy property, however, Reg. Sec. 1.48-9(d)(2) specifically excludes from qualification as energy property "passive solar systems" based on the use of conductive, convective, or radiant energy transfer. Reg. Sec. 1.48-9(d)(3) provides, in part, that solar energy property includes equipment that uses solar energy to generate electricity, and includes storage devices, power conditioning equipment, transfer equipment, and parts related to the functioning of those items.

The IRS stated that the reflective roof satisfies the definition of energy property under Reg. Secs. 1.48-9(d)(1) and 1.48-9(d)(3) when installed in connection with the system. Because the unique double-sided panels generate electricity using sunlight reflected from the surface on which the panels rest, the reflective roof helped enable the system to generate significant amounts of electricity, and was part of the equipment and materials using solar energy to directly generate electricity. Thus the IRS ruled it constituted energy property under Code Sec. 48 to the extent that the cost of the reflective roofing exceeded the cost of reroofing the Taxpayer's building with a non-reflective roof.

For a discussion of energy credits, see Parker Tax ¶104,315

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Absentee Owner-President of Corporation Was "Responsible Person" For Payroll Taxes

An absentee owner-president of a tractor dealership was unable to escape liability for payroll taxes his unscrupulous manager failed to remit as his technical authority over the company made him a "responsible person". Shore v. U.S., 2014 PTC 586 (D. Idaho 12/4/14).

In 2004, William Shore started Bear River Equipment, Inc. (BRE), a tractor dealership, and hired Tom Lewis to manage every aspect of the business, with the intent that Lewis would one day purchase BRE. Lewis managed the day to day operations of BRE, including financial management, purchasing of product lines, employee management, and paying BRE's bills.

Lewis was also responsible for submitting all tax forms and paying the payroll taxes. Shore treated BRE as if it belonged to Lewis, acting primarily as an investor and playing a limited role in operations. However, Shore also signed the Articles of Incorporation as President of BRE, signed contracts on behalf of BRE, personally guaranteed an operating line of credit, and was the sole shareholder. Shore also discussed operations with Lewis twice a month, reviewed BRE balance sheets and annual statements, and had authority to sign BRE checks.

In 2005, Shore became aware of unpaid payroll obligations and directed Lewis to pay them. In 2007, Shore discovered that Lewis had embezzled from BRE, stolen assets, and failed to pay creditors or pay BREs taxes for 2006 and 2007. Shore then fired Lewis, took over management of BRE, paid more than $120,000 to unsecured creditors, and ultimately decided to close the company. Shore paid $101,583.09 in trust fund recovery penalties to the United States and then sought a refund of the penalty amount, claiming he was not liable for the payments because he was not a "responsible party" during Lewis's tenure as manager and his conduct was not "willful" as he did not know about BRE's tax liability at the time BRE failed to remit payroll taxes in 2006 and 2007.

Generally, employers must withhold federal income and social security taxes from the wages of their employees. Code Secs. 3102(a) and 2402(a). Under Code Sec. 6672(a), the IRS may assess a 100 percent penalty on responsible persons who willfully fail to collect, account for, and pay over the taxes to the United States. In order for the United States to assess the penalty, two requirements must be met:  

(1) the party assessed must be a "responsible person," required to "collect, truthfully account for and pay over the tax; and  

(2) the party assessed must have "willfully refused to pay the tax."

The court ruled Shore was liable for the unpaid withholding taxes as a "responsible person" under Code Sec. 6672, and denied the refund request. The court found Shore was a "responsible person" because he had the authority to conduct the financial affairs of the corporation, and by extension, had the authority to ensure withheld employment taxes were paid. The court pointed to his title, full stock ownership, check writing authority, and ability to force Lewis out of the business as evidence of his duty and authority. The court also emphasized Shore's previous actions to ensure payroll taxes were paid in 2005 after he learned they had not been remitted and the fact Shore ultimately took complete control over BRE upon learning of the tax liability.

The court also found Shore acted "willfully" based on his awareness that withholding taxes had gone unpaid and breached his duty under Code Sec. 6672 by using after-acquired money to pay debts, wages and expenses to keep BRE running rather than paying the back taxes he owed to the IRS.

The court also denied Shore relief under the narrow Slodov exception, which allows new managers to escape liability for actions taken by prior management. The court noted the exception did not apply since Shore was a "responsible person" at all times.

For more information on Responsible Persons, see Parker Tax ¶ 210, 108;

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IRS Issues 2015 Standard Mileage Rates for Business, Medical and Moving

The IRS issued the 2015 optional standard mileage rates used to calculate the deductible costs of operating an automobile for business, charitable, medical or moving purposes. Notice 2014-79.

Beginning on January 1, 2015, the standard mileage rates for the use of a car (also vans, pickups or panel trucks) will be:

• 57.5 cents per mile for business miles driven;
• 23 cents per mile driven for medical or moving purposes
• 14 cents per mile driven in service of charitable organizations

While the business rate increased by 1.5 cents, the medical, and moving expense rates decreased one-half cent from the 2014 rates. The charitable rate is a fixed statutory amount that does not change from year to year.

The standard mileage rate for business is based on an annual study of the fixed and variable costs of operating an automobile. The rate for medical and moving purposes is based on the variable costs.

Taxpayers have the option of calculating the actual costs of using their vehicle rather than using the standard mileage rates. A taxpayer may not use the business standard mileage rate for a vehicle after using any depreciation method under the Modified Accelerated Cost Recovery System (MACRS) or after claiming a Code Sec. 179 deduction for that vehicle. In addition, the business standard mileage rate cannot be used for more than four vehicles used simultaneously.

These and other requirements for a taxpayer to use a standard mileage rate to calculate the amount of a deductible business, moving, medical, or charitable expense are in Rev. Proc. 2010-51. Notice 2014-79 also contains the amount a taxpayer must use in calculating reductions to basis for depreciation taken under the business standard mileage rate and the maximum standard automobile cost that a taxpayer may use in computing the allowance under a fixed and variable rate plan.

For a discussion of the rules relating to the use of the standard mileage rate, see Parker Tax ¶91,110.