Federal Tax Bulletin - Issue 77 - December 5, 2014

House Approves Tax Extenders Bill, Possibly Breaking Year-Long Impasse

On December 3, 2014, the House of Representatives made the latest move in this year's tax extenders drama, passing a bill that would extend numerous expired tax provisions through the end of 2014. H.R. 5771 (12/3/2014).

Titled the "Tax Increase Prevention Act of 2014", the House bill would extend 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, H.R. 5771 corrects numerous technical and clerical errors in the tax code, as well as eliminating many superfluous provisions (known as "deadwood").

To become law, H.R. 5771 still needs to pass the Senate and be signed by the President.

The following is a summary of the House bill's key provisions and a brief recap of the Senate and White House reactions. For a complete synopsis of the bill, see the Ways and Means Committee Tax Staff Summary of H.R. 5771 (available on the Parker Tax Pro Library site).

Individual Tax Extenders

H.R. 5771 would extend eight tax relief provisions for individuals through the end of 2104. Of the more notable provisions:

Section 102 of H.R. 5771 would extend the exclusion from gross income from the discharge of qualified principal residence indebtedness.

Section 104 of the bill would continue the treatment of qualified mortgage insurance premiums as interest for purposes of the mortgage interest deduction. This deduction phases out ratably for taxpayers with adjusted gross income between $100,000 and $110,000 (half those amounts for married taxpayers filing separately).

Section 108 would extend the exclusion from gross income of qualified charitable distributions from IRAs of individuals at least 70 1/2 years of age. The exclusion is for up to $100,000 per taxpayer per year.

H.R. 5771 would also extend the following tax breaks through the end of 2014:

(1) Above-the-line deduction for higher education expenses.

(2) Deduction for expenses of elementary and secondary school teachers.

(3) Increased exclusion from income for employer-provided mass transit and parking benefits.

(4) Deduction for state and local general sales taxes.

(5) Special rules for contributions of capital gain real property made for conservation purposes.

Business Tax Extenders

H.R. 5771 would extend 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.

Section 111 of H.R. 5771 would extend the research and development tax credit, which generally allows taxpayers a 20 percent credit for qualified research expenses or a 14 percent alternative simplified credit. Although this provision would reduce revenues by $7.629 billion, it comes with strong support from both sides of the aisle.

Section 125 of the bill would extend 50 percent bonus depreciation to property acquired and placed in service during 2014 (2015 for certain property with a longer production period). This provision would continue to allow taxpayers to elect to accelerate the use of AMT credits in lieu of bonus depreciation under special rules for property placed in service during 2014. The provision would also continue a special accounting rule involving long-term contracts and a special rule for regulated utilities.

Section 127 would extend 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 also would be extended through 2014.

Other notable tax breaks that would be extended through the end of 2014 include:

(1) New markets tax credit.

(2) Work opportunity tax credit.

(3) 15-year straight-line cost recovery for qualified leasehold improvements, qualified restaurant buildings and improvements, and qualified retail improvements.

(4) Enhanced charitable deduction for contributions of food inventory.

(5) Look-through treatment of payments between related controlled foreign corporations under foreign personal holding company rules.

(6) Temporary exclusion of 100 percent of gain on certain small business stock.

(7) Reduction in S-corporation recognition period for built-in gains

Energy Tax Extenders

H.R. 5771 also would extend multiple tax incentives for alternative and renewable energy sources, including (1) credits for nonbusiness energy property, (2) an extension of the second generation biofuel producer credit, (3) credits for facilities producing energy from certain renewable resources including wind power, (4) credits for energy-efficient new homes, and (5) deductions for energy efficient commercial buildings.

Section 151 of the House bill would extend the credit 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.

Section 156 of the bill would extend the tax credit for manufacturers of energy-efficient residential homes. An eligible contractor may claim a tax credit of $1,000 or $2,000 for the construction or manufacture of a new energy efficient home that meets qualifying criteria.

Technical Corrections and Deadwood Provisions

In addition to the tax extenders provisions, H.R. 5771 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 H.R. 5771 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 H.R. 5771 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.

Senate and White House Reactions

For a fairly tame piece of legislation that passed the House with overwhelming bipartisan support, H.R. 5771 received a surprisingly vitriolic initial response from the Senate, which had stalled on its own tax extenders bill earlier this year.

The Expiring Provisions Improvement Reform and Efficiency (EXPIRE) Act of 2014, which would have extended tax breaks for two years, was passed by the Senate Finance Committee but was blocked when it reached the Senate floor in May. Aside from the two-year time frame, the Senate bill is nearly identical in substance to the House bill.

Despite members' dissatisfaction with the House version, it appears likely that the Senate will vote to pass the year-long extension. A top Senate Democrat suggested that they may have little alternative but to accept the House's plan, as time is running out and a mindset that one year is better than none is setting in. According to Treasury Secretary Jack Lew, the Obama administration is open to the short term deal.

If the Senate does follow the House and passes the one-year bill and the President signs it into law, Congress will have set itself up to revisit the extenders again in 2015.

[Return to Table of Contents]

Construction Company Can Deduct Motocross Racing Expenses of Owner's Son

A construction company's outlays to sponsor the motocross racing activities of the owner's son were valid promotional expenditures, deductible as ordinary and necessary business expenses. Evans v. Comm'r, T.C. Memo 2014-237.

Background

Dave Evans Construction (DEC) is a construction company based in Boise, Idaho, owned and operated by William Evans. DEC develops land and constructs residential homes and commercial buildings in the Boise area. The company, which is not licensed to operate in any state other than Idaho, had gross revenues of over $16.2 million in 2006 and over $16.7 million in 2007. DEC was operated as a sole proprietorship through mid-2006 and as an S corporation thereafter.

Evans' son Ben is a talented motocross racer who has been competing since the age of seven. In 2005, Ben's racing career took off as he competed in nationally televised races and was featured in various motocross magazines. Sponsors, including industry leaders such as American Honda, began coming forward to support him. Realizing that his teenage son's talent and "star power" might help to boost DEC's business, Evans consulted with his CPA, who advised him that supporting Ben's motocross racing could be a valid promotional activity for DEC. The company subsequently became one of Ben's sponsors and DECs logos were placed prominently on Ben's motorcycles, trailer, and promotional posters.

In 2006 and 2007 DEC incurred motocross-racing-related expenses (excluding depreciation and Code Sec. 179 expenses) totaling at least $86,619 and $74,579, respectively. These expenses consisted mostly of payments for motorcycles, parts, equipment, racing fees, membership fees, fuel, and food. In addition, DEC claimed depreciation and Code Sec. 179 expenses for three capital assets purchased for the motocross activity: a motorhome and two trailers.

Following a 2007 win at Loretta Lynn, a premiere title in the national amateur racing circuit, Ben began racing as a professional, and DEC's sponsorship of his racing activities came to an end.

Analysis

The main issue before for the Tax Court was whether DEC's outlays on Ben's motocross racing activities were ordinary and necessary business expenses deductible under Code Sec. 162.

Under Reg. Sec. 1.162-1(a), for an expenditure to be an ordinary and necessary business expense, the taxpayer must show a bona fide business purpose for the expenditure and a proximate relationship between the expenditure and the taxpayer's business. As explained in Welch v. Helvering, 290 U.S. at 113, to be "necessary" within the meaning of section 162, an expense needs to be "appropriate and helpful" to the taxpayer's business. The requirement that an expense be "ordinary" connotes that "the transaction which gives rise to it must be of common or frequent occurrence in the type of business involved."

The Tax Court previously found, in Boomershine v. Comm'r, T.C. Memo. 1987-384, a proximate relationship between car racing activities undertaken for promotional purposes and businesses engaged in construction.

The IRS argued there was no proximate relationship between the motocross racing activity and DEC's construction business. Seeking to distinguish the current case, the IRS argued that: (1) the motocross racing activity expenses were actually personal expenses, (2) most of Ben's races took place outside of DEC's operating area, and (3) DEC failed to show that the motocross racing activity brought in new customers.

To support its claim that Ben's motocross racing expenses were personal in nature, the IRS pointed out that the Evans had supported all of their five children in motorcycle racing pursuits. The Tax Court rejected the arguments, observing that the taxpayers had deducted expenses only for Ben's activity because he was the only one of their children to attain a level of celebrity that held promotional value to DEC. Moreover, the taxpayers made the decision to treat Ben's racing activity as a form of promotion for DEC's business after consulting with their CPA and reasonably calculating that it would be beneficial to the company. The court noted that DEC was not the only company to capitalize on Ben's celebrity: Ben had a number of other corporate sponsors including Western Power Sports, Carl's Cycle Sales, American Honda, all leading companies in the sport.

The IRS also argued that the racing activity's promotional value was virtually nonexistent because most of Ben's races took place outside of the Boise area whereas DEC performs work only in Idaho. The Tax Court disagreed, citing its own precedent in Brallier v. Comm'r, T.C. Memo. 1986-42. The court pointed out that Ben's increasing national stature, fueled by his participation in races on the national circuit, served to improve his fame and name recognition locally.

Finally, the IRS argued that the taxpayers had failed to prove that the motocross racing activity brought in new customers and was therefore was not a valid promotional activity. The court rejected this argument as well, concluding that: (1) the taxpayers provided credible evidence that sponsoring Ben's motocross racing activity did help DEC to attract business; (2) the development of business relationships resulting from the sponsorship benefited DEC's bottom line; and (3) it mattered not whether benefits to DEC came in the form of deals with subcontractors and investors or from increased sales.

Thus, the Tax Court concluded that DEC's outlay's on Ben's motocross racing activities were ordinary and necessary business expenses, deductible under Code Sec. 162.

[Return to Table of Contents]

Tax Court Erred in Treating Sale of Interest in Litigation as Ordinary Income

The Eleventh Circuit reversed the Tax Court, holding that a taxpayer's income from the sale of his interest in the outcome of a lawsuit was capital gain not ordinary income. Long v. Comm'r, 2014 PTC 577 (11th Cir. 2014).

Background

From 1994 to 2006, Philip Long owned and operated Las Olas Tower Company, Inc. (LOTC) as a sole proprietor. LOTC was created to design and build a luxury high-rise condominium called the Las Olas Tower on property owned by the Las Olas Riverside Hotel (LORH). To facilitate the building of the condominium, Long formed Alhambra Joint Ventures (AJV) with Steelervest, Inc. In November 2001, Steelervest purchased Long's interest in AJV (the AJV Agreement).

In 2002, Long, negotiating on behalf of LOTC, entered into an agreement with LORH (the Riverside Agreement) whereby LOTC agreed to buy land owned by LORH for $8,282,800 in order to build the condominium. LORH subsequently terminated the contract unilaterally. In March 2004, Long filed suit in Florida state court against LORH for specific performance of the contract and other damages. Long won at trial, and in November 2005, the state court ordered LORH to honor the Riverside Agreement and proceed with the sale of the land to LOTC. LORH appealed the judgment.

In August 2006, during the appeals process for the Riverside Agreement litigation, Steelervest and Long renegotiated the terms of the AJV Agreement, and, in a new agreement (the Amended AJV Agreement), Long agreed to pay Steelervest fifty percent of the first $1.75 million of monies received by Long as a result of the Riverside Agreement litigation. In September 2006, Long entered into an agreement with Louis Ferris, Jr. (the Assignment Agreement), whereby Long sold his position as plaintiff in the Riverside Agreement lawsuit to Ferris for $5,750,000.

For reasons unknown, Long filed a federal income tax return for 2006, reporting taxable income of $0. In 2010, the IRS served Long with a notice of deficiency indicating that he had taxable income of $4,145,423 and a tax liability of $1,430,743 in 2006. Long filed a pro se petition in the Tax Court seeking a redetermination.

The Tax Court, treating LORH's land as the putative capital asset, found that Long intended to sell the land to a developer. The court reasoned that the determination of whether it ultimately qualified for capital gain treatment depended on whether Long had intended to sell the land to customers in the ordinary course of his business. The Tax Court concluded that, while Long only intended to sell the land for the Las Olas Tower project, and not the individual condominium units themselves, the $5.75 million payment for Long's position in the lawsuit nevertheless constituted ordinary income because Long intended to sell the land to customers in the ordinary course of his business. Long appealed to the Eleventh Circuit.

Appeal and Analysis

The primary issue before the circuit court was whether the tax court erred in characterizing the gain as ordinary income. An important secondary issue was whether any gain was short- or long-term.

In support of his position that the $5.75 million he received from the Assignment Agreement should be taxed as a long-term capital gain, Long noted that he only had an option to purchase LORH's land, and the only asset he ever had in the Las Olas Tower project was the Riverside Agreement.

In response, the IRS argued that Long's proceeds from the Assignment Agreement were not a capital gain, but rather a lump sum substitution for the ordinary income he would have earned from developing the Las Olas Tower project. Thus, under the "substitute for ordinary income doctrine," the $5.75 million lump sum payment was taxable as ordinary income. The IRS also argued that the $5.75 million, which constitutes Long's proceeds from the sale of his judgment, is a short-term gain, because Long sold the judgment to Ferris on September 13, 2006, less than a year after the court entered judgment on November 21, 2005.

Income representing proceeds from the sale or exchange of a capital asset that a taxpayer holds for over a year is considered a capital gain and is taxed at a favorable rate. Womack v. Comm'r, 510 F.3d 1295 (11th Cir. 2007). "Capital asset" means property held by the taxpayer (whether or not connected with his trade or business), but does not include property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business. Code Sec. 1221(a)(1). In certain circumstances, contract rights may be capital assets. Pounds v. United States, 372 F.2d 342 (5th Cir. 1967).

The Circuit Court held the Tax Court erred by misconstruing the "property" subject to capital gains analysis under Code Sec. 1221. The Tax Court analyzed the capital gains issue as if the land subject to the Riverside Agreement was the "property" that Long disposed of for in return for $5.75 million. However, the Circuit Court noted that Long never actually owned the land, and, instead, sold a judgment giving the exclusive right to purchase LORH's land pursuant to the terms of the Riverside Agreement. The court determined Long did not sell the land itself, but rather his right to purchase the land, which was a distinct contractual right and potentially a capital asset. Thus, the "property" subject to the capital gains analysis was really Long's exclusive right to purchase the property pursuant to the Florida court judgment.

The Circuit Court also rejected the IRS's argument that the gain was short-term. The court noted that if the asset subject to capital gains treatment was an assignment of litigation rights, then Long acquired the asset when he filed suit in March of 2004, not when he obtained the judgment. The court further opined that the real asset at issue was Long's exclusive right to purchase the land, which he obtained pursuant to his execution of the Riverside Agreement in 2002, well over the one-year period required for long-term capital gains treatment.

Accordingly, the Circuit Court held that the profit from the $5.75 million Long received in the sale of his position in the Riverside Agreement lawsuit was more appropriately characterized as a long-term capital gain. The ruling of the Tax Court was reversed and remanded with instructions to determine Long's new tax liability.

For a discussion of capital assets, see Parker Tax ¶111,105.

[Return to Table of Contents]

IRS Issues Guidance on Exclusion for Employer-Provided Transit Smartcards

The IRS has provided guidance on when smartcards or similar electronic media used to purchase transit fares may be excluded as transportation fringe benefits. Key factors are whether the cards are restricted to purchasing only fare media, and whether suitable substantiation procedures exist for those that are not restricted. Rev. Rul. 2014-32.

In 2006, the IRS issued Rev. Rul. 2006-57 addressing the use of smartcards, debit cards, or other electronic media to provide employees with transportation fringe benefits, and included illustrations of four situations. Because terminal-restricted debit cards were not widely used when Rev. Rul. 2006-57 was issued, the IRS acknowledged that it lacked the factual information needed to develop comprehensive guidance. Rev. Rul. 2006-57 provided that, in the interim, the IRS would not challenge the ability of employers to provide qualified transportation fringes in the form of cash reimbursement for transit passes when the only available voucher or similar item was a terminal-restricted debit card. Rev. Rul. 2014-32 modifies and supersedes Rev. Rul. 2006-57.

The new ruling includes examples of eight different scenarios designed to illustrate whether employer-provided transportation benefits provided through electronic media (i.e. transit smart-cards) are excluded from gross income under Code Secs. 132(a)(5) and 132(f). The examples include scenarios where the provided electronic media can only be used to purchase transit fares, where media can be used at merchants that provide goods and services other than transit fares, and the effects of different reimbursement programs. In all scenarios the amount of the fringe benefits were within the statutory limits.

Section 132(a)(5) provides that any fringe benefit that is a qualified transportation fringe is excluded from gross income. Section 132(f)(1) provides that the term "qualified transportation fringe" means (1) transportation in a commuter highway vehicle between home and work, (2) any transit pass, and (3) qualified parking. Section 132(f)(2) provides a monthly limit on the amount of the fringe benefit which may be excluded from income.

Sections 132(f)(5)(A) and 1.132-9(b), Q/A-3 provide that a transit pass is any pass, token, farecard, voucher or similar item entitling a person to transportation (or transportation at a reduced price) if such transportation is on mass transit facilities or is provided by any person in the business of transporting persons for compensation or hire in a commuter highway vehicle.

Under Reg. Sec. 1.132-9(b) Q/A-16(c), whether a reimbursement is made under a bona fide reimbursement arrangement depends upon the facts and circumstances. The employer must implement reasonable procedures to ensure that the amount equal to the reimbursement was incurred for transportation in a commuter highway vehicle, transit passes, or qualified parking.

In the scenarios where the fare media value stored on the smartcards is usable only as fare media for a particular transit system, or where a terminal-restricted debit card is issued that may only be used at merchant terminals for which only fare media for local transit systems can be purchased, the IRS determined these qualify as a transit passes and may be excluded from gross income and from wages without requiring substantiation.

In the scenarios where employers provide debit cards restricted for use with merchants assigned a merchant category code (MCC) indicating that the merchant sells fare media, but might also sell other merchandise, the IRS determined these do not qualify as transit system vouchers because it was possible they may be used to purchase items other than fare media and are thus not excludable as fringe benefits. However, if the employer implements reasonable substantiation procedures for reimbursement for the use of the debit cards, amounts spent on fare media are excludable.

This substantiation requirement is clearly illustrated by Situation 4 in Rev. Rul. 2014-32:

Example: An employer provides its employees with MCC-restricted debit cards as soon as they begin work. Prior to using his or her card, an employee must certify that it will be used only to purchase fare media. However, the employees are not required to substantiate their fair media expenses. This does not constitute a bona fide reimbursement arrangement because it provides for advances rather than reimbursements and because it relies solely on employee certifications provided before the expense is incurred. Those certifications, standing alone, do not provide the substantiation necessary for there to be a bona fide reimbursement arrangement.

Finally, beginning after December 31, 2015, employers will no longer be permitted to provide qualified transportation fringe benefits in the form of cash reimbursement in geographic areas where a terminal-restricted debit card is readily available. Whether terminal-restricted debit cards are readily available must be determined under the standards in Sec. 1.132-9(b) Q/A-16(b)(5) and (b)(6).

[Return to Table of Contents]

IRS Abused Discretion in Conditioning Installment Agreement on Filing Tax Lien

The Tax Court held that an IRS appeals officer had abused her discretion when she conditioned an offer of an installment agreement on the filing of a notice of tax lien. The appeals officer misinterpreted the Internal Revenue Manual (IRM) as giving her no discretion in the matter and failed to give due consideration to the taxpayer's arguments against filing a lien notice. Budish v. Comm'r, T.C. Memo. 2014-239.

Background

James Budish is a sculptor who works in cast bronze and sells his artwork through his wholly owned S corporation, Jim Budish Sculptor, Ltd. Over the years, he has relied on Metalphysic Sculpture Studio, Inc. (foundry) to provide the material he uses in his sculptures and to do the actual casting. Typically, buyers commission sculptures and pay for them before casting.

On his 2007 income tax return Budish reported a tax liability of $164,928 and a withholding credit of $1,000. He failed to remit the $163,928 balance due with his return. In 2008, the IRS assessed the tax shown on the 2007 return, along with accrued interest and penalties. In 2009, the IRS notified Budish of its intent to collect the unpaid taxes by levy. Budish timely requested a Collection Due Process (CDP) hearing, where he claimed a levy was inappropriate and requested an installment agreement. The Appeals officer offered to grant the installment agreement, but insisted that the Internal Revenue Manual (IRM) required that a notice of federal tax lien (NFTL) be filed under the circumstances and conditioned the agreement on the filing.

Through counsel, Budish argued that a notice of lien would hamper rather than facilitate collection of his tax liability by effectively putting him out of business, thereby terminating the flow of income necessary to honor the installment agreement. Specifically, he represented that, should the IRS file a notice of lien, his longstanding business relationship with the foundry would be drastically altered as he would be required to immediately pay for all past work and make "up front" payments for all future work. Finally, Budish represented that a notice of lien would cause the buyers of his sculptures to cease paying up front for artwork they might never receive because of his financial difficulties.

Notwithstanding Budish's arguments, the Appeals officer stood by her position that the installment agreement must be conditioned on filing a lien notice. Because of her insistence on this point, Budish rejected the offer. The Appeals officer then closed out her case and recommended that Appeals sustain the proposed levy. Appeals accepted the recommendation and issued a notice of determination reflecting its decision.

Analysis

The issue before the Tax Court was whether the Appeals officer abused her discretion by insisting on the filing of a notice of lien as a condition of entering into an installment agreement with petitioner (the terms of which were agreed to).

In reaching a decision, the court focused on an attachment to the IRS's notice of determination. In the attachment, the Appeals officer gave two specific reasons for insisting on a lien notice, both of which were based on her interpretation of provisions of the IRM. The first reason was that, under IRM 5.12.2.4.1, the balance due of over $200,000 requires that a lien notice be filed in order to protect the government's interest. The second stated reason was that "IRM 5.12.2.4 requires a[n] NFTL be filed if an installment agreement does not meet streamlined, guaranteed, or in business trust filed express criteria."

The IRS argued that it has discretionary authority to enter into installment agreements and can condition such an agreement on the filing of a NFTL. Additionally, it claimed the records indicated the Appeals officer's insistence on the lien was reasonable given Budish's excessive deficiency and his substantial income.

The Tax Court agreed with Budish that the Appeals officer misinterpreted and, in fact, overstated the directives set forth in the cited IRM provisions in determining that the filing of a notice of lien was required. The court noted that the language of IRM pt. 5.12.2.4.1 (i.e. "in general" and "should be filed") clearly indicated that there may be occasions in which filing a NFTL would not be necessary, even under the circumstances described in that section. Additionally, IRM 5.12.2.4 lists circumstances under which an NFTL filing determination must be made, rather than circumstance under which a notice of lien must be filed. Thus, the court believed the Appeals officer misinterpreted the IRM in thinking it required an NFTL be filed under the circumstances.

The Appeals officer also ran afoul of Code Sec. 6330(c)(3)(C), which provides that a determination by an appeals officer must take into consideration whether a proposed collection action balances the need for the efficient collection of taxes with the legitimate concern of the taxpayer that any collection action be no more intrusive than necessary.

The Tax Court found that, while the Appeals officer attempted to balance the need for a notice of lien against Budish's concern that such action was more intrusive than necessary, her rational was unpersuasive and fell short of the balancing requirement. First, she stated that Budish failed to show how withholding the lien would be in the best interest of the government. Second, she claimed that though the lien was intrusive, it did balance the concerns. The court noted, however, that the Appeals officer gave no rational for these statements and gave no indication that she actually did engage in a balancing test. Rather, the court believed that the Appeals officer gave little, if any, consideration to Budish's arguments and, instead, decided a notice of lien should be filed because of her mistaken belief that she lacked discretion to do otherwise under the IRM.

Because of the Appeals officer's erroneous interpretation of the IRM and resulting failure to correctly apply the balancing test of Code Sec. 6330(c)(3)(C), the Tax Court remanding the case to Appeals for further consideration.

For a discussion of tax liens and IRS collection procedures, see Parker Tax ¶260,530.

[Return to Table of Contents]

Final Regs Clarify Minimum Essential Coverage Requirement for Individual Mandate

The IRS released final regulations clarifying the requirement to maintain minimum essential coverage under the individual healthcare mandate and the rules governing certain types of exemptions from the mandate. T.D. 9705 (11/26/2014).

Background

Under the Affordable Care Act (ACA), nonexempt U.S. citizens and legal residents must maintain minimum essential healthcare coverage or pay a penalty in the form of a "shared-responsibility payment" imposed by Code Sec. 5000A.

Minimum essential health coverage includes eligible employer-sponsored health insurance, health coverage under government sponsored programs such as Medicare and Medicaid, plans offered through a state health insurance exchange, grandfathered health plans, and certain other coverage recognized by the Secretary of the Treasury and the Secretary of Health and Human Services.

Observation: On November 7, 2014, the Department of Health and Human Services (HHS) provided guidance on the considerations that it intends to apply in recognizing minimum essential coverage. HHS Centers for Medicare & Medicaid Services, Minimum Essential Coverage (SHO #14-002). Many of the modifications and clarifications made in the final regulations reference this publication.

In January 2014, proposed regulations addressing various issues relating to the requirement to maintain minimum essential coverage were published in the Federal Register as REG-141036-13. After consideration of comments, minor changes and clarifications were made and the IRS released the final regulations in T.D. 9705.

The regulations are effective as of November 26, 2014.

Coverage for Medically Needy

The final regulations retain the rule that Medicaid coverage offered to individuals with high medical expenses who would be eligible for Medicaid but for their income level (medically needy individuals) is not government-sponsored minimum essential coverage under section 5000A(f)(1)(A). However, the Department of Health and Human Services (HHS) may in appropriate circumstances designate certain coverage for medically needy individuals as minimum essential coverage pursuant to section 5000A(f)(1)(E).

Employer Contributions to a Cafeteria Plan

The final regulations address comments about how employer contributions under a Code Sec. 125 cafeteria plan to the extent employees may not opt to receive the employer contribution as a taxable benefit should be taken into account for purposes of determining the affordability of coverage. The final regulations provide that, for purposes of determining the affordability of coverage, the required contribution is reduced by any contributions made by an employer under a Code Sec. 125 cafeteria plan that (1) may not be taken as a taxable benefit, (2) may be used to pay for minimum essential coverage, and (3) may be used only to pay for medical care within the meaning of section 213.

Additionally, the final regulations provide that health flex contributions made available for the current plan year are taken into account for purposes of determining an individual's required contribution. As a result, health flex contributions reduce an employee's or related individual's required contribution for employer-sponsored coverage.

Health Reimbursement Arrangements

The final regulations clarify that amounts newly made available under a health reimbursement arrangement (HRA) count toward an employee's required contribution if the HRA would have been integrated with an eligible employer-sponsored plan if the employee had enrolled in the primary plan. Additionally, the final regulations provide that, for purposes of determining an individual's required contribution, an HRA is taken into account only if the HRA and the primary eligible employer-sponsored coverage are offered by the same employer.

The final regulations also clarify that, in general, HRA contributions count toward affordability and not minimum value for purposes of determining minimum essential coverage, if an employee may use the HRA contributions to pay premiums for the primary plan only, or to pay cost-sharing or benefits not covered by the primary plan in addition to premiums. Accordingly, HRA contributions that can be used only to pay for cost-sharing do not count toward affordability.

HRA contributions that can be used for premiums and cost-sharing will only count for affordability and there will be no double counting of these contributions. Accordingly, the final regulations clarify that employer contributions to an HRA count towards an employee's required contribution only to the extent the amount of the annual contribution is required under the terms of the plan or is otherwise determinable within a reasonable time before the employee must decide whether to enroll.

Wellness Program Incentives

The final regulations retain the rule that, in determining whether coverage under an eligible employer-sponsored plan is affordable for purposes of the affordability exemption in Code Sec. 5000A(e)(1), nondiscriminatory wellness program incentives are treated as earned only if the incentives relate to tobacco use. Additionally, wellness incentives unrelated to tobacco use are treated as unearned.

The final regulations clarify that a wellness incentive that includes any component unrelated to tobacco use is treated as unearned. If, however, there is an incentive for completing a program unrelated to tobacco use and a separate incentive for completing a program related to tobacco use, then the incentive related to tobacco use may be treated as earned.

Hardship Exemptions

The final regulations provide that, under certain circumstances, a taxpayer may claim a hardship exemption on a Federal income tax return without first obtaining a hardship exemption certification from a Marketplace. To consolidate the list of such circumstances described in the proposed regulations with any additional circumstances that have been or will be identified, the final regulations removed the references to specific hardship circumstances and instead provides that a taxpayer may claim a hardship exemption on a Federal income tax return without obtaining an exemption certification for any month that includes a day on which the taxpayer satisfies the requirements of a hardship for which HHS and the IRS have issued published guidance.

Notice 2014-76, released concurrently with the regulations, provides a comprehensive list of all hardship exemptions that may be claimed on a Federal income tax return without obtaining a hardship exemption certification.

For a discussion of Penalty for Failure to Maintain Minimum Essential Health Coverage, see Parker Tax ¶190,100.

[Return to Table of Contents]

Losses on Vacation Home Rental Limited Because of Excessive Personal Use Days

After analyzing numerous trips to a vacation home to determine if they were for business or personal purposes, the Tax Court concluded that the taxpayer spent more than 14 personal use days at the property, thereby limiting rental use deductions under Code Sec. 280A. Van Malssen v. Comm'r, T.C. Memo. 2014-236.

Background

In March 2007, Mark Van Malssen and his wife purchased a vacation condominium in South Carolina. In 2008 through 2010, years in which they made the condo available for rental use by vacationers, they stayed in it on numerous occasions. Some of their stays were for personal use, others for business use (performing needed modeling and repairs), and some for a combination.

The condo was in use for a total of 81 days in 2008, 59 days in 2009, and 45 days in 2010. Included in the 2008 total was seven days of use by Van Malssen's brother. Van Malssen made the 350-mile trip from his home to the condo numerous times to perform remodeling and repair work and kept logbooks detailing his personal and business use.

He and his wife reported large losses for the rental activity on their 1040s resulting in deficiency assessments by the IRS of $19,198, $14,543, and $11,626 for 2008, 2009, and 2010, respectively.

Analysis

Generally, under Code Sec. 280A(c)(5), when a taxpayer rents a dwelling unit to others but also uses it a residence during the same year, the deductions attributable to the rental use cannot exceed gross rental income. Under Code Sec. 280A(d)(1), a dwelling unit is considered a residence if the taxpayer uses it for personal purposes for a number of days exceeding the greater of:

(1) 14 days; or  

(2) 10% of the number of days during the year for which the unit is rented at a fair rental value.

Under Code Sec. 280A(d)(2), if a taxpayer uses a dwelling unit for personal purposes for any part of a day, that day is counted as a personal use day. But if the taxpayer is engaged in repair and maintenance of the residence on a substantially full-time basis for any day, that day is not considered a personal use day. Any personal use by a qualifying relative is imputed to the taxpayer.

Even if a taxpayer avoids having a dwelling classified as a residence, Code Sec. 280A(e) requires a taxpayer who uses the dwelling unit for personal purposes for even a single day during the tax year to limit his or her deduction for any rental activity by allocating expenses between personal uses days and rental use days. Days spent performing repairs and maintenance are disregarded when making the allocation.

The primary issue before the Tax Court was to determine the number of personal use days Van Malssen spent at the condominium for purposes of the Code Sec. 280A(c)(5) limitation on deductions and the Code Sec. 280A(e) calculations.

Although Van Malssen conceded that he personally used the condominium for 14 days in 2008 and 2010, he and the IRS disputed how to characterize: (1) the days spent traveling to the condominium and (2) his brother's use of the condominium in 2008.

Van Malssen argued, and the court agreed, that travel to the condominium to make repairs should not count as personal use days. Examples under Reg. Sec. 1.280A-1(e)(6), prior case law, and the plain language of the code indicated that Congress did not intend for days spent primarily repairing and maintaining a vacation home to count as personal use days. The court reasoned that, by extension, days spent traveling to the site where such work was to be performed should not count as personal used days either.

The court then analyzed Van Malssen's numerous trips to determine the principle purpose behind each, and thus the number of personal use days spent at the rental property. It accepted that 16 trips (between 2008 and 2010) were made principally to perform repairs and maintenance, and thus did not include any personal use days. But the court concluded that out of 12 trips made for mixed business and pleasure, only four were primarily for business (i.e, repairs and maintenance). Hence, the travel days associated with the eight mixed-purpose trips made predominately for pleasure counted as personal use days.

The Tax Court also concluded that the seven days of use by Van Malssen's brother in 2008 counted as personal use days. The brother was clearly a qualifying relative under Code Sec. 267(c)(4) and Van Malssen could not substantiate claims that the brother paid a fair rental price.

After completing its analysis, the Tax Court found that Van Malssen personally used the condominium for a total of 24 days in 2008, 19 days in 2009, and 16 days in 2010. Accordingly, the court held that the Code Sec. 280A(c)(5) limitation applied for all three years, and thus deductions attributable to the rental use were limited to gross rental income.

For a discussion of residential rental property, see Parker Tax ¶86,100.

[Return to Table of Contents]

IRS Grants Extension to Exclude Income from Discharge of Indebtedness

Taxpayer's accountant failed to discuss the possibility of an election to exclude cancellation of debt income prior to filing Form 1040; in a private ruling the IRS granted an extension of time to file the election. PLR 201447011.

Background

The taxpayer owns an interest in LLC, a limited liability company that is treated as a partnership for federal income tax purposes. The taxpayer entered into a Final Forbearance Agreement that resulted in cancellation of indebtedness income (COD). In Year 1, the taxpayer received a Schedule K-1 from LLC that showed COD attributable to the taxpayer based on his ownership interest in LLC.

The taxpayer represented that as a partner of LLC, he was eligible to exclude COD income pursuant to Code Sec. 108(c), which relates to qualified real property business indebtedness. This exclusion required the taxpayer to make an election pursuant to Code Sec. 108(c)(3)(C) and Reg. Sec. 1.108-5(b) on a timely filed Year 1 Form 1040.

The taxpayer's Year 1 Form 1040 was prepared by Firm, a qualified tax professional with many years of experience. However, due to an oversight, Firm did not discuss the election with the taxpayer nor did Firm make the election on the taxpayer's behalf to reduce the basis of depreciable real property and to exclude income resulting from the discharge of qualified real property business indebtedness.

In Year 2, it was discovered that the taxpayer had been eligible to make the election relating to COD income in Year 1. After realizing Firm's oversight in not including the Form 982 required to make the Code Sec. 108(c)(3)(C) election on the taxpayer's Year 1 Form 1040, the taxpayer requested a ruling granting an extension of time to make the election.

Analysis

Code Sec. 108(a)(1)(D) provides that gross income does not include any amount would be includible in gross income by reason of the discharge of indebtedness if, in the case of a taxpayer other than a C corporation, the indebtedness discharged is qualified real property business indebtedness. Code Sec. 108(c)(3)(C) requires a taxpayer to make an election to exclude COD income under Code Sec. 108(a)(1)(D).

Pursuant to Reg. Sec. 1.108-5(b), this election is made on a completed Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment).

Reg. Sec. 301.9100-3(a) provides that requests for extension of time for regulatory elections will be granted when the taxpayer provides evidence (including affidavits) to establish that the taxpayer acted reasonably and in good faith and the grant of relief will not prejudice the interests of the Government. Under Reg. Sec. 301.9100-3(b) a taxpayer is deemed to have acted reasonably and in good faith if the taxpayer reasonably relied on a qualified tax professional and the tax professional failed to make, or advise the taxpayer to make, the election.

Based on the taxpayer's representations, the IRS concluded that the taxpayer met the criteria of Reg. Sec. 301.9100-3 and granted an extension of 45 days from the date of the PLR for the taxpayer to file an amended return to make the election under Code Sec. 108(c)(3)(C) and Reg. Sec. 1.108-5(b).

For a discussion of cancellation of debt income, see Parker Tax ¶72,300.