Parker's Federal Tax Bulletin - Issue 81 - February 1, 2015

IRS Announces Penalty Relief Relating to Premium Tax Credit Advance Payments

The IRS has announced limited relief from tax penalties for taxpayers who have a balance due on their 2014 income tax return as a result of reconciling advance payments of the premium tax credit against the premium tax credit allowed on the tax return. This relief applies only for the 2014 tax year. Notice 2015-9.

Practice Aid: See ¶ 320,165 for a sample client letter requesting relief under Notice 2015-9 from Code Sec. 6651(a)(2) penalty for failure to pay tax relating. As discussed under "Procedure for Requesting Penalty Relief" below, the letter is to be sent in response to receiving a penalty notice after a taxpayer's 2014 return is filed.

Practice Aid: See ¶ 320,167 for a sample statement that can be attached to a client's 2014 Form 1040 requesting a waiver under Notice 2015-9 of the Code Sec. 6654(a) penalty for underpayment of estimated tax.

Background

Beginning in 2014, eligible individuals who are covered under a qualified health plan through a Health Insurance Marketplace, are allowed a premium tax credit under Code Sec. 36B. Taxpayers generally receive advance payments of the premium tax credit to assist in paying for their health insurance. These advance credit payments are made directly to the insurance provider. The amount of the advance credit payments is determined when an individual enrolls in a qualified health plan and is based on his or her projected household income and family size.

Under Reg. Sec. 1.36B-4(a)(1)(i), a taxpayer is required to reconcile on his or her tax return the amount of the premium tax credit allowed with the amount of advance credit payments actually received. A difference between the amount of advance credit payments received and the premium tax credit allowed may occur if there were changes in the taxpayer's circumstances during the year, such as getting married or divorced, or having an increase or decrease in income. If advance credit payments are more than the premium tax credit allowed, the difference is treated as additional tax and may result in either a smaller refund or a larger balance due. If the premium tax credit allowed is more than the advance credit payments made, the excess credit amount may result in a larger refund or lower balance due. 2014 is the first year where taxpayers will have to reconcile advance credit payments with the premium tax credit.

Penalty Relief for 2014

Some taxpayers who, because of a difference in their advance credit payments and the premium tax credit calculated on their returns, have an increase in their tax liability may not be able to pay by the due date, generally April 15. Taxpayers who do not pay their entire tax liability generally would be liable for the Code Sec. 6651(a)(2) penalty for failure to pay.

Additionally, some taxpayers may discover that their estimated tax payments made throughout the year were understated due to the difference in the advance payments received and premium credit allowed, potentially leading to a Code Sec. 6654(a) estimated tax penalty. In consideration of these factors, the IRS is providing relief from the Code Sec. 6651(a)(2) and Code Sec. 6654(a) penalties for taxpayers who satisfy certain requirements.

The IRS will abate the Code Sec. 6651(a)(2) penalty for 2014 for taxpayers who (1) are otherwise current with their filing and payment obligations; (2) have a balance due for 2014 due to excess advance payments of the premium tax credit; and (3) report the amount of excess advance credit payments on their timely filed 2014 tax return, including extensions.

Additionally, the IRS will waive the Code Sec. 6654 penalty for 2014 for an underpayment of estimated tax for taxpayers who have an underpayment attributable to excess advance credit payments if the taxpayers (1) are otherwise current with their filing and payment obligations; and (2) report the amount of the excess advance credit payments on a timely filed 2014 tax return, including extensions.

Caution: The relief provided by the IRS does not apply to any underpayment of the individual shared responsibility payment resulting from the application of Code Sec. 5000A because such underpayments are not subject to either the Code Sec. 6651(a)(2) penalty or the Code Sec. 6654(a) penalty. Additionally, the relief granted does not extend the time to file a return and does not alleviate taxpayers of the requirement to pay interest on balances due.

Taxpayers are considered current with their filing and payment obligations if, by the time they file their 2014 income tax returns, they (1) have filed, or filed an extension for, their required federal tax returns, and (2) paid or have entered into an installment agreement, an offer in compromise, or both to satisfy a federal tax liability. If a taxpayer has not paid a tax due because there is a genuine ongoing dispute with the IRS, the amount of tax in dispute will be treated as being current during the dispute.

Procedure for Claiming Penalty Relief

Generally, the IRS automatically assesses the Code Sec. 6651(a)(2) penalty against taxpayers and sends a notice demanding payment. If a taxpayer eligible for relief receives such a notice, he or she should submit a letter to the address listed in the notice with the statement: "I am eligible for the relief granted under Notice 2015-9 because I received excess advance payment of the premium tax credit."

Taxpayers who file their returns by April 15, 2015 will be entitled to relief even if they have not fully paid the underlying liability by the time they request relief. Taxpayers who file their returns after April 15, 2015 must fully pay the underlying liability by April 15, 2016 to be eligible for relief. However, interest will still accrue until the underlying liability is fully paid.

To request a waiver of the Code Sec. 6654(a) penalty, taxpayers should check box A in Part II of Form 2210, Underpayment of Estimated Tax by Individuals, Estates, and Trusts, complete page 1 of the form, and include the form with their return, along with the statement: "Received excess advance payment of the premium tax credit." Taxpayers do not need to attach documentation from the Exchange, or explain the circumstances under which they received an excess advance payment, or complete any page other than page 1 of the Form 2210. Taxpayers also do not need to calculate the amount of penalty for the penalty to be waived.

For a discussion of the premium tax credit, see Parker Tax ¶ 102,610.

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Long-Awaited Proposed Regs Clarify Research Credit for Internal Use Software

Last week, the IRS released proposed regulations clarifying the meaning of "internal use software" for purposes of the Code Sec. 41 research credit, and providing additional guidance regarding the three-part "high threshold of innovation" test such software must pass in order to qualify for the credit. REG-153656-03 (1/20/2015).

The proposed regulations also provide guidance on software that is developed for both internal and non-internal use (dual function computer software), including a safe harbor for determining if any of the expenditures with respect to dual function computer software are qualified research expenditures.

Although the proposed regulations are not effective until finalized, the IRS will not challenge return positions consistent with these proposed regulations for taxable years ending on or after January 20, 2015.

Background

Under Code Sec. 41, taxpayers may take a credit for increasing expenditures on qualified research activities. Code Sec. 41(d)(4)(E) generally excludes from the credit research with respect to computer software that is developed by the taxpayer primarily for its own internal use ("internal use software"). Internal use software may, however, be eligible for the credit if the research undertaken to create the software meets a three-part "high threshold of innovation" test which requires that: Read more...

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Tax Court: Payments for Egg Donations are Taxable Compensation for Services

Despite the pain and suffering incurred during the procedures, the amounts a taxpayer received from donating her eggs was taxable compensation for services, not excludable damages under Code Sec. 104. Perez v. Comm'r, 144 T.C. No. 4 (2015).

Background

In 2009, Nicole Perez entered into two contracts with Donor Source International, LLC, an egg-donation agency in California that matches egg donors with women and couples struggling to conceive on their own. Perez received payments in exchange for undergoing several painful operations and procedures to donate her eggs to infertile couples. Under the contracts, the payments Perez received were designated compensation for pain and suffering.

Pursuant to her arrangement with Donor Source, Perez took birth control pills to sync her menstrual cycle with that of the intended mother and underwent a series of intrusive physical examinations. She frequently had to undergo invasive internal ultrasound examinations, have blood drawn by syringe, and self-administer hormonal and other intramuscular injections using large needles. The shots caused Perez to experience physical pain deep within her muscles and also extreme abdominal bloating. After the eggs were harvested, Perez suffered from mood swings, headaches, nausea, and fatigue.

Perez underwent this process twice during 2009 and Donor Source sent her a Form 1099 for $20,000 based on the payments she received in connection with the two egg extractions. After consulting other egg donors online, Perez concluded that the money was not taxable because it compensated her only for pain and suffering; therefore, she left it off her tax return. The IRS disagreed and sent her a notice of deficiency

Analysis

The Tax Court was asked to address whether a taxpayer who suffers physical pain or injury while performing a contract for personal services may exclude the amounts paid under that contract as "damages received on account of personal physical injuries or physical sickness" under Code Sec. 104(a)(2) even though the taxpayer knew that such injury or sickness might occur and consented to it in advance.

Perez argued that the payments were in exchange for the pain, suffering, and physical injuries she endured as part of the egg-retrieval process, while the IRS argued Perez was simply compensated for services rendered. Both parties agreed that the payments Perez received were not for the sale of her eggs.

Reg. Sec. 104(a)(2) excludes from gross income the amount of any damages (other than punitive damages) received (whether by suit or agreement and whether as lump sums or as periodic payments) on account of personal physical injuries or physical sickness (Reg. Sec. 1.104-1(c)(1)).

The court first assessed the nature of Perez's compensation, concluding Perez was compensated for a service, rather than for the eggs themselves. The court distinguished Green v. Comm'r, 74 T.C. 1229 (1980) (holding taxpayer compensated for blood plasma was engaged in the sale of tangible personal property rather than performance of services) and U.S. v. Garber, 607 F.2d 92 (5th Cir. 1979) (suggesting taxpayer compensated for blood plasma might be engaged in sale of property because compensation was directly related to concentration of antibodies produced), the only two cases the court found that were comparable to Perez's situation.

The court reasoned that unlike the taxpayers in Green and Garber, who were paid by the quantity and the quality of plasma produced, Perez's compensation didn't depended on the quantity or quality of the eggs retrieved, but solely on how far into the egg-retrieval process she went. Accordingly, the court concluded Perez was not being compensated for her eggs, but was being paid in a service capacity to undergo the painful procedures associated with the egg harvesting process.

The court then turned to the question of whether the payments could be considered damages excludible from income under Code Sec. 104. The court rejected Perez's assertion that the court should interpret "damages" in Code Sec. 104(a)(2) broadly to mean compensation in money received for a loss, regardless of any legal suit or action. The court noted that traditionally awards or settlement proceeds from personal injuries have been excluded from income as a "tort or tort-type right" under regulations, but later amendments to the regulations removed the "tort and tort-type right" requirement and broadened the definition to include administrative and statutory remedies (Reg. Sec. 1.104-1(c)(1)).

The court concluded, however, that even under the more expansive definition, Code Sec. 104 still did not apply to Perez, as the regulation addresses situations where a taxpayer settles a claim for physical injuries or physical sickness before, or at least in lieu of, seeing litigation through to its conclusion. The court reasoned that since Perez voluntarily signed a contract to be paid to endure the painful procedures, her actions were similar to an advance waiver of possible future damages for personal injuries and were therefore distinguishable from the case law she cited and consequently the amounts she received must be included as taxable income.

Lastly, the court noted that ruling in Perez's favor would open the door for individuals who endure physical injuries as a result of their profession, such as professional athletes and laborers, to claim a portion of their salaries allocable to pain and suffering from injuries sustained in the course of their employment. The court found that prospect untenable, noting that individuals who take on those risks of pain and suffering do so voluntarily before they begin their work and therefore payment in such cases is properly taxable compensation and not excludable damages.

For a discussion of damages received on account of physical injuries or sickness, see Parker Tax ¶ 75,910.

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No Foreign Earned Income Exclusion for Taxpayer with Multiple U.S. Residences

Despite spending a considerable amount of time living in Russia as part of his job in the oil industry, the Tax Court held that the taxpayer's strongest ties were to his residences in Louisiana, and thus he could not take the foreign earned income exclusion. Evans v. Comm'r, T.C. Memo. 2015-12.

Background

Joel Evans began working in the oil industry in 1988 and was regularly assigned to drilling locations overseas. While abroad, he used his parents' house in West Monroe, Louisiana as his address for purposes of receiving mail. During this time, his mother generally managed his business affairs. In 1997, Evans began working for Parker Drilling Co. (Parker). During breaks from his overseas assignments, he would return home and stay with his parents.

After Evans married his first wife in 2003, they built a house in West Monroe. Once it was completed, Evans would return there when he came back to the United States on home leave. In 2006, Evans was promoted to a management position at Parker's facilities on Sakhalin Island in Russia, where he worked through 2010. Evans' work schedule during 2007-2010 consisted of alternating 30-day periods on and off duty. During his on-duty periods, he lived in employer provided housing, sometimes on offshore drilling platforms. During his 30-day off-duty periods, Evans usually returned to West Monroe in order to spend time with his family, alternating between his own home and his parents' home.

Following his divorce in 2007, Evans moved his daughter in with his parents. His house sat empty until September 2009, when he remarried. After that, Evans spent virtually all his off-duty periods with his family at his own house.

No family member ever accompanied Evans to Russia. He held a Russian visa with a "resident work" permit. Although this visa allowed him to remain in Russia long term, it did not permit him to bring family members with him. Evans was registered to vote in Louisiana, held a Louisiana driver's license, had bank and credit card accounts in Louisiana, and registered and maintained vehicles there. His tax returns listed his parents' address, as his mailing address.

On his tax returns for 2007 through 2010, Evans took the position that his tax home was in Russia and accordingly excluded his wages earned in Russia from his gross income under Code Sec. 911(a). The IRS determined that Evans was not entitled to claim the foreign earned income exclusion and assessed deficiencies for each tax year. Evans petitioned the Tax Court, challenging the IRS's determination.

Analysis

U.S. citizens are taxed on their worldwide income unless a specific exclusion applies. A qualified individual may elect to exclude from gross income (up to the statutory maximum amount) his or her foreign earned income. To be entitled to this exclusion, a taxpayer must satisfy two requirements: (1) he must be an individual whose tax home is in a foreign country (Code Sec. 911(d)(1)(A); and (2) he must either be a bona fide resident of one or more foreign countries or be physically present in such country or countries during at least 330 days in a 12-month period (Code Sec. 911(d)(1)(B)).

Observation: The Tax Court could have easily resolved this case by reference to the 330-day "physical presence" test (the court even pointed out in a footnote that Evans clearly failed the test). Instead, the court decided to proceed with the more difficult "tax home" analysis, yielding a longer and more interesting opinion than the case might have required.

The Tax Court determined that, despite frequently living abroad in Russia for work, Evans was not eligible to exclude his foreign earned income.

The court first considered whether Evans' tax home during 2007 through 2010 was in Russia. The court noted that Code Sec. 911(d)(3) defines the term "tax home" to mean an individual's home for purposes of Code Sec. 162(a)(2). Citing Mitchell v. Comm'r, 74 T.C. 578 (1980), the court found that a person's home is generally considered to be the location of his regular or principal place of business. However, Code Sec. 911(d)(3) also provides that an individual does not have a tax home in a foreign country for any period for which his abode is within the United States. Thus, the court reasoned, a person whose "abode" is within the United States cannot establish that his "tax home" is in a foreign country. Relying on precedent established by Bujol v. Comm'r, 842 F.2d 328 (5th Cir. 1988), the court determined a taxpayer's "abode" is generally in the country in which he has the strongest economic, family, and personal ties.

The court found that during 2007 through 2010, Evans clearly had very strong ties to his residences in Louisiana. Throughout that period, he owned a house that he had built. While he was overseas, his first wife, his second wife, and his daughter lived in that house or with his parents. During his off-duty periods he regularly returned to West Monroe. His business affairs were generally handled by his mother, whose address he used. His driver's license, voter registration, bank accounts, and motor vehicles were all centered in Louisiana. His ties to Russia, by contrast, were entirely transitory and did not extend much beyond the bare minimum required to perform his duties there.

Evans attempted to argue that as because his ties to Louisiana were divided between two residences - his parents' home and his own home - he did not reside at either location within the meaning of the statute. The court noted, however, that Code Sec. 911(a) does not require determining which particular building in West Monroe constituted Evans' "abode." Rather, the statute asks whether his "abode" was in the United States or in Russia. Finding that Evans had the strongest ties to his residences in the United States, the Court held that his tax home was within the United States and thus Evans could not exclude income he earned in Russia under the foreign earned income exclusion.

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

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IRS Updates and Clarifies Procedures for Accounting Method Changes

The IRS has released two revenue procedures that update and revise the general procedures to obtain the consent of the IRS to change a method of accounting for federal income tax purposes. Rev. Proc. 2015-13 and Rev. Proc. 2015-14.

Background

Under Code Sec. 446(e), once a taxpayer has used an accounting method and filed a first return, the taxpayer must receive approval from the IRS before making any change to that accounting method. In general, a taxpayer must file a current Form 3115, Application for Change in Accounting Method, to request a change in either an overall accounting method or the accounting treatment of any item. In certain cases, the IRS issues revenue procedures granting a taxpayer automatic consent to change an accounting method as long as the provisions of the revenue procedure are followed.

Rev. Procs. 2015-13 and 2015-14

The newly issued revenue procedures amplify, clarify, modify and partly supersede Rev. Proc. 2011-14. The two new revenue procedures effectively split former Rev. Proc. 2011-14 in two parts; Rev. Proc. 2015-13 contains the general procedures for changing methods of accounting, either with IRS consent or automatically, and Rev. Proc. 2015-14 lists the automatic changes originally contained in the appendix to Rev. Proc. 2011-14.

While the new revenue procedures contain substantially the same methods and procedures as before, a few significant changes, clarifications, and modifications have been made.

Significant Changes in Rev. Proc. 2015-13

The following is a list of some of the more important changes made by Rev. Proc. 2015-13 affecting both Rev. Proc. 2011-14 and Rev. Proc. 97-27:

(1) Section 3.04(2)(f) clarifies that a sale or exchange of 50 percent or more of the total interest in partnership capital and profits under Code Sec. 708(b)(1)(B) is a transaction that constitutes the cessation of a partnership's trade or business.

(2) Section 3.08 clarifies and modifies the rules for when a method of accounting for an item is under consideration. It provides that an issue is under consideration as of the date of the operative written notification to the taxpayer.

(3) Section 3.17(2) provides that, in the case of a consolidated group, "taxpayer" refers to the individual member of the consolidated group for which the change in method of accounting is requested, or to the common parent of the group acting on behalf of that member.

(4) Section 5.01 modifies the rules for when a taxpayer under examination may file a Form 3115 by including broad eligibility rules that allow taxpayers under examination to request changes in method of accounting.

(5) Section 7.06 provides, consistent with existing practice, a term and condition that requires a taxpayer to maintain accounting records for the year of change and subsequent taxable years to support the method of accounting for which consent is granted to the taxpayer.

(6) Section 8.02(1)(a) modifies the rules for when a taxpayer under examination filing a Form 3115 may receive audit protection by replacing the 90-day window that began on the first day of the taxpayer's taxable year in Rev. Proc. 97-27 and Rev. Proc. 2011-14 with a three-month window that applies to taxpayers that have been under examination for at least 12 consecutive months as of the first day of the three-month window. In addition, in certain circumstances a CFC or 10/50 corporation is eligible to change its method of accounting during the three-month window.

(7) Section 8.02(1)(b) makes a CFC or 10/50 corporation ineligible for the 120-day window.

Additional separate changes to Rev. Proc. 2011-14 and Rev. Proc. 97-27 can be found in Sections 18.02 and 18.03, respectively.

Significant Changes in Rev. Proc. 2015-14

The following is a list of some of the more important changes made by Rev. Proc. 2015-14 affecting the List of Automatic Changes (formerly known as the Appendix of Rev. Proc. 2011-14):

(1) Section 3.01, relating to advances made by a lawyer on behalf of clients includes method changes involving cases handled on a non-contingent fee basis.

(2) Section 7.01, relating to changes for research and experimental (R&E) expenditures under Code Sec. 174, applies to a method change from treating R&E expenditures under any section other than Code Sec. 174 (including Code Sec. 263A) to treating R&E expenditures under Code Sec. 174. This also applies where a taxpayer already has a valid Code Sec. 174 election in effect, but fails to treat a portion of its R&E expenditures in accordance with its valid election. Additionally, a taxpayer may change its method regarding that portion of its R&E expenditures to conform to its valid election.

(3) Section 10.11, relating to changes for tangible property, removes the term "transaction" in describing costs in addition to commissions that facilitate the sale of property by a dealer in property. This term is removed to eliminate inconsistencies and to more accurately reflect the costs described under Reg. Sec. 1.263(a)-1(e)(2).

(4) Section 14.01, relating to overall change from the cash method to an accrual method, provides that a concurrent change to a special method is permitted to be made, if such change is also an automatic change, a section of the Code, or regulations, or in other guidance published in the Internal Revenue Bulletin.

(5) Section 18.01, relating to changes for long-term contracts, includes a change made by a taxpayer that is required to change its method of accounting for its long-term contracts as defined in Code Sec. 460(f) to the percentage of completion method (PCM) described in Reg. Sec. 1.460-3(b)(2) if the taxpayer fails to use the PCM in the first taxable year and the succeeding taxable year(s).

The following were added to the List of Automatic Changes to provide additional changes in method of accounting: (a) Section 5.02, relating to changes to comply with Code Sec. 163(e)(3); (b) Section 11.14, relating to depletion; (c) Section 23.02, relating to changes from the mark-to-market method of accounting described in Code Sec. 475 to a realization method of accounting; and (d) Section 25.03, relating to changes in qualification as life/nonlife insurance company under Code Sec. 816(a).

The following sections include a reduced filing requirement of the Form 3115 by qualified small taxpayers: (a) Sections 6.01 and 6.02, relating to a change from an impermissible or permissible method to a permissible method of accounting for depreciation; (b) Sections 6.09 and 6.10, relating to a change in general asset account treatment or a change in method of accounting for depreciation due to a change in the use of MACRS property; (c) Section 6.11, relating to depreciation of qualified non-personal use vans and light trucks; and (d) Section 6.17, relating to a change from impermissible to permissible method of accounting for depreciation or amortization for disposed depreciable or amortizable property.

Effective Date and Transition Rules

Except as provided by the transition rules, Rev. Proc. 2015-13 is effective for Forms 3115 filed on or after January 16, 2015, for a year of change ending on or after May 31, 2014.

A taxpayer may file a Form 3115 to request consent to change a method of accounting under the procedures of Rev. Proc. 97-27 or Rev. Proc. 2015-13 for a taxable year ending on or after November 30, 2014, and on or before January 16, 2015, until March 2, 2015.

A taxpayer may convert a Form 3115 filed under Rev. Proc. 97-27 to a request for consent under Rev. Proc. 2015-13 for the same requested change in method of accounting and year of change if the taxpayer is otherwise eligible to use Rev. Proc. 2015-13 and: (a) the Form 3115 was filed before January 16, 2015, and the Form 3115 is pending with the national office on January 16, 2015, or (b) the Form 3115 was filed on or after January 16, 2015, and on or before March 2, 2015.

A taxpayer may convert a Form 3115 to the non-automatic change procedures, if eligible, by notifying the national office contact person before the later of (a) March 31, 2015, or (b) the issuance of a letter ruling granting or denying consent for the change. A taxpayer may convert a Form 3115 to the automatic change procedures, if eligible, by notifying the national office contact person before the later of (a) March 31, 2015, or (b) the issuance of a letter ruling granting or denying consent for the change.

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Son Could Deduct Mortgage Interest as Equitable Owner of his Mother's House

The Tax Court held that a taxpayer's family had granted him an equitable interest in his mother's house and was therefore allowed to take interest deductions for mortgage payments he made on the property. Phan v. Comm'r, T.C. Summary 2015-1.

Background

In 2008, Qui Van Phan moved into a house on a three-acre ranch in California to help his mother, who was unable to care for the property herself. In 2010, the legal title to the property was held by Phan's mother, brother, and father. His brother and father were not living at the property. During this time, his mother was in the process of divorcing his father. Although Phan was not able to buy the property himself, he entered into an oral agreement with his mother and his siblings that he would pay the mortgage loan and the property taxes and these payments would increase his equity interest in the home. Phan's name was eventually added to the legal title to the property in 2013.

On his 2010 tax return, Phan claimed a $35,880 deduction for home mortgage interest paid on behalf of his family. In 2013, the IRS issued a notice of deficiency disallowing the interest deduction and determined a deficiency of $8,970. Phan petitioned the tax court, claiming he was entitled to the mortgage interest deductions as an equitable owner of the property.

Analysis

Under Reg. Sec. 1.163-1(b), a taxpayer may deduct interest paid on a mortgage upon real estate of which he or she is the legal or equitable owner (as determined by state law), even though the taxpayer is not directly liable for the bond or note secured by the mortgage. A taxpayer becomes the equitable owner of property when he or she assumes the benefits and burdens of ownership. Under California law, the owner of legal title to property is presumed to be the equitable owner as well. One way to overcome this presumption is by showing that an agreement or understanding exists between the parties transferring the benefits and burdens of ownership. The presumption cannot be overcome solely by tracing the funds used to pay for the property.

The Tax Court found that Phan had testified credibly that his family had granted him an interest in the property and would allow him to add his name to the title at any time if he paid the property expenses. The court stated it has previously held that a taxpayer may become the equitable owner of property if he or she assumes the benefits and burdens of ownership, and noted that the agreement and his conduct showed he was a beneficial owner of the property.

The court noted Phan resided at the property in 2010, consistent with his right to possess and enjoy use of the property, and also took a number of actions consistent with performing his duties, responsibilities, and obligations under the agreement with his family. The court also pointed out that Phan made the mortgage payments before, during, and after 2010. The court further noted that he testified credibly that he made the property tax and insurance payments, paid the cable bill, maintained the property, and made improvements to the property. As a result of these actions, he was granted the right to add his name to the legal title to the property. Based on these facts and circumstances the court concluded that Phan provided clear and convincing evidence that he was an equitable owner of the property in 2010, and was thus allowed the mortgage interest deductions.

For a discussion of mortgage interest deductions, see Parker Tax ¶83,515.

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Bankruptcy Court Prorates Tax Refund Between Debtor and Bankruptcy Estate

After reviewing conflicting circuit court precedents, a bankruptcy court within the Eleventh Circuit held that a bankruptcy trustee was entitled to a turnover of only a portion of amounts debtor received as tax refunds after filing for bankruptcy. In re: Mooney, 2015 PTC 19 (Bankr. M.D. Ga. 2015).

Background

Denise Mooney is a physical therapist who owns Rehab Specialists of South Georgia, Inc. Mooney's tax returns show that she receives income from her salary, investments, rental real estate, and S corporations. In 2013, Mooney had state and federal income tax withheld from her salary paychecks, which she received every two weeks. In addition, she made estimated tax payments. In June of 2013, she sent two checks for $3,300 each to the Georgia Department of Revenue for her first and second quarter 2013 state estimated tax payments, and also sent two checks for $18,350 each to the United States Treasury for her first and second quarter 2013 federal estimate tax payments.

Mooney filed for bankruptcy shortly after making the June 2013 estimated tax payments and disclosed the payments on her Statement of Financial Affairs, but did not list her 2012 state refund, her 2013 estimated tax credits, or her 2013 potential federal and state refunds as assets on her Schedule B. The bankruptcy trustee demanded, pursuant to Bankruptcy Code Section 542(a), that Mooney turn over the federal and state tax refunds arising from the 2013 estimated tax payments that she made before filing her bankruptcy case.

Mooney had received her 2013 federal and state tax refunds, totaling $36,700 and $6,600 respectively, by the time the trustee brought the case, but portions of those refunds had not been received when Mooney filed for bankruptcy. The refunds were held in her attorney's trust account pending the court's decision.

The trustee contended the tax credits were property of the bankruptcy estate, within the "control of the debtor" for purposes of Bankruptcy Code Section 542(a), and therefore subject to turnover.

Analysis

The Bankruptcy Court, located in the Eleventh Circuit, noted that the issue was one of first impression, as neither the Eleventh Circuit Court of Appeals nor any district court or bankruptcy court within the Eleventh Circuit had published a decision on the issue. Further, the court observed that while the Ninth Circuit and Tenth Circuit had each published decisions, they had reached opposite conclusions.

In Nichols v. Birdsell, 491 F.3d 987 (9th Cir. 2007), the debtors elected to have their 2001 tax refund applied to their 2002 tax liability and sixteen days later, the debtors filed bankruptcy. The Ninth Circuit held that Bankruptcy Code Section 541(a) defines property of the bankruptcy estate as "all legal or equitable interests of the debtor in property as of the commencement of the case." The court further noted that Bankruptcy Code Section 541(c)(1) provides that a debtor's interests become property of the estate even in circumstances in which the interest cannot be liquidated and transferred by the debtor. Thus, as the debtors had control over the refunds prior to declaring bankruptcy, the Ninth Circuit held that the tax credits were property of the estate and ordered a turnover.

The Tenth Circuit, in Weinman v. Graves, 609 F.3d 1153 (10th Cir. 2010), faced with similar facts and relying in part on Nichols, acknowledged that the tax credits were property of the estate, but noted that a trustee takes property subject to the same restrictions that existed at the commencement of the case, and to the extent an interest was limited in the hands of a debtor, it was equally limited as property of the estate. The Court noted the debtors had no right to any cash from their prior year refund applied as a prepayment of their current taxes until their current tax liability was determined, and then only if they were entitled to a further refund. Having found that the estate's interest in the debtor's tax credits was limited to the same extent the debtor's interest was limited by the uncertainty of the amount of any potential refund, the court held that the debtors were never in "possession, custody, or control" of their interest in the prepayment of their current year taxes, and thus were not required to turn over those amount to the estate.

The bankruptcy court noted that the Eleventh Circuit, in Raborn v. Menotte, 470 F.3d 1319 (11th Cir. 2006), recognized that the trustee succeeds only to the title and rights in the property that the debtor possessed prior to petitioning the bankruptcy court. The only interest which Mooney had in the pre-petition estimated payments was the right to a refund after filing her tax return.

Finding that both the facts of Mooney's case and the precedent in Raborn favored siding with the reasoning of the Tenth Circuit in Graves, the bankruptcy court held that the trustee was not entitled to turnover of the prepetition estimated tax payments. Mooney could thus recover the refunds from the estimated payments made prepetition, but was still required to turn over $16,769, representing the prorated prepetition portion of her federal and state tax refunds which she received after filing for bankruptcy.

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Tax-Turtle Taxpayer Can't Deduct Travel Expenses

The Tax Court held that because a truck driver taxpayer was a "tax-turtle" with no permanent residence, his travel expenses were not incurred while he was away from home and were therefore not deductible. Jacobs v. Comm'r, T.C. Summary 2015-3.

Background

Shalom Jacobs has been a truck driver since 2002. His trips were mainly long haul "over the road," meaning he spent a significant number of weeks and months on the road and was paid by the mile. When he wasn't on the road, Jacobs considered his home to be in Cottage Grove, Minnesota, where he stayed in the guest room of his longtime friend Shimon Casper. Jacobs claimed he contributed around $10,000 per year for living expenses at the Casper household, though he offered no evidence to substantiate his claim.

Jacobs admitted he had some taxable income in 2009 that he did not report, but claimed he was entitled to travel expenses that would offset most of his income for that year. The IRS disagreed, and refused to allow Jacob deductions for travel expenses after concluding Jacobs was living on the road.

Jacobs argued his residence was in Cottage Grove, Minnesota with the Caspers and that his expenses were for when he was on the road away from them. The IRS argued that Jacobs didn't reside in Cottage Grove, but was either living on the road without a permanent residence or in California during 2009 when he was between jobs.

Analysis

A taxpayer may deduct reasonable and necessary travel expenses incurred while away from his home in the pursuit of a trade or business, although no deductions may be claimed for any personal, living, or family expenses. A taxpayer must have adequate records for all claimed deductions, and must also show he was actually away from home when the expenses were incurred (Code Sec. 274). A taxpayer who is constantly in motion is considered a "tax turtle" - someone with no fixed residence who carries his "home" with him - and is not entitled to business deductions for traveling expenses (Kroll v. Comm'r, 49 T.C. 577 (1968)).

In determining whether Jacobs had a tax home, the court relied on a three factor test put forth in Rev. Rul. 73-529: (1) the business connection to the locale of the claimed home; (2) the duplicative nature of the taxpayer's living expenses while traveling and at the claimed home; and (3) personal attachments to the claimed home.

The court could not find any business connection to the location of Jacobs' supposed residence at the Casper household. Further, the court stated that any use of the Casper household address for mailing, voting, or other incidentals Jacobs claimed (but did not provided evidence for) was for his convenience only, and not for any business reasons. Although Jacobs claimed to have incurred living expenses while at the Casper residence, the court found that he lacked evidence showing he financially contributed to the Casper home, and further noted that the expenses duplicated those that he incurred on the road. Finally, the court noted that Jacobs's records for 2009 indicated he spent more time in California than in Cottage Grove, and the court found it especially telling that Casper, in his testimony, said that Jacobs occupied the "guest room," the same room other visitors used when they visited.

As Jacobs was not able to substantiate his claim that the Casper residence in Cottage Grove was his tax home, the court found instead that Jacobs was an itinerant worker - a tax turtle - whose tax home followed him on the road and that he was therefore ineligible to deduct his travel expenses.

For a discussion of travel expense deductions, see Parker Tax ¶ 91,105.

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Tax Court Rejects Taxpayer's Attempt to Prioritize Alimony Over Child Support

A taxpayer saw most of his alimony deduction disallowed after overstating the total amount paid and failing to properly allocate payments between child support and alimony. Becker v. Comm'r, T.C. Summary 2015-2.

Background

Joseph Becker and his wife, Jennifer, separated in 2009. Under their final divorce decree, Becker owed $8,205 for alimony and $8,307 for child support in 2011. After making payments to Jennifer totaling $9,688, Becker claimed an alimony paid deduction of $12,036 on his 2011 tax return.

The IRS disallowed the entire alimony expense deduction. Becker challenged that determination, arguing that he allocated payments between child support and alimony in 2011. In accordance with instructions from his family law attorney to deduct the child-related expenses that he paid directly rather than to his wife, Becker claimed he was allowed to reduce the child support for those direct payments but not the alimony. He acknowledged, however, that the amount he claimed on his 2011 tax return for alimony paid also included child support payments and would need to be adjusted accordingly.

Becker argued, by his calculations, he paid $5,462 in alimony and therefore should be entitled to a $5,462 deduction. The IRS conceded he was entitled to a $1,381 deduction.

Analysis

In general, amounts fixed by the divorce or separation instrument as a sum which is payable for child support are not deductible (Code Sec. 71(c)(1)). Where the payments actually made are less than the amounts specified in the divorce instrument for alimony and child support, those payments are considered to have been made towards child support first and are only allocated towards the alimony portion once child support has been fully paid (Code Sec. 71(c)(3)).

The Tax Court examined the divorce instrument, which specifically designated amounts for alimony and for child support totaling $8,205 and $8,307, respectively, and noted that Becker only made payments of $9,688. The court reasoned that Becker failed to account for Code Sec. 71(c)(3), which applied to the underpayment of support and required applying the amounts to child support before alimony. Consequently, the court agreed with the IRS's calculation and determined that $8,307 of the $9,688 of payments should be allocated as child support, leaving the $1,381 remainder allocated as alimony. Accordingly, the court concluded Becker's deduction was limited to that amount.

The court also upheld the 20 percent accuracy-related penalty levied by the IRS under Code Sec. 6662 based on Becker's substantial understatement of his income tax and his attempt to claim a deduction in excess of the amounts he actually paid. The court reasoned that, while the return had been prepared by a C.P.A. and the reduced child support calculations were made on the advice of his lawyer, Becker failed to explain the disparity between the $12,036 claimed deduction and $9,688 total paid in alimony and child support.

For a discussion of alimony and transfers between spouses, see Parker Tax ¶ 14,200.