IRS Allows Method of Accounting Change for Merged Consolidated Groups; IRS Sets Maximum Face Amount of Qualified Zone Academy Bonds for 2014; IRS Issues Retroactive Updates to the 2014 Luxury Vehicle Bonus Depreciation Limits ...
IRS Fails to Provide New Accounting Method "Change Numbers" in Form 3115 Instructions
Badly outdated instructions for Form 3115 lack dozens of automatic accounting method "change numbers" required for changes relating to new repair and capitalization regs, which are expected to drive an unprecedented wave of 3115 filings.
The AICPA released a statement to its members this week addressing growing anxiety about implementation of the IRS's new repair and capitalization regs. Many of the issues causing the deepest concerns involved the filing requirements for Form 3115, Application for Change in Accounting Method.
No Capital Gain Treatment for Properties Purchased at Tax Auctions for Quick Resale
The Tax Court found that because taxpayers purchased a high volume of properties from county tax auctions and frequently resold the properties for quick profits, the could not treat the properties as capital assets and should have reported their profits as ordinary income. SI Boo, LLC, et al. v. Comm'r, T.C. Memo. 2015-19.
The Eleventh Circuit affirmed a district court ruling that, because payments to an environmental engineering firm were not contingent on the success of its contracted research, the firm was "funded" by its clients within the meaning of Code Sec. 41 and was not eligible for the research credit. Geosyntec Consultants, Inc. v. U.S., 2015 PTC 31 (11th Cir. 2015).
If a missing or corrected Form W-2 or Form 1099 is not received by February 14, the IRS should be contacted, and the IRS will attempt to obtain the information from the employer.
The Tax Court held a taxpayer was entitled to dependency exemptions, earned income tax credit, and additional child tax credit for her daughter and grandchild, as the daughter was not in a common law marriage and could be claimed as a qualifying child by the taxpayer. Saenz v. Comm'r, T.C. Summary 2015-6.
A taxpayer was unable to take a large portion of claimed deductions as records substantiating expenses were destroyed due to a burst water pipe. But because the situation was beyond his control, the Tax Court declined to assess an accuracy-related penalty. Lain v. Comm'r, T.C. Summary 2015-5.
Corporate Director Cannot Seek Contribution from CFO for Withholding Tax Penalties
A district court determined that a corporate director could not seek contribution from a CFO for penalties arising from his willful failure to pay over withholding taxes. Despite the fact that the CFO was "responsible person", such contribution is only available after penalties have been paid in full by the taxpayer. Happy v. McNeil, 2015 PTC 43 (W.D. Tex. 2015).
The IRS issued the 2015 luxury vehicle depreciation limitations and the income inclusion amounts for leased vehicles. Rev. Proc. 2015-19.
IRS Fails to Provide New Accounting Method "Change Numbers" in Form 3115 Instructions
Badly outdated instructions for Form 3115 lack dozens of automatic accounting method "change numbers" required for changes relating to new repair and capitalization regs, which are expected to drive an unprecedented wave of 3115 filings.
Background
In 2013, the IRS issued final tangible property regulations which provided rules for (1) amounts paid or incurred for materials and supplies; (2) amounts paid or incurred for repairs and maintenance; (3) capital expenditures; (4) amounts paid or incurred for the acquisition and production of tangible property; and (5) amounts paid or incurred for the improvement of tangible property. The IRS followed in 2014 with final regulations for determining the gain or loss on dispositions of tangible property, identifying the asset disposed of, and accounting for partial dispositions of MACRS property. For most taxpayers, the new rules apply to tax years beginning on or after January 1, 2014.
In many situations, complying with the regulations will involve accounting method changes that will require filing Form 3115, Application for Change in Accounting Method. Officially designated accounting method "change numbers" are required to complete the form. In the past, these numbers have been available for lookup in a comprehensive list appearing in the form's instructions.
Practitioners trying to locate change numbers relating to the new repair and capitalization regs, however, have experienced an unpleasant surprise; because the instructions have not been updated since 2012, none of the change numbers relating to the new rules are on the list. In fact, the only IRS sources for the new change numbers are the unwieldy revenue procedures they derive from, some of which run to more than 300 pages.
Key Change Numbers Relating to New Capitalization and Repair Regulations
To help bridge the gap until the IRS updates the Form 3115 instructions, Parker has put together a list of the 39 automatic accounting method change numbers relating to the new repair and capitalization regs.
Practice Aid: For the complete list of the new accounting method change numbers, including cites to the underlying IRS revenue procedures and regulations, see ¶241,592.
The following are the more important change numbers for use in preparing 2014 Forms 3115:
184. Deducting amounts for repair and maintenance or capitalizing amounts for improvements to tangible property: Change number "184" applies to changing to deducting amounts paid or incurred for repair and maintenance or changing to capitalizing amounts paid or incurred for improvements to tangible property and, if depreciable, to depreciating such property under Code Secs. 167 or 168. This includes a change, if any, in the method of identifying the unit of property, or in the case of a building, identifying the building structure or building systems for the purpose of making this change. See Reg. Secs. 1.162-4, 1.263(a)-3; Section 10.11 in Rev. Proc. 2015-14.
185. Change to the regulatory accounting method: Change number "185" applies to changing to the regulatory accounting method to determine whether amounts paid to repair, maintain, or improve tangible property are to be treated as deductible expenses or capital expenditures. See Reg. Sec. 1.263(a)-3(m); Section 10.11 in Rev. Proc. 2015-14.
186. Change to deducting non-incidental materials and supplies when used or consumed: Change number "186" applies to changing to deducting non-incidental materials and supplies when used or consumed. See Reg. Secs. 1.162-3(a)(1), (c)(1); Section 10.11 in Rev. Proc. 2015-14.
187. Change to deducting incidental materials and supplies when paid or incurred: Change number "187" applies to changing to deducting incidental materials and supplies when paid or incurred. See Reg. Secs. 1.162-3(a)(2), (c)(1); Section 10.11 in Rev. Proc. 2015-14.
190. Change by a dealer in property to deduct commissions: Change number "190" applies to a change by a dealer in property to deduct commissions and other amounts paid to facilitate the sale of property. See Reg. Sec. 1.263(a)-1(e)(2); Section 10.11 in Rev. Proc. 2015-14.
191. Change by a non-dealer in property to capitalizing commission: Change number "191" applies to a change by a non-dealer in property to capitalizing commissions and other costs that facilitate the sale of property. See Reg. Sec. 1.263(a)-1(e)(1); Section 10.11 in Rev. Proc. 2015-14.
192. Change to capitalizing acquisition or production costs: Change number "192" applies to changing to capitalizing acquisition or production costs and, if depreciable, to depreciating such property under Code Secs. 167 or 168. See Reg. Sec. 1.263(a)-2; Section 10.11 in Rev. Proc. 2015-14.
193. Change to deducting costs for investigating or pursuing acquisition of real property: Change number "193" applies to changing to deducting certain costs for investigating or pursuing the acquisition of real property. An amount paid by the taxpayer in investigating or otherwise pursuing the acquisition of real property does not facilitate the acquisition if it relates to activities performed in determining whether to acquire real property and which real property to acquire. See Reg. Sec. 1.263(a)-2(f)(2)(iii); Section 10.11 in Rev. Proc. 2015-14.
194. Change to a reasonable allocation method for self-constructed assets: Change number "194" applies to a producer or a reseller-producer that wants to change to a reasonable allocation method within the meaning of Reg. Sec. 1.263A-1(f)(4), other than the methods specifically described in Reg. Secs. 1.263A-1(f)(2) or (3), for self-constructed assets produced during the taxable year, including any necessary changes in the identification of costs subject to Code Sec. 263A that will be accounted for using the proposed method. This also includes a change from not capitalizing a cost subject to Code Sec. 263A to capitalizing that cost for a producer or reseller-producer under a reasonable allocation method within the meaning of Reg. Sec. 1.263A-1(f)(4) that the producer or reseller-producer is already using for self-constructed assets, other than the methods specifically described in Reg. Sec. 1.263A-1(f)(2) or (3). See Section 11.09 in Rev. Proc. 2015-14.
196. Late partial disposition election: Change number "196" applies to a taxpayer that wants to make a late partial disposition election under Reg. Sec. 1.168(i)-8(d)(2)(i) or Prop. Reg. Sec. 1.168(i)-8(d)(2)(i) for the disposition of a portion of an asset by the taxpayer. This change also may affect whether the taxpayer must capitalize amounts paid to restore a unit of property. See Reg. Sec. 1.168(i)-8; Section 6.33 in Rev. Proc. 2015-14.
199. Depreciation of leasehold improvements: Change number "199" applies to a taxpayer that wants to change its method of accounting to comply with Reg. Sec. 1.167(a)-4 for leasehold improvements in which the taxpayer has a depreciable interest at the beginning of the year of change. See Reg. Sec. 1.167(a)-4; Section 6.36 in Rev. Proc. 2015-14.
205. Disposition of a building or structural component: Change number "205" applies to a taxpayer that wants to make a change in method of accounting that is specified in Section 6.38(3) of Rev. Proc. 2015-14 for disposing of a building or a structural component or disposing of a portion of a building (including its structural components) to which the partial disposition rule in Reg. Sec. 1.168(i)-8(d)(1) applies. This change also affects the determination of gain or loss and may affect whether the taxpayer must capitalize amounts paid to restore a unit of property. See Reg. Sec. 1.168(i)-8; Section 6.38 in Rev. Proc. 2015-14.
206. Dispositions of tangible depreciable assets other than a building or its structural components: Change number "206" applies to a taxpayer that wants to make a change in method of accounting specified in Section 6.39(3) of Rev. Proc. 2015-14 for disposing of Code Sec. 1245 property or a depreciable land improvement or disposing of a portion of Code Sec. 1245 property or a depreciable land improvement to which the partial disposition rule in Reg. Sec. 1.168(i)-8(d)(1) applies. This change also affects the determination of gain or loss and may affect whether the taxpayer must capitalize amounts paid to restore a unit of property under Reg. Sec. 1.263(a)-3T(i) or Reg. Sec. 1.263(a)-3(k), as applicable. See Reg. Sec. 1.168(i)-8; Section 6.39 in Rev. Proc. 2015-14.
215. Depletion: Change number "215" applies to a taxpayer that wants to change its method of accounting for depletion to treat these amounts as an indirect cost that is only properly allocable to property that has been sold (that is, for purposes of determining gain or loss on the sale of the property) under Reg. Sec. 1.263A-1(e)(3)(ii)(J). See Section 11.14 in Rev. Proc. 2015-14.
For a discussion of automatic changes in accounting method, see ¶ 241,590.40. For a complete list of change numbers relating to the new repair and capitalization regulations, see ¶241,592.
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AICPA Addresses Escalating Concerns Surrounding Repair and Capitalization Regs
The AICPA released a statement to its members this week addressing growing anxiety about implementation of the IRS's new repair and capitalization regs. Many of the issues causing the deepest concerns involved the filing requirements for Form 3115, Application for Change in Accounting Method.
Background
The AICPA's statement comes at a time when practitioners are sharply divided in their interpretation of the rules.
One school of thought holds that nearly every business with depreciable property must file a Form 3115 adopting any applicable method of accounting rules changed by the regs, even though the change is being initiated by the IRS (in the form of new regs), not the taxpayer. The alternative view is that no Form 3115 is required in situations in which the new rules lead to the same result as the old rules (e.g., the taxpayer was capitalizing under the old rules and will continue to capitalize under the new rules), because there really is no change in accounting method in such situations.
The IRS, which has not updated the instructions to Form 3115 in nearly three years, has remained silent about filing requirements under the new repair and capitalization regs.
AICPA Relief Proposal
The AICPA has stepped into the void by amplifying its earlier proposal to the IRS that the following relief should be offered to small businesses:
- Make Form 3115, as well as the section 481 adjustment, optional.
- Allow for the adoption of a "cut-off method" and apply the rules prospectively.
- Accept a statement in lieu of Form 3115 to acknowledge compliance with the regulations.
- Raise the de minimis safe harbor from $500 to $2,500.
The IRS has not responded publicly to the AICPA's proposal. Some well-respected practitioners have, however, indicated that (based on their conversations with IRS personnel) the issue is coming to a head within the IRS and additional guidance will be released.
The AICPA's Recommendations to Members
The AICPA's statement included a surprisingly frank assessment of the situation:
"We find ourselves in a challenging predicament. On the one hand, we are hopeful that the IRS will issue relief which would ease the burden for small businesses. On the other hand, there is no guarantee that relief will come in time (if at all). As we move further into tax season, tensions continue to mount as rumors spread regarding what the IRS may or may not provide in terms of guidance, relief, support or enforcement. We have heard that many practitioners are deferring the preparation of Form 3115 in anticipation of possible relief."
Based on this assessment, the AICPA indicated that it sees only two options for its members working on returns for which it's not clear whether a Form 3115 is required:
(1) Continue under current rules and adapt if/when the IRS issues relief (running the risk that work may need to be revised or may prove obsolete); or
(2) Temporarily suspend all related work in hopes of near-term IRS relief (running the risk that such relief may not be forthcoming).
Based on the context, it appears that when the AICPA refers to continuing "under the current rules", it is referring to a strict interpretation of the regs that would result in filing Forms 3115 for a great many business taxpayers.
In the statement's concluding paragraph, the AICPA makes clear that while it cannot formally advise its members to disregard existing law and regulations and simply not comply, it is ultimately up to the firms to make an informed decision on how to handle the Form 3115 quandary based on their unique circumstances, client mix, and resources.
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No Capital Gain Treatment for Properties Purchased at Tax Auctions for Quick Resale
The Tax Court found that because taxpayers purchased a high volume of properties from county tax auctions and frequently resold the properties for quick profits, the could not treat the properties as capital assets and should have reported their profits as ordinary income. SI Boo, LLC, et al. v. Comm'r, T.C. Memo. 2015-19.
Background
S. I. Securities, Sabre, and SI Boo ("taxpayers") were organized in Illinois as limited liability companies and were treated as partnerships. S. I. Securities and Sabre participated in tax lien auctions throughout Illinois, purchasing judgment liens in the hopes of turning a profit.
In Illinois, county tax collectors may offer to sell certificates of tax liens at public auctions after the county has won judgments for nonpayment of taxes and the lien purchaser pays the county the delinquent taxes owed on the property. The owner of the property may redeem the encumbered property within a certain redemption period by paying the certificate amount, an accrued penalty, and certain other costs. If the period expires and the property has not been redeemed, then the owner of the tax lien certificate may petition for a tax deed with respect to that property, providing the owner of the certificate with merchantable title to the property.
Between 2007 and 2008, the taxpayers' acquisition of tax lien certificates from these auctions totaled approximately 6,500 certificates. To fund the purchases of the certificates, the entities drew against lines of credit established with several banks. Because interest accrued on the lines of credit, the taxpayers' hoped to make a profit on the spread between the interest rates charged against their lines of credit and the penalty rates they received if and when the certificates were redeemed.
If the certificates were not redeemed, the taxpayers' planned to sell the properties to third parties by quitclaim deed or contract for deed. In attempting to sell these properties, the taxpayers' intent was not to hold onto them for appreciation in value but rather to sell the properties quickly to recover their investment costs or to make a profit. During 2007 and 2008, the taxpayers' collectively sold 259 parcels of property by either quitclaim deed or by contract for deed and reported income they received from the sales as capital gains.
In 2010, the IRS issued final partnership administrative adjustments (FPAAs), in which it determined that because the entities held the properties acquired by tax deeds primarily for sale, rather than for investment, the proceeds should be classified as ordinary income. The tax matters partners for the three entities filed petitions with the Tax Court for readjustment of the partnership items.
Analysis
Capital assets do 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)). Whether property is held primarily for sale to customers in the ordinary course of a taxpayer's trade or business is a question of fact which must be determined by consideration of all the surrounding circumstances. (Guardian Indus. Corp. & Subs. v. Comm'r, 97 T.C. 308 (1991)). Courts consider numerous factors to determine the purpose for which property is primarily held and generally look to the taxpayer's purpose at the time the property is sold.
The Tax Court considered two factors to be particularly relevant to this case: (1) the frequency and regularity of sales of real properties; and (2) the substantiality of the sales and the relative amounts of income taxpayers derived from their regular business and the sales of real properties.
The taxpayers contended that the sales were not frequent in comparison to the number of certificates of purchase of tax lien they acquired. However, the court disagreed, noting that the taxpayers' accounting records, as well as the testimony presented at trial, showed that they intended to dispose of the properties quickly and frequently and with the intent to make a profit, and were successful in doing so. The court also pointed out that the taxpayers' effectively conceded in their written submissions to the court that most of the properties sold by quitclaim deed were sold within one year of their acquisition. Because of this, the court gave little weight to the fact that the taxpayers acquired more certificates of purchase of tax lien than tax deeds.
The court also noted that the taxpayers' sales of real properties were substantial, especially when viewed with respect to the total amounts of income each entity earned. The court pointed out that, as a general matter, frequent, regular, and substantial sales of real property are indicative of sales being made in the ordinary course of a trade or business, whereas infrequent sales of these properties are more indicative of real property held for investment purposes.
After applying the factors it considered relevant, the court concluded that the properties that the taxpayers acquired from certificates of purchase of tax lien and converted into tax deeds were properties held by the taxpayers primarily for sale to customers in the ordinary course of their trades or businesses, precluding characterization of those assets as capital.
The court additionally concluded that the taxpayers improperly reported their earnings by excluding the real estate sales from their net earnings computation and by reporting the sales as capital gains not subject to a tax on the net earnings. Based on Code Secs. 1401(a) and (b), which impose a tax on the net earnings from self-employment derived from any trade or business carried on by the taxpayer, and the court's findings that the taxpayers earned income from the proceeds of sales of real properties, the court held that the taxpayers should have included the income in their reported net earnings from self-employment.
For a discussion of capital assets, see Parker Tax ¶ 111,105.
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Client Funding Prevents Engineering Firm from Claiming Research Credit
The Eleventh Circuit affirmed a district court ruling that, because payments to an environmental engineering firm were not contingent on the success of its contracted research, the firm was "funded" by its clients within the meaning of Code Sec. 41 and was not eligible for the research credit. Geosyntec Consultants, Inc. v. U.S., 2015 PTC 31 (11th Cir. 2015).
Background
Geosyntec is a specialized consulting and engineering firm that provides services on projects involving the environment, natural resources, and geological infrastructure. In 2012, Geosyntec filed suit in district court seeking a federal income tax refund of $1,677,432 stemming from research tax credits for qualified research expenses incurred on client projects from 2002 to 2005, including several contracts subject to a maximum payment, also known as "capped contracts." The district court was asked to decide whether Geosyntec's research was "funded" by its clients within the meaning of Code Sec. 41 such that it would not be eligible for the research credit.
The district court found the capped contracts were funded, making Geosyntec ineligible for the research tax credit. Geosyntec appealed, contending the district court erred in in its findings with respect to two of the contracts: (1) a contract with the Delaware Solid Waste Authority (DSWA) to expand the capacity of the Cherry Island Landfill in Wilmington, Delaware (the Cherry Island Contract); and (2) a contract with Waste Management, Inc. (WM) to evaluate technology for remediating groundwater beneath a warehouse in Niagara, New York (the WM Contract).
Analysis
Under Code Sec. 41, a taxpayer may claim a tax credit based on the amount of qualified research expenses incurred in the performance of qualified research, subject to certain exclusions. The funded research exclusion prevents a taxpayer from claiming a tax credit for research funded by any grant, contract, or otherwise by another person or governmental entity (Code Sec. 41(d)(4)(H)). Research is not considered funded where an agreement makes payment to the researcher contingent on the success of its research (Reg. Sec. 1.41-4A(d)).
The Eleventh Circuit identified Fairchild Indus., Inc. v. United States, 71 F.3d 868 (Fed. Cir. 1995) as the benchmark for determining whether a research contract is funded or not for purposes of the research credit. In Fairchild, an airplane manufacturer contracted with the United States Air Force to design and produce an aircraft. Under the terms of the contract, the Air Force was obligated to pay Fairchild only if Fairchild produced results that met the contract's specifications; equally, Fairchild was entitled to payment only for work delivered to and accepted by the Air Force. Since Fairchild bore the financial risk of failed research, as payment was contingent on success, the court concluded that the contract was not funded under the meaning of Code Sec. 41, making Fairchild eligible for the research tax credit.
The Eleventh Circuit examined both the Cherry Island Contract and WM Contract to determine whether Geosyntec's right to payment was contingent on the success of its research.
Geosyntec argued that both contracts fell squarely within the gambit of Fairchild. Geosyntec contended that it faced substantial financial risk under the capped contracts because it would only be paid for expenses incurred, eliminating an opportunity to make a profit on the research should it come in under budget, and it bore the risk that its expenses would exceed the ceiling price for each contract. Geosyntec further argued that it bore the financial risk of the failure of its research to produce the desired product or result, even if success was not expressly mandated by the terms of either contract.
First, the court dismissed Geosyntec's general economic risk arguments, as payment under the contracts was still not contingent on success. Geosyntec merely noted that it ran a risk of not earning the maximum stated amount, or going over budget, which was not the financial risk contemplated in Fairchild.
Second, the court noted that neither contract expressly made payment to Geosyntec contingent on the success of the research. In the WM Contract, Geosyntec was to be paid for the labor and materials, regardless of whether the tests yielded the results WM sought. In the Cherry Island contract DSWA had the right to review and comment on Geosyntec's design work, but each task was not subject to complex contract specifications, nor was the work subject to inspection and testing before acceptance. The court noted in contrast, Fairchild had to succeed at each step of the development phase in order to be paid under the explicit terms of its contract.
Third, the court further noted that the contracts did not place risk of failure on Geosyntec. Under neither contract was Geosyntec subject to quality assurance procedures akin to those in Fairchild. The WM Contract required only that all services be completed by a specified date. Under the Cherry Island Contract, certain work was subject to review by DSWA, but there was no method to measure success. Monthly invoices submitted by Geosyntec to DSWA and to WM were payable upon submission unless an item or sum shown due on the invoice was in dispute. In contrast, unless and until Fairchild fully succeeded in each phase of the project, it had no right to payment, and the Air Force was not required to pay if it deemed the work unacceptable. The court found that under neither contract did the right to dispute sums shown due on an invoice equate to a requirement that Geosyntec's work product be evaluated and accepted prior to payment.
In sum, the Eleventh Circuit found Geosyntec was entitled to payment under both contracts, regardless of the success of its research. Both DSWA and WM contracted with Geosyntec to reimburse Geosyntec for labor and costs for pre-defined tasks at pre-defined rates. Neither the Cherry Island Contract nor the WM Contract provided that DSWA or WM was obligated to reimburse Geosyntec only if Geosyntec produced results that met the contracts' specifications. Similarly, Geosyntec was not entitled to payment only for work product delivered to and accepted by its clients. Because payment to Geosyntec was not contingent on the success of its research, the Eleventh Circuit held that the contracts were funded by Geosyntec's clients under the meaning of Code Sec. 41 and, accordingly, it was not eligible for the research credit.
For a discussion of the research tax credit, see Parker Tax ¶ 104,900.
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How to Handle Missing or Incorrect Forms W-2 and 1099
If a missing or corrected Form W-2 or Form 1099 is not received by February 14, the IRS should be contacted, and the IRS will attempt to obtain the information from the employer.
Employers/payers have until January 31 to issue certain informational documents. If a Form W-2 or Form 1099-R is not received by January 31, or the information is incorrect on these forms, the taxpayer should contact the employer/payer.
If a missing or corrected Form W-2 or Form 1099 is still not received by February 14, the IRS should be contacted at 800-829-1040 for assistance. When calling the IRS, the following information is necessary: the taxpayer's name, address (including ZIP code), phone number, and social security number, as well as the employer/payer's name, address (including ZIP code), and phone number, employer identification number (if known), an estimate of the wages earned by the employee, the federal income tax withheld, and the dates of employment.
After February 14, the IRS will contact the employer/payer and request the missing form. The IRS will also send the taxpayer a Form 4852, Substitute for Form W-2, Wage and Tax Statement, or Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., along with a letter containing instructions.
Where a taxpayer does not receive the missing form in sufficient time to file his or her tax return on a timely basis, the taxpayer may use the Form 4852 to complete the return. If the taxpayer subsequently receives the missing or corrected Form W-2 or Form 1099-R after a return is filed and a correction to the originally filed return needs to be made, then the taxpayer should file Form 1040X, Amended U.S. Individual Income Tax Return.
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Tax Court: Dependency Exemption Stands, Daughter Not Married under Common Law
The Tax Court held a taxpayer was entitled to dependency exemptions, earned income tax credit, and additional child tax credit for her daughter and grandchild, as the daughter was not in a common law marriage and could be claimed as a qualifying child by the taxpayer. Saenz v. Comm'r, T.C. Summary 2015-6.
Background
From January until August of 2011, Leticia Saenz supported her daughter and grandchild, allowing them to live in her home. For the remainder of 2011, Saenz's daughter and grandchild resided with the daughter's boyfriend, Michael Nieto.
In 2012, Saenz filed her 2011 return and claimed dependency exemption deductions and the earned income tax credit with respect to her daughter and grandchild, as well as the additional child tax credit with respect to her grandchild. On April 15, 2012, Saenz's daughter and Mr. Nieto filed a joint return for 2011 and attached a statement representing that they were married. On their joint return, they also claimed a dependency exemption deduction and the earned income tax credit with respect to Saenz's grandchild.
On April 1, 2013, the IRS mailed Saenz a notice of deficiency and disallowed her deductions and credits, noting that Saenz's daughter and grandchild were claimed on another return filed for that year. The IRS contended that Saenz was not entitled to these credits and deductions because her daughter and her daughter's boyfriend were "common law" married under Texas law and had filed a joint return. Saenz argued that her daughter and grandchild were qualifying children, as her daughter was not actually married.
Analysis
Taxpayers are entitled to claim the Code Sec. 32 earned income tax credit and the Code Sec. 24 additional child tax credit for all qualified children. Under Code Sec. 152(c), a qualifying child must be the taxpayer's child or a descendant of the taxpayer's child. In addition to other requirements, a qualifying child must be an individual who has not filed a joint return with the individual's spouse under Code Sec. 6013 for the same tax year for which the taxpayer is claiming the qualifying child (Code Sec. 152(c)(1)(E)).
The Tax Court reasoned that while Saenz's daughter and Mr. Nieto resided together during part of 2011, they failed to meet the requirements of common law marriage under Texas law, which requires (1) the couple agree to be married; (2) after the agreement, they live together as husband and wife; and (3) they represent to others that they are married.
The court found that the couple fell short of the meeting these requirements. The court noted Mr. Nieto's testimony, in which Nieto stated that he and Saenz's daughter agreed to be married when they signed and filed their 2011 tax return. As the 2011 tax return was jointly filed in 2012, the court found they did not agree to be married until 2012, the year following the tax year in question. Additionally, Saenz's son testified that he believed Mr. Nieto was his sister's boyfriend, not husband.
Finding that Saenz's daughter was not married, common law or otherwise, to Mr. Nieto in 2011, the court concluded the daughter did not file a joint return with her spouse "under section 6013" and therefore did not fail the requirement in Code Sec. 152(c)(1)(E). The court determined Saenz could claim her daughter as a qualifying child for purposes of the dependency exemption deduction and the earned income tax credit on her 2011 tax return.
Consequently, even though both Saenz and her daughter claimed Saenz's grandchild as a qualifying child on their respective 2011 returns, Saenz's daughter was barred from doing so because she was a dependent of Saenz for that year. Accordingly, Saenz could claim her grandchild as a qualifying child for purposes of the dependency exemption deduction, the earned income tax credit, and the additional child tax credit for the 2011 tax year.
For a discussion on the dependency exemption deduction, see Parker Tax ¶10,700
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Burst Water Pipe Helps Taxpayers Avoid Accuracy-Related Penalty
A taxpayer was unable to take a large portion of claimed deductions as records substantiating expenses were destroyed due to a burst water pipe. But because the situation was beyond his control, the Tax Court declined to assess an accuracy-related penalty. Lain v. Comm'r, T.C. Summary 2015-5.
Background
S. Scott Lain worked in Florida as a stockbroker for Chase Investment Bank during the first half of 2010, and as an insurance salesman for MetLife during the latter half. Lain's work at both Chase and MetLife required him to drive his vehicle from his offices to the offices and homes of prospective and current clients to discuss investments, retirement income plans, and other services Chase and MetLife offered.
Lain and his wife have one child, JL, who was diagnosed with autism spectrum disorder when he was three years old, necessitating numerous medical and educational expenses.
On his joint 2010 tax return, Lain reported various deductions related to medical and education expenses for JL, charitable contributions, and unreimbursed employee expenses. Lain took medical and education expense deductions of $46,596, charitable contribution deductions of $8,880, and miscellaneous itemized deductions of $17,091.
The IRS disallowed all of Lain's claimed deductions and assessed an accuracy-related penalty. Lain then petitioned the Tax Court for redetermination, arguing that he was unable to substantiate many of the expenses underlying the claimed deductions because his tax records were destroyed by water from a pipe that had burst. Lain believed that because the destruction of his records were beyond his control, the IRS incorrectly disallowed his deductions.
Analysis
Taxpayers are required to maintain records that are sufficient to enable the IRS to determine their correct tax liability (Code Sec. 6001). When a taxpayer's records have been destroyed or lost due to circumstances beyond the taxpayer's control, the taxpayer may substantiate his or her claimed expenses, including Code Sec. 274(d) expenses, through reasonable reconstruction (Malinowski v. Commissioner, 71 T.C. 1120 (1979)).
On the basis of Lain's testimony, the Tax Court was satisfied that his 2010 tax records were destroyed because of circumstances beyond his control, as it was impossible for Lain to have anticipated a burst pipe would destroy the records substantiating his expenses. Nonetheless, the court noted that even if a taxpayer establishes that his records were lost or destroyed because of circumstances beyond his control, he must still substantiate the claimed expenditures through secondary evidence (Boyd v. Comm'r, 122 T.C. 305 (2004)). Based on Lain's testimony and secondary records, the court only allowed, $22,499 of the $72,567 total claimed deductions.
Although Lain's burst pipe did not relieve him of his duty to substantiate claimed expenses, it did enable him to avoid the accuracy related penalty imposed by the IRS. Code Sec. 6664(c)(1) provides an exception to the accuracy related penalty if the taxpayer establishes that there was reasonable cause for, and the taxpayer acted in good faith with respect to, the underpayment.
Relying in part on Higbee v. Comm'r, 116 T.C. 438 (2001) the court found that the destruction of tax records resulting from the burst pipe constituted a reasonable cause for the underpayments. Because the water incident prevented Lain from accurately substantiating his deductions, despite his best efforts to do so, and because he prevailed with respect to some of the claimed deductions, the court believed that he might have been able to substantiate many of his claimed deductions had his records stayed intact, and declined to impose an accuracy-related penalty.
For a discussion of accuracy related penalties, see Parker Tax ¶ 262,120.
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Corporate Director Cannot Seek Contribution from CFO for Withholding Tax Penalties
A district court determined that a corporate director could not seek contribution from a CFO for penalties arising from his willful failure to pay over withholding taxes. Despite the fact that the CFO was "responsible person", such contribution is only available after penalties have been paid in full by the taxpayer. Happy v. McNeil, 2015 PTC 43 (W.D. Tex. 2015).
Background
Jack Happy and Lowery McNeil were principals of Green Aggregates, Inc. Happy was a director and McNeil was president and CFO. For several consecutive quarters, Green Aggregates withheld income taxes and social security contributions from the wages it paid to its employees, but did not pay those funds to the IRS as required by law.
In 2007, Green Aggregates filed for bankruptcy owing more than $300,000 in withholding taxes to the IRS pursuant to Code Sec. 6672(a). The IRS subsequently assessed a penalty against both Happy and McNeil. Happy testified that he paid the IRS $15,000, and that the balance of the unpaid penalty was approximately $325,000.
Relying upon Code. Sec. 6672(d), Happy sought a judgment against McNeil for one-half of the $15,000 already paid, and also sought a declaratory judgment that McNeil is liable for one-half of all future payments made by Happy in satisfaction of the penalty. McNeil contended that Happy was entitled to no contribution at all until Happy paid his proportionate share of the outstanding penalty.
Analysis
To be entitled to contribution under Code. Sec. 6672(d), the person from whom contribution is sought must be (1) a responsible person (2) who willfully failed to pay over withheld taxes. If more than one person is liable for a penalty Code Sec. 6672(a), each person who paid such penalty is entitled to recover from other liable persons an amount equal to the excess of the amount paid by such person over such person's proportionate share of the penalty (Code Sec. 6672(d)).
The court found that McNeil was a responsible person and that he acted willfully in failing to pay over the withheld taxes as he admitted to paying other creditors while knowing that withheld funds were due and owing to the IRS. However, the court concluded Happy was not presently entitled to contribution as, under the plain language of Code Sec. 6672(d), a responsible person who is liable for a penalty cannot seek contribution until he has paid his proportionate share of the penalty. As Happy had only paid $15,000 towards the $325,000 penalty, he had not paid an amount equal to or more than his proportionate share, and consequently was unable to seek contribution from McNeil under Code Sec. 6672(d).
For a discussion of withholding requirements and responsible persons, see Parker Tax ¶ 210,108
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2015 Luxury Vehicle Depreciation Limits and Lease Inclusion Amounts Announced
The IRS issued the 2015 luxury vehicle depreciation limitations and the income inclusion amounts for leased vehicles. Rev. Proc. 2015-19.
Background
Under Code Sec. 280F(a), depreciation deductions allowable for passenger automobiles, trucks, and vans are limited to a maximum dollar amount each tax year. This limitation is known as the luxury automobile limitation. The amounts allowable are adjusted each year by an inflation adjustment.
Code Sec. 280F(c) requires a reduction in the deduction allowed to the lessee of a leased passenger automobile, truck, or van. The reduction must be substantially equivalent to the limitations on the depreciation deductions imposed on owners of such vehicles. This reduction requires a lessee to include in gross income an amount determined by applying a formula to the amount obtained from a table. Each table (one for passenger automobiles and one for trucks and vans) shows inclusion amounts for a range of fair market values for each tax year after the vehicle is first leased.
2015 Depreciation Limitations
The depreciation limitations for passenger automobiles placed in service in calendar year 2015 are:
- 1st Tax Year - $3,160
- 2nd Tax Year - $5,100
- 3rd Tax Year - $3,050
- Each Succeeding Year - $1,875.
The depreciation limitations for trucks and vans placed in service in calendar year 2015 are:
- 1st Tax Year - $3,460
- 2nd Tax Year - $5,600
- 3rd Tax Year - $3,350
- Each Succeeding Year - $1,975
For a discussion of the luxury auto limitations, see Parker Tax ¶94,920. For a discussion of the lease inclusion rules, see Parker Tax ¶94,915.
