TOP TAX DEVELOPMENTS OF 2016

(Parker Tax Publishing January 9, 2017)

In 2016, the tax practitioners experienced the usual slew of important court decisions and major new IRS regulations, procedures, and rulings. But the biggest development was a seismic shift in the political terrain, expected to produce the most significant tax changes in a generation.

The following is a summary of 2016's most important tax developments.

Republican Victory in November Sets the Stage for Major Tax Changes in 2017

By winning the White House and holding on to their majorities in the House and Senate, Republicans put themselves in a position to fulfill campaign promises to reduce individual and corporate tax rates, repeal healthcare taxes, repeal the estate tax, and possibly implement broad, substantive tax reform.

With a Republican government seated for the first time in a decade, it's anticipated that 2017 will bring extensive tax changes. Among the most likely to pass: (1) reductions in most individual income tax rates; (2) reduction in the top corporate income tax rate; (3) repeal of healthcare taxes and credits enacted under the Affordable Care Act (Obamacare); and (4) repeal of the estate tax. A large increase in standard deduction amounts and a sharp curtailment of itemized deductions will also be on the table, along with broad corporate tax reform.

The proposed changes were centerpieces of the Trump campaign and were also featured in a tax reform plan put forward last summer by House Speaker Paul Ryan and Ways and Means Chairman Kevin Brady ("Ryan-Brady plan").

For a discussion of the various tax plans, see Parker's in-depth article:
Republican Victory in November Sets the Stage for Major Tax Changes in 2017.

Obama Administration Tries to Implement New Federal Overtime Rules;
District Court Judge Shoots Them Down

Less than ten days before major updates to federal overtime rules were to take effect in December, a Texas district court judge issued a preliminary injunction blocking the new rules and effectively killing them.

The revised overtime rules were estimated to affect over 4.2 million workers. They would have doubled the salary threshold at which a white collar worker could be classified as an "exempt employee" not entitled to overtime pay. The regulations also would have increased the salary threshold for highly compensated employees, who are subject to looser exemption criteria.

Instead, on November 22, 2016, the judge granted an injunction blocking implementation indefinitely after concluding that the Department of Labor had overstepped its regulatory authority.

For a discussion of the overtime rules that had been scheduled to take effect in December 2016, see
New Overtime Rules Go Into Effect December 1st; What Tax Practitioners Need to Know.

Proposed Regs Would Disallow Valuation Discounts for Family Businesses;
Draw Criticism from All Corners

The IRS issued controversial proposed regulations in REG-163113-02 (8/4/16) which seek to eliminate loopholes by reducing the availability of valuation discounts for transfers among family members of interests in family owned businesses. Citing concerns over certain transactions taxpayers have used to avoid the application of Code Sec. 2704, the regulations address deathbed transfers that result in the lapse of a liquidation right, refine the definition of the term "applicable restriction," add a new class of disregarded restrictions, and address restrictions on the liquidation of an individual interest in an entity and the effect of insubstantial interests held by persons who are not members of the family.

The regulations have received almost universal criticism from the AICPA, ABA, and family business tax planners because they would eliminate most valuation discounts on redemptions and transfers of family business interests among family members when a single family controls the business both before and after the transfer.

Observation: While President-elect Trump has vowed to eliminate the estate tax, these rules would still be applicable for gift tax purposes.

The regulations are proposed to be effective when finalized.

For a discussion of the proposed regulations, see
Prop. Regs Aim to Close Loopholes on Valuation of Certain Transferred Interests.

Self-Directed IRA Cases Highlight Potential Pitfalls

Self-directed individual retirement accounts (IRAs) have been gaining in popularity because they provide more flexibility to taxpayers as far as investments that can be held in the IRA. A self-directed IRA is simply an IRA under which the IRA owner has control over the type of investments held in the IRA. Thus, the owner of a self-directed IRA may choose from the complete range of investments permitted for IRAs - including real estate, limited partnerships, mortgages, notes, franchise businesses, etc. - rather than being limited to the typical investments offered by IRA custodians and trustees (stocks, bonds, mutual funds, etc.). While this higher degree of flexibility in choosing IRA investments allows the IRA owner to invest in assets with greater wealth-building potential, there are potential pitfalls. In 2016, two Tax Court cases involving self-directed IRAs highlighted some issues that can arise.

In McGaugh v. Comm'r, T.C. Memo. 2016-28, the IRS tried argue that a taxpayer missed the 60-day tax-free rollover period when he requested that Merrill Lynch initiate a wire transfer directly from his IRA account to a corporation whose stock the taxpayer wanted to add to his IRA. The stock was delivered to the taxpayer's IRA more than 60 days after the wire transfer. The IRS determined that the wire transfer issued by Merrill Lynch to the corporation was constructively received by the taxpayer and was includible in his gross income because it was not rolled over within the mandatory 60-day period. In addition, because he had not yet reached age 59 1/2, it was an early distribution subject to the 10 percent penalty tax of Code Sec. 72(t). The Tax Court rejected the IRS's "constructive receipt" reasoning and held that an owner of an IRA is entitled to direct the investment of the funds without forfeiting the tax benefits of the IRA. The court concluded there was no distribution to the taxpayer and thus the 60-day rule did not apply.

However, the taxpayers in Thiessen v. Comm'r, 146 T.C. No. 7 (2016), weren't so lucky. In that case, a couple made loan guarantees with respect to transactions involving their self-directed IRAs. The Tax Court held that they had engaged in prohibited transactions and thus received deemed distributions from their IRA, which were subject to tax as well as the 10 percent penalty tax under Code Sec. 72(t).

For a full discussion of the McGaugh case, see
Taxpayer Escapes Penalty Where Self-Directed IRA Funds Went Straight to Investment.

For a discussion of the Thiessen case, see
Loan Guarantees to Self-Directed IRA Results in Deemed Distribution and Penalties to Owners.

Income from Forfeited Deposit Is Ordinary Income, Not Capital Gain

In a case of first impression, the Tax Court held that where a partnership received as income a $9.7 million deposit forfeited by a prospective buyer of its hotel, the deposit was taxable as ordinary income. The Tax Court rejected the partnership's argument that, under Code Sec. 1234A, the income was capital gain because the sale of the hotel would have been treated as capital gain under Code Sec. 1231.

In CRI-Leslie, LLC v. Comm'r, 147 T.C. No. 8 (2016), the Tax Court noted that while Code Sec. 1234A extends to rights or obligations relating to capital assets, Code Sec. 1221(a)(2) excludes depreciable property used in the taxpayer's trade or business, as well as real property used in his trade or business, from the definition of a capital asset.

For a discussion of the CRI-Leslie, LLC case, see
Partnership Not Entitled to Capital Gain Treatment on Forfeited Deposit.

Final Regs Overhaul Partnership Disguised Sale and Partnership Liability Rules

In October, the IRS issued final, temporary, and proposed regulations (T.D. 9787, T.D. 9788, REG-122855-15 (10/5/16)) that substantially alter the partnership disguised sale rules, as well as the rules relating to the treatment of partnership liabilities. To a large extent, the rules eliminate the ability to engage in tax-deferred leveraged partnership transactions and to defer taxable gain by using bottom-dollar payment obligations when allocating partnership liabilities.

For an in depth discussion of the final, temporary, and proposed regulations, see
IRS Revamps Partnership Disguised Sale Rules and Partnership Liability Regs.

New IRS Procedure Lets Taxpayers Self-Certify Eligibility for Waiver of 60-Day Rollover Requirement

Taxpayers are eligible to rollover distributions from an IRA if certain requirements are met one being that the rollover must be completed within a 60-day period. If the requirement is not met, the distribution is treated as taxable and may be subject to the 10 percent penalty tax of Code Sec. 72(t), depending on the taxpayer's age. The IRS receives numerous letter ruling requests each year from taxpayers asking for waivers of this rule due to the deadline being missed because of circumstances beyond a taxpayer's control. Submitting a letter ruling request to the IRS can be costly because of the CPA and/or lawyer's time required in preparing the request, as well as the IRS user fees involved.

In August, the IRS issued Rev. Proc. 2016-47, which provides a self-certification procedure for taxpayers to claim eligibility for a waiver of the 60-day rollover requirement in certain circumstances. A plan administrator or an IRA trustee can rely on such certification in accepting and reporting receipt of a rollover contribution where the untimely rollover is due to an error on the part of a financial institution. There is no IRS fee for using the self-certification procedure.

For a discussion of Rev. Proc. 2016-47, see
New IRS Procedure Lets Taxpayers Self-Certify Eligibility for Waiver of 60-Day Rollover Requirement.

Blue Book Addresses Issues Involving New Partnership Audit Regime

In March, The Joint Committee on Taxation released the General Explanation of Tax Legislation Enacted in 2015 (JCS-1-16), otherwise referred to as the "Blue Book." The Blue Book provides insight into the overhaul of the partnership audit rules and addresses some of the questions that had been posed by practitioners on various aspects of how the new rules might apply.

While the new partnership audit rules are generally effective for partnership tax years beginning after December 31, 2017, partnerships may elect to apply them to any partnership returns for partnership tax years beginning after November 2, 2015, and before January 1, 2018.

For a discussion of the partnership audit issues as highlighted in the Blue Book, see
Recently Released Blue Book Addresses Questions Posed by the
New Partnership Audit Regime.

Sharply Increased Form 1099 Penalties Take Effect

Starting in 2017, hefty increases in the penalties imposed under Code Sec. 6721 and Code Sec. 6722 apply if a payer fails to timely file an information return, fails to include all information required to be shown on an information return, or includes incorrect information on an information return (including all variations of Form 1099). The new penalties run as high as $250 per information return, with maximum total penalties of $1,000,000 for certain small businesses and $3,000,000 for all others.

For a full discussion of the increased information return penalties, see
1099 Reporting Takes on New Prominence as Sharp Penalty Increases Take Effect.

IRS Releases Form 8971 for Reporting Estate Distributions

In 2015, Congress enacted Code Sec. 1014(f) and Code Sec. 6035, imposing two new estate tax reporting requirements. Under Code Sec. 1014(f), the basis of certain property acquired from a decedent may not exceed the value of that property as finally determined for federal estate tax purposes, or if not finally determined, the value of that property as reported on a statement made under Code Sec. 6035. Code Sec. 6035 imposes reporting requirements with respect to the value of property included in a decedent's gross estate for federal estate tax purposes.

Early in 2016, the IRS finalized Form 8971, Information Regarding Beneficiaries Acquiring Property From a Decedent, which is used to fulfill these new reporting requirements.

For a full discussion of the requirements for filing Form 8971, see
IRS Finalizes New Form 8971 for Reporting Estate Distributions;
Delays Filing Deadline to 03/31.

IRS Revises List of Automatic Accounting Method Changes

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 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. Rev. Proc. 2015-13 contains the general procedures for changing methods of accounting, either with IRS consent or automatically.

In Rev. Proc. 2016-29, the IRS issued a revised list of automatic changes to which the automatic accounting method change procedures of Rev. Proc. 2015-13 apply. It covers a wide variety of accounting method changes, such as changes involving depreciation methods, certain trade or business expenses, capital expenditures, and uniform capitalization methods.

For a discussion of Rev. Proc. 2016-29, see
IRS Updates List of Automatic Changes for Accounting Methods.

IRS Weighs In on Tax Treatment of Cash Rewards and Premium Reimbursements under Wellness Programs

Business wellness programs have taken off in the past several years as employers realize the benefits of a healthy workforce. In CCA 201622031, the IRS weighed in on the tax treatment of incentives to get employees to join wellness programs.

According to the IRS, employers may not exclude from an employee's income cash rewards for participating in a wellness program, nor may they exclude reimbursements of premiums for participating in such programs made by salary reduction through a cafeteria plan. Such amounts are includible in income and subject to employment taxes.

For a discussion of CCA 201622031, see
Taxable Income Includes Cash Rewards and Premium Reimbursements
under Wellness Programs.

Passive Participation in Oil and Gas Venture Leads to Self-Employment Tax

An individual's self-employment income is subject to self-employment tax. Disagreements between taxpayers and the IRS often involve the question of whether earnings are from self-employment. Under Code Sec. 1402(a), net earnings from self-employment are generally defined as the gross income derived by an individual from any trade or business carried on by the individual, less allowed deductions attributable to such trade or business, plus the individual's distributable share of income or loss from any trade or business carried on by a partnership of which he is a member.

In Methvin v. Comm'r, 2016 PTC 231 (10th Cir. 2016), the issue was whether or not income from a passive investor's working interests in several oil and gas ventures, where the parties elected under Code Sec. 761(a) to be excluded from the application of the partnership rules under subchapter K, constituted self-employment income. The Tax Court and Tenth Circuit concluded that the working interest owners and the well operator created a pool or joint venture for the operation of the wells and the taxpayer's income from the working interests was income from a partnership of which he was a member under the broad definition of "partnership" found in Code Sec. 7701(a)(2).

For a discussion of the Methvin case, see
Passive Participation in Oil and Gas Ventures Is Subject to Self-Employment Tax.

Two Cases Illustrate Importance of Material Participation for Real Estate Professionals

In 2016, two tax cases highlighted the challenges taxpayers face when attempting to use the real estate professional exception to deduct rental losses. In one, Gragg v. U.S., 2016 PTC 288 (9th Cir. 2016), the Ninth Circuit affirmed a district court and held that Code Sec. 469(c)(7) does not automatically render a licensed real estate professional's rental losses nonpassive and deductible where the taxpayer did not materially participate in the real estate endeavors. In the other, Hailstock v. Comm'r, T.C. Memo. 2016-146, the Tax Court found that because of her credible testimony and the substantial amount of money and time devoted to her rental properties, a woman who quit her job to go into the real estate business met the material participation requirements in Reg. Sec. 1.469-5T(a)(7) and could deduct her rental losses.

For a discussion of these cases, see
Two Cases Illustrate Importance of Material Participation for Real Estate Professionals.

Ninth Circuit Green Lights Homebuilder's Use of Completed Contract Method

In 2014, a real estate developer scored a big victory against the IRS when it successfully argued before the Tax Court that it could defer millions in profits under the completed contract method. The IRS challenged the result and, in Shea Homes, Inc. and Subsidiaries v. Comm'r, 2016 PTC 323 (9th Cir. 2016), the Ninth Circuit affirmed the Tax Court's holding. As a result, the developer was able to defer income on home sales in a planned community until 95 percent of that community, including common improvements and amenities, was completed and accepted.

Before the Ninth Circuit, the IRS had argued that the developer should report income from its long-term contracts for the years in which the contracts closed in escrow because the subject matter of the contract was the home and the lot upon which it sat. The Ninth Circuit rejected that argument, noting that it was clear that the primary subject matter of the contracts included the improvements to the lot as well as the common improvements and thus the improvements were an essential element of the home purchase and sale contract.

For a discussion of the Shea Homes case, see
Ninth Circuit Affirms Home Builder's Use of Completed Contract Method
for Planned Community.

Estate Could Deduct Theft Loss Decedent's LLC Suffered in Madoff Ponzi Scheme

Under Code Sec. 2054, estates are generally entitled to deductions relating to losses incurred during the settlement of the estate "arising" from theft. In Est. of Heller v. Comm'r, 147 T.C. No. 11 (2016), the Tax Court was asked to decide an issue of first impression: whether or not an estate could take a theft loss deduction for a loss the decedent's LLC incurred when its account with Madoff Investment Securities became worthless.

The Tax Court held that the decedent's estate was entitled to the theft loss deduction. The estate lost value, the court pointed out, because its interest in the LLC had been reduced to zero as a result of the Madoff Ponzi scheme.

For a discussion of Est. of Heller v. Comm'r, see
Estate Could Deduct Theft Loss Decedent's LLC Suffered in Madoff Ponzi Scheme.

Former Tax Court Judge and Husband Indicted on Tax-Related Charges

Diane Kroupa, a long-serving U.S. Tax Court judge, and her husband were indicted in April on various tax-related charges. Kroupa's husband, Robert Fackler, worked as a lobbyist and political consultant. The indictment in U.S. v. Fackler, 2016 PTC 134 (D. Minn. 2016) charged that numerous personal expenses, including vacations to China, Australia and Thailand, were deducted on the business tax return of Fackler's lobbying firm. The couple subsequently pled guilty to understating income by approximately $1 million.

For a discussion of the case, see
Former Tax Court Judge and Husband Indicted for Tax Evasion, Filing False Returns, and Impeding an Audit.

New Law Enacts HRAs for Small Businesses

On December 13, 2016, President Obama signed into law the 21st Century Cures Act (Pub. L. 114-255). The law exempts qualified small employer health reimbursement arrangements (QSEHRAs) from certain requirements that apply to group health plans. As a result, such plans can now be offered to employees of small businesses.

For a discussion of the requirements that must be met for an arrangement to qualify as a QSEHRA, see 21st Century Cures Act Allows Small Employers to Offer Health Reimbursement Arrangements.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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