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Top 12 Tax Developments of 2021

(Parker Tax Publishing December 2021)

The year began and ended with legislative developments, as Congress enacted the American Rescue Plan (ARP) Act in March and the Infrastructure Investment and Jobs Act (IIJA) in November, but came to an impasse in December over the Build Back Better (BBB) Act, which stalled in the Senate after weeks of intense negotiations among Democrats. To keep up with the extensive Covid-related relief provisions contained in the ARP and earlier legislation, the IRS issued numerous pieces of guidance throughout the year. Several important court decisions were also handed down in 2021, in cases dealing with challenges to the $10,000 cap on the state and local tax deduction, the application of penalties to willful failures to report bank accounts, and other areas.

The following is a summary of the most important tax developments of 2021.

President Signs American Rescue Plan Act into Law

The biggest piece of legislation enacted in 2021 was the American Rescue Plan (ARP) Act of 2021 (P.L. 117-2), which was signed into law on March 11. For individuals, the ARP provided a third round of economic impact payments of $1,400 per individual, subject to phaseouts at adjusted gross incomes over $75,000 ($150,000 for joint filers and $112,500 for heads of household). The ARP also made major changes to the child tax credit (CTC), the earned income tax credit (EITC), the premium tax credit (PTC), and the child and dependent care tax credit (CDCTC). These changes included increasing the amount of the CTC from $2,000 to $3,000 or, for children under 6, to $3,600 and making the credit fully refundable, in addition to providing advance payments of the CTC for the last six months of 2021. For the EITC, the ARP reduced the minimum age for workers without qualifying children to claim the credit from 25 to 19 and increased the maximum EITC amount for 2021 for a childless individual from $543 to $1,502. Changes to the PTC allowed more individuals to be eligible for the PTC. Those changes included the elimination of the eligibility cap of 400 percent of the federal poverty level so that for tax years beginning in 2021 or 2022, anyone may qualify for the subsidy. Improvements to the CDCTC included making the credit refundable and increasing the amount of expenses eligible for the credit from $3,000 to $8,000 for one qualifying individual and from $6,000 to $16,000 for two or more qualifying individuals. The ARP also increased the exclusion for employer-provided dependent care assistance under Code Sec. 129 from $5,000 to $10,500 for 2021.

For businesses, the ARP extended access to Paycheck Protection Program (PPP) loans to nonprofits and internet publishing companies. The employee retention credit (ERC), which generally applies to 70 percent of qualified wages up to $10,000 per employee per quarter, was extended by the ARP through 2021 (although it was later terminated effective September 30, 2021, by the Infrastructure Investment and Jobs Act for businesses other than recovery startup businesses). The refundable employment tax credits available to employers that provided paid leave to employees affected by COVID-19 were extended to September 30, 2021, as were the equivalent credits available for self-employed individuals. The ARP also established the Restaurant Revitalization Fund to provide restaurants and similar businesses with nontaxable grants to cover expenses incurred during the COVID-19 pandemic. In addition, the ARP provided additional funding for targeted Economic Injury Disaster Loan (EIDL) advances and provided that such advances are excluded from gross income.

For a full discussion of the ARP, see the March 11, 2021, issue of Parker's Federal Tax Bulletin (PFTB 2021-03-11).

IRS: Employee Retention Credit Does Not Apply to Wages of Owner and Family

In August, the IRS surprised taxpayers and practitioners alike with a bit of unpopular guidance concerning eligibility for the ERC. In Notice 2021-49, the IRS addressed a range of issues dealing with the ERC. One of these issues was whether wages paid to an employee who owns more than 50 percent (i.e., a majority owner) of the value of a corporation may be treated as qualified wages for purposes of the ERC, as well as whether wages paid to a spouse of a majority owner may also be treated as qualified wages. In Notice 2021-49, the IRS advised that wages paid to majority owners of a corporation, their spouses, and children generally are not qualified wages for purposes of calculating the ERC. Specifically, applying the constructive ownership rules of Code Sec. 267(c), the direct majority owner's ownership of the corporation is attributed to each of the owner's family members with a relationship described in Code Sec. 267(c)(4); further, because each of those family members is considered to own more than 50 percent of the stock of the corporation after applying Code Sec. 267(c), the direct majority owner of the corporation would have a relationship as defined in Code Sec. 152(d)(2)(A)-(H) to the family member who is a constructive majority owner. Therefore, the direct majority owner is a related individual for purposes of the ERC. This conclusion was regarded by legislators and practitioners as running contrary to the intent of the ERC legislation.

IRS Issues Gross Receipts Safe Harbor for Employee Retention Credit

In Rev. Proc. 2021-33, the IRS issued a safe harbor allowing employers to exclude certain items from their gross receipts solely for determining eligibility for the ERC. The items covered by the safe harbor are: (1) the amount of the forgiveness of a PPP loan, (2) a shuttered venue operators grant under Section 324 of the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act, and (3) a restaurant revitalization grant under the ARP. The IRS noted that the safe harbor was necessary because an employer that participated in one or more of these Covid relief programs, and that otherwise has the requisite percentage decline in gross receipts, might be precluded from claiming an ERC with respect to a calendar quarter in which there is a decline in gross receipts solely because the employer's participation in one of the relief programs resulted in a temporary increase in gross receipts.

Compliance Tip: An employer elects to use the safe harbor by excluding the amount of the forgiveness of a PPP loan and/or the amount of the grant from its gross receipts when determining eligibility to claim the ERC on its employment tax return for that calendar quarter or, for employers that file employment tax returns on an annual basis, for the year including the calendar quarter.

IRS Provides Guidance on Tax Treatment of Items Affected by Forgiven PPP Loans

In November, the IRS issued three procedures - Rev. Procs. 2021-48, 2021-49, and 2021-50 - that address the tax treatment of expenses and income related to PPP loans. In Rev. Proc. 2021-48, the IRS provides that taxpayers have three options for how to treat PPP amounts that are excluded from gross income (tax-exempt income) in connection with the forgiveness of PPP loans as received or accrued: (1) as eligible expenses are paid or incurred, (2) when an application for PPP loan forgiveness is filed, or (3) when PPP loan forgiveness is granted. To the extent tax-exempt income resulting from the forgiveness of a PPP loan is treated as gross receipts under a particular federal tax provision, Rev. Proc. 2021-48 applies for purposes of determining the timing and, to the extent relevant, reporting of such gross receipts.

Rev. Proc. 2021-49 provides guidance for partners and their partnerships regarding tax-exempt income and deductions relating to the PPP and certain other COVID-19 relief programs. Among other things, Rev. Proc. 2021-49 provides: (1) rules for partners and their partnerships regarding: (i) allocations under Code Sec. 704(b) of tax-exempt income arising from the forgiveness of PPP loans, (ii) the receipt of certain grant proceeds, or (iii) the subsidized payment of certain principal, interest and fees; (2) allocations under Code Sec. 704(b) of deductions resulting from expenditures attributable to the use of forgiven PPP loans or certain grant proceeds, or subsidized payments of certain interest and fees; and (3) the corresponding adjustments to be made with respect to the partners' bases in their partnership interests under Code Sec. 705.

In Rev. Proc. 2021-50, the IRS provides that eligible Bipartisan Budget Act of 2015 (BBA) partnerships can file amended Forms 1065 and furnish amended Schedules K-1 on or before December 31, 2021, to adopt the guidance set forth in Rev. Proc. 2021-48 and Rev. Proc. 2021-49 if certain requirements are met. Rev. Proc. 2021-50 explains how a BBA partnership that wishes to take advantage of Rev. Proc. 2021-48 or Rev. Proc. 2021-49 may do so without filing an administrative adjustment request (AAR). Under Rev. Proc. 2021-50, a BBA partnership has the option to file an amended return instead of an AAR, though it does not prevent a partnership from filing an AAR to obtain the benefits of Rev. Proc. 2021-48, Rev. Proc. 2021-49, or any other tax benefits to which the partnership is entitled.

IRS Issues Final Regulations on Deductibility of Fines and Penalties

The IRS published final regulations in T.D. 9946 addressing the deduction for fines and penalties as provided for in Code Sec. 162(f), as amended by the Tax Cuts and Jobs Act of 2017 (TCJA). As amended by the TCJA, Code Sec. 162(f)(1) provides that no deduction is allowed for any amount paid or incurred to, or at the direction of, a government or governmental entity in relation to the violation of any law or the investigation or inquiry by such government or governmental entity into the potential violation of any law. Under Code Sec. 162(f)(2), an exception applies for certain amounts paid or incurred for restitution, remediation, or to come into compliance with a law. To qualify for this exception, (1) the taxpayer must establish that such amounts were paid or incurred as restitution (including remediation of property) or to come into compliance with a law (establishment requirement), and (2) that there was a court order or settlement agreement identifying the amounts as restitution, remediation, or amounts paid or incurred to come into compliance with a law (identification requirement).

Under the final regulations, the general rule of Code Sec. 162(f)(1) applies whether or not the taxpayer admits guilt or liability, or pays the amount imposed for any other reason, including to avoid the expense or uncertain outcome of an investigation or litigation. The final regulations also clarify that, in general, amounts paid or incurred for routine investigations such as audits or inspections. which are not related to any evidence of wrongdoing, are not amounts paid or incurred relating to the potential violation of any law. Regarding the identification requirement, the regulations provide that the requirement is met even if the order or agreement does not specifically state that the payment constitutes restitution, remediation, or an amount paid to come into compliance with a law, if the nature and purpose of the payment are clearly and unambiguously to restore the injured party or property or to correct the noncompliance. The final regulations also state that the establishment requirement is met if documentary evidence proves that the taxpayer was legally obligated to pay the amount identified in the order or agreement as restitution, remediation, or to come into compliance with a law and that it was paid or incurred for the nature and purpose identified. Under the final regulations, a Form 1098-F, Fines, Penalties, and other Amounts, submitted by a government or government entity does not satisfy either the establishment or the identification requirement.

Circuit Courts Split on Whether FBAR Penalty Applies Per Filing or Per Bank Account

In 2021, a split among the Fifth and Ninth Circuit courts arose regarding the application of the penalty for failing to file a Foreign Bank Account Report (FBAR). Under 31 U.S.C. Section 5314, an individual with a foreign bank account balance exceeding $10,000 must file an FBAR to report the foreign bank account. Civil penalties are imposed under 31 U.S.C. Section 5321(a)(5)(A) on any person who violates Section 5314. For a non-willful violation, the amount of any civil penalty imposed cannot exceed $10,000, while the penalty for a willful FBAR violation equals the greater of $100,000 or 50 percent of the balance in the account at the time of the violation.

In U.S. v. Boyd, 2021 PTC 72 (9th Cir. 2021), a panel of the Ninth Circuit held that the FBAR penalty statute authorizes the IRS to impose only one non-willful penalty when an untimely, but accurate, FBAR is filed, no matter how many foreign bank accounts are held by the taxpayer. Thus, the Ninth Circuit concluded that the penalty applies on a per-filing basis rather than a per-account basis. The Ninth Circuit focused on the fact that when Congress amended Section 5321 in 2004 to extend the existing penalties to non-willful violations, it omitted the per-account language from the non-willful penalty provisions. The court concluded that the non-willful penalty provision allows the IRS to assess one penalty not to exceed $10,000 per violation. However, in U.S. v. Bittner, 2021 PTC 372 (5th Cir. 2021), the Fifth Circuit reached the opposite conclusion and held that the penalty applies to each account not reported on the FBAR. The Fifth Circuit reasoned that, by authorizing a penalty for "any violation of any provision of" Section 5314, Section 5321(a)(5)(A) most naturally reads as referring to the statutory requirement to report each account - not the regulatory requirement to file FBARs in a particular manner. The Fifth Circuit's decision resulted in an increase of the taxpayer's penalty liability from $50,000 ($10,000 for each of five FBARs not filed) to $2.72 million (50 percent of the balances of the accounts not reported).

Second Circuit Rejects States' Constitutional Challenges to SALT Deduction Cap

In State of New York v. Yellen, 2021 PTC 323 (2d Cir. 2021), the Second Circuit rejected constitutional challenges to the $10,000 limit on the deduction for state and local taxes (SALT) under Code Sec. 164(b)(6), as enacted by TCJA. Four states - New York, Connecticut, New Jersey, and Maryland - sued the federal government asserting that the SALT deduction cap is unconstitutional on its face or that it unconstitutionally coerces them to abandon their preferred fiscal policies. The states argued that their taxpayers were likely to bear the brunt of the SALT deduction cap as a disproportionate share of their taxpayers' state and local tax burdens exceed the $10,000 maximum, and that the cap would make homeownership more expensive, depress home equity values, and lead to job losses in their states. The Second Circuit rejected the states' arguments after finding that the $10,000 cap does not undermine the states' sovereign authority and is a valid exercise of Congress's taxing and spending authority to influence states' policy choices.

Observation: The version of the Build Back Better Act passed by the House on November 19 amends Code Sec. 164(b)(6) to increase the SALT deduction cap to $80,000. Subsequently, however, the Senate Finance Committee released updated text of the BBB which does not include an increase to the SALT deduction cap but instead includes a placeholder "for compromise" on the provision.

Ninth Circuit Reverses Tax Court's Substance-Over-Form Ruling in Roth IRA Case

In Mazzei v. Comm'r, 2021 PTC 153 (9th Cir. 2021), a panel of the Ninth Circuit held that the Tax Court erred when it invoked substance-over-form principles to recharacterize a transaction involving the taxpayers' Roth IRAs and a foreign sales corporation (FSC). In Mazzei v. Comm'r, 150 T.C. No. 7 (2018), the Tax Court determined that the purchase by the taxpayers' Roth IRAs of stock in the FSC did not reflect the underlying economic reality. Applying substance over form, the Tax Court treated the taxpayers as the owners of the stock for federal tax purposes, resulting in excess contributions that were subject to excise taxes. The Ninth Circuit panel reversed the Tax Court and held that the substance over form doctrine did not apply to the FSC structure used by the taxpayers. According to the Ninth Circuit, there are some circumstances where form - and form alone - determines the tax consequences of a transaction, such as when a statute (like the FSC provisions) deliberately elevates form over substance.

In upholding the transaction, the Ninth Circuit joined three other circuits that had reversed the Tax Court's decision in Summa Holdings, Inc. v. Comm'r, T.C. Memo. 2015-119 (2015), a case involving a domestic international sales corporation (DISC), which is similar to an FSC. In Summa Holdings, Inc. v. Comm'r, 2017 PTC 58 (6th Cir. 2017); Benenson v. Comm'r, 2018 PTC 98 (1st Cir. 2018); and Benenson v. Comm'r, 2018 PTC 431 (2d Cir. 2018), the Sixth, Second, and First Circuits disallowed the invocation of substance-over-form principles to undo the congressionally authorized separation of substance and form using DISCs.

Circuit Courts Split on Jurisdiction Over Claims for Interest on Overpayments

Under 28 U.S.C. Section 1346(a)(1), district courts have jurisdiction, concurrent with the Court of Federal Claims, over (1) actions for refunds of taxes, (2) penalties collected without authority, or (3) "any sum alleged to have been excessive or in any manner wrongfully collected under the internal revenue laws." If an overpayment interest claim does not fall into one of these three categories, then the Court of Federal Claims has exclusive jurisdiction over the claim. In Paresky v. U.S., 2021 PTC 126 (11th Cir. 2021), the Eleventh Circuit held that the Court of Federal Claims has exclusive jurisdiction over a taxpayer's action to recover interest on overpayments of tax. The issue in Paresky was whether such an action falls under the third category as an action to recover a sum alleged to have been "excessive." The Eleventh Circuit found that in the context of overpayment interest, there is no amount that would be proper for the government to hold once the taxpayer is entitled to interest and therefore, interpreting the third category of Section 1346(a)(1) to include standalone overpayment interest claims would change the plain and ordinary meaning of the phrase "any sum alleged to have been excessive" to mean "any sum alleged to have been wrongfully held." In reaching its conclusion, the Eleventh Circuit split with the Sixth Circuit's decision in E.W. Scripps Company and Subsidiaries v. U.S., 420 F.3d 589 (6th Cir. 2005), where the Sixth Circuit found that overpayment interest does fall within Section 1346(a)(1).

Court Enjoins Enforcement of IRS Reporting Rules for Micro-captive Transactions

In CIC Services, LLC v. IRS, 2021 PTC 303 (E.D. Tenn. 2021), a district court enjoined the IRS from enforcing Notice 2016-66, which identifies micro-captive insurance transactions as transactions of interest and requires taxpayers and material advisors to disclose their involvement in them. A micro-captive transaction is typically an insurance agreement between a parent company and a "captive" insurer under its control which provides tax advantages including a deduction for the insured party's premium payments as business expenses under Code Sec. 162(a) and the exclusion by the insurer of those premiums from its own taxable income under Code Sec. 831(b). Notice 2016-66 identifies micro-captive transactions as having the potential for tax avoidance and classifies them as reportable transactions. Taxpayers and material advisors that fail to report such transactions face civil penalties for non-willful violations and fines and imprisonment for willful violations. CIC Services, a manager of captive insurance companies and a material advisor to taxpayers participating in micro-captive insurance transactions, brought an action to challenge the lawfulness of Notice 2016-66 and asked the court for a preliminary injunction to bar the IRS from enforcing the disclosure requirements. The district court granted the injunction after finding that Notice 2016-66 is a legislative rule, subject to the notice and comment procedures of the Administrative Procedure Act, because it imposes new requirements on taxpayers rather than simply interpreting existing legal norms.

Tax Court Holds That Some Purchases Using Credit Card Awards Are Taxable

One case that generated a lot of buzz among practitioners in 2021 was the Tax Court's ruling in Anikeev, T.C. Memo. 2021-23. The taxpayers in Anikeev were American Express cardholders who enrolled in the American Express reward dollars program. This program paid reward dollars for eligible purchases made on the card for goods and services. To generate as many reward dollars as possible, the taxpayers used their American Express cards to purchase Visa gift cards, then used the gift cards to buy money orders and reloadable debit cards. They deposited the money orders into their bank accounts and when they paid their American Express bills, they received reward dollars equal to the applicable percentage of the gift card purchases. In 2013 and 2014, the taxpayers deposited over $4 million in money orders into their bank accounts and redeemed over $300,000 in reward dollars as statement credits. The Tax Court held that the taxpayers realized income in the amount of the rewards relating to the money orders and debit cards, but not the Visa gift cards. In the court's view, the Visa gift card purchases were for goods and services and therefore the rewards were rebates that resulted in a downward price adjustment of the gift cards. However, the court found that such rebate treatment did not apply for the purchases of money orders and debit cards because no product or service was obtained with those purchases.

President Signs Bipartisan Infrastructure Investment and Jobs Act into Law

On November 15, President Biden signed the Infrastructure Investment and Jobs Act (IIJA) (Pub. L. 117-58) into law. While not primarily a tax bill, the IIJA enacted several significant tax provisions. Most importantly, the IIJA terminated of the ERC as of September 30, 2021, for taxpayers other than recovery startup businesses. As previously noted, the ARP had extended the ERC through the end of 2021 for all taxpayers, but its early termination was necessary to provide revenue for the IIJA's infrastructure programs.

Observation: In Notice 2021-65, the IRS provided guidance to employers that received advance payments of the ERC or that reduced employment tax deposits in anticipation of the credit for the fourth quarter of 2021, but became ineligible for the credit due to the change in the law. According to the IRS, such employers must repay any ERC excess advance payments by the due date for the applicable employment tax return that includes the fourth calendar quarter of 2021. Employers that reduced employment tax deposits can avoid penalties by depositing the amounts initially retained in anticipation of the ERC on or before the relevant due date for wages paid on December 31, 2021, and reporting the tax liability on the employment tax return that includes the fourth quarter of 2021.

The IIJA also provided clarification around the mandatory 60-day extension period for certain time-sensitive acts to be performed by taxpayers affected by federally declared disasters, a provision which was enacted by the Consolidated Appropriations Act, 2020. Under the IIJA, the time-sensitive acts to which the mandatory 60-day postponement apply are the acts described in Code Sec. 7508(a)(1)(A)-(F) (i.e., acts relating to filing returns, paying taxes, filing a Tax Court petition, the allowance of a credit or refund, filing a claim for a credit or refund, and bringing a lawsuit for a credit or refund). The IIJA also amended the tolling period for the time for filing a Tax Court petition when a Tax Court filing location (including the court's online case management system) is unavailable to the general public. Further, the IIJA added a "significant fire" to the list of events that result in the postponement of federal deadlines under Code Sec. 7508A. A significant fire is defined as any fire with respect to which assistance is provided under Section 420 of the Robert T. Stafford Disaster Relief and Emergency Assistance Act.

New information reporting requirements for transactions involving cryptocurrency and other digital assets will take effect in 2024 as a result of the IIJA for transactions occurring in 2023. Any person doing business as a broker will be required to file Form 1099-B, Proceeds from Broker and Barter Exchange Transactions, to report certain information about their customers to the IRS and furnish the same information to their customers. The IIJA also amended the definition of "broker" to include any person who (for consideration) is responsible for regularly providing any service effectuating transfers of digital assets on behalf of another person.

For a full discussion of the IIJA, see the November 10, 2021, issue of Parker's Federal Tax Bulletin (PFTB 2021-11-10).

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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