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Income Tax Annotations (Agricultural Law and Tax)

This page contains summaries of significant recent court opinions and IRS developments involving taxation, with a particular focus on tax issues that could impact agricultural clients.

Posted November 24, 2017

Ranching Activity Not a Hobby – Simply Incurring Net Losses Doesn’t Mean An Activity Is Conducted Without a Profit Intent. The petitioner, confined to a wheelchair since his freshman year of college, went on to obtain his Ph.D. and teach at several universities over a 40-year span. In the 1970s he founded a consulting business. In the early 1980s he formed another business that provided software to researchers, and developed a statistical program in 2007 to assist businesses in their hiring practices. In 1987, he purchased 130 acres that would become the ranching activity at the center of the case. The petitioner grew the ranch to 8,700 acres comprised of seven tracts and various divisions. The headquarters of the ranch contains two duplexes on 20 acres and were used to house ranch hands when needed and leased out when the ranch hands were not needed. The petitioner’s original intent was to grow hay as a cash crop and to raise some cattle on the first 130 acres he had purchased. Over time, the ranch grew to become a multi-operational, 8,700-acre ranch with 25 full-time employees who received annual salaries ranging from $25,000 to $115,000. Center Ranch also had a vet clinic that provided services for large and small animals. 8 Construction on the vet clinic began in 2003; it was originally built to support Center Ranch's horse operation. All of the vet clinic's employees—except the veterinarians—were Center Ranch employees. There was a licensed veterinarian on site during each of the years in issue. Petitioner rented the vet clinic facilities to the veterinarians and had management services agreements and licensing agreements with them. The vet clinic provided services for Center Ranch animals under the management services agreements. It provided services for animals owned by the public for a fee. The vet clinic was a separate entity and filed its own tax returns for the years in issue. The ranch also had a trucking operation and owned numerous 18-wheel trucks that were used to move cattle and hay around the ranch and to transport cattle to and from market and perform backhauls. The ranch also conducted timber operations and employed a timber manager. The petitioner also subscribed to numerous professional publications. The petitioner changed the type of cattle that the ranch raised to increase profitability. Steadily increasing herd size. The hay operation was also modified to maximize profitability due to weather issues. In addition, the ranch built its own feed mill that was used to chopping and dry storage of the hay. In 2003, the petitioner also started construction of a horse center as part of the ranch headquarters, including a breeding facility that operated in tandem with the veterinary clinic. Ultimately, the petitioner’s horses were entered in cutting competitions, with winning increasing annually from 2007 to 2010. The IRS issued notices of deficiency for 2007-2010. For the years in issue the petitioner had total losses of approximately $15 million and gross income of approximately $7 million. For those years, the petitioner’s primary expense was depreciation. The IRS claimed that the ranching activity was not engaged in for profit and the expenses were deductible only to the extent of income. The Tax Court determined that all of the petitioner’s activities were economically intertwined and constituted a single ranching activity. On the profit issue, the court determined that none of the factors in the Treasury Regulations §1.183-2(b) favored the IRS. While IRS claimed that mistakes in the petitioner’s books and records were highly relevant, the court disagreed noting that some mistakes on the books and records of a multi-million-dollar activity does not negate that the activity was carried on in a business-like manner. In addition, the court noted that the ranch had separate bank accounts from the petitioner’s bank accounts. The court also noted that the petitioner made changes in the activity upon realizing that certain aspects of the ranch were not profitable. The ranch also paid ranch hands, when needed, and paid some of its employees above median wages in the area so as to attract the best managers and employees. The court also noted that the petitioner had been involved in agriculture for practically all of his life, and that his time spent on weekends at the ranch and daily communications with ranch managers was sufficient to show a profit intent. The court also determined that the petitioner showed that the expected the ranch assets to appreciate in value, and that the IRS argument that the assets would not appreciate as much as the petitioner and his experts claimed they would was inadequate. It was not necessary that the petitioner have a profit motive that expects recoupment of all of the ranch’s past losses. While the court found that the ranch’s history of income and losses and the amount of occasional profits, if any, favored the IRS, the court did not give these factors as much weight because the cattle and horse operations were in their startup phases during the years in issue. The petitioner’s financial status and whether personal pleasure or recreation were present were held to be neutral factors. The court noted that the petitioner had put over $9 million of his own funds into the ranch and had been in a wheelchair since college which restricted his ability to derive personal pleasure from the ranch. Accordingly, the petitioner’s ranching activity was held to be conducted for-profit and the losses were fully deductible. The court specifically rejected the IRS argument that a profit motive could not be present when millions of dollars of losses were generated. Welch, et al. v. Comr., T.C. Memo. 2017-229.

IRS Provides Safe Harbor For Loss to Personal Residence From Crumbling Concrete Foundation. Based on the conclusions of an investigation conducted by the Connecticut Attorney General’s Office that Pyrrhottite, a mineral in stone aggregate that is used in making concrete, causes concrete to prematurely deteriorate, the IRS has provided a safe harbor for deducting a casualty loss to a taxpayer’s home based on a deteriorating concrete foundation. Under the safe harbor, a taxpayer who pays to repair damage to the taxpayer’s personal residence caused by a deteriorating concrete foundation may treat the amount paid as a casualty loss in the year of payment. Under the safe harbor, the term “deteriorating concrete foundation” means a concrete foundation that is damaged as a result of the presence of the mineral pyrrhotite in the concrete mixture used to pour the foundation. The safe harbor is available to a Connecticut taxpayer who has obtained a written evaluation from a licensed engineer indicating that the foundation was made with defective concrete, and has requested and received a reassessment report that shows the reduced reassessed value of the residential property based on the written evaluation from the engineer and an inspection pursuant to Connecticut Public Act No. 16-45 (Act). The safe harbor also is available to a taxpayer whose personal residence is outside of Connecticut, provided the taxpayer has obtained a written evaluation from a licensed engineer indicating that the foundation was made with defective concrete containing the mineral pyrrhotite. The amount of a taxpayer’s loss resulting from the deteriorating concrete foundation is limited to the taxpayer’s adjusted basis in the property. In addition, the IRS noted that the amount of the loss may be limited depending on whether the taxpayer has a pending claim for reimbursement (or intends to pursue reimbursement) of the loss through property insurance, litigation, or otherwise. A taxpayer who does not have a pending claim for reimbursement, and who does not intend to pursue reimbursement, may claim as a loss all unreimbursed amounts (subject to the adjusted basis limitation) paid during the taxable year to repair damage to the taxpayer’s personal residence caused by the deteriorating concrete foundation. A taxpayer who has a pending claim for reimbursement, or who intends to pursue reimbursement, may claim a loss for 75 percent of the unreimbursed amounts paid during the taxable year to repair damage to the taxpayer’s personal residence caused by the deteriorating concrete foundation. The IRS noted that taxpayer who has been fully reimbursed before filing a return for the year the loss was sustained may not claim a loss, and that amounts paid for improvements or additions that increase the value of the taxpayer’s personal residence above its pre-loss value are not allowed as a casualty loss. Only amounts paid to restore the taxpayer’s personal residence to the condition existing immediately prior to the damage qualify for loss treatment. The IRS noted that a taxpayer claiming a casualty loss under the safe harbor must report the amount of the loss on Form 4684 and must mark “Revenue Procedure 2017-60” at the top of that form. Taxpayers are subject to the $100 limitation imposed by § 165(h)(1) and the 10-percent-of-AGI limitation imposed by §165(h)(2). Taxpayers not choosing to apply the safe harbor treatment are subject to all of the generally applicable provisions governing the deductibility of losses under § 165. Thus, taxpayers not utilizing the safe harbor must establish that the damage, destruction, or loss of property resulted from an identifiable event that is sudden, unexpected, and unusual, and was not the result of progressive deterioration. Rev. Proc. 2017-60, 2017-50 I.R.B.

Posted November 23, 2017

Poor Recordkeeping Results in Passive Loss Treatment. The petitioners, a married couple, had a medical practice in which the husband saw just shy of 200 urology patients monthly and the wife was the office manager. A management company, however handled all back- office functions, including payroll processing employee benefits and insurance reimbursement. The husband held a limited partnership interest in partnership that operated a medical center for which he did consulting concerning office space design. The husband estimated that the spent less than 10 hours per week at the center. The petitioners formed a partnership to hold two rental properties - a commercial building and a single-family home. The wife handled the bank account and met with contractors on occasion. The petitioner’s son was the manager of the commercial building who spent about 16 hours/week managing the building for a share of the gross receipts from the building. A landscape company maintained the outside of the building and contractors cleaned and repaired both properties. The building tenant testified to have never seen the petitioners. The petitioners also formed another limited partnership with the husband holding the beneficial interest. This partnership owned a ranch that raised hay and, allegedly, also conducted a rental activity. The ranch was used as the petitioners’ weekend retreat and vacation property, with practically all ranch work performed by contractors and hired labor. The petitioners had no evidence to substantiate the time spent on farming or ranching activities. The medical center flowed a loss through to the husband and he also claimed a loss on the rental activity. The petitioners also claimed a loss from the ranching activity. The petitioners fully deducted the losses as ordinary losses. The IRS disagreed, recharacterizing the losses as passive losses subject to the limitations of the passive loss rules of I.R.C. §469. The Tax Court agreed with the IRS. The husband, the court noted, held a limited partner interest in the medical center partnership and he couldn’t prove that he spent more than 500 hours in the center’s activities during the tax years at issue. In addition, the court noted that the petitioners outsourced much of the work for the urology practice and the lack of records did not support the petitioners’ claim of involvement on a non-passive basis. As for the ranching activity, the petitioners had no documentation to substantiate claims that they had purchased livestock and had begun raising them. In addition, the husband was still a full-time employee of the medical practice during the year at issue. The court also held that the ranching activity was not a personal service activity (which would not be subject to the passive loss limitations). The court noted that was the case because capital was a material income-producing factor for the ranch. The petitioners also failed the facts and circumstances test of Treas. Reg. §1.469-5T(a)(7), noting that practically all of the ranch work was performed by hired labor. Syed v. Comr., T.C. Memo. 2017-226.

Posted November 9, 2017

Insufficient S Corp Basis To Deduct Indirect Loan Loss. The petitioners, a married couple, formed an investment advisory firm. They also each owned 40 percent of the outstanding stock of an S corporation. The S corporation subsequently became the 100 percent owner of another business that elected to be a qualified subchapter S subsidiary (QSUB). The QSUB borrowed money from an unrelated third party to finance the acquisition of another business. The petitioners then formed another S corporation that they were the sole owners of. They then used that second S corporation to buy the debt of the QSUB. The petitioners claimed that they could use the QSUB debt that the second S corporation held to increase their tax basis in the first S corporation so that they could deduct losses that passed through to them from the first S corporation. The petitioners claimed that the second S corporation was to be ignored because it was merely acting as an agent or conduit of the petitioners (an incorporated pocketbook of the petitioners). Thus, the petitioners claimed that they had made an actual economic outlay with respect to the acquisition of the QSUB debt to their financial detriment. As such, the petitioners claimed that the second S corporation should be ignored and its debt actually ran directly between the first S corporation and its shareholders, of which they owned (combined) 80 percent. The IRS disallowed the loss deduction due to insufficient basis and the Tax Court agreed. The Tax Court determined that there was no evidence to support the claim that the second S corporation was operating as the petitioners’ incorporated pocketbook. The Tax Court noted that the second S corporation had no purpose other than to acquire the debt of the QSUB, and the petitioners did not use the second S corporation to pay their expenses of the expenses of the first S corporation. There also was no evidence that the second S corporation was the petitioners’ agent because the corporation operated in its own name and for its own account. The Tax Court also held that the petitioners had not made any economic outlay except to the second S corporation. As such, the second S corporation could not be ignored and the petitioners could not use its debt to increase their tax basis. The Tax Court noted that 2014 IRS final regulations and I.R.C. §1366(d)(1)(B) require that shareholder loans must run directly between the S corporation and the shareholder. Messina v. Comr., T.C. Memo. 2017-213.

Posted October 31, 2017

IRS Clarifies Requirements for Qualified Small Employer Health Reimbursement Arrangement (QSEHRA). The IRS has reiterated that if the requirements for a QSEHRA are not followed, the plan is a “group health plan” subject to Obamacare’s “market reform” requirements and a penalty up to a $100/day/employee. IRS pointed out that an arrangement that reimburses premiums can vary the benefit amount only because of the age of the eligible employee or family member, or because of the number of family members of the eligible employee with respect to the same insurance policy. Likewise, an employer may offer a single benefit to single employees and employees with a family, or the employer may offer a single benefit to single employees and a family benefit to employees with a family. The IRS also clarified that an employer may provide a QSEHRA to its employees and contribute to an employee’s HSA, but only if the QSEHRA reimburses premiums and nothing else. The IRS noted that employees with an HRA that reimburses medical expenses are not eligible for an HSA. The IRS also stated that a QSEHRA cannot provide for an employee opt-out – it must be provided on the same terms to all eligible employees. In addition, employees covered by a QSEHRA are not eligible for an I.R.C. §36B premium assistance tax credit (PATC) if the QSEHRA constitutes “affordable” employer coverage under Obamacare. Thus, if the employee’s cost to buy a silver plan under Obamacare for self-only coverage less the amount of the QSEHRA reimbursement is less than or equal to 9.69 percent of the employee’s household income, a PATC is not available. If the QSEHRA is not affordable coverage, the PATC will be allowed, but will be reduced by the amount of the permitted benefit. The IRS noted that an employee’s permitted benefit will be shown in W-2 Box 12, Code FF. The full amount permitted (not the amount actually reimbursed) is shown on the W-2. Any overpayment of the PATC via Form 8962 are to be reconciled on the return for the tax year in which the overpayment was made. Also, IRS pointed out that all reimbursements must be substantiated to avoid being taxable; an employer can reimburse premiums for the employer coverage of a spouse (but if such amount is tax-free, the reimbursement is taxable); reimbursement is permissible for over-the-counter medicine, but such reimbursed amount is taxable; and not I.R.C. §162(l) deduction can be claimed if the QSEHRA covers the family. An employer must provide written notice to a covered employee by the later of February 19, 2018 or 90 days before the first day of the QSEHRA’s plan year. An employer providing a QSEHRA need not file Form 1095-B, but must file Form 720 and pay the PCORI fee. IRS Notice 2017-67, 2017-47 I.R.B. 517.

Posted October 26, 2017

No DPAD For Customer Discount Fees Generated for Online Services Because of No “Disposition.” The taxpayer processes credit and debit card payment transactions for its customers through various credit/debit card networks. The taxpayer gathers sales information from the customer, gets authorization for a transaction, collects funds from the issuing bank, and reimburses the customer. The taxpayer provides the services only after the customer’s application is approved with any resulting arrangement governed by agreements between the taxpayer and the customers. The taxpayer develops, maintains, and operates specialized software to facilitate processing and settlement of the card transactions. The taxpayer also periodically sells and leases point-of-sale data processing equipment and software to customers. To process and settle card transactions for its customers, the taxpayer utilizes software that it developed that it hosts on its servers. The servers capture transactions from customers and routs those transactions for approval, clearing and settling. The taxpayer custom designs the software systems to comply the requirements of the card networks and financial institutions involved in the transactions with the customers. The taxpayer claimed the servers constituted “online software” for purposes of the I.R.C. §199 deduction and that the customer fees were domestic production gross receipts (DPGR) via Treas. Reg. §1.199-3(i)(6)(iii)(B). The IRS disagreed on the basis that the fees were not derived “from providing customers access to computer software.” Instead, the discount fees were derived from the provision of customer “acquiring services” and the online services rather than a disposition of computer software. Neither the “self-comparable” or “third-party” exceptions of Treas. Reg. §1.199-3(i)(6)(iii) applied. CCM 20174201F (Aug. 7, 2017).

Posted October 23, 2017

No Deduction For Education Expenses That Qualify Taxpayer for New Trade or Business. The taxpayer was a licensed engineer with a master’s degree in applied mathematics. He was enrolled in a Ph.D program in structural engineering even though he was not required to in order to maintain his license. He deducted the expenses associated with researching and writing his doctoral thesis as an ordinary and necessary business expense under I.R.C. §162. The IRS denied the deduction and the court agreed, noting that deductible education-related expenses must merely maintain or improve the taxpayer’s skills required by the taxpayer’s employment. The court also noted that the Ph.D program would qualify the taxpayer for a new trade or business. Accordingly, the court denied the taxpayer’s refund claim. Czarnecki v. United States, No. 15-1381T, 2017 U.S. Claims LEXIS 1274 (Fed. Cl. Oct. 13, 2017).

Posted October 20, 2017

Comparable Sales Apply to Determine Property Tax Assessment on Hunting Club Parcels. The plaintiff owned several tracts of land that constituted a hunting club. The plaintiff challenged the property tax assessment on the parcels primarily on the basis that the club was the true owner of the land. The court determined that the applicable statutory and case law required an examination of the substantive rights of the parties even though the plaintiff held legal title. Based on a review of the facts, the court noted that the plaintiff did not enjoy unrestricted use of the properties. In fact, the plaintiff’s ownership interest gave the plaintiff a membership in the hunting club and equal access to all of the club land, but the plaintiff was restricted from building a residence on the land, subdividing it or conducting mining or drilling operations. Instead, the club maintained the exclusive right to maintain roads, lakes, ditches and fences across all of the parcels, exclusive hunting and fishing rights and several other rights. In addition, the plaintiff’s access to the land was contingent on being in good standing with the club. Because the club maintained control over the land and because the petitioner was subject to the club’s control when using the property, the court deemed the club to be the true owner of the land. Accordingly, the plaintiff’s “ownership” was more akin to a license. As a result, the proper valuation of the property should have been based on comparable sales rather than on the sale of licenses to members. HDH Partnership et al. v. Hinsdale County Bd. of Equalization, No. 16CA1723, 2017 Colo. App. LEXIS 1339 (Colo Ct. App. Oct. 19, 2017).

Posted October 19, 2017

IRS Rebate Exceeding Tax Shown on Return Increases Deficiency. The petitioners, a married couple, claimed a $7,500 credit under I.R.C. §25A for postsecondary education expenses of their children on their 2011 return. However, they did not carry the $4,500 non-refundable portion of the credit from Form 8863 to Form 1040. Instead, they claimed on Form 1040 only the $3,000 refundable portion. As a consequence, their tax liability on their return dropped from $6,984 to $3,984. When the return was processed, the IRS adjusted the petitioners’ tax liability to account for the $4,500 non-refundable portion of the credit and refunded $4,500 more than the petitioners had requested. On audit, the IRS completely disallowed the $7,500 credit and the petitioners conceded. The issue before the Tax Court was the amount of the deficiency. The Tax Court determined that the rebated amount exceeding the tax liability shown on the return caused an increase in the petitioners’ tax liability. Consequently, the deficiency under I.R.C. §6211 was $7,500, the full amount of the disallowed credit. Galloway v. Comr., 149 T.C. No. 19 (2017).

Posted October 15, 2017

IRS Powers of Attorney For Information Returns Must Be Specific. The IRS has taken the position in a Chief Counsel Advice (CCA) that completing Form 2848 (Power of Attorney and Declaration of Representative) by simply filling out the line on the form for the type of tax in first column, Form 1040 in the second column (for example) and the year in issue in the third column is insufficient to allow the IRS to discuss with the authorized representative all forms filed with or attached to the Form 1040. The IRS noted that completing the Form 2848 in that manner would be inadequate to cover civil penalties that relate to the non-filing or incomplete filing of an international information return that was either attached or should have been attached to the Form 1040. The IRS noted, for example that it could not discuss penalty issues with the authorized representative that relate to a Form 5471 if the Form 2848 only listed Form 1120. The IRS has taken this position based on Treas. Reg. §601.503(a)(6). That regulation requires a “clear expression of the taxpayer’s intention concerning the scope of the authority granted to the recognized representative.” Thus, in light of the IRS position, all applicable information returns should be listed that are relevant to the purpose of Form 2848. Otherwise, a new Form 2848 the covers the required forms can be submitted. In addition, the IRS noted that the designation of a Form 1040 of Form 1120 similarly does not give authority to issues that relate to information returns that are not attached to the income tax return. Likewise, the IRS noted that communications with the authorized representative concerning tax, civil penalties, payment and interest may only occur with respect to the specific form that is listed. CCA 201736021 (Aug. 1, 2017).

Court Says IRS Wrong on Numerous Points Concerning Passive Loss Rules; IRS Issues Non-Acquiescence. The IRS, in this case, reclassified a significant portion of the taxpayers' (a married couple) income from non-passive to passive resulting in an increase in the taxpayers' tax liability of over $120,000 for the two years at issue - 2009 and 2010. The husband had practiced law, but then started working full-time as President of a property management company. He was working half-time at the company during the tax years in issue. He also was President of a company that provided telecommunications services to the properties that the property management company managed. The couple had minority ownership interests in business entities that owned or operated the rental properties and adjoining golf courses that the property management company managed, and directly owned two rental properties, two percent of a third rental property and interests in 88 (in 2010) and 90 (in 2009) additional entities via a family trust. They reported all of their income and losses from the various entities as non-passive, Schedule E income on the basis that the husband was a real estate professional under I.R.C. Sec. 469(c)(7) and that they had appropriately grouped their real estate and business activities. The IRS claimed that the husband was not a 5 percent owner of the property management company, thus his services as an employee did not constitute material participation. IRS also claimed that the husband was not a real estate professional and that the activities were not appropriately grouped. The court agreed with the taxpayers, determining that the husband was a real estate professional on the basis that he owned at least 5 percent of the stock of the property management company. The court determined that he had adequately substantiated his stock ownership and he performed more than 750 hours of services for the property management company - a company in the real property business. The court also determined that the taxpayers had appropriately grouped their rental activities, rejecting the IRS argument that real estate professional couldn't group rental activities with non-rental activities to determine income and loss. The court held that that Treas. Reg. Sec. 1.469-9(e)(3)(i) only governs grouping for purposes of determining material participation, and doesn't bar real estate professional from grouping rental activity with non-rental activity when determining income and loss (as the IRS argued). Accordingly, the taxpayers had appropriately grouped their renal activity with the activities of the telecommunications company and the adjacent golf courses as an appropriate economic unit. As such, the grouped non-rental activities were not substantial when compared to the aggregated rental activity. The activities were under common control and, under Treas. Reg. Sec. 1.469-9(e)(3)(ii), the husband could count as material participation everything that he did in managing his own real estate interests - his work for the management company could count as work performed managing his real estate interests. Note - in CCA 201427016 (Apr. 28, 2014), the IRS said that the aggregation election under Treas. Reg. Sec. 1.469-9(g) has no bearing on the issue of whether a taxpayer qualifies as a real estate professional and the 750-hour test is not applied as to each separate activity. This was not involved in the case. Stanley v. United States, No. 5:14-CV-05236, 2015 U.S. Dist. LEXIS 153166 (W.D. Ark. Nov. 12, 2015).

The IRS has announced that it will not follow the results achieved in the case. Specifically, the IRS disagrees with the court’s holding that mere possession of a stock certificate, irrespective of other conditions, restrictions or limitations on the possessor’s rights regarding the stock, constitutes ownership for purposes of I.R.C. §469(c)(7)(D)(ii). The IRS also indicated that it disagreed with the court’s holding that work performed by the taxpayer in a rental real estate activity for purposes of I.R.C. §469(c)(7)(A) may also constitute work performed by the taxpayer in the taxpayer’s non-rental business activities for other I.R.C. §469 purposes. The IRS non-acquiescence is A.O.D. 2017-07.

Subordination Requirement Strictly Applied - Conservation Easement Perpetuity Requirement Not Satisfied. The petitioner transferred a façade easement via deed to a qualified charity. The easement deed placed restrictions on the petitioner and its successors with respect to the façade easement and the building. The building was subject to two mortgages, but before executing the easement deed, the petitioner obtained mortgage subordination agreements from its mortgagee banks. But, the easement deed provided that in the event the façade easement was extinguished through a judicial proceeding, the mortgagee banks will have claims before that of the donee charity to any proceeds received from the condemnation proceedings until the mortgage is satisfied. The petitioner claimed a charitable contribution deduction for the tax year of the easement contribution. The IRS disallowed the deduction, claiming that the easement deed failed to satisfy the perpetuity requirements of I.R.C. §170 and Treas. Reg. §1.170A-14(g)(6)(ii) because it provided the mortgagees with prior claims to the extinguishment proceeds in preference to the donee. Specifically, the lender had agreed to subordinate the debt to the charity's claims, but the easement deed said that the lender would have priority access to any insurance proceeds on the property if the donor had insurance on the property. The easement deed also said that the lender would have priority to any condemnation proceeds. The petitioner claimed that the First Circuit's decision in Kaufman v. Comr., 687 F.3d 21 (1st Cir. 2012) applied. In that case, the First Circuit rejected the view that a subordination must remove any preferential treatment of the lender in all situations, creating an exception for unusual situations that could possibly occur at some point in the future. The First Circuit determined that the Tax Court's reading of what is necessary to grant a perpetual easement would eliminate easement donations because an easement represented only a partial interest in property. In addition, the First Circuit reasoned that a broad reading was improper because, for example, a tax lien could arise if the donor failed to pay property tax when they became due which could result in the loss of the property without the charity receiving a pro rata portion of the property value. However, in the present case, the Tax Court rejected the view of the First Circuit, noting that its decision would be appealable to the Seventh Circuit which meant that the Tax Court was not bound by the First Circuit's decision. The Tax Court reasoned that because the lender had superior rights in certain situations, the mortgages did not meet the subordination requirement of Treas. Reg. §1.170A-14(g). Thus, the donated easement did not meet the perpetuity requirement of I.R.C. §170(h)(5). The Tax court also pointed out that other Circuits had agreed with the Tax Court's interpretation of the subordination rule since Kaufman was decided. The Tax Court also noted a difference concerning what must be done to subordinate an existing liability at the time of the donation (such as a mortgage) as opposed to a possible future liability that was not yet in existence. The Tax Court also noted that the Treasury Regulations specifically mentioned mortgages in the list of requirements necessary to satisfy the perpetuity requirement, but made no mention of a need to have taxing agencies to agree to give up rights to a priority interest that might arise in the future for delinquent taxes when the taxes were not delinquent. Palmolive Building Investors, LLC v. Comr., 149 T.C. No. 18 (2017).

Rental and Employment Agreements Appropriately Structured; No Self-Employment Tax on Rental Income. The petitioners, a married couple, operated a farm in Texas. In late 1999, they built the first of eight poultry houses to raise broilers under a production contract with a large poultry integrator. The petitioners formed an S corporation in 2004, and set up oral employment agreements with the S corporation based on an appraisal for the farm which guided them as to the cost of their labor and management services. They also pegged their salaries at levels consistent with other growers. The wife provided bookkeeping services and the husband provided labor and management. In 2005, they assigned the balance of their contract to the S corporation. Thus, the corporation became the "grower" under the contract. In 2005, the petitioners entered into a lease agreement with the S corporation. Under the agreement, the petitioners rented their farm to the S corporation, under which the S corporation would pay rent of $1.3 million to the petitioners over a five-year period. The court noted that the rent amount was consistent with other growers under contract with the integrator. The petitioners reported rental income of $259,000 and $271,000 for 2008 and 2009 respectively, and the IRS determined that the amounts were subject to self-employment tax because the petitioners were engaged in an "arrangement" that required their material participation in the production of agricultural commodities on their farm. The Tax Court noted that the IRS agreed that the facts of the case were on all fours with McNamara v. Comr., T.C. Memo. 1999-333 where the Tax Court determined that the rental arrangement and the wife's employment were to be combined, which meant that the rental income was subject to self-employment tax. However, the Tax Court's decision in that case was reversed by the Eighth Circuit on appeal. McNamara v. Comr., 236 F.3d 410 (8th Cir. 2000). The Tax Court, in the current case, determined that the Eighth Circuit's rationale in McNamara was persuasive and that the "derived under an arrangement" language in I.R.C. §1402(a)(1) meant that a nexus had to be present between the rents the petitioners received and the "arrangement" that required their material participation. In other words, there must be a tie between the real property lease agreement and the employment agreement. The court noted the petitioners received rent payments that were consistent with the integrator's other growers for the use of similar premises. That fact was sufficient to establish that the rental agreement stood on its own as an appropriate measure as a return on the petitioners' investment in their facilities. Similarly, the employment agreement was appropriately structured as a part of the petitioners' conduct of a legitimate business. Importantly, the court noted that the IRS failed to brief the nexus issue, relying solely on its non-acquiescence to McNamara (A.O.D. 2003-003, I.R.B. 2003-42 (Oct. 22, 2003)) and relying on the court to broadly interpret "arrangement" to include all contracts related to the S corporation. The Tax Court refused to do so and, accordingly, the court held that the petitioner's rental income was not subject to self-employment tax. Martin v. Comr., 149 T.C. No. 12 (2017).

Proposed Regulations Eliminate Signature Requirement for I.R.C. §754 Election. Proposed regulations specify that a partnership election under I.R.C. §754 do not need to be signed by a partnership representative. The proposed regulation is designed to deal with the situation of an unsigned I.R.C. §754 election statement with the partnership return (whether filed electronically or in paper) which constituted an invalid I.R.C. §754 election. In those situations, the partnership had to seek relief under the I.R.C. §9100 regulations (automatic relief for errors discovered and corrected within 12 months) or file a private letter ruling request (with payment of fee) seeking relief under Treas. Reg. §302.9200-3. Many private letter ruling requests for relief were submitted and the IRS determined that the removal of the signature requirement would eliminate the need for the IRS to deal with the requests. Accordingly, the IRS determined that removing the signature requirement would eliminate many of the largely identical requests. Under the proposed regulation, a partnership making an I.R.C. §754 election must file a statement with its return that sets forth the name and address of the partnership making the election, and declare that the partnership is electing under I.R.C. §754 to apply the provisions of I.R.C. §§734(b) and 743(b). The proposed regulation can be relied upon immediately upon issuance. REG-116256-17; 82 F.R. 47408-47409 (Oct. 12, 2017).

Ministerial Housing Allowance Income Exclusion Unconstitutional. The plaintiff, an atheist organization, challenged as unconstitutional the cash allowance provision of I.R.C. §107(2) that excludes from gross income a minister's rental allowance paid to the minister as part of compensation for a home that the minister owns. The trial court determined that I.R.C. §107(2) is facially unconstitutional under the Establishment Clause based on Texas Monthly, Inc. v. Bullock, 489 U.S. 1 (1989) because the exemption provides a benefit to religious persons and no one else, even though the provision is not necessary to alleviate a special burden on religious exercise. The court noted that religion should not affect a person's legal rights or duties or benefits, and that ruling was not hostile against religion. The court noted that if a statute imposed a tax solely against ministers (or granted an exemption to everyone except ministers) without a secular reason for doing so, the law would similarly violate the Constitution. The court also noted that the defendants (U.S. Treasury Department) did not identify any reason why a requirement on ministers to pay taxes on a housing allowance is more burdensome for them than for non-minister taxpayers who must pay taxes on income used for housing expenses. In addition, the court noted that the Congress could rewrite the law to include a housing allowance to cover all taxpayers regardless of faith or lack thereof. On appeal, the court vacated the trial court's decision and remanded the case for dismissal because the plaintiff lacked standing. While the plaintiff claimed that they had standing because they were denied a benefit (a tax exemption for their employer-provided housing allowance) that is conditioned on religious affiliation, the court noted that the argument failed because the plaintiff was not denied the parsonage tax break because they had never asked for it and were denied. As such, the plaintiff's complaint is simply a general grievance about an allegedly unconstitutional tax provision. Importantly, I.R.C. §107(1) was not implicated and, as such, a church can provide a minister with a parsonage and exclude from the minister's income the rental value of the parsonage provided as part of the minister's compensation. Freedom From Religion Foundation, Inc. v. Lew, 773 F.3d 815 (7th Cir. 2014), vacating and remanding, 983 F. Supp. 2d 1051 (W.D. Wisc. 2013). In order to establish standing, the plaintiff then filed several amended returns that claimed refunds based on the exclusion for a housing allowance from the employee's income. The IRS paid one refund claim, failed to act within the required six months on another amended return, and denied the refund on another amended return and the plaintiff sued challenging the denial of the refund. The IRS later disallowed the refund on another amended return. On the standing issue, the trial court (in an opinion written by the same judge that wrote the initial trial court opinion in 2013) determined (sua sponte) that standing could be established when the IRS fails to act within six months. The court also noted that the IRS had explained its rationale for the disallowed refund claim, which indicated that the IRS would take future action on this issue with other taxpayers and provided a basis for standing. On the merits, the court again determined that I.R.C. §107(2) was an unconstitutional violation of the Establishment Clause of the First Amendment as an endorsement of religion that served no secular purpose in violation of Lemon v. Kurtzman, 403 U.S. 602 (1971). The provision, the court noted, inappropriately provided financial assistance to a group of religious employees without any consideration to secular employees that are similarly situated. However, the court did not provide a remedy because the parties did not develop any argument in favor or a refund, a particular injunction or both or otherwise develop an argument regarding what the court should do if it found I.R.C. §107(2) was found unconstitutional. Thus, the court issued declaratory relief to give the parties a chance to file supplemental briefs regarding the additional remedies that are appropriate. In addition, the court instructed the parties to address the question of whether relief should be stayed pending a potential appeal. Thus, the present status of the law remains unchanged. The trial court clearly believes that its decision will be appealed with the case possibly landing with the U.S. Supreme Court. Gaylor v. Mnuchin, 16-cv-215-bbc, 2017 U.S. Dist. LEXIS 165957 (W.D. Wisc. Oct. 6, 2017).

Posted October 9, 2017

Even With Frequent Travel, Residence Was Tax-Home. The petitioner lived in Las Vegas and had a business that provided video recording to a client produced in the client휩s Las Vegas studio. The client then moved to Washington, D.C. and built a new studio there. As a result, the petitioner spent at least two months each year traveling to Washington, D.C. and staying in hotels or a rented condo. The petitioner deducted his unreimbursed travel expenses in accordance with I.R.C. §162. The IRS disallowed the deductions on the basis that the expenses that Washington D.C. was the petitioner's new "tax-home." The court focused on the fact that the petitioner had four rental properties in Las Vegas that he managed. The court determined that Las Vegas was where the petitioner did the bulk of his work and that much of the video production work was still performed in Las Vegas from his home. That made travel outside of his on account of business deductible travel in accordance with Rev. Rul. 99-7. Barrett v. Comr., T.C. Memo. 2017-195.

Posted October 7, 2017

C Corporate Distributions Taxable. The petitioner was the sole shareholder of a C corporation. The C corporation also made direct payments to the petitioner of $107,500 in 2011 and paid about $5,000 of the petitioner's personal expenses. In 2012, the C corporation made direct payments of $130,000 to the petitioner and again paid about $5,000 of the petitioner's personal expenses. The C corporation's return for 2011 reported that it paid the petitioner $30,000 as compensation, and that amount was also reflected on the petitioner's individual return. The compensation paid to the petitioner in 2012 was also reported on both the corporate return and the petitioner's return. For 2012, the corporation reported a net operating loss (NOL). The parties stipulated to many issues, but not certain amounts of the non-compensation direct payments which the petitioner classified as a non-taxable return of capital, but the IRS believed were taxable dividends. The petitioner claimed that the payments in question were intended to be distributions of capital rather be payments from corporate earnings and profits, and were recorded as such on the corporate books. However, the court noted that for 2011 the corporation had sufficient earnings and profits to make the distribution from and the corporation's intent was irrelevant as was how the corporation treated the distribution on its books. The court also noted that, for 2012, the corporation had sufficient earnings and profits to make the non-compensation distribution in issue. The court noted that under I.R.C. §316(a), a C corporate distribution is made out of earnings and profits if earnings and profits is at least equal to the amount of the distribution. Accordingly, the court upheld the IRS determination including accuracy-related penalties imposed on the corporation. Western Property Restoration, Inc. v. Comr., T.C. Memo. 2017-190.

Posted September 25, 2017

Advance PATCs Must Be Paid Back. The petitioners, a married couple, had an adult son that did not live with them during 2014. The son had government health insurance obtained through a government exchange for 2014 and had $4,628.80 of premiums paid via an advance premium assistance tax credit (PATC). In early 2015, the exchange sent the son Form 1095-A showing the amount of the advance PATC. The petitioners claimed the son as a dependent on their joint return for 2014 which also claimed a refund of $6,880. The petitioners did not report the advance PATC as income on their return thereby reducing their refund. The IRS asserted that the petitioners were not entitled to the advance PATC and that their refund should be decreased accordingly. The petitioners admitted that their income level made them ineligible for the PATC, but claimed that the son did not receive government subsidized insurance in 2014. The court held that the evidence indicated otherwise and that the IRS was correct. Gibson v. Comr., T.C. Memo. 2017-187.

IRS Fails To Prove Willful FBAR Reporting Failure. The plaintiff is the CEO of a company that manufactures and distributes generic medications. In the early 1970s, he traveled internationally for business and opened a savings account in Switzerland which he used to access funds while traveling abroad. The savings account was later converted into an investment account, which resulted in a second account being created. It was unclear whether the plaintiff knew of the creation of the second account. From 1972-2007, the plaintiff had an accountant who prepared his returns, but didn't inform him of the requirement to report the foreign accounts until the mid-1990s. At that time, the accountant informed the plaintiff to take no action and have his estate deal with the matter upon the plaintiff's death. The accountant died in 2007 and the plaintiff hired a new accountant. The plaintiff's 2007 return, prepared with the same information that the plaintiff had always provided his previous accountant, disclosed the presence of one of the foreign accounts containing $240,000, but did not disclose the other account that contained about $2 million. The plaintiff also filed amended returns for 2004 to the present time paying taxes on the gains on the Swiss accounts. The plaintiff also closed the Swiss accounts in 2008. The IRS notified the plaintiff in 2011 that he was being audited, and asserted an FBAR penalty. The plaintiff paid the $9,757.89 penalty (for a non-willful violation) and sued for a refund. The IRS counterclaimed for what it claimed was the full amount of the penalty for a willful violation - $1,007,345.48. The trial court denied summary judgment for both parties and conducted a bench trial on the issue of the plaintiff's willfulness under 31 U.S.C. §5314 and whether the IRS satisfied its burden of proof regarding the calculation of the penalty amount for a willful violation (greater of $100,000 or 50 percent of the balance in the account at the time of the violation of 31 U.S.C. §5321(a)(5)(B)(i)) with no reasonable cause exception. The court noted that there was no precise statutory definition of "willful," but that the federal courts have required either a knowing or reckless failure to file an FBAR. The court determined that the failure to file an FBAR for 2007 was not willful based on the facts. Rather, the court determined that the plaintiff simply committed an unintentional oversight or a negligent act. The court determined that did not do anything to conceal or mislead and inadvertently failed to report the second account on the FBAR. The court noted that the plaintiff had retained an accounting firm to file amended returns and rectify the issue before learning of an IRS audit. The court determined that there was no tax avoidance motive and reasoned that the plaintiff's conduct was not the type intended by the Congress or IRS to constitute a willful violation. The court also determined that the penalty amount that the plaintiff paid had been illegally exacted and ordered the IRS to return those funds to the plaintiff. Bedrosian v. United States, No. 15-5853, 2017 U.S. Dist. LEXIS 154625 (E.D. Pa. Sept. 20, 2017).

Posted September 23, 2017

Payments for Physical Injury Resulting From Emotional Distress Not Excludible. The petitioner sued his employer for workplace discrimination and retaliation, alleging that he "suffered severe emotional distress and anxiety, with physical manifestations, including high blood pressure." The parties settled the case with the employer paying the petitioner a settlement amount of $275,000 that included an $85,000 allocation to "emotional distress." The petitioner excluded the amount from his taxable income on his return, but the IRS denied the exclusion. The Tax Court agreed with the IRS. The court noted that I.R.C. §104(a)(2) excludes from gross income damages paid on account of physical injury or sickness. However, the court noted that this code section also says that emotional distress, by itself, does not count as physical injury or sickness. Thus, damages paid on account of emotional distress are not excludible. The court noted the legislative history behind I.R.C. §104(a) states that the Congress "intended that the term emotional distress includes symptoms (e.g., insomnia, headaches, stomach disorders) which may result from such emotional distress." However, the court also noted that Treas. Reg. §1.104-1(c)(2) states that emotional distress damages "attributable to a physical injury or physical sickness" are excluded from gross income. Thus, the court noted that if emotional distress results from a physical injury any resulting damages are excluded from gross income. However, if the physical injury results from emotional distress, damage payments are not excludible. In this case, the petitioner's damage payment was paid on account of emotional distress that then caused physical injury and were not excludible. Collins v. Comr., T.C. Sum. Op. 2017-74.

Posted September 16, 2017

South Dakota Sales Tax on Remote Sellers Unconstitutional. In 2016, the South Dakota legislature deliberately enacted unconstitutional legislation (S.B. 106) imposing sales tax on remote sellers that had no physical presence in the State. S.B. 106 imposed sales tax on sellers with gross revenue from South Dakota sales exceeding $100,000 per calendar year or sellers with 200 or more 흉separate transactions흩 in South Dakota within the same calendar year. S.B. 106 authorized the state to bring a declaratory judgment action against any person believed to meet the criteria of the bill to establish that the obligation to remit sales tax applied and was valid under federal law. The bill also authorized a motion to dismiss or a motion for summary judgment in the declaratory judgment action. The bill also provided that the filing of a declaratory judgment action would operate as an injunction during the pendency of the suit which would bar the State from enforcing the collection of sales tax. Once the South Dakota Department of Revenue began enforcing the enacted legislation, the State filed a declaratory judgment action against several remote sellers that did not obtain the required sales tax licenses and remit sales tax. The defendants, remote sellers, sought to remove the case to federal court on the basis of federal question jurisdiction, but that court remanded the case to the trial court in South Dakota. South Dakota v. Wayfair, Inc., 229 F. Supp. 3d 1026 (D. S.D. 2017). In the State trial court, the defendants motioned for summary judgment based on the U.S. Supreme Court decisions in National Bellas Hess, Inc. v. Department of Revenue, 386 U.S. 753 (1967), Quill Corporation v. North Dakota, 504 U.S. 298 (1992), and Direct Marketing Association v. Brohl, 135 S. Ct. 1124 (2015), rev휩g., and remanding, 735 F.3d 904 (10th Cir. 2013), remand decision at 814 F.3d 1129 (10th Cir. 2016). The trial court granted the motion, noting that the State supported the motion and no facts were in dispute and enjoined the enforcing of the obligation to collect and remit sales tax against the defendants. The State then appealed to the South Dakota Supreme Court, which affirmed the trial court휩s decision on the basis that S.B. 106 unconstitutionally imposed an obligation on the defendants to collect and remit sales tax to South Dakota because none of the defendants had a physical presence in the State. The South Dakota Supreme Court cited the U.S. Supreme Court decision in Quill for its rationale and holding. The State announced its intent to petition the U.S. Supreme Court for review by mid-October. State v. Wayfair, Inc., et al., No. 28160, 2017 S.D. LEXIS 111 (S.D. Sup. Ct. Sept. 13, 2017).

Posted September 5, 2017

Easement Deed Served as a Contemporaneous Written Acknowledgement. The petitioner owned a cork factory that it converted into a luxury apartment building while maintaining and preserving the building휩s historic features. The petitioner deeded a historic preservation and conservation easement on the façade of the building to a qualified charity via a deed of easement and claimed a $7.14 million charitable deduction. IRS Form 8283 that accompanied the transfer failed to include a statement that there was no exchange of goods and services, but a later letter by the charity did include that information. The letter was determined not to be a contemporaneous written acknowledgement, but the easement deed, by itself, did qualify as a contemporaneous written acknowledgement. The deed language excluded the possibility of separate payments in exchange for the property and constituted the 흉entire agreement흩 between the petitioner and the charity according to the Tax Court, and the lack of description of any payment in the deed was insufficient to cause the requirements of I.R.C. §170(f)(8)(B) to not be satisfied. The Tax Court also noted that the deed of easement was properly signed and provided a description and estimate of the monitoring activities to be conducted by the charity. Big River Development, L.P. v. Comr., T.C. Memo. 2017-166.

Posted September 2, 2017

IRS Says 흉Shacking-Up흩 Constitutes a Marriage if State Says So. While federal tax law doesn휩t define a 흉marriage흩 for tax purposes, the Treas. Reg. §301.7701-18(b)(1) defers to state law. As such, if a state recognizes a 흉common law흩 marriage, such recognition is binding on the IRS. Those states that recognize a common law marriage are CO, IA, KS, MT, NH, SC, TX and UT. Other states previously recognized common law marriages until a change in the law, but grant 흉grandfathered흩 status to the prior recognized common law marriages. Those states are FL, GA, IN, OH and PA. Tech. Adv. Memo. 201734007 (May 1, 2017).

IRS Grants Relief For Late-Filed Partnership Returns. On July 31, 2015, the Highway Trust Fund Extension legislation was signed into law. The law contained numerous changed to due dates for various types of federal tax returns for tax years beginning after December 31, 2015. In other words, the changes prescribed by the law became effective for 2016 tax returns prepared during the 2017 tax filing season. One such change was applicable to calendar year partnership returns. The law changed the due date from April 15 to March 15 (the extended due date remains September 15). The IRS has now granted relief from late filing penalties for partnerships that either filed Form 1065 or a request for an extension of time to file via Form 7004 after March 15, but on or before April 18 of 2017. The relief applies to partnerships who filed the following forms by the pre-2017 deadline: Form 1065; Form 1065-B; Form 8804; Form 8805; Form 7004, and; Form 5471. With respect to Forms 7004 and 5471, the relief only applies to an affected tax law partnership with no relief for other filers. For relief to be granted, at least one of two conditions must be satisfied: 1) the partnership filed the specified Form and furnished copies (or Schedules K-1) to the partners by the date that would have been timely under I.R.C. §6072 before the change in the law; or 2) the partnership filed Form 7004 to request an extension of time to file by the date that would have been timely under I.R.C. §6072 before the change in the law. IRS indicated that an eligible partnership need do nothing to obtain the relief, and if a penalty has not already been imposed, relief is to be automatically granted. For those situations where the penalty has already been imposed, the partnership is to receive a letter within 흉the next several months흩 stating that the penalties are abated. If such abatement is not received by February 28, 2018, the partnership is to contact the IRS at the telephone number noted in the letter and tell the IRS that the partnership qualifies for relief under Notice 2017-47. No relief is provided for partnerships that failed to timely request an extension by March 15 and became aware of the due date before April 18, and did not file either Form 7004 or the return by April 18. IRS did not mention whether the relief granted applies to deemed extensions of time to file such as for the purpose of funding a retirement plan or making elections that are due by the due date (including extensions). IRS Notice 2017-47.

Posted September 1, 2017

Intra-Family Transaction Leads to Tax Mess. The petitioner bought a home with his parents. He contributed $234,312 of the purchase price and the parents paid $40,000. The parents then gifted their interest in the home to the petitioner. The home휩s value increased substantially, and the petitioner refinanced the mortgage and received cash in the process. Ultimately, the petitioner borrowed $664,000 against the property and then sold the property to his parents. The parents borrowed $682,500 to buy the property and paid off the petitioner휩s loans. On the closing statement, the total consideration for the sale was noted as $975,000. The closing statement also indicated that the petitioner gifted equity to his parents of $295,655.35, and listed settlement charges of $16,751.24 that the petitioner incurred. For the year of sale (2007), the petitioner did not file a return. The return for 2007 was ultimately filed in 2013, but no gain from the transaction was reported. The Form 1099-S issued for 2007 concerning the transaction showed gross proceeds of $975,000, which the IRS claimed was capital gain. The Tax Court disagreed, noting that the petitioner휩s basis in the home was is original cost basis, plus the $40,000 of cost basis attributable to his parents휩 interest in the home that he obtained by gift. The Tax Court also determined that the petitioner had $664,000 of discharge of debt, less settlement costs of $16,750 ($647,250). The sale price of $975,000 less the discharge debt of $647,250 ($327,750) was determined to be a gift from the petitioner to his parents. The resulting gain on the transaction to the petitioner was $372,500 ($647,250 less the petitioner휩s cost basis). With the exclusion under I.R.C. §121 of $250,000 the petitioner휩s recognized long-term capital gain was $122,500. The court upheld the imposition of accuracy-related and underpayment penalties. Fiscalini v. Comr., T.C. Memo. 2017-163.

Posted August 30, 2017

Advanced Premium Assistance Tax Credit Must Be Included In Income. The petitioners (a married couple) purchased Obamacare health insurance for 2014 and the California health insurance exchange determined that the petitioners were eligible for an advance premium assistance tax credit under I.R.C. §36B in the amount of $7,092 to be applied against the $14,183.64 annual cost of the insurance. As of the time of the application, the wife was not employed, but she later began working at a job that paid $600/week. The petitioners notified the exchange, and the exchange advised the petitioners that it was an amount that would cause them to be disqualified for the PATC in a letter dated June 14, 2014. However, the petitioners did not receive the letter and the exchange never did take into account the change in the petitioners휩 household income. Due to a change in address, the petitioners did not receive Form 1095-A showing the calculation of the PATC and repeated attempts to contact the exchange were futile. On their 2014 return, the petitioners noted that they had health insurance for the full year, but left blank the line for the PATC and did not attach the related computation form 힩 Form 8962. Consequently, they did not include in income any of the advanced PATC. On audit, the IRS determined that the $7,092 should not have been claimed as a credit. The petitioners claimed that it was unfair for the IRS to deny them the credit, because it was the exchange that failed to properly administer the credit. The petitioners stated that they would not have paid the exorbitant cost of Obamacare insurance at $14,000 per year because they couldn휩t afford it unless they could use other people휩s money to help pay for it. They said that they would have continued to shop in the private market or simply pay the penalty tax for not having the government mandated insurance. The Tax Court noted that the statute was clear and the advanced PATC was properly denied. However, the court did not uphold the negligence penalty or the accuracy-related penalty. McGuire v. Comr., 149 T.C. No. 9 (2017).

Posted August 26, 2017

Non-Safe Harbor 흉Parking흩 Reverse Exchange Approved, But IRS Disagrees. The taxpayer (a drugstore chain) sought a new drugstore while it was still operating an existing drugstore that it owned. The taxpayer identified the location where the new store was to be built, and assigned its rights to the purchase contract in the property to a Q.I. in April of 2000. The taxpayer then entered into a second agreement with the Q.I. that provided that the Q.I. would buy the property, with the taxpayer having the right to buy the property from the Q.I. for a stated period and price. The taxpayer, in June of 2001, leased the tract from the Q.I. until it disposed of the existing drugstore in September of 2001. The taxpayer then used the proceeds of the existing drugstore to buy the new store from the intermediary, with the transaction closing in December of 2001. Because the new store was acquired before the existing store was disposed of, it met the definition of a reverse exchange. However, the safe harbor did not apply because the exchange was undertaken before the safe harbor became effective. If the safe harbor had applied, the transaction would not have been within it because the Q.I. held title for much longer than 180 days. Despite that, the IRS nixed the tax deferral of the exchange because it viewed the taxpayer as having, in substance, already acquired the replacement property. In other words, it was the taxpayer rather than the Q.I. that held the burdens and benefits of ownership before the transfer which negated income tax deferral. An exchange with oneself is not permissible. As a result, eliminated was the deferral of about $2.8 million of gain realized on the transaction in 2001. The Tax Court noted that existing caselaw did not require the Q.I. to acquire the benefits and burdens of ownership as long as the Q.I. took title to the replacement property before the exchange. The Tax Court noted that it was important that the third-party facilitator was used from the outset. While the safe harbor didn휩t apply to the transaction, the Tax Court noted that 45 and 180-day periods begin to run on 흉the date on which the taxpayer transfers the property relinquished in the exchange,흩 and that the taxpayer satisfied them. The Tax Court also noted that caselaw does not impose any specific time limits, and supported a taxpayer휩s pre-exchange control and financing of the construction of improvements on the replacement property during the time a Q.I. holds title to it. The taxpayer휩s temporary possession of the replacement property via the lease, the court reasoned, should produce the same result. Because the facts of the case involved pre-2004 years, the Tax Court did not need to address Rev. Proc. 2004-51 and how the IRS tightened the screws on the safe harbor at that time. Estate of Bartell v. Comr., 147 T.C. No. 5 (2016). The IRS, in August of 2017, issued a non-acquiescence to the Tax Court휩s decision. A.O.D. 2017-06, IRB 2017-33.

Cancelled Debt of Partnership Is Passed Through To Partners. The petitioners were a married couple who practiced law and specialized in estate planning and partnership taxation. The husband was a member of a partnership that ultimately settled some of its debts for less than the full amount. He also was, on another matter, convicted for obstruction of the internal revenue laws for creating fictitious debenture transactions for clients. As for the discharged partnership debt, the partnership issued the husband a K-1 reporting the deemed distribution of the partnership liabilities attributable to the husband as a partner, but he failed to report the amount on his individual return. He claimed that Missouri law did not make him personally liable for the partnership휩s debts and, as a result, he was not relieved of any partnership liability. The IRS disagreed, and the Tax Court noted the basic principle that partners must recognize as ordinary income their distributive share of partnership discharge of indebtedness income. It matters not, the court noted, whether a partner is personally liable on the obligation that the partnership is relieved of citing prior case law. This principle applies even to relief of nonrecourse debt partnership liability. The Tax Court also held that the husband had no remaining basis in his partnership interest at the end of the partnership year in which the loss occurred and, as a result, could not deduct his share of partnership losses. Kohn v. Comr., T.C. Memo. 2017-159.

Posted August 25, 2017

Deed of Easement For Donated Conservation Easement Satisfies Acknowledgement Requirement. The petitioner acquired a building and began renovating it by converting it from commercial office use to residential use. In late 2005, the petitioner executed a preservation deed of easement granting a qualified charity an easement over the façade of the building. The deed was recorded the same day. The deed stated that 흉the subject matter of this conveyance is a perpetual donation to charity which can no longer be transferred, hypothecated or subjected to liens or encumbrances by Grantor.흩 The granting clause stated that the grant was of a conservation easement in perpetuity for the purpose of preserving the 흉protected elements.흩 The deed provided that the charity would monitor the petitioner휩s compliance with the easement restrictions and authorized the charity to inspect the premises for compliance. The deed did not contain any reference that the petitioner received any goods or services from the charity in return for the grant of the easement, and said nothing about the charity receiving any consideration for providing goods or services to the petitioner. The easement was valued at $26.7 million by the petitioner휩s appraiser, and the petitioner claimed a charitable deduction of $26.7 million, attaching Form 8283 to its return. Form 8283 did not state whether the charity had provided any goods or services to the petitioner in exchange for the donation. Over three years later, the charity gave the petitioner a letter stating that 흉no goods or services have been provided to you in consideration of your prior donation.흩 While the charity believed that it had given a similar letter to the petitioner at the time of the donation, a copy of such a letter could not be found. The IRS examined the 2005 return and proposed disallowing the charitable deduction. In 2012, the charity filed an amended Form 990 for its fiscal year ending June 30, 2006. The amended 990 referred to the easement and said that no goods or services had been furnished to the petitioner in exchange for the gift. The return was unsigned and did not identify the petitioner as the donor. In 2014, the IRS disallowed the deduction and also determined that the value of the donation was $1.6 million and applied a 40 percent gross valuation misstatement. The charity, on its 2014 Form 990, stated that the petitioner had not received any goods or services in exchange for the 2005 gift. The IRS moved for summary judgment on the basis that the petitioner did not receive a contemporaneous written acknowledgment that satisfied the requirements of I.R.C. §170(f)(8)(A) at the time of the donation. The Tax Court noted that tax returns subsequently filed by the charity do not relieve the petitioner of the obligation to have a contemporaneous written acknowledgement. However, the court noted that a contemporaneous written acknowledgement didn휩t have to take any particular form and that a deed of easement can constitute a contemporaneous written acknowledgement if it is properly executed and is contemporaneous. The Tax Court determined that the deed of easement was properly executed and recorded on the same day of the execution. Thus, it was 흉contemporaneous.흩 It also contained an affirmative indication that the charity didn휩t provide any goods or services to the petitioner in exchange for the donated easement and represented the parties휩 entire agreement which negated the provision or receipt of any consideration not stated therein. The boilerplate language in the deed was of no legal effect for purposes of I.R.C. §170(f)(8). The Tax Court granted the petitioner휩s motion for summary judgment and denied that of the IRS. 310 Retail, LLC v. Comr., T.C. Memo. 2017-164.

No $33 Million Charitable Deduction Due To Improper Disclosure. A partnership paid just shy of $3 million in 2002 to acquire a remainder interest in particular property. The acquisition came along with certain covenants that were designed to maintain the property휩s value. In addition, if the covenants were breached the remainder interest holder would get immediate possession of the property without any damages being paid by the holder of the term interest. About 18 months later, the partnership assigned the remainder interest to a University and claimed a deduction of over $33 million. The partnership completed and filed Form 8283 with its return, but it left blank the space on the Form where it was to provide its cost or adjusted basis in the property 힩 the partnership either simply forgot or didn휩t want to alert the IRS that it had likely overvalued the amount of the donation. But, that was a fatal mistake. The omission of that basis information violated Treas. Reg. §1.170A-13(c)(4)(ii)(E). No deduction was allowed. RERI Holdings I, LLC v. Comr., 149 T.C. No. 1 (2017).

Posted August 19, 2017

IRS Says There Is No Exception From Filing A Partnership Return. On a question raised by an IRS Senior Technician Reviewer, the IRS Chief Counsel휩s Office has stated that Rev. Prov. 84-35, 1984-2 C.B. 488, does not provide an automatic exemption from the requirement to file Form 1065 (U.S. Return of Partnership Income). Under Rev. Proc. 84-35, IRS noted that domestic partnerships with 10 or fewer partners that fall within the I.R.C. §6231(a)(1)(B) exceptions are deemed to meet the reasonable cause test and are not liable for the I.R.C. §6698 penalty. IRS explained that I.R.C. §6031 requires partnerships to file Form 1065 each tax year and that failing to file is subject to penalties under I.R.C. §6698 unless the failure to file if due to reasonable cause. Neither I.R.C. §6031 nor I.R.C. §6698 contain an automatic exception to the general filing requirement of I.R.C. §6031(a) for a partnership as defined in I.R.C. §761(a). IRS noted that it cannot determine whether a partnership meets the reasonable cause criteria or qualifies for relief under Rev. Proc. 84-35 unless the partnership files Form 1065 or some other document. IRS also noted that the returns of partners are not linked together during initial processing, and IRS does not know the number of partners in the partnership or whether the partners timely filed individual income tax returns until either a partner or the partnership is audited. The reasonable cause requirement can be met, IRS noted, if the partnership or any of the partners establishes (if required by the IRS) that all partners have fully reported their shares of the income, deductions and credits of the partnership on their timely filed income tax returns. Reasonable cause under Rev. Proc. 84-35 is determined on a case-by-case basis and I.R.M. Section 20.1.2.3.3.1 sets forth the procedures for applying the guidance of Rev. Proc. 84-35. C.C.A. 201733013 (Jul. 12, 2017).

Posted August 15, 2017

Conservation Easement Deduction Allowed 힩 Tax Court Decision Vacated. The petitioner owned land that included the habitat of the endangered golden-cheeked warbler. The petitioner granted conservation easements over the property to the North American Land Trust (NALT), claiming a multi-million-dollar charitable deduction for the easement donation. The easement deed allowed the petitioner and NALT to change the location of the easement restriction, and the petitioners retained the right to raise livestock on the property as well as hunt the property, cut down trees, construct buildings, recreational facilities, skeet shooting stations, deer hunting stands, wildlife viewing towers, fences, ponds, roads and wells. The petitioners also sold partnership interests to unrelated parties who received homesites on adjacent land. The appraisal at issue was untimely and inaccurately described the property subject to the easement, and a NALT executive failed to clarify the inconsistencies. The Tax Court denied the charitable deduction and also imposed the additional 40 percent penalty for overvaluation (the easement was actually worth nothing). On appeal, the court reversed. The appellate court noted that the property subject to the easements could be amended only to the limited extent needed to modify the boundaries of the five-acre homesite parcels, wholly within the ranch ad without increasing the homesite parcels above five acres. Such a retained right, the appellate court reasoned, had no impact on the perpetuity of the easements and actually served to promote the underlying conservation interests. They added flexibility to address changing or unforeseen conditions on or under the property subject to an easement. In addition, the NALT could withhold consent to adjustments in the easement grants. The appellate court also held that the petitioner did provide sufficient documentation of the condition of the property before the easement donations to satisfy the requirements of Treas. Reg. §1.170A-14(g)(5)(i), and that the Tax Court had utilized a 흉hyper-technical흩 approach to determining whether the required documentation had been submitted. Bosque Canyon Ranch II, L.P., et al. v. Comr., No. 16-60068, 2017 U.S. App. LEXIS 14917 (5th Cir. Aug. 11, 2017), vacating and remanding, T.C. Memo. 2015-130.

Posted August 8, 2017

흉Qualified Farmer흩 Definition Not Satisfied For Purpose of 100 Percent Deductibility of Conservation Easement. The petitioners, two brothers, were co-owners of an LLC that was taxed as a partnership. The LLC owned various tracts of farmland that it leased to other farming entities in which the petitioners had ownership interests.  In 2009, the LLC sold a conservation easement on a 355-acre tract to a public charity for $1,504,960, claiming a charitable contribution of $1,335,040. An appraisal valued the unencumbered value of the property at the time of the grant of the easement at $4,970,000 and at $2,130,000 post-easement, and the $1,335,040 charitable contribution represented the difference in value before and after the easement conveyance less the amount received for the sale of the easement. The LLC then sold its interest in the tract to third party for $1,995,040. Each petitioner claimed a charitable contribution deduction of $667,520 on their respective Schedule A's. Each of them also reported their share of the$877,057 gain on the sale of the property to the third party. Each petitioner had a small amount of wage and interest income and a pass-through loss of almost $200,000. Each petitioner justified the amount of charitable contribution deduction on the basis that they were 흉qualified farmers흩 under I.R.C. §170(b)(1)(E) having gross income from the trade or business of farming that exceeded 50 percent of total gross income for the tax year. To reach that result, the petitioners claimed that the proceeds from the sale of the property and the proceeds from the sale of the development rights constituted income from the trade or business of farming. The IRS disagreed, and limited the charitable deduction to 50 percent of each petitioner휩s contribution base with respect to the conservation easement. The court agreed with the IRS. The court noted that the income from the sale of the conservation easement and the sale of the land did not meet the definition of income from farming as set forth in I.R.C. §2032A(e)(5) by virtue of I.R.C. §170(b)(1)(E)(v). The parties agreed as to each petitioner휩s gross income, but not on the amount of income each petitioner had from the trade or business of farming. The court noted that the statute was clear and that neither income from the sale of land nor income from the sale of development rights was included in the list of income from farming. While the court pointed out that there was no question that the petitioners were farmers and continued to be after the conveyance of the easement, they were not 흉qualified farmers흩 for purposes of I.R.C. §170(b)(1)(E)(iv)(I). Furthermore, the court pointed out that the LLC was not engaged in the business of farming, but was in the business of leasing real estate. The IRS also challenged the value of the conservation easement, and a later trial will be held on that issue. Rutkoske v. Comr., 149 T.C. No. 6 (2017).

Posted August 7, 2017

No Deductions for Pot Dispensary. The petitioner was a medical marijuana dispensary organized as a mutual benefit corporation under California law (thus, considered to be a non-profit entity). The petitioner operated at a deficit, but its officers and directors were paid salaries far in excess of salaries paid to other employees. In addition, corporate funds were used to pay for automobiles for the officers. The petitioner also claimed operating deductions for its business expenses, such as salaries. The Tax Court, following its holding in Olive v. Comr., 139 T.C. No. 2 (2015), determined that the sale of cannabis is always considered to be 흉trafficking흩 in a controlled substance for purposes of I.R.C. §280E, even when permitted by state law. The Tax Court noted that the petitioner stipulated that is was in the business of distributing medical marijuana, and received income from the sale of books and T-shirts. But, the evidence was not sufficient to allow the Tax Court to determine the percentage of income derived from books and T-shirts as opposed to the sale of cannabis as a separate trade or business conducted Thus, the Tax Court held that the petitioner was only engaged in the sale of cannabis, and all of the petitioner휩s operating expenses were disallowed. On appeal, the appellate court affirmed, and did not consider any of the petitioner휩s arguments that were not raised at the Tax Court. Canna Care, Inc. v. Comr., No. 16-70265, 2017 U.S. App. LEXIS 13444 (9th Cir. Jul. 25, 2017).

Posted August 4, 2017

No FICA Tax on Railroad Company Stock Paid to Employees. The plaintiff, a railroad company, paid company stock as compensation to employees. Under the Railroad Retirement Tax Act (RRTA), RRTA taxes (e.g., railroad employment taxes) apply only to 흉money흩 compensation.흩 The IRS, in its RRTA Desk Guide (2009) notes that 흉for calendar years after December 31, 1992, Treas. Reg. § 31.3231(e)-1(a)(1) provides that "compensation" for computation of RRTA taxes has the same meaning as the term "wages" under I.R.C. § 3121(a), except as specifically limited by the Railroad Retirement Act or regulations. The Desk Guide goes on to state, 흉Because this is a separate system for railroad employers, payments subject to railroad retirement taxes are specifically excepted from FICA, FUTA, and the Self-Employment Contributions Act (SECA).흩 Nevertheless, from 1991 to 2007, the IRS assessed over $75 million in FICA tax on the plaintiff휩s stock payments to employees based on the argument that 흉money흩 in the RRTA included stock paid to employees for services rendered. The appellate court, reversing the trial court, disagreed. The appellate court noted that the RRTA definition of 흉money흩 has the ordinary meaning it had at the time the RRTA was enacted 힩 which did not include corporate stocks at the time of enactment. In addition, the appellate court determined that stock payments did not constitute money remuneration because stock is not a medium of exchange. The court also rejected the IRS argument that the RRTA and FICA had the same purpose and should, therefore, have equal application to stock payments. Such a policy argument, the court reasoned, had to yield to the actual text of the statutes. Likewise, the appellate court held that 흉ratification흩 payments made to employees upon approval of collective bargaining agreements were also not 흉money remuneration흩 made for services that employees rendered. Union Pacific Railroad Company v. United States, No. 16-3574, 2017 U.S. App. LEXIS 14078 (8th Cir. Aug. 1, 2017).

Posted August 3, 2017

Sale of Farmland Fails To Qualify for Iowa Capital Gain Deduction. A married couple bought on Iowa farm in 1978, and the husband actively farmed it through April of 2002, when they executed a like-kind exchange of the farm for another farm in the same county. The husband continued to farm the replacement property through the end of 2003. From 2004 through 2009, the couple leased the farm on a cash-rent basis. The husband turned 62 on April 27, 2008, and began receiving Social Security in June of 2008. In late 2010, the couple sold the farm, triggering capital gain on the sale in the amount of $713,060 for which they claimed a deduction of the same amount in accordance with Iowa Code §422.7(21)(a)(1) which requires that the taxpayer have owned and materially participated in farming the land for 10 years before the sale. The Iowa Department of Revenue (IDOR) conceded that the ownership requirement had been satisfied, but denied the deduction on the basis that the material participation requirement had not been satisfied. The IDOR based its conclusion on 70 Iowa Admin. Code §40.38(1)(c) which requires a retired farmer to have materially participated in the farming activity on the land for at least five of the last eight years before retirement (defined as receiving Social Security benefits). The Administrative Law Judge noted that the husband retired in 2008. Thus, he only had three years of material participation in the last eight years before retiring, and the IDOR휩s denial of the cap gain deduction was upheld as correct. In re Brandt, No. 14 DORFC018 (IDOR Admin. Hearing Div. Jun. 14, 2016).

Posted August 2, 2017

Social Security Number Not Required On State (or Federal) Return To Get State Dependency Deduction. The plaintiff did not obtain Social Security numbers for his three children based on a religious objection. Likewise, he did not obtain any IRS-issued taxpayer identification number (TIN) for them either. The plaintiff filed his 2013 federal tax return claiming a dependency exemption for each child based on the fact that each of them was either under the age of 19 or a student under age 24 that met all of the requirements for the exemption. The IRS sent the plaintiff a letter seeking documented verification of each child휩s birth and identity. The plaintiff provided sufficient information for IRS to verify each child as his and granted the federal dependency exemptions for each child. However, on the state (IN) return, the IN Department of State Revenue (IDOSR) disallowed the IN dependency deduction (a $1,500 deduction per child) for each child. The plaintiff filed a protest, but the IDOSR denied the protest and the plaintiff appealed. The court noted that while IN law provided that no one can be compelled by any state agency to provide their Social Security number to a state agency against their will, that provision did not apply to the IDOSR. However, I.C. §6-3-1-3.5(a)(5)(A) says that the IN dependency deduction is available for each federal dependency exemption 흉allowed흩 under the Internal Revenue Code. Thus, the court reasoned, there is no requirement that a dependent휩s Social Security number be provided to the IDOSR for a taxpayer to receive the dependency deduction. The only requirement, the court concluded, is that the taxpayer receive a federal dependency exemption. Because the plaintiff had provided sufficient documentation to obtain the federal dependency exemptions for his children, he was entitled to the IN dependency deductions for each child. Larsen v. Indiana Department of State Revenue, No. 49T10-1503-TA-00008, 2017 Ind. Tax LEXIS 26 (Ind. Tax Ct. Jul. 31, 2017).

Posted July 31, 2017

No Charitable Deduction When Trust Changed From Non-Grantor to Grantor Trust. The taxpayer created a charitable lead trust which called for an annuity amount to be distributed to charity annually for which the trust was allowed a deduction under I.R.C. §642(c)(1) for the amount of gross income that was annually included in the annuity. The taxpayer wanted to amend the trust to allow a sibling (non-trustee) to be able to acquire or reacquire the trust휩s principal by substituting other property of equal value, determined on the date of each substitution. The taxpayer wanted to be able to be able to claim a charitable deduction for the deemed distribution from the trust to the taxpayer, and the transfer from the taxpayer to the trust. The taxpayer based that position on the point that transfers to a charitable lead trust that is a grantor trust are eligible for a charitable deduction for the transfer. The IRS disagreed on the basis that when a trust is converted from a non-grantor trust to a grantor trust, a property transfer for income tax purposes has not occurred. The IRS cited no case law for this position. Priv. Ltr. Rul. 201730012 (May 1, 2017).

No Earned Income To Indians From Gaming Revenue. For purposes of the definition of earned income for purposes of the foreign earned income exclusion (I.R.C. §911(d)(2)) and the 흉kiddie-tax흩 (I.R.C. §1(g)(4), the IRS has determined that gaming revenue distributed by an Indian tribe to its members are not earned income. Rather, they are 흉per capita payments.흩 C.C.A. 201729001 (Jun. 20, 2017).

Posted July 29, 2017

Insufficient Profit Motive for Car Racing Business. The petitioner formed a racing business in 2006 and reported net losses of $19,900 on Schedule C in 2006 and $16,600 of losses in 2007. He had no car-racing activity for 2008 or 2009, and filed Chapter 7 bankruptcy in 2009. In 2011, the petitioner withdrew funds from his 401(k) plan account to form another racing business. He had no formal business education, but was determined to operate the business for profit. He reported losses from the activity in 2011 ($63,000) and 2012 ($16,000) and then showed minimal profits (less than $5,000) for each of 2013-2015. The IRS disallowed the loss for 2011. The petitioner timely filed Form 5213 to elect to postpone the determination as to whether the presumption applied that the racing activity was engaged in with a profit motive in accordance with I.R.C. §183(e). The election allows a taxpayer to defer the determination of whether the three-out-of-five year presumption applies until the close of the fourth taxable year after the first year in which the activity was engaged in. The court determined that the petitioner actually had losses from the activity for years 2013-2015, and was not entitled to the presumption that the business was engaged in with a profit intent. Thus, under the nine-factor test of Treas. Reg. §1.183-2(b), only two of them (time and effort expended; taxpayer휩s financial status) favored the petitioner. Six factors favored the IRS and one factor (taxpayer휩s expertise) was neutral. Thus, the petitioner휩s deductions could not be used to offset taxable income from other sources. Stettner v. Comr., T.C. Memo. 2017-113.

S Corporation Status Terminated Immediately When Shareholder Died. The taxpayer was a 100 percent owner of an S corporation. He then transferred his entire interest to an LLC that he owned 100 percent of. The LLC was treated as a disregarded entity for tax purposes which meant that the taxpayer held the LLC interests were directly. The taxpayer then transferred some of his LLC interest to a grantor trust that was treated as entirely owned by himself. The trust was an eligible S corporation shareholder under I.R.C. §1361(c)(2)(A)(i). The taxpayer then died, which caused the trust to cease from being a grantor trust. This caused the LLC, as the sole owner of the S corporation, to become a partnership for federal tax purposes (because there were then two partners) under the check-the-box regulations, terminating the S election (because a partnership cannot be an S corporation). The LLC then redeemed the shares held by the taxpayer휩s estate, which again caused the LLC to be treated as a disregarded entity owned by the trust for federal tax purposes. The IRS determined that the events causing termination of the S election were inadvertent. Priv. Ltr. Rul. 201730002 (Apr. 24, 2017).

Posted July 28, 2017

Taxpayer Used IRA To Invest in Taxpayer휩s Business Without Business Purpose. The petitioner conducted business via several corporations that manufactured concrete blocks under patents that the petitioner held. The petitioner sold the patents to an LLC. The petitioner and family members established Roth IRAs, with each IRA originally funded with a contribution that was then used to buy the LLC interests. Royalties from the petitioner휩s business were paid to the LLC and then distributed to the IRAs as LLC owners in amounts in excess of the contributions limits applicable to Roth IRAs. The court held that the LLC was simply a conduit for payment of the IRA contribution. The court reached that conclusion because the sale of the patents to the LLC had no impact on the business of the petitioner, the business operations continued to be operated by the corporations rather than the LLC, and the LLC didn휩t have any employees or business activity. The excess contributions penalty applied. Block Developers, LLC, et al. v. Comr., T.C. Memo. 2017-141.

Repaid Unemployment Benefits Taxed in Year Received. The petitioner received $3,360 in unemployment benefits in 2012, but the state later determined that he shouldn휩t have received the benefits and that the last date for a review of that determination was in late November of 2012. The petitioner didn휩t contest the determination, and repaid the full amount in 2013. The state issued the petitioner a Form 1099-G reporting the $3,360 amount, but the petitioner did not report it on his 2012 return. The court determined that the petitioner had a repayment obligation in the same year he received the payments, but he made no attempt to repay them in 2012. Thus, under the claim of right doctrine applied and the exception for rescission didn휩t apply because the parties (petitioner and the state) did not get restored to their relative positions in 2012. Yoklic v. Comr., T.C. Memo. 2017-143.

Failure to File Form 709 Keeps Statute of Limitations Open. The IRS determined that the period of limitations on assessing gift tax (I.R.C. §6501(c)(3)) remained open for the years that the taxpayer did not file Form 709 to report taxable gifts. In addition, the IRS determined for another year that the limitations period under I.R.C. §6501(c)(9) remained open because the filed Form 709 didn휩t describe the gifted property or provide a description of how its value was determined. F.S.A. 20172801F (May 10, 2017).

Lack of Proof Concerning How Broker Should Sell Shares Results in Improper Reporting. The petitioner had a brokerage account with Scottrade, with many of his holdings being short-term. The petitioner frequently bought and sold small blocks of stock but, in 2013, the petitioner took a long-term investment position in FNMA stock, acquiring the shares at various times. During 2013, the petitioner, had 51 sales with Scottrade. 16 of those sales involved FNMA stock, but the petitioner didn휩t report the income from any of those sales on his return for 2013. The petitioner claimed that Scottrade improperly reported the stock sales with a first-in, first-out (FIFO) basis. The petitioner claimed that a last-in, first-out method should have been used instead. Under Treas. Reg. §1.1012-1(c)(1), a taxpayer is deemed to first sell the shares that were first purchased 힩 the FIFO method. But, under Treas. Reg. §1.1012-1(c)(2) and (3), stocks that a broker holds can be identified by the taxpayer as the shares to be sold. However, the identification must occur before the shares are sold. While the petitioner claimed to have attempted to inform Scottrade of the intended use of the LIFO method for the FNMA shares, the Tax Court determined that there was a lack of evidence to support that assertion. Thus, the FIFO method applied and the IRS determination was upheld. Turan v. Comr., T.C. Memo. 2017-141.

Taxpayer Not 흉Away From Home흩 With Result That Commuting Expenses Not Deductible. The petitioner worked as a plumber/pipefitter for a contractor at various locations. Some work locations were 20-25 miles from the petitioner휩s home and others were further away. The petitioner kept travel records and deducted his mileage and meals consumed at the work locations. While commuting expenses are generally not deductible under I.R.C. §262(a) and Treas. Reg. §1.262-1(b)(5), an exception applies for travel and meal expenses associated with travel to a temporary work location. The Tax Court determined that the petitioner휩s commutes were not outside the metro area where he normally worked which meant that his commuting (mileage) expenses were not deductible. However, reasonable meal expenses while away from home are deductible if incurred in connection with the taxpayer휩s trade or business. The court determined, however, that the petitioner was not 흉away from home흩 because the trips would not require him to stop and take time for sleep or rest for a substantial period. Thus, the court upheld the IRS determination that denied any deduction for travel expenses. Wooten v. Comr., T.C. Sum. Op. 2017-58.

Posted July 25, 2017

IRS To Offer Virtual Appeals Conferences. Effective Aug. 1, 2017, the IRS will begin a pilot program whereby the IRS Office of Appeals will offer taxpayers and their representatives a web-based virtual Appeals conference option. Upon issuance of the 흉30-day letter흩 of a proposed tax liability determination, the taxpayer has the right to an administrative appeal to the regional IRS Appeals Office. Upon issuance of the 흉90-day흩 letter, if the taxpayer requests, the Appeals Office may take up the case for settlement and a conference on disputed granted may be granted. While these conferences used to be in-person, the IRS curtailed in-person conferences several years ago limiting them to phone conferences (or videoconference in a limited number of appeals offices). Beginning Aug. 1, the pilot program will offer a virtual videoconference. I.R. 2017-122.

Failure to Record Deed Means Conservation Easement Not Protected In Perpetuity. The petitioner owned an old warehouse and executed a 흉Conservation Deed of Easement흩 that granted a façade easement on the warehouse to the National Architectural Trust (NAT). The deed was accepted in late 2004, but was not recorded until late in 2006. On its 2004 tax return, the petitioner, claimed a noncash charitable deduction of $11.4 million in accordance with an appraisal. The IRS disallowed the deduction in its entirety, and imposed a 40 percent gross valuation misstatement penalty or, alternatively, the 20 percent accuracy-related penalty. Under I.R.C. §170(h)(2) and (h)(5)(A), to be deductible, a qualified conservation easement must be granted in perpetuity. Thus, the donee must have a legally enforceable right under state law. However, because the deed was not recorded until late 2006, the perpetuity requirement could not be satisfied in 2004. Citing prior caselaw based on New York law, the Tax Court determined that the deed was effective only upon recording and that a deed to create a conservation easement must be recorded to be effective. Thus, the Tax Court upheld the IRS determination. Ten Twenty Six Investors v. Comr., T.C. Memo. 2017-115.

Posted July 24, 2017

Taxpayer on Cash Method Can Elect To Deduct Additions To Reserve Fund for Landfill Closing and Reclamation Costs. The petitioner휩s S corporation operated a landfill on the cash basis. The petitioner is legally required to pay reclamation and closing costs upon closing the landfill. While waste disposal site closing and reclamation expenses cannot be deducted until, and to the extent, they are incurred, I.R.C. §468(a)(1) allows a 흉taxpayer흩 to deduct additions to a reserve fund for future closing and reclamation costs. The petitioners did not claim any current deductions for estimated clean-up costs for several years until discovering that the election could be made. The petitioner claimed approximately $100,000 for estimated clean-up costs on its 2008 return, and claimed a similar amount for estimated future costs on its 2009 return. The IRS denied the deductions on the basis that the petitioner was on the cash method. The Tax Court, disagreeing with the IRS, held that the election applied to any 흉taxpayer흩 because I.R.C. §468(a)(1) instructs a 흉taxpayer흩 making the election the process for calculating the deduction. In addition, the Tax Court noted that I.R.C. §7701(a)(14) defines the terms 흉taxpayer흩 as 흉any person subject to any internal revenue tax.흩 Because the petitioner was an S corporation that paid taxes (Social Security and unemployment tax), it was a 흉taxpayer.흩 The Tax Court scolded the IRS by noting that the term 흉taxpayer흩 is a basic term in the Code, and that the IRS could have issued regulations based on the legislative history of I.R.C. §468 to define 흉taxpayer흩 for purposes of the election as meaning a taxpayer on the accrual method. Gregory v. Comr., 149 T.C. No. 2 (2017).

Posted July 22, 2017

IRS Ignoring Executive Order on Obamacare Penalties. In three Information Letters released on June 30, 2017, the IRS stated that it would not follow President Trump휩s Executive Order issued on January 20, 2017, directing federal agencies to exercise their discretion to reduce potential burdens that Obamacare imposes. The IRS states the obvious in two of the Information Letters 힩 that the Executive Order does not change the law, but also notes that IRS refuses to exercise its discretion to not enforce Obamacare penalties. The IRS notes that there is no provision in Obamacare providing for the waiver of the penalty imposed on a 흉large흩 employer for failing to offer health insurance coverage to full-time employees (provided the remaining statutory conditions are satisfied). The IRS did note that an eligible non-profit religious organization can exclude the provision of birth-control services for religious reasons from its health plan for employees. The IRS, in a third Information Letter, noted that there is no statutory exception from the individual mandate tax penalty for an individual that does not have minimum essential coverage for each month, unless a statutory exception applies. As such, the IRS stated that it would be ignoring the Executive Order and would not exercise its discretion to reduce the Obamacare burdens on taxpayers. IRS Information Letters, 2017-0010, 2017-0013 and 2017-0017 (Apr. 14, 2017).

Posted July 18, 2017

Advanced Obamacare Tax Credit Must Be Paid Back, With Additional Penalty Amount. The petitioners, a married couple, received health care insurance via the California insurance 흉marketplace흩 as established pursuant to the 2010 federal health care legislation 힩 Obamacare. The petitioners satisfied the law휩s requirement of having the policy for the full year. While the monthly premium of the government insurance was approximately $1,400, they received an advanced premium assistance tax credit (PTC), a refundable credit under I.R.C. §36B, of $12,924 with was paid directly to the insurer. In order to receive the advance PTC, the petitioners certified that their household income for the tax year would be at least 100 percent but not greater than 400 percent of the federal poverty line for a family of their size. Upon filing their return for the tax year, they reconciled the advanced PTC with the amount they were actually entitled to via Forms 1095-A and Form 8962, and discovered that their modified adjusted gross income exceeded the federal poverty limit for claiming any PTC. Accordingly, I.R.C. §36B requires that the excess amount be included in the petitioners휩 federal tax liability for the year, and the IRS asserted a deficiency and added an accuracy-related penalty of $2,584. The petitioners claimed that the California 흉market흩 representatives told them that they qualified for the advanced PTC and that they wouldn휩t have purchased the government insurance had they known that they wouldn휩t have qualified for the advanced PTC. The Tax Court rejected that argument and upheld the deficiency and the accuracy-related penalty. Walker v. Comr., T.C. Sum. Op. 2017-50.

Posted July 7, 2017

No Charitable Gift Due to Retained Control. The petitioner bought a movie theatre with the intent of developing it and converting it to housing. After the purchase, the petitioner contributed it to what he believed to be a charity. However, the charity was not yet recognized by the IRS as a qualified charity. Consequently, the petitioners, transferred the property to a different charity on the stipulation that the charity couldn휩t sell the property for five years. In addition, the petitioner retained the power to require the charity to transfer the property to the initial charity when it received IRS approval as a qualified charity. The taxpayer claimed a charitable deduction for the donation and the IRS denied it. The court upheld the denial on the basis that the contract terms allowing the petitioner to potentially direct the future transfer of the property made the donation conditional and the possibility of the exercise of the right to direct a future transfer was not negligible. Fakiris v. Comr., T.C. Memo. 2017-126.

Posted July 3, 2017

Oil Production Equipment Not Tax-Exempt. Under Kansas law, equipment used to produce oil is tax-exempt pursuant to K.S.A. §79-201t(a), which also exempts certain law-production oil leases. The petitioners received an exemption for their law production oil leases, but the County assessed tax on the equipment that was used to produce oil from the tax-exempt wells. The petitioners claimed that the equipment was tax-exempt as being part of the lease. However, the court agreed with the county (and the Board of Tax Appeals) on the basis that the Oil and Gas Appraisal Guide did not include equipment in the exemption under K.S.A. §79-201t(a). The court also determined that the equipment was not exempt because the phrase 흉together with헩all other equipment흩 could not reasonably be construed the mean that equipment is part of an oil lease for purposes of the tax exemption. The court also reasoned that the legislature could have specifically included equipment in the exemption statute, and that it was not likely that the legislature intended 흉oil lease흩 to include equipment. That is particularly true, the court noted, because equipment and oil leases are separately categorized and assessed. The court also noted that the statutes for oil leases and exemptions have nearly identical language and the statute involving equipment differs. In re Barker, No. 116,034, 2017 Kan. App. LEXIS 52 (Kan. Ct. App. Jun. 30, 2017).

Posted July 1, 2017

No Income Triggered From IRA휩s Purchase of Stock. The petitioner sought to buy stock for his IRA, which was not a prohibited transaction. Even though the stock purchase was not a prohibited transaction, the trustee would not complete the transaction. Thus, the petitioner, had the trustee wire the purchase price directly to the corporation with the corporation issuing the stock certificate to the petitioner휩s IRA 흉for the benefit of흩 the petitioner. The trustee claimed that the stock certificate was received in the following tax year and attempted to mail it on two occasions to the petitioner. The trustee asserted, however, that the petitioner received the stock certificate in the year following the year of the transaction. The trustee issued the petitioner a Form 1099-R for the year of the transaction equal to the purchase price. The petitioner didn휩t report the income and the IRS asserted a deficiency. However, the court determined that the petitioner did not have income from the transaction because no funds actually passed through his hands. The court noted that an IRA owner can direct how the IRA funds are invested without giving up the tax benefits of the IRA. Here, the court noted, the funds the IRA used to buy the stock 흉went straight to the investment and resulted in the stock shares휩 being issued straight to the IRA.흩 The petitioner had no claim of right to the funds, merely serving as a conduit, and was not in constructive receipt of the funds. The appellate court affirmed, noting that the transaction was a prototypical, permissible IRA transaction. McGaugh v. Comr., No. 16-2987, 2017 U.S. App. LEXIS 11329, aff휩g., T.C. Memo. 2016-28.

Posted June 29, 2017

Meals Provided to NHL Players While on Road Trips Fully Deductible. The petitioners, a married couple, own the Boston Bruins NHL franchise via two S corporations. During the hockey season, the team plays approximately one-half of its games away from Boston throughout the United States and Canada. The players stay in hotels during the road trips and the franchise contracts with the hotels to provide the players and team personnel pre-game meals. The petitioners deducted the full cost of the meals, and the IRS limited the deduction in accordance with the 50 percent limitation of I.R.C. §274(n)(1). The NHL has specific rules governing travel to out-of-town games which requires a team to arrive at the away city the night before the game whenever the travel requires a plane trip of longer than 2.5 hours. To satisfy the travel requirement, the petitioners contracted with host city hotels for meals and lodging to be served in meal rooms. Player attendance at the meals is mandatory and specific food is ordered for the players to meet their specific needs. The court noted that the 50 percent limitation is inapplicable if the meals qualify as a de minimis fringe benefit and are provided in a nondiscriminatory manner. The court determined that the nondiscriminatory requirement was satisfied because all of the staff that traveled with the team were entitled to use the meal rooms. The court also determined that the de minimis rule was satisfied if the eating facility (meal rooms) was owned or leased by the petitioner, operated by the petitioner, located on or near the petitioner휩s business premises, and the meals were furnished during or immediately before or after the workday. In addition, the court noted that the annual revenue from the eating facility would need to normally equal or exceed the direct operating cost of the facility. The IRS conceded that the meals were provided during or immediately before or after the employees휩 workday, but claimed that the other requirements were not satisfied. However, the court determined that the petitioners did satisfy the other requirements on the basis that they can be satisfied via contract with a third party to operate an eating facility for the petitioners휩 employees. As for the business purpose requirement, the court noted that the hotels where the team stayed at while traveling for road games constituted a significant portion of the employees휩 responsibilities and where the team conducted a significant portion of its business. The court also noted that the revenue/cost test is satisfied if the employer can reasonably determine that the meals were excudible from income under I.R.C. §119, and are furnished for the employer휩s convenience on the business premises. The court determined that those factors were also satisfied. Thus, the cost of the meals qualified as a fully deductible de minimis fringe benefit. Jacobs v. Comr., 148 T.C. No. 24 (2017).

No Deduction For Business Expenses Unless Activity Engaged For Profit. The petitioner was a minister that, on occasion performed weddings and conducted seminars. He was not paid for being a minister and did not have income from his writings and seminars. However, he did incur expenses associated with the activities which the IRS disallowed. The court agreed with the IRS, noting that under Comr. v. Groetzinger, 480 U.S. 23 (1987), to be engaged in a trade or business within the definition of I.R.C. §162, the taxpayer휩s primary purpose for engaging in an activity must be for income or profit. In addition, the court noted that the petitioner had no accounting records or bank statements, and no invoices or any other business-related records. The petitioner only submitted to the court credit card statements and a summary of expenses. Thus, the petitioner휩s deductions were limited to the income from his activities of which there was none. Lewis v. Comr., T.C. Memo. 2017-117.

Evidence Fails to Convince Court That Real Estate Professional Test Satisfied. The petitioner owned multiples residential rental properties. She kept logs and calendars of her time spent working at the properties, but the court believed that they were inconsistent and the logs did not provide a specific description of services rendered. The court also did not find credible the petitioner휩s claim of hours spent based on her non-rental activities. Accordingly, the court held that the petitioner failed to meet the 750-hour test or the 50% test of I.R.C. §469(c)(7)(B) and her losses from the rental activities were passive. Ostrom v. Comr., T.C. Memo. 2017-118.

Posted June 27, 2017

Mortgage Not Subordinated at Time of Donation 힩 No Charitable Deduction for Conservation Easement. The petitioner made a charitable contribution a permanent conservation easement on two private golf courses in the Kansas City area in 2003 valued at $16.4 million. The IRS challenged the charitable contribution deduction on numerous grounds, and in an earlier action, the petitioner conceded that the donation did not satisfy the open space conservation test, granting the IRS summary judgment on that issue, with other issues remaining in dispute. At the time of the donation, two banks held senior deeds of trust on the land at issue. Subordination agreements were not recorded until approximately three months after the donation stating that they were effective at the time of the donation. In addition, the petitioner had no power or authority to enforce the easement with respect to a portion of the property due to its lack of ownership of the property. The Tax Court cited Mitchell v. Comr., 775 F.3d 1243 (10th Cir. 2015) and Minnick v. Comr., 796 F.3d 1156 (9th Cir. 2015) as precedent on the issue that the donor must obtain a subordination agreement from the lender at the time the donation is made. Here, the court held that the evidence failed to establish that the petitioner and the lenders entered into any agreements to subordinate their interests that would be binding under state (MO) law on or before the date of the transfer to the qualified charity. As a result, the donated easement was not protected into perpetuity and failed to qualify as a qualified conservation contribution. RP Golf, LLC v. Comr., No. 16-3277, 2017 U.S. App. LEXIS 11286 (8th Cir. Jun. 26, 2017), aff휩g., T.C. Memo. 2016-80.

Posted June 21, 2017

Tax Prep Business May Have Tort Action Against IRS For Sting Operation. The plaintiff, an affiliate of a tax return preparation business, loaned money to taxpayers who were awaiting federal income tax refunds. The business prepared the taxpayers휩 returns and referred those that wanted an advance on their refund to the plaintiff. The plaintiff loaned the funds based on the anticipated tax refund with the taxpayer then telling the IRS to send the refund check to the plaintiff. Another tax preparer, working secretly with IRS Criminal Investigations Division, referred several clients to the plaintiff for refund anticipation loans. When a client tried to cash the plaintiff휩s check, the bank notified the plaintiff that the client was using a fake I.D. and the plaintiff had the bank hold the check. The plaintiff told the other preparer of the matter and then learned that the other preparer was working undercover with the IRS. The plaintiff then requested that the bank stop payment on all checks that the plaintiff had issued to the other preparer휩s clients, but the IRS refused to allow the checks to be stopped due to interference with the criminal investigation, assuring the plaintiff that it would be repaid. An IRS supervisor confirmed the sting operation and the plaintiff issued additional checks with further assurance that it would be 흉made whole.흩 However, the bank had not been informed of the sting operation and the plaintiff incurred additional cost to keep its bank accounts open. IRS ignored repeated requests to confirm in writing the promise to repay the plaintiff휩s costs, and didn휩t make the plaintiff whole after the sting operation and revoked the e-filing privilege of the affiliated business at the beginning of the tax prep season, forcing the plaintiff and the affiliated business into bankruptcy. The plaintiff (and the affiliated business) sued IRS under the Federal Tort Claims Act (FTCA), and the IRS claimed it was immune from suit, but the plaintiff claimed that IRS was neither assessing tax nor collecting it, but simply trying to find tax cheaters and, as a result, sovereign immunity did not apply. The trial court granted the IRS motion to dismiss, but the appellate court reversed. The appellate court determined that the FTCA does not grant absolute immunity to the IRS when IRS is not taking action to assess or collect tax, and that the plaintiff had properly made out claims for conversion under state (CA) law as well as abuse of process. Snyder & Associates Acquisitions, LLC v. United States, No. 15-56011, 2017 U.S. App. LEXIS 10696 (9th Cir. Jun. 16, 2017).

Posted June 7, 2017

Taxpayers Could Not Substantiate Claims of Time Spent on Rental Activities. The petitioners, married couple, had various rental properties for which they claimed substantial losses for the two years at issue. They did maintain a journal of their activity with respect to the rental properties, but the court held that the journal failed to substantiate the time spent in the rental activities. Thus, the petitioners were not able to meet the 750-hour test or the 50 percent test of I.R.C. §469(c)(2) or the material participation test of I.R.C. §469(c)(1)(B). As a result, the petitioners were not real estate professionals. The petitioners also did not elect to treat their rental activities as a single rental activity. Thus, the petitioners could not offset losses arising from the rental activities against their other income. McNally v. Comr., T.C. Memo. 2017-93.

IRS Can Require PTINs, But Can휩t Charge For Them. In 2010 and 2011, the Treasury Department developed regulations that imposed certain requirements that an individual had to comply with to be able to prepare tax returns 힩 a person had to become a 흉registered tax return preparer.흩 These previously unregulated persons had to pass a one-time competency exam and a suitability check. They also had to (along with all other preparers) obtain a Preparer Tax Identification Number (PTIN) and paying a user fee to obtain the PTIN. The plaintiff class challenged the authority of the government to require a PTIN and charge a fee for obtaining it. The IRS claimed that the regulations were necessary for the need to oversee tax return preparers to ensure good service. I.R.C. §6109(a)(4), in existence prior to the regulations at issue, requires a preparer to provide identification and state that the preparer휩s social security number shall be used as the required identification. The regulations at issue, however, required preparers to obtain (at a fee paid to the Treasury) a PTIN as the identifying number. Preparers without a PTIN could no longer prepare returns for a fee. The IRS argued that by creating the PTIN requirement, it had created a 흉thing of value흩 which allowed it to charge a fee, citing 31 U.S.C. §9701(b). However, the plaintiffs claimed that the PTIN requirements are arbitrary and capricious under the Administrative Procedure Act or, alternatively is unlawful as an unauthorized exercise of licensing authority over tax return preparers because the fee does not confer a 흉service or thing of value.흩 The court determined that the IRS can require the exclusive use of a PTIN because it aids in the identification and oversight of preparers and their administration. However, the court held that the IRS cannot impose user fees for PTINs. The court determined that PTINs are not a 흉service or thing of value흩 because they are interrelated to testing and eligibility requirements and the accuracy of tax returns is unrelated to paying a PTIN fee. A prior federal court decision held that the IRS cannot regulate tax return preparers (Loving v. IRS, 742 F.3d 1013 (D.C. Cir. 2014), thus charging a fee for a PTIN would be the equivalent of imposing a regulatory licensing scheme which IRS cannot do. Prior caselaw holding that the IRS can charge a fee for a PTIN were issued before the Loving decision, and are no longer good law. Steele v. United States, No. 14-cv-1523-RCL, 2017 U.S. Dist. LEXIS 84117 (D. D.C. Jun. 1, 2017).

Posted June 6, 2017

Crop-Share Rent Was Not Passive to S Corporation Landlord. An S corporation was engaged in farming and leased its land to a tenant via a crop-share lease. The S corporation and the tenant split all taxes, assessments or charged levied or assessed on products of the land in proportion to the split of the crops between the parties under the lease. The parties split the cost of fertilizer and soil conditioners equally, and the corporation paid the cost of the power and fuel necessary to operate drainage pumping plants, as well as the cost of maintaining irrigation and drainage canals and irrigation pipe line. The corporation also is responsible for the box rent and the grower휩s share of the state inspection fee. Crop processing expenses incurred to prepare them for sale that relate to the corporation휩s crop share are paid by the corporation. In addition, the corporation determined the percentage of the land to be farmed and the types of crops to be planted. The corporation is at risk for crop yields and marketing. For a later year, a new crop-share lease was executed with similar terms and specifically requiring the corporation to provide insurance on all improvements and fixtures that the corporation owns. The corporation also pays all maintenance and repair costs of the drainage pumps. The IRS determined that under I.R.C. §1362(d)(3)(C) and Treas. Reg. §1.1362(c)(5)(ii)(B)(1) the lease income was not passive in the hands of the S corporation. Thus, the corporation was not at risk of having its S election terminated by having too much passive investment income pursuant to I.R.C. §1362(d)(3)(C). Priv. Ltr. Rul. 201722019 (Mar. 2, 2017).

Posted June 5, 2017

Horse Activity Not Engaged In With Profit Intent. The petitioner was a dressage trainer and rider and tried to deduct her horse-related expenses. Based on the nine-factor analysis of the regulations, the court concluded that the petitioner did not conduct the activity with a profit intent. Importantly, the petitioner had only tack as an asset in the activity and there was no expectation that it would increase in value. The petitioner had no other successes in relevant businesses, and the horse-related expenses were far greater than income from the activity. The petitioner also had significant income from other sources and derived pleasure from the horse activity. McMillan v. Comr., No. 13-73139, 2017 U.S. App. LEXIS 8540 (9th Cir. May 15, 2017), aff휩g., T.C. Memo. 2015-109.

Posted May 27, 2017

Estate Allowed to Make Late Election To Claim Charitable Contributions, and Rules for Estate and Trust Donations Outlined. An estate or trust can claim a deduction for charitable contributions via I.R.C. §642(c) in the year in which the contribution was paid, on the return for the year before the year the contribution was paid if the trust elects under I.R.C. §642(c)(1), or in the year in which amounts are permanently set aside by the trust for charitable purposes (if the estate or trust was created before Oct. 9, 1969). Under the facts of the ruling, the estate did not elect to claim the charitable deduction in the year before the year of the donation, and the estate sought IRS permission to make a late election to do so in accordance with Treas. Reg. §301.9100-1(c). The IRS granted relief of 120 days to file the election if the estate files amended returns for each year in which the estate makes the election. The amended returns must be filed within the 120-day period. The IRS noted that I.R.C. §642(c) allows a charitable deduction on Form 1041 if the charitable contribution is made from gross income (as defined under I.R.C. §61) and the amount is paid pursuant to the governing instrument. Once those requirements are satisfied, the deduction is allowed with no percentage limitation. Priv. Ltr. Rul. 201720003 (Feb. 6, 2017).

Posted May 26, 2017

S Corporation Shareholder Can휩t Claim Losses Due to Insufficient Basis. The petitioner was the sole shareholder of multiple S corporations that operated nursing homes. His business strategy was to acquire distressed nursing homes and make them profitable again. During tax years 2007-2010, several of the S corporations sustained losses that the petitioner deducted on his personal returns. The S corporations funded the losses by borrowing funds from various LLCs that the petitioner and his spouse had interests in as well as other operating companies that the petitioner owned (and banks and other commercial lenders). The petitioner signed as a co-borrower or guarantor in his individual capacity on the loans. The lenders advanced the funds directly to the S corporations and the S corporations made payments on the loans directly to the lenders, with the petitioner never expending any personal funds in satisfaction of the S corporation휩s debt. The IRS determined that the petitioner휩s status as co-guarantor of the debt of the S corporations did not amount to basis and, thus, did not allow him to deduct the losses for 2007-2008. The petitioner claimed that state (AR) law characterized a co-borrower as being 흉directly liable흩 with the same liability as a borrower to whom the loan was made individually. Thus, the petitioner claimed that the corporations were in debt to him and his funds were at risk. The court disagreed, finding that his potential liability without any economic outlay was not enough to establish bases. The court noted that the petitioner had not pledged any personal assets and had no evidence showing that the lenders looked to him as the primary obligor and no funds were advanced to him individually. Hargis v. Comr., T.C. Memo. 2016-232.

Posted May 25, 2017

NOL Carryforward (and other deductions) Disallowed For Lack of Substantiation. In 2007, the petitioner obtained a $500,000 loan, pledging his house as collateral, to pay on a judgment that had been entered against him. Due to general economic issues, the petitioner could not pay off the loan. The petitioner and his wife divorced, and he orally agreed to pay his ex-wife $2,000/month. The petitioner later increased the amount he paid her to $5,000/month. The petitioner claimed $130,000 in alimony deductions, but the IRS denied the deductions for lack of substantiation. The court agreed on the basis that the oral agreement did not suffice for documentation needed to substantiate the deduction for the two years at issue. The petitioner also claimed over $70,000 in interest deductions associated with the loan, but was not able to substantiate the amount of principal payments that he made or the interest payments. Thus, the court disallowed the purported interest deductions. The petitioner also claimed a net operating loss carryforward exceeding $185,000. The court disallowed the carryforward loss even though the petitioner asserted that it was merely put on the wrong line of the tax form by mistake and that his TurboTax software was responsible for the error (as well as other errors on his returns). The court disagreed, noting that 흉tax preparation software is only as good as the information one inputs into it.흩 Bulakites v. Comr., T.C. Memo. 2017-79.

Posted May 20, 2017

IRS Confirms That Form 7004 Is Correct. Under the Surface Transportation and Veteran휩s Health Care Choice Improvement Act, signed into law on July 31, 2015, set the due date for Form 1120 (U.S. Corporation Income Tax Return) as the 15th day of the fourth month after the close of the corporation휩s tax year. A five-month extension is provided for calendar year C corporations (until 2026), via an amendment to I.R.C. §6081(b). However, the IRS instructions to Form 7004 states that a calendar year C corporation has a six-month filing extension. Via its website, the IRS explains that the instructions are not incorrect because IRS has the authority under I.R.C. §6081(a) to grant a longer extension period. Fiscal year C corporations have a six-month extended due date by virtue of I.R.C. §6081(b), except that C corporations with a June 30 year-end are allowed a seventh month extension (until 2026).

Employee Not Entitled To Deduct Unreimbursed Business Expenses. The petitioner휩s employer required employees to get permission before incurring a reimbursable business expense. The petitioner incurred reimbursable expenses, but did not seek reimbursement. The petitioner deducted the expenses, but the IRS denied the deductions and the court agreed with the IRS. The court noted that the petitioner bore the burden of establishing that the employer would not have reimbursed the expenses had they been submitted. In addition, the court noted that once an employer has a policy of reimbursing, the employee must seek reimbursement. Humphrey v. Comr., T.C. Memo. 2017-78.

Posted May 4, 2017

No Residential Energy Credit For New Windows. The petitioner installed 흉energy-efficient흩 new windows at his residence and claimed a residential energy credit of $1,500. The IRS disallowed the credit for lack of substantiation, and the court agreed. The court noted that the petitioner휩s invoice did not contain the petitioner휩s name such that it could be determined whether the petitioner was the party that paid for the windows. The petitioner휩s home had suffered a casualty, and the court also disallowed a casualty loss deduction due to the petitioner휩s lack of substantiation of the insurance reimbursement amount. Wainwright v. Comr., T.C. Memo. 2017-70.

Posted May 3, 2017

Affiliated Corporation Can휩t Join Consolidated Return. The plaintiff is a holding company that owns and operates subsidiaries that engage in retail sales in Iowa. One subsidiary serves as a management company, and all revenue is transferred to it and is used to pay the expenses of the various subsidiaries. Another subsidiary owns an airplane that is use for business travel. The plaintiff does not, by itself, sell products or provide services in Iowa. At issue was the 2009 and 2010 consolidated income tax returns of the Iowa subsidiaries. The 2009 return included the plaintiff and all of its subsidiaries, including the non-Iowa subsidiaries. The 2010 consolidated return included the Iowa subsidiaries, but not the plaintiff. The 2009 consolidated return did not include the interest and amortization as an expense for the subsidiaries because all of it had been allocated to the plaintiff. For 2010, the interest and amortization expense was allocated to the Iowa subsidiaries based on a percentage of revenue approach. The Iowa Department of Revenue disallowed the expenses and the plaintiff filed a protest. An ALJ reversed on the expenses and the IDOR appealed to the Director of Revenue. The Director ruled that the plaintiff should not be included on the Iowa subsidiaries휩 consolidated returns. On further review, the court agreed. The plaintiff did not establish a taxable nexus with Iowa and merely owned and controlled subsidiary corporations within the meaning of Iowa Code §422.34A(5). The court also determined that the plaintiff did not establish that the expenses in issue were paid by the subsidiaries in Iowa. Romantix Holdings, Inc., et al. v. Iowa Department of Revenue, No. 16-0416, 2017 Iowa App. LEXIS 426 (Iowa Ct. App. May 3, 2017).

흉Vacation Home흩 Rules Sink Deductions for Bed and Breakfast. The petitioner, and Alaska resident, created an LLC which purchased a home in Indiana that the petitioner operated as a bed and breakfast using on-site managers to run the bed and breakfast. The on-site managers were provided with an apartment on the premises to use as their personal residence. The bed and breakfast ceased operating in 2010, but deduction associated with the business continued into 2011. The IRS disallowed associated losses under the 흉vacation home흩 rules of I.R.C. §280A(a) which disallows deductions associated with a dwelling unit that the taxpayer uses as a residence during the taxable year. A dwelling unit is used as a 흉residence흩 if the taxpayer uses it for personal purposes for more than the greater of 14 days or 10 percent of the number of days during the taxable year that the unit is rented at a fair rental value. The petitioner휩s pass-through entity, the LLC, is considered to have made personal use of a dwelling unit on any day on which any beneficial owner would be considered to have made personal use of the unit. Days count toward the 14 day/10 percent limit if they are not personal use days (days spent primarily repairing and maintaining the property). The evidence showed that the petitioner stayed at the home 26 days in 2010 and 33 days in 2011, and the petitioner couldn휩t establish evidence to the contrary. The petitioner휩s daily activity logs were created during the IRS examination of the matter, and didn휩t provide specific details about the activities that he performed. The petitioner also employed a landscaping firm during the tax years in issue. Thus, all of the losses associated with the home were disallowed, a worse result that had they been disallowed under the passive loss rules of I.R.C. §469 which would be deferred until the home is disposed of in a taxable transaction. The court also imposed a 20 percent accuracy-related penalty. Cooke v. Comr., T.C. Memo. 2017-74.

Posted April 27, 2017

Real Estate Professional Test Satisfied For Purposes of Passive Loss Rules. The petitioner had been a stock broker for over 30 years and continued to work in a brokerage department for the tax year in issue, working approximately 15 hours per week. The petitioner submitted evidence that she worked approximately 900 hours on a real estate activity during the tax year. The court determined that she worked at least 750 hours in the real estate business and that more time was spent on real estate activities than on non-real estate activities. Thus, the petitioner휩s losses weren휩t automatically passive. The court also determined that the petitioner had materially participated in the real estate activities based on the fact that the petitioner was the sole person that rendered all of the participation in the activity. As for other deductions, the court disallowed automobile expenses due to the petitioner not having a mileage log. The petitioner also did not keep records to substantiate business and charitable deductions, but the court allowed one-third of the claimed deductions for office supplies, stamps and calendar expenses under the Cohan rule. Windham v. Comr., T.C. Memo. 2017-68.

Posted April 25, 2017

Home Sale Proceeds Retained By Wife Not Reachable to Pay Husband휩s Tax Debt. In 2002, the defendant and his business partner sold his business for approximately $15 million, which included stock in another business that the defendant later sold for $3.4 million. The defendant used a tax shelter to reduce his taxable gain on the transaction, and reported a $2.5 million loss on his 2002 return. The 2002 return was filed separately from the defendant휩s wife. He then filed amended returns for 1997-2001 and carried back the loss. The IRS refunded almost all of the taxes that the defendant and his wife had paid for the 1999-2001 tax years. The defendant deposited the proceeds from the sale of the stock in a trust in the Cayman Islands with instructions for the trustee to invest the corpus in a hedge fund that turned out to be a Ponzi scheme that lost all of the money by 2005. Later in 2005, the defendant and his wife bought a house in Massachusetts and took title as tenants by the entirety. The couple paid slightly over $1.6 million. The couple remortgaged the home in 2007 with the defendant as the sole mortgagor. They also established a trust naming the wife as the trustee and transferred the home휩s title to the trust. They established a second trust that named the wife as trustee and the two children as co-beneficiaries. They transferred a beach house to the second trust. The wife sold the beech house in late 2007 and deposited the $433,000 of sale proceeds into a bank account that the second trust owned. The wife used the funds to pay down loans that the Massachusetts house secured and living expenses. The couple divorced in 2008 and the settlement agreement gave most of the assets to the wife and the liabilities to the defendant and that the defendant could continue to live in the Massachusetts home. A court entered a $5 million tax judgment against the defendant in 2015, and the trial court set aside the divorce settlement as a fraudulent transfer. The trial court divided the assets 50/50 in accordance with Massachusetts common law that divides property 흉equitably흩 in divorce, and the IRS liens attached to the assets allocated to the defendant. However, the IRS claimed that their liens attached indirectly to certain assets allocated to the wife. As a result, the trial court ordered the Massachusetts home to be sold and the proceeds split evenly between the IRS and the wife. The IRS claimed entitlement to the wife휩s half of the proceeds via a lien-tracing theory. The trial court rejected this claim and the IRS appealed. The appellate court noted that Massachusetts휩 law required 14 factors to be utilized to determine how to divide the marital property, and that the trial court had not split the property in accordance with that analysis. The court vacated and remanded on the property division issue. However, the appellate court upheld the trial court휩s determination that the IRS lien did not attach to the wife휩s house sale proceeds because the IRS failed to show the amount or number of mortgage payments made to support its lien-tracing theory simply based on the testimony of the defendant and his wife which was deemed not credible. United States v. Baker, 852 F.3d 97 (1st Cir. 2017), vac휩g. and remanding, No. 13-11078-RGS, 2016 U.S. Dist. LEXIS 20445 (D. Mass. Feb. 16, 2016).

Posted April 23, 2017

Real Estate Professional Status Not Obtained Under Passive Loss Rules. The petitioner was fully employed as an entry-level field sterilization technician and also worked as a sales account representative in the fall of each year. While he often worked from home, he did travel to clients on an as-needed basis. During 2012, the petitioner worked 2,194 hours for his employer. The petitioner was also a licensed real estate broker and marketed commercial and residential properties for several clients. He was also engaged in a rental real estate activity through his S corporation. For 2012, the IRS recharacterized about $56,000 of non-passive losses from the S corporation as a passive loss on the basis that the petitioner did not qualify as a real estate professional under I.R.C. §469(c). The IRS claimed that the petitioner did not put more hours into his real estate activities than he did in his other activities. The result was that the petitioner휩s deduction for passive real estate losses was denied in full. The IRS also asserted an accuracy-related penalty. The court upheld the IRS determination based on the inability to substantiate the hours that the petitioner spent on real estate activities in 2012. The court believed that the petitioner휩s monthly calendars greatly exaggerated the hours he spent on real estate activities which the petitioner claimed to be four to six hours each weekday and 10-12 hours on each Saturday and Sunday in addition to the hours spent on his full-time job. The court did not believe that the petitioner was working a total of 90 hours per week on average. The calendar entries were rounded to the nearest half-hour and did not specify a start or end time or include the time spent driving to and from a property. Penley v. Comr., T.C. Memo. 2017-65.

Posted April 22, 2017

IRS Provides Guidance on Bonus and Expense Method Depreciation. The IRS has provided guidance clarifying that, effective for property placed in service in a tax year after 2015, I.R.C. §179 is available on heating and air conditioning units that qualify as I.R.C. §1245 property (such as portable air conditioning and heating units). However, IRS stated that if a component of a central air conditioning or heating system of a building is qualified real property under I.R.C. §179(f)(2), and the component is placed in service in a tax year that begins after 2015, then the component can qualify for I.R.C. §179 if the qualified real property is elected to be treated as I.R.C. §179 property. The IRS also again stated that an I.R.C. §179 election can be made or revoked on an amended return for an open tax year. As for the eligibility of 흉qualified improvement property흩 specified in I.R.C. §168(k) that is placed in service after 2015, bonus depreciation can be claimed on it if it is an improvement to the interior portion of a building that is nonresidential real property if the improvement is placed in service after the date the building was first placed in service which means the first time the building was placed in service b any taxpayer. IRS stated that the rules of Treas. Reg. §1.168(k)-1(c) apply to qualified improvement property. Qualified restaurant improvements that are 15-year property under I.R.C. §168(e)(7) are also treated as qualified improvement property, but restaurant buildings do not qualify for bonus depreciation. The IRS also reiterated that then bonus depreciation is elected out of, no AMT adjustment is required on property for which bonus depreciation is claimed. As for specified plants, the IRS stated that for a 2015/2016 fiscal-year taxpayer who planted or grafted a specified plant in 2016, the taxpayer will be treated as having made a valid election if bonus depreciation was claimed on the plant. In addition, the IRS noted that if bonus depreciation is elected for a specified plant, the adjusted basis of the plant is reduced by the greater of the amount of the bonus depreciation allowed or allowable. The remaining adjusted basis is the cost of the specified plant for purposes of I.R.C. §179. Rev. Proc. 2017-33, I.R.B. 2017-19 (eff. Apr. 20, 2017).

Posted April 21, 2017

Modifications to Variable Prepaid Forward Contracts Not Taxable. The petitioner is the estate of the deceased founder and CEO of Monster Worldwide, Inc. Before death, the decedent had entered into contracts to sell stock in corporate stock to Bank of America and Morgan Stanley & Co., International. The contracts were structured as variable prepaid forward contracts (VPFC) that required the banks to pay a forward price (discounted to present value) to the decedent on the date the contracts were executed, rather than the date of contract maturity. Accordingly, the decedent received a cash prepayment from Bank of America of approximately $51 million on September 14, 2007. On September 27, 2017, the decedent received a cash prepayment from Morgan Stanley & Co. of slightly over $142 million. The prepayments obligated the decedent to deliver to the banks stock shares pledged as collateral at the time of contract formation, and certain other stock shares that weren휩t pledged as collateral or an equal amount of cash. The actual number of shares or their cash equivalent is determined via a formula that accounts for stock market changes. Under the contracts as originally executed in September of 2007, the decedent was to deliver to the banks every day for 10 consecutive business days in September of 2008. Each day, one tenth of the total number of shares agreed to be transferred was to be delivered as determined by adjusting the number of shares by the ratio of an agreed floor price over the stock closing price for that particular day, or a cash equivalent to the stock. However, in July of 2008, the banks agreed to extend the settlement dates to early 2010. To get the extension, the decedent paid Morgan Stanley & Co. slightly over $8 million on July 15, 2008, for delivery over 10 consecutive days in early January of 2010, and paid Bank of America approximately $3.5 million on July 24, 2008, for delivery over 10 consecutive days in early February of 2010. For tax purposes, the decedent treated the original transactions as 흉open흩 transactions in accordance with Rev. Rul. 2003-7, 2003-1 C.B. 363 and did not report any gain or loss for 2007 related to the contracts. In addition, the decedent did not report any gain or loss related to the contract extensions that were executed in 2008 on the basis that the extensions also involved 흉open흩 transactions. The decedent died in late 2008, and on July 15, 2009, the decedent휩s estate transferred shares of stock to settle the Morgan Stanley & Co. contracts. The estate filed a Form 1040 for the decedent휩s taxable year 2008, and the IRS issued a deficiency notice for over $41 million claiming that when the decedent executed the extensions in 2008 that triggered a realized capital gain of slightly over $200 million comprised of a short-term capital gain of $88 million and $112 of long-term capital gain from the constructive sale of shares pledged under the contracts. The IRS claimed that the decedent had no tax basis in the stock pledged as collateral. The court disagreed with the IRS on the basis that the 흉open transaction흩 doctrine applied because of the impossibility of computing gain or loss with any reasonable accuracy at the time the contracts were entered into. In addition, the court rejected the argument of the IRS that the extensions of the original contracts closed the contracts which triggered gain or loss at the time the extensions were executed. The court specifically noted that, in accordance with Rev. Rul. 2003-7, VPFCs are open transactions at the time of execution and don휩t trigger gain or loss until the time of delivery because the taxpayer doesn휩t know the identity or amount of property to be delivered until the future settlement date arrives and delivery is made. Until delivery, the only thing that the decedent had was an obligation to deliver and not property that could be exchanged under I.R.C. §1001. The court also noted that the open transaction doctrine applied because the identity and adjusted basis of the property sold, disposed of or exchanged was not known until settlement occurred. The court also stated that an option is a 흉familiar흩 type of open transaction from which we can distill applicable principles.흩 Estate of McKelvey v. Comr., 148 T.C. No. 13 (2017).

Posted April 18, 2017

S Corporation Not Required To Pay Reasonable Compensation In Loss Situation. The petitioner, an S corporation, operated a business servicing, repairing and modifying recreational vehicles. The petitioner established a $224,000 home equity line of credit in 2006, but the petitioner휩s sole owner had quickly drawn on the entire line and advanced the funds to the corporation. The owner refinanced his home mortgage and established another line of credit for $87,443 and advance the full amount to the corporation. In 2008, the sole owner established a general business line of credit for $115,000 and advanced the funds to the corporation. The sole owner also borrowed $220,000 from his mother (and her boyfriend) and advanced the funds to the corporation in 2007 and 2008. The total amount advanced to the corporation between 2006 and 2008 was $664,443. All of the advances were reported as loans to the corporation and were treated as such on the corporation휩s general ledgers and Forms 1120S. No promissory notes between the corporation and the owner were executed, and no interest was charged, and no maturity dates were imposed. The owner borrowed another $513,000 from 2009 through 2011, with the corporation reporting a $103,305 loss for 2010 and another $235,542 for 2011. In those years, the corporation paid the owner휩s personal creditors $181,872.09. The corporation treated the payments as non-deductible repayment of shareholder loans. The IRS claimed that the sole owner was an employee that should be paid a reasonable wage subject to employment tax (plus penalties). The basic IRS argument was that the advanced funds were contributions to capital and the corporate payments made on the owner휩s behalf were wages. The Tax Court disagreed. The court noted that the corporation reported the advanced as loans on its books and Forms 1120S and showed the advanced as increases in loans and the expenses paid on the owner휩s behalf as repayments of shareholder loans. Thus, the court reasoned that the parties intended to form a debtor/creditor relationship and that the corporation conformed to that intent. This was supported by the fact that the corporate payments were made when the corporation was operating at a loss. Thus, the S corporation was not forced to pay a wage to the owner/employee while it was suffering losses. Scott Singer Installations, Inc. v. Comr., T.C. Memo. 2016-161.

In early 2017, the IRS announced that it was acquiescing in result only. The IRS noted that unless a taxpayer objectively substantiates both the existence of a loan and that payments were in repayment of that loan, that it would continue to assert that the payment of personal expenses by an S corporation on behalf of its corporate officer/employee constitute wages that are subject to federal employment taxes. A.O.D. 2017-04, I.R.B. 2017-15.

Posted April 15, 2017

No Joint and Several Liability Because Wife Didn휩t Know That Husband Did Not Have Profit Objective for 흉Ranching흩 Activity. The IRS determined a deficiency in the petitioner휩s joint 2011 return of over $30,000 primarily attributable to disallowed depreciation associated with a 6,000 square-foot barn. The petitioner sought relief from joint and several liability with her spouse to the extent the deficiency related to the disallowed Schedule C deductions. The petitioner and her spouse bought a 5.5-acre tract on which they built their home and run-in shed for their horses. In 2008, the husband purchased a 14.8-acre tract adjacent to their home parcel with the intent to use it for cattle ranching. He built the barn on the tract, researched various breeds of cattle and maintained records for the activity. The barn was not customarily used to stable horses, and the husband never participated in 흉ranching흩 activity. On their 2011 joint return, the couple attached two Schedule Cs. One for the wife realtor business and the other for the cattle 흉ranching흩 activity. The cattle activity reported gross income of $1,598 and a net loss of $133,277 resulting largely from depreciation deductions of $123,681 attributable to the barn. The couple separated in 2011, divorced in 2012 and the IRS examined the 2011 return in 2013, issuing the notice of deficiency in 2014. The court allowed the petitioner to be treated as having filed a separate return in 2011 pursuant to an I.R.C. §6015(c) election because the IRS failed to prove that the petitioner had actual knowledge of the erroneous deduction due to the husband휩s lack of profit motive. Harris v. Comr., T.C. Sum. Op. 2017-21.

Sales Tax Definition of 흉Agricultural Machinery or Equipment흩 Determined. The petitioners are two cooperatives that buy and sell agricultural products and inputs. They also provide on-farm services and products. In 2014, they submitted forms to the state (NE) Department of Revenue (NDOR) seeking refunds of sales and use taxes paid on agricultural machinery and equipment repairs and parts. In early 2015, the NDOR denied a portion of the requested refund attributable to the purchase of nondeductible repairs or parts such as alternators, bolts, gaskets, sensors and an air conditioner. The plaintiffs claimed the NDOR휩s definition of depreciable repair or replacement parts used was incorrect. Under Neb. Rev. Stat. §77-2708.01, any purchaser of depreciable repairs or parts for agricultural machinery or equipment used in commercial agriculture may apply for a refund of all of the Nebraska sales or use taxes and all of the local option sales or use taxes paid before October 1, 2014, on the repairs or parts. The NDOR published an information guide interpreting the phrase 흉depreciable repairs or parts.흩 The guide defined repairs and parts as depreciable if they appreciably prolonged the life of the property, arrested its deterioration, or increased its value or usefulness and is an ordinary capital expenditure for which a deduction is allowed through depreciation. The court found the phrase 흉depreciable repairs or parts흩 to be ambiguous, but noted that Neb. Rev. Stat. §77-202(3) requires the payment of property taxes on tangible personal property which is not depreciable tangible personal property, and that personal property tax must be paid on depreciable repair parts even if sales tax is paid on the item. In addition, repairs and replacement parts for ag machinery and equipment are subject to sales tax. Because the petitioners didn휩t provide the NDOR with the necessary information to verify that the claimed repairs and parts were taxed as personal property, the petitioners didn휩t establish entitlement to the refund of taxes for the amounts disallowed. Farmers Cooperative, et al. v. Nebraska, 296 Neb. 347 (2017).

Posted April 11, 2017

IRS Claim That Building Not Placed in Service Until Store Open For Business "Totally Without Merit," But IRS Then Issues Non-Acquiescence. The petitioner operated a retail business that sold home building materials and supplies. The petitioner built two new retail stores. As of December 31, 2008, the buildings were substantially complete and partially occupied and the petitioner had obtained certificates of completion and occupancy and customers could enter the stores. However, the stores were not open for business as of the end of 2008. The petitioner claimed the 50 percent GoZone depreciation allowance for 2008 on the two buildings which created a tax loss for 2008 and allowed the petitioner to carry back the losses for the 2003-2005 tax years and received a refund. The IRS disallowed the depreciation deduction on the basis that the petitioner had not put the buildings in service and assessed a deficiency of over $2.1 million for tax years 2003-2008. The petitioner paid the deficiency and sued for a refund. The IRS argued that allowing the depreciation would offend the "matching principle" because the petitioner's revenue from the buildings would not match the depreciation deductions for a particular tax year. The court held that this argument was "totally without merit." As to the government's "placed in service" argument, the court noted that Treas. Reg. Sec. 1.167(a)-11(e)(1) says that placed in service means that the asset is in a condition of readiness and availability for its assigned function. With respect to a building, the court noted that this meant that the building must be in a state of readiness and availability without regard to whether equipment or machinery housed in the building has been placed in service. The court held that there was no requirement that the petitioner's business must have begun by year-end. Cases that the IRS cited involving equipment (in one case an airplane) being placed in service were not applicable, the court determined. The court also noted that the IRS's own Audit Technique Guide for Rehabilitation Tax Credits stated that "[A] 'Certificate of Occupancy' is one means of verifying the 'Placed in Service' date for the entire building (or part thereof)". The court noted that the IRS had failed to cite even a single authority for the proposition that "placed in service" means "open for business," and that during oral arguments admitted that no authority existed. The court granted summary judgment for the petitioner and noted that the petitioner could pursue attorney fees if desired. However, the IRS later issued a non-acquiescence to the court휩s decision without giving any reason(s) why it disagreed with its own regulation and audit technique guide on the matter. Stine, LLC v. United States, No. 2:13-03224, 2015 U.S. Dist. LEXIS 9850 (W.D. La. Jan. 27, 2015), non-acq., 2017-02 (Apr. 10, 2017).

Posted March 27, 2017

Tax Return Preparation Is Not 흉Practice Before the IRS.흩 The plaintiff prepared a client휩s 2010 and 2011 federal income tax returns and offered to provide the client with a written memo than analyzed her tax options. However, the client learned that the plaintiff had been disbarred and suspended from practice before the IRS before accepting the plaintiff휩s offer. The client fired the plaintiff and filed a complaint with the IRS Office of Professional Responsibility (OPR). The OPR sent the plaintiff a request for information and the plaintiff asserted that the OPR had no right to demand information from him because he was no longer engaged in practicing before the IRS in accordance with 31 U.S.C. §330 and the regulations thereunder (i.e., Circular 230). The plaintiff claimed that the court휩s decision in Loving v. Internal Revenue Service, 742 F.3d 1013 (D.C. Cir. 2014) controlled. In that case, the court held that 흉practice before the IRS흩 did not include tax return preparation. The court, in this case, agreed. The court rejected the IRS휩 claim that suspended practitioners remained under jurisdiction of the OPR, and also rejected the OPR휩s claim that it had 흉inherent authority흩 over practitioners lacking credentials. The court then agreed with the Loving court that tax return preparation activities do not constitute 흉practice before the IRS.흩 The court also held that the while the IRS can impose standards on providing written advice, it cannot sanction the advice or its offering to clients. Sexton v. Hawkins, No. 2:13-cv-00893-RFB-VCF, 2017 U.S. Dist. LEXIS 38706 (D. Nev. Mar. 17, 2017).

Affiliated Corporation Can휩t Join Consolidated State Return. The plaintiff was incorporated in Delaware and had its primary place of business in Texas. The plaintiff also had ownership interests in several subsidiary companies which included two Delaware LLCs that engaged in natural gas pipeline transmission and storage and did business in Iowa. The plaintiff owned 80 percent of one LLC and 100 percent of the other LLC. The companies filed a consolidated return for federal and state tax purposes for 2009. The state (IA) return showed an apportioned net loss exceeding $10 million and an estimated tax overpayment of approximately $2.2 million for 2009. The Iowa Department of Revenue (IDOR) took the position that the petitioner should be excluded from the consolidated return, because the petitioner had no taxable nexus with Iowa as a result of not receiving any income subject to Iowa corporate tax under Iowa Code §422.33(1). The petitioner휩s exclusion from the consolidated return resulted in an increase in tax of almost $2.6 million. The trial court agreed and the petitioner appealed. Under Iowa law, an affiliated corporation can only join a consolidated return to the extent its income is taxable in Iowa. An out-of-state corporation lacks a sufficient taxing nexus with IA if its only activities amount to owning and controlling a subsidiary corporation and the company has no physical presence in IA. The petitioner claimed that is provision of significant management, administration, strategic planning and financial support to the IA LLCs was sufficient to cause the petitioner to be taxed in IA. On further review, the Iowa Supreme Court affirmed the trial court. The Court noted that the petitioner휩s distributed earnings that it received were tied to its activities that were exclusively associated with 흉owning and controlling a subsidiary corporation흩 under Iowa Code §422.34A and did not amount to 흉doing business in the state or deriving income from sources within the state as defined by Iowa Code §422.33(1). In addition, the petitioner휩s decision to allow the LLCs to make payments on a quarterly basis was insufficient to cause the petitioner to be subject to tax in Iowa. The Court also determined that the petitioner휩s ownership of stock shares and money did not create a taxable nexus with Iowa. Myria Holdings, Inc. & Subsidiaries v. Iowa Department of Revenue, No. 15-0296, 2017 Iowa Sup. LEXIS 28 (Iowa Sup. Ct. Mar. 24, 2017).

Posted March 25, 2017

Waiver of Sales and Use Tax on Property and Services Required to Repair or Replace Fences in Wildfire Area.  Effective March 23, 2017 and continuing through 2018, Kansas sales and use tax is waived on the sale of tangible personal property and services purchased during 2017 and 2018 that is necessary to reconstruct, repair or replace any fence used to enclose land devoted to agricultural use that was destroyed by wildfires occurring during 2016 and 2017. If the fence in issue also encloses a residence, the exemption may only be utilized for the property devoted to agricultural use 힩 the portion of the fence around the residence does not qualify for the exemption. To get the sales tax refund, buyers of fencing material will need a sales receipt or invoice showing the amount of tax paid on purchases and a completed Form ST-3. Under the exemption approach, anyone contracting for reconstruction, repair or replacement must get an exemption certificate from the Kansas Department of Revenue for the particular project. The program also requires parties performing such fence work to provide the certificate number to all suppliers at the time materials are purchased. To get the certificate, Form PR-70FEN will need to be filled-out. The Form can be obtained by calling (785) 296-3081 or emailing Kathleen Smith at kathleen.smith@ks.gov. In turn, suppliers must execute invoices with the certificate number. When a project is complete, the contractor must provide the person obtaining the exemption certificate a sworn statement on a form to be provided by the Director of Taxation. The statement must certify that all purchases made are entitled to the exemption. Exempt items include barbed wire, T-posts, concrete mix, post caps, T-post clips, screw hooks, nails, staples, gates, electric fence posts, and electric insulators. Items not qualifying for the exemption or refund include gloves, sandpaper, sand sponges, welding tools, oil for chainsaws, magnetic levelers, ratchet ties and pallets. Also, tools and new, non-agricultural machinery and equipment (e.g., a skid-steer, that is purchased to replace and repair fencing) does not qualify for the exemption. However, machinery and equipment rented or leased to replace, repair or rebuild agricultural fencing is exempt from sales tax. H.B. 2387, signed into law on Mar. 22, 2017.

K-1 Amounts Must Be Reported Even Though No Distribution Received. The petitioner was an S corporation shareholder along with his brother. Eventually, the petitioner wanted out of the S corporation and ended up in litigation with his brother. Ultimately, the lawsuit was settled and the petitioner transferred his shares to his brother. The S corporation filed a final 1120S for its short tax year and issued a K-1 to the petitioner reporting the petitioner휩s share of ordinary business income as $451,531. The petitioner filed a return for the same year reporting the $451,531 of pass-through income on Schedule E. However, the petitioner also indicated on line 17 of his Form 1040 Schedule E income of $323,777 and also stated that line 17 was 흉incorrect흩 and would be amended. No amended return was filed and the petitioner didn휩t pay the amount shown on the return. The IRS assessed the amount indicated on the return and added penalties. In Tax Court, the petitioner claimed that he didn휩t owe the amount of tax because he didn휩t receive a distribution. The court disagreed, noting that it was immaterial that the petitioner didn휩t receive a distribution. Dalton v. Comr., T.C. Memo. 2017-43.

No Constructive Dividend For S Corporation Shareholder But Basis to Deduct Losses. The petitioner was the sole owner of an S corporation and reported an ordinary business loss of $501,488 in 2007 and a shareholder loan beginning balance of $218,342 and an ending balance of zero. 2007 was the corporation휩s final year. During 2007, the S corporation owed its lender almost $2 million. That petitioner guaranteed the loan and during 2007 the lender took some of the S corporation휩s assets and sold them in partial satisfaction of the debt. After the asset sales, the petitioner still owed $500,000 on the debt. The petitioner reported pass-through losses of $343,939 in 2007 and $107,298 in 2008. The petitioner also owned a second S corporation and reported a pass-through loss in 2008 of $187,503. The IRS claimed that the petitioner had received a constructive dividend and could not deduct the losses due to insufficient basis. The court disagreed. The court held that the petitioner had not received a constructive dividend as a result of the discharge of the petitioner휩s debt owed to the corporation. There also was no constructive dividend, the court held, when the petitioner휩s debt of $218,342 was discharged because the S corporation did not have any earnings and profits. On this point, the court noted that S corporation distributions are not included in the shareholder휩s income to the extent they don휩t exceed the shareholder휩s stock basis. The court also determined that that sale of S corporation assets in partial satisfaction of the S corporation휩s debt increased the petitioner휩s basis by $496,000. That meant that the petitioner휩s basis was sufficient to allow the deduction of the passed-through losses in 2007. The court denied the 2008 pass-through losses because 2007 was the final year of the S corporation and the petitioner had no basis. Franklin v. Comr., T.C. Memo. 2016-207.

Posted March 22, 2017

Lack of Authority To Practice Law Has No Impact on Settlement with IRS. The petitioners sustained a $435,751 loss on a 2009 real estate sale. The petitioners consulted an attorney (who they did not hire to represent them) who advised the petitioners that they could claim 50 percent of the loss as a deduction. The petitioners stipulated with the IRS as to the 50 percent deduction. But, upon learning that the attorney was not authorized to practice law in the jurisdiction (IL) at the time for failure to pay bar dues, the petitioners claimed that the stipulation was not valid and they should be entitled to a 100 percent loss deduction. The Tax Court ruled for the IRS, upholding the stipulation to a 50 percent loss deduction. On appeal, the appellate court vacated the Tax Court휩s opinion and remanded the case for a determination of whether the attorney was competent to advise the petitioners. On remand, the Tax Court again upheld the stipulation to a 50 percent loss deduction. The Tax Court noted that the lawyer had never been disciplined or disbarred, but was simply not authorized to practice in IL because, after 2009, he had not paid annual bar dues. The Tax Court noted that the attorney휩s advice was 흉competent, valuable, diligent and effective assistance.흩 The Tax Court noted that the failure to pay bar dues did not strip the attorney 흉헩of his years of technical knowledge, training, and experience and was not longer competent to practice law merely because he failed to pay those required dues.흩 The petitioners appealed and the appellate court affirmed. The appellate court cited the maxim of 흉no harm, no foul흩 and the fact that there isn휩t even any right to counsel in a Tax Court proceeding. Shamrock v. Comr., No. 16-3811, 2017 U.S. App. LEXIS 4423 (7th Cir. Mar. 14, 2017).

No Equitable Interest In Home Means No Mortgage Interest Deduction. For tax years 2011-2012, the petitioner lived with his girlfriend in a residence that she had purchased in 2005. She financed the purchased with a mortgage and was listed on the deed as the sole owner. She was also the only person responsible on the mortgage. The petitioner claimed a mortgage interest deduction and the IRS disallowed it. The petitioner claimed to have transferred $1,000 in cash to the girlfriend every month to make 흉interest only흩 mortgage payments on the residence. But, he couldn휩t substantiate the alleged transferred amounts. The girlfriend paid all of the homeowners insurance premiums and property taxes on the residence. There also was no showing that the petitioner could make improvements to the property without her consent or that the petitioner could obtain legal title by paying off the mortgage. The court agreed with the IRS and determined that without her testimony, there was no way to establish that the petitioner held an interest in the property similar to a community property interest under state (NV) law. Jackson v. Comr., T.C. Sum. Op. 2016-33; T.C. Sum. Op. 2017-11

Posted March 21, 2017

Rodeo Not Tax-Exempt. A member-based organization conducted rodeo events. The organization applied for tax-exempt status under I.R.C. §501(c)(3) and stated that it is organized and operates for the purpose of fostering national or international sports competitions. The participants pay a fee to enter events and compete for prizes. The IRS noted that I.R.C. §501(c)(3) is available for the purpose of fostering amateur sports competition only if no part of the activities involve the provision of athletic facilities or equipment. A qualified amateur sports organization must meet the requirements of I.R.C. §501(j)(2) and must be both organized and operated for an exempt purpose. Here, the IRS determined that the organization was a professional rodeo organization and it did not meet both the organizational and operational tests for tax exemption under I.R.C. §501(c)(3). Priv. Ltr. Rul. 201706019 (Nov. 18, 2016).

Mixer-Feeder Trucks Are Tax-Exempt Farm Machinery and Equipment. The petitioner operated a cattle feedlot and owned several mixer-feeder trucks to mix feed ingredients in and then haul the feed to the cattle in the feedlot. The trucks were equipped with augers that blended the feed ingredients as well as a hydraulic system that operates the augers. The trucks were capable of a maximum speed of 17 miles/hour while mixing feed and 20 miles/hour when not mixing feed. If the governor were removed, the trucks could reach a speed of 45 miles/hour. The trucks exceeded the legal vehicle width for road use by four inches, and almost always remained within the feedlot with the only exception being when they were taken out for maintenance off-site. Although even in those situations, most of the time they were loaded on trailers and taken off-site. The local county appraiser assessed an escaped property tax penalty on the petitioner for failing to pay tax on the feeder trucks for 2013 and 2014 tax years. The petitioner paid the penalty under protest and filed an appeal with the Board of Tax Appeals (BOTA) claiming that the trucks were exempt from tax as farm machinery and equipment under K.S.A. §79-2011. The BOTA determined that the mixer-feeder trucks were tax-exempt as farm machinery and equipment and the county sought reconsideration. The BOTA denied the county휩s request for reconsideration. The county appealed. On review, the court determined that the BOTA did not err. The mixer-feeder trucks did not meet the definition of 흉truck흩 contained in K.S.A. §8-126(nn). They were not used to deliver freight or merchandise, nor were they used to transport 10 or more persons. Instead, they were regularly used in a farming operation. In re Reeve Cattle Co., No. 116,005, 2017 Kan. App. LEXIS 25 (Kan. Ct. App. Mar. 17, 2017).

Posted March 5, 2017

IRS Grants Transition Relief for Small Employers. The IRS has extended the period of time a small employer (one with less than 50 full-time employees that does not offer a group health plan to any of its employees) to furnish an initial written notice to its eligible employees regarding a qualified small employer health reimbursement arrangement (QSEHRA). The period is extended until no earlier than 90-days after the IRS issues guidance with respect to the contents of such a notice. Employers that provide written notice earlier can rely on a reasonable good faith interpretation of I.R.C. §9831(d)(4). Under legislation enacted in late 2016, a QSEHRA can be offered to eligible employees of a small employer without the $100/day penalty under Obamacare. But, the employer must furnish a written notice containing specified information to eligible employees at least 90 days before the beginning of a year for which the QSEHRA is provided. However, the legislation said that for a year beginning in 2017, the notice will not be treated as failing to timely furnish the initial written notice if the notice is furnished to its eligible employees no later than 90 days after the date of enactment. That 90-day timeframe expired on March 13, 2017. IRS did not publish guidance by March 13 and, thus, extended the timeframe. IRS Notice 2017-20.

No Charitable Deduction for Lack of Written Acknowledgement. The petitioner donated his one-half interest in a vintage airplane to a museum. The petitioner didn휩t claim a charitable contribution on his original returns for the years at issue, but later claimed the deduction on an amended return. The petitioner attached a letter with his amended return that he had received from the museum, but the court determined that the letter was not a contemporaneous written acknowledgement because the letter was not addressed to the petitioner, did not include his taxpayer I.D. number and did not acknowledge the gift or state whether the donee provided any goods or services in consideration for the airplane. In addition, the petitioner did not sign the airplane donation agreement and, thus, it couldn휩t qualify as a written acknowledgement. That agreement also did not contain the petitioner휩s I.D. number. In addition, the petitioner did not file his amended return until five years after the donation. Also, the donee did not file Form 1098-C on a timely basis resulting in no contemporaneous document that could cure the defects in the donation agreement. Thus, the requirements of I.R.C. §170(f)(12)(B) had not been satisfied. Izen v. Comr., 148 T.C. No. 5 (2017).

Posted February 27, 2017

Dentist is Real Estate Pro for Hobby Loss Purposes. The petitioner was a dentist that worked in a dental practice with his wife. The petitioner also spent many hours on brokerage-related activities and managing the couple휩s four rental properties. During each year at issue, the petitioner spent over 1,000 hours on the real estate activities and materially participated in those activities by performing 흉substantially all흩 of the participation in the activities in accordance with Treas. Reg. §1.469-5T(a)(2). The hours were supported by the petitioner휩s records and testimony that the court viewed as credible. The court also determined that the petitioner휩s records also showed that he spent more time on real estate activities than he did on the dental practice. Zarrinnegar v. Comr., T.C. Memo. 2017-34.

Posted February 25, 2017

Transaction Did Not Give Rise to Bad Debt Deduction. The petitioner휩s friend had a business that negotiated reduced interest rates for credit card borrowers having high balances. However, the business needed to establish a 흉merchant account흩 with a bank so it could charge its fees to customers휩 credit cards. Because of the business휩s poor credit, the business could not obtain a merchant account on its own. Consequently, the petitioner allowed his better credit status to help the friend휩s business get a merchant account via a partnership established with a third party. Ultimately, the petitioner휩s girlfriend provided $84,000 to the petitioner with no evidence that the funds were ever received by the friend휩s business. The petitioner later claimed a business bad debt deduction (ordinary loss), on the basis of lack of evidence ever went to the friend휩s business and because the transaction appeared to be a gift rather than a loan entered into in a business context. However, the court noted, in dicta, that even if a business transaction were established, the petitioner was not in the business of lending money to allow ordinary loss treatment. Scheurer v. Comr., T.C. Memo. 2017-36.

Financial Services Company휩s Incorrect Rollover of IRA Triggers Tax To Surviving Spouse. Upon the death of an IRA owner, a financial services company (Wachovia) rolled the IRA into an IRA of the decedent휩s surviving spouse rather than having it paid to his estate. The surviving spouse then distributed funds from the IRA to her stepson. The court held that the IRA distribution rules triggered tax to the surviving spouse on the funds distributed from the IRA even though the funds were derived from the IRA rolled-over from the predeceased spouse. The court refused to unwind the transaction. The surviving spouse was also triggered the additional 10 percent penalty tax of I.R.C. §72(t) as an early distribution. Ozimkoski v. Comr., T.C. Memo. 2016-228.

Posted February 15, 2017

Material Participation of Trust Measured under Mattie K. Carter Trust Standard. In a non-binding, informal opinion, the Iowa Department of Revenue (IDOR) stated that if a trust is the taxpayer, then material participation for purposes of the Iowa capital gain deduction is to be measured at the trust level under the standard set forth in Mattie K. Carter Trust v. United States, 256 F. Supp. 2d 536 (N.D. Tex. 2003). In that case, the court determined that the material participation test for passive loss purposes is determined by reference to the persons who conducted business on the trust휩s behalf. However, in pending litigation in another case involving the same issue, the IDOR took the position in a reply brief that, 흉헩to the extent Taxpayers argue Mattie K. Carter Trust v. United States...support the position that a trust may claim the Iowa net capital gain deduction, such argument must be rejected. Federal law may not dictate which categories of taxpayers are entitled to a deduction under Iowa law." The IDOR failed to inform the administrative law judge of the policy letter in which it took the exact opposite position. Iowa Dept. of Rev. Policy Ltr. 16201075 (Oct. 28, 2016).

Posted February 13, 2017

No Deduction for Losses from Rental Real Estate Activity. The petitioner owned and operated an insurance company through which he sold insurance policies. He was paid for 520 hours of work in 2011 and 173 hours in 2012. He employed three people in the insurance business. The petitioner also performed personal services for 10 single-home rental real estate properties in 2011 and 11 rental properties in 2012. No management company was involved, the petitioner performed numerous personal services himself. The petitioner휩s logs showed 951 hours in 2011 and 1,040 hours in 2012, with much of the time being travel time. Some of the hours were likely attributable to the petitioner휩s wife, and the logs provided generalized and abbreviated descriptions of the work the petitioner performed. On his return for 2011 and 2012, the petitioner showed net losses on the rental properties, and about 20,000 business driving miles for the insurance business in those same years. The IRS denied the rental real estate losses for failure to satisfy the requirements of I.R.C. §469(c)(7). The court upheld the IRS determination on the basis that the petitioner did not present evidence of total time spent performing services in the insurance company during the years in issue. Thus, the court couldn휩t determine whether the petitioner put more time in the rental activities than in the insurance activity. Jones v. Comr., T.C. Sum. Op. 2017-6.

Posted February 10, 2017

Once Taxes Are Paid, City Must Pay Tax Rebate to Manufacturer. In 2008, the defendant entered into an agreement with the plaintiff under which the plaintiff would expand its business in the defendant휩s city if the defendant would rebate a portion of the plaintiff휩s taxes each year for eight years. The defendant paid the rebates for three years, but hen then stopped paying them and cancelled the agreement. The trial court held the defendant in breach and awarded the plaintiff $494,924.28 in damages. On appeal, the appellate court noted that tax increment financing agreements are authorized by state (IA) law under Iowa Code §403.6 with the stated purpose of encouraging economic development. Under the agreement, the defendant agreed to rebate the plaintiff over eight years the incremental property taxes paid with respect to improvements that the plaintiff made in the defendant휩s city. After the plaintiff paid its taxes for a particular year, the defendant would rebate a portion of the taxes for that year. The rebate amount would get included in the defendant휩s budget and then be paid. The defendant stopped paying the rebate on the basis that the plaintiff failed to meet its obligations under the agreement. The trial court awarded damages for tax rebates that the defendant had obligated for appropriation but did not pay. The defendant claimed that the rebates were subject to annual appropriation of the City Council and that any rebate was no appropriated until the moment it was paid. Thus, the defendant claimed it could decide not to pay the rebates obligation for appropriation up until the time they were paid. The court rejected that rationale and held that once the plaintiff paid its taxes for any given year, the contract required the payment of the rebate for that year within 30 days. Thus, the defendant breached the agreement upon declining to pay rebates that it had obligated for appropriation in fiscal years 2013 and 2014 after the plaintiff had paid its taxes for those years. Acciona Windpower North America, LLC v. City of West Branch, No. 16-1735, 2017 U.S. App. LEXIS 2148 (8th Cir. Feb. 7, 2017).

Posted February 8, 2017

No Economic Hardship Exception From Early Withdrawal Penalty. The petitioner and his wife withdrew funds from their IRA before reaching age 59.5. They did so to cover ordinary family living expenses in a year in which they were partly unemployed and had lower income. They reported the withdrawn amounts as income, but did not pay the additional 10 percent penalty tax. The court noted that there is no exception from the early withdrawal penalty for hardship distributions under I.R.C. §72(t). Cheves v. Comr., T.C. Memo. 2017-22.

Posted February 7, 2017

IRS Notice of Deficiency Was Unclear, But Good Enough To Give Tax Court Jurisdiction. The Tax Court, sitting en banc, upheld an IRS statutory notice of deficiency (SNOD) even though the SNOD was ambiguous with respect to the amount. The taxpayer claimed the premium assistance tax credit, a refundable credit contained in I.R.C. §36B. The SNOD stated that the petitioner was not entitled to the credit, but then showed a deficiency of zero on page one. A majority of the judges ruled that the only thing a SNOD needs to do to be valid is 흉fairly advise the taxpayer of a deficiency for a particular year and specify the amount. The court said the analysis to determine validity of a SNOD first looks for the required material for facial validity and if it has the required information, it is valid. If the SNOD is not facially valid, then the question is whether the taxpayer either knew or should have known that the IRS was asserting a deficiency. Here, the court determined that the SNOD was ambiguous. Because the SNOD stated that the IRS was disallowing a refundable credit which triggered the deficiency, and a subsequent page of the SNOD stated the amount, the taxpayer was on notice. Thus, the Tax Court had jurisdiction. Dees v. Comr., 148 T.C. No. 1 (2017).

Penalty Tied to Reportable Transaction is Not Unconstitutional. The petitioners, a married couple, participated in a distressed asset tax shelter. They contested the penalties imposed under I.R.C. §6662A(c) as unconstitutional under the Eighth Amendment as an excessive fine. The penalty under that Code section is set at 30 percent when the taxpayer fails to disclose what the IRS defines as a 흉reportable transaction.흩 However, the penalty is avoidable if the taxpayer discloses the transaction and has reasonable cause and good faith for the position taken on the return. The court noted that the fine, to be constitutional, must bear some relationship to the gravity of the offense that it is designed to punish. In addition, the court noted that the 30% fine only applies to transactions that the IRS has determined are abusive or have a significant purpose of avoiding or evading tax. As a result, the court determined that the penalty was proportional to the harm that participating in such a listed transaction could impose on the government. Thompson v. Comr., 148 T.C. No. 3 (2017).

Posted February 6, 2017

Legal Fees Are Miscellaneous Itemized Deduction. The petitioner was paid a bonus in mid-2010 and reported it as wage income on the 2010 return. About two months after receiving the bonus, also in 2010, the employer terminated the petitioner, filed a complaint against her and attempted to recover the bonus. The petitioner filed an employment discrimination counterclaim, and in 2011 the parties entered into a settlement agreement and mutual release effective May 17, 2011. Under the agreement, neither party owed anything and released all claims against each other. The petitioner incurred $25,000 in legal expenses in 2010 and $55,798 in legal expenses in 2011, and the petitioner reported it as negative 흉other income흩 for those years. The IRS disallowed the amounts as negative 흉other income흩 but allowed them as miscellaneous itemized deductions subject to the limitations in I.R.C. §67(a). That limitation had the effect of reducing the deductions to $4,525 in 2010 and $50,579 in 2011. After noting that the burden of proof did not shift to the IRS, the court noted that none of the amount included in income was a result of an unlawful discrimination claim. In addition, the legal fees were associated with her employment and not her personal business. Thus, they were itemized deductions and not ordinary and necessary business expenses. Sas v. Comr., T.C. Sum. Op. 2017-2.

No Passthrough Loss Deduction From Defunct S Corporation. The petitioner owned an S corporation and an LLC. The S corporation allegedly made a payment for salary and wages. However, the S corporation did not conduct any trade or business in the year the deduction was claimed, and was not in existence. In any event, the court noted that the deduction would have been disallowed anyway because the payment was actually made by the LLC to the trust account of the lawyer of the petitioner, and then were paid to the IRS. The S corporation was not involved in the payment stream. In addition, the court determined that the payment appeared to be on account of the taxpayers휩 individual trust fund tax recovery penalty liabilities. As such, the payments would not have been deductible under I.R.C. §162(f). Brown v. Comr., T.C. Memo. 2017-18.

Changes to Separation Agreement Wiped Out Alimony Deduction. The petitioner and his spouse executed a separation agreement that was poorly drafted and contained inconsistencies. It characterized payments the petitioner made under the agreement to the deductible alimony, but also referred to child support payments that the petitioner needed to make. The agreement also stated that the petitioner and spouse agreed to designated all payments to be paid to the spouse as 흉excludable and non-deductible payments.흩 The IRS asserted that the payments were designated as child support and were non-deductible. The petitioner claimed that one portion of the agreement provided for 흉unallocated support흩 payments as opposed to alimony or child support payments. The Tax Court determined that the intent of the parties didn휩t matter and that the result was based on the interpretation of the settlement agreement. On that point, the court noted that I.R.C. §71(b)(1)(B) requires that the settlement agreement not state that the payment is neither includible in gross income nor allowable as a deduction. As a whole, the various exhibits had to be read in tandem and that the unallocated support payments are subject to the entire agreement. Accordingly, the provision that the unallocated support payments are excludible from income and not allowable as deductions violated I.R.C. §71(b)(1)(B). Quintal v. Comr., T.C. Sum. Op. 2017-3.

Posted January 27, 2017

No Medical Expense Deduction For In Vitro Fertilization Costs. The petitioner was a male engaged homosexual that incurred in vitro fertilization costs in an attempt to have a child via an egg donor and gestational surrogate. He deducted the associated expenses as a medical expense under I.R.C. §213. The IRS disallowed the deduction and the trial court agreed. The court noted that I.R.C. §213 limits deductions to costs incurred by a taxpayer or spouse or dependents and not those relating to procedures performed on third parties/egg donor or surrogate. In addition, the expenses were outside the scope of I.R.C. §213 because they weren휩t for the diagnosis, cure, mitigation, treatment or prevention of disease, nor were they for the purpose of affecting any bodily structure or function of the taxpayer. The court rejected the petitioner휩s argument that his homosexual conduct rendered him effectively infertile so that the amounts paid to donors and surrogates affected his own bodily functions. The court also rejected the petitioner휩s constitutional argument that the deduction denial deprived him of fundamental constitutional rights and equal protection, because the denial of the deduction wasn휩t based on the petitioner휩s conduct or claimed sexual orientation status. Morrissey v. United States, No. 8:15-cv-2736-T-26AEP, 119 AFTR 2d 2017-___(M.D. Fla. Dec. 22, 2016).

Posted January 26, 2017

California Franchise Tax Does Not Apply to Out-Of-State Corporation. The plaintiff is an Iowa corporation operated farmland in Kansas where it fed cattle for sale in Nebraska. The plaintiff had no physical presence in California 힩 no physical plant, no employees no real estate and no personal property. The plaintiff does not sell or market products or services in or to CA and is not registered with the CA Secretary of State to transact interstate business. The only connection that the plaintiff had with CA was that, in 2007, it invested in a CA manager-managed LLC and became a member. The plaintiff휩s investment was a 0.2 percent ownership interest. The LLC later elected to be taxed as a partnership under federal and CA law. The CA Franchise Tax Board (FTB) determined that the plaintiff was required to file a CA corporate franchise tax return and pay the $800 minimum franchise tax. The plaintiff paid the tax (along with penalties and interest), but then contested it and sought a refund. The plaintiff challenged the FTB휩s position based on constitutional due process and commerce clause grounds. The FTB denied the plaintiff휩s request for refund. The plaintiff appealed and the trial court granted the plaintiff휩s motion for summary judgment and awarded the refund. On appeal, the appellate court affirmed. The court noted that the plaintiff was a passive investor in the LLC and had no ability to participate in the management of the LLC and the business activities of the partnership cannot be attributed to a limited partner such as the plaintiff. Swart Enterprises, Inc. v. Franchise Tax Board, No. F070922, 2017 Cal. App. LEXIS 21 (Cal. Ct. App. Jan. 12, 2017).

Posted January 25, 2017

IRS Says No AMT Depreciation Adjustment For Property Elected Out of Bonus. The IRS has stated that the instructions for the 2016 tax forms (Form 6251 and For 4626 and Form 1041, Schedule I) that relate to the Alternative Minimum Tax (AMT) will be amended to explain that property for which an election out of bonus depreciation is made will not be subject to an AMT depreciation adjustment. The clarification applies to property placed in service after 2015. Section 143 of the 2015 extender bill (P.L. 114-113, Dec. 18, 205). stated that the AMT adjustment does not apply to 흉qualified property흩 as defined by I.R.C. §168(k)(2). But, if the election out is made for a class of property, then I.R.C. §168(k)(7) specifies that bonus depreciation does not apply. Thus, the status of property for which an election out remained 흉qualified property흩 under I.R.C. §168(k)(2) and the AMT adjustment applied. Before the change in the law, the AMT adjustment was waived only for property for which bonus depreciation was claimed. IRS has said that it will be issuing a Rev. Proc. to explain the rule change. IRS Announcement, Jan. 19, 2016.

Payments Made Under Employer휩s Fixed Indemnity Health Plan Not Excludible For Employee.  An employer provided all employees with the chance to enroll in coverage under a fixed indemnity health plan that would qualify as an accident and health plan under I.R.C. §106. The employees pay premiums for the plan by deducting the amount of the premium each pay period from the employee휩s salary. The deducted amount is included in gross income and is treated as wages for tax purposes. The fixed indemnity plan pays employees $100 for each medical office visit and $200 for each day in the hospital without regard to the amount of medical expenses otherwise incurred by the employee. Another factual situation stated that the employer provided the coverage to the employees at no cost to the employee. Still another factual situation specified that employees participating in the health indemnity plan pay premiums via a salary reduction through an I.R.C. §125 plan. As for the first situation, the IRS determined that the amounts paid by the plan are excluded from gross income and wages under I.R.C. §104(a)(3). As for the fixed premium amounts, because those are paid with amounts not included in the employee휩s gross income and wages, they are not excluded from income and wages irrespective of any medical expenses the employee incurs. For the situation where the premiums are paid with amounts that are not included in the employee휩s gross income and wages, those amounts are also included income and wages. C.C.A. 201703013 (Dec. 12, 2016).

Entry Into USPS Tracking System Is Not a Postmark. The petitioner sought a redetermination from the Tax Court that his petition was delivered to the court on the 98th day - 8 days beyond the 90-day deadline of I.R.C. §7502(a)(1) and the corresponding regulation (Treas. Reg. §301.7502-1(c)(1)(iii)(B)(1)). Normally, the petition is considered to have been filed at the time of mailing. The petition's envelope included a "postmark" by Stamps.com on the 90th day. However, the envelope also had a certified mail label with a tracking number and tracking data of the U.S. Postal Service (USPS) showed that the USPS received the envelope on the 92nd day. The court ignored the Stamps.com "postmark" and held that the petition had not been timely filed. On appeal, the Circuit Court reversed. The appellate court noted that the parties agreed on the facts that determined jurisdiction, and the Tax Court had no sound reason to doubt that the envelope was actually handed to the USPS on the 90th day. IRS had also acknowledged that certified mail sometimes takes eight days to reach the Tax Court. The court determined that the Tax Court was mistaken that Treas. Reg. §301.7502-1(c)(1)(iii) specifies the result if an envelope has both a private postmark and a USPS postmark. The petitioner휩s envelope had just one postmark. The regulation at issue does not address whether a date that is not a 흉postmark흩 is the same as a 흉postmark.흩 The regulation only addresses the issue if there are competing postmarks. The appellate court also noted that entry into the USPS tracking system does not indicate when IRS receives an envelope. The appellate court reversed the Tax Court decision and remanded the case for a decision on the merits. Tilden v. Comr., No. 15-3838, 2017 U.S. App. LEXIS 697 (7th Cir. Jan. 13, 2017), T.C. Memo. 2015-188.

Posted January 21, 2017

Donated Tract Made With Donative Intent. The petitioners, a married couple, gave a fee-simple interest in a 20-acre tract of undeveloped land to the Heritage Conservancy in Pennsylvania. They also donated a conservation easement on a separate 25-acre tract containing their homestead to the township in which the tract was located. They claimed a charitable deduction of $2.35 million for the donation of each tract, spread out over five years. The IRS completely disallowed all deductions for all years associated with the gifts on the basis that the gifts were part of a quid pro quo exchange rather than being an outright gift with no strings attached. The court disagreed with the IRS, and noted that on the valuation issue, the petitioners had relied in good faith on appraisals from a state-certified appraiser who valued the tracts at their highest and best use as residential development property. The court determined that the gift of the fee simple tract could not be 흉clawed back흩 and was not conditioned on the Heritage Conservancy returning any type of benefit to the petitioners. The court also disagreed with the contention of the IRS that the petitioners had failed to satisfy reporting requirements. However, the court reduced the total allowed deduction to $3,654,792, but did not hold the petitioners liable for penalties. McGrady v. Comr., T.C. Memo. 2016-233.

Posted January 18, 2017

Interest in LLC Is Passive and Not Grouped With Active Business. The petitioner is a plastic surgeon that purchased a 12 percent interest in an LLC that operated a facility in which the plaintiff could conduct surgeries when necessary. The petitioner also conducts surgeries in his own office separate from the LLC facility. The petitioner also owned a separate company run by his wife for his surgical practice. The petitioner is a passive investor in the LLC, but his accountant reported his earnings from his surgical practice business run by his wife and the LLC as subject to self-employment tax based on the K-1. The accountant, in a later year, reported the petitioner휩s interest in his surgical practice business as active, the interest in the LLC as passive. This allowed the petitioner to deduct passive losses, including passive losses carried forward from years for which the petitioner reported all of his interests as active. But, the carried forward losses are not allowed, the court determined, because had they been reported in prior years as passive, when carried forward the losses would have absorbed the petitioner휩s taxable income from that particular source. The petitioner could not utilize equitable recoupment because the petitioner only raised the issue post-trial. The IRS claimed that the petitioner had grouped his interest in his surgical practice and the LLC, making both interests active. However, the petitioner휩s accountant asserted that no grouping election had been made. The court did not allow the IRS to group the two activities together based on the weight of the evidence that supported treating the two activities as separate economic units. The petitioner did not have any management responsibilities in the LLC, did not share building space, employees, billing functions or accounting services with the LLC. In addition, the petitioner휩s income from the LLC was not linked to his medical practice. Hardy v. Comr., T.C. Memo. 2017-17.

Posted December 16, 2016

Capitalization Required For Interest and Real Property Taxes Associated with Crops Having More Than Two-Year Preproductive Period. The petitioner (three partnerships) bought land that they planned to use for growing almonds. They financed the purchase by borrowing money and paying interest on the debt. They then began planting almond trees. They deducted the interest and property taxes on their returns. The IRS objected to the deduction on the basis that the interest and taxes were indirect costs of the 흉production of real property흩 (i.e., the almonds trees that were growing on the land. The Tax Court agreed with the IRS noting that I.R.C. §263A requires the capitalization of certain costs and that those costs include the interest paid to buy the land and the property taxes paid on the land attributable to growing crops and plants where the preproductive period of the crop or plant exceeds two years. I.R.C. §263A(f)(1) states that 흉interest is capitalized where (1) the interest is paid during the production period and (2) the interest is allocable to real property that the taxpayer produced and that has a long useful life, an estimated production period exceeding two years, or an estimated production period exceeding one year and a cost exceeding $1 million.흩 The corresponding regulation, the court noted, requires that the interest be capitalized under the avoided cost method. The court also noted that the definition of 흉real property produced by the taxpayer for the taxpayer휩s use in a trade or business or in an activity conducted for profit흩 included 흉land흩 and 흉unsevered natural products of the land흩 and that 흉unsevered natural products of the land흩 general includes growing crops and plants where the preproductive period of the crop or plant exceeds two years. Because almond trees have a preproductive period exceeding two years in accordance with IRS Notice 2000-45, and because the land was 흉necessarily intertwined흩 with the growing of the almond trees, the interest and tax cost of the land is a necessary and indispensable part of the growing of the almond trees and must be capitalized. Wasco Real Properties I, LLC, et al. v. Comr., T.C. Memo. 2016-224.

Posted December 14, 2016

No Recapture of Prepaid Expenses Deducted in Prior Year When Surviving Spouse Claims Same Deduction in Later Year. The decedent, a materially participating Nebraska farmer, bought farm inputs in 2010 and deducted their cost on his 2010 Schedule F. He died in the spring of 2011 before using the inputs to put the spring 2011 crop in the ground. Upon his death, the inputs were included in the decedent휩s estate at their purchase price value and then passed to a testamentary trust for the benefit of his wife. The surviving spouse took over the farming operation, and in the spring of 2011, took a distribution of the inputs from the trust to plant the 2011 crops. For 2011, two Schedule Fs were filed. A Schedule F was filed for the decedent to report the crop sales deferred to 2011, and a Schedule F was filed for the wife to report the crops sold by her in 2011 and claim the expenses of producing the crop which included the amount of the inputs (at their date-of-death value which equaled their purchase price) that had been previously deducted as prepaid inputs by the husband on the couple휩s joint 2010 return. The IRS denied the deduction on the basis that the farming expense deduction by the surviving spouse was inconsistent with the deduction for prepaid inputs taken in the prior year by the decedent and, as a result, the 흉tax benefit rule흩 applied. The court disagreed, noting that the basis step-up rule of I.R.C. §1014 allowed the deduction by the surviving spouse which was not inconsistent with the deduction for the same inputs in her deceased husband휩s separate farming business. The court also noted that inherited property is not recognized as income by the recipient, which meant that another requisite for application of the tax benefit rule did not apply. Estate of Backemeyer v. Comr., 147 T.C. No. 17 (2016).

Posted December 7, 2016

Deduction for Kid Wages Disallowed. The petitioner hired his 10-year old stepson to perform tasks associated with the petitioner휩s network marketing business. He paid the stepson $6,315 as cash wages for the tax year in issue and deducted the amount on Schedule C as labor expense. The stepson performed such tasks as taking out the trash, cleaning the pool, and setting up chairs, among other things. The court did not believe that the records use to substantiate the cash wages had been prepared contemporaneously and, because they were in cash, had doubts as to whether they had actually been paid. The court also questioned whether the amount of the cash wages was reasonable in light of the petitioner휩s age and skills, and whether the work was ordinary and necessary in relation to the petitioner휩s business. In addition, the petitioner did not issue a Form 1099-Misc or W-2. The court also disallowed a home office deduction on the basis that the petitioner did not show that the claimed home office space was used regularly and exclusively for his business. Alexander v. Comr., T.C. Memo. 2016-214.

Posted December 5, 2016

No Deduction for Permanent Conservation Easement and Accuracy-Related Penalty Applied. The petitioners, a married couple, donated a permanent façade easement to a qualified trust. A 흉side letter흩 from the trust stated that the easement would be refunded to the petitioners if the deduction was later disallowed. The court ruled that the letter created a subsequent event that could make the easement unenforceable. Thus, the donated easement was a non-deductible conditional gift. The IRS levied a 40-percent gross valuation misstatement penalty and a 20 percent accuracy-related penalty coupled with a computation of zero which barred the penalties from stacking improperly. The court held that the 20 percent penalty was not imposed improperly because the notice clearly informed the petitioners that the 20 percent penalty was an alternative penalty that would only be imposed if the 40 percent penalty were not imposed. The petitioners were not able to show good faith reliance on a tax professional because they didn휩t inform their CPA of the 흉side letter흩 from the trust, and they did not have substantial authority for their position. Graev v. Comr., 147 T.C. No. 16 (2016).

Posted November 30, 2016

Recourse Debt Not Deductible Until Year of Foreclosure Sale. The petitioner's S corporation claimed a net operating loss (NOL) as a result of writing down real estate holdings due to the collapse of the real estate market. The petitioner claimed that the properties had been abandoned in that same year or had become worthless. The IRS disallowed the NOL and the Tax Court agreed. The petitioner never abandoned the properties and a loss on account of worthlessness of property that is mortgaged, the court noted, means worthless of the petitioner's equity in accordance with I.R.C. Sec. 165. The court noted that, with respect to recourse debt, the petitioner could not claim any loss deduction until the year in which a foreclosure sale occur. Thus, the petitioner was not entitled to any deduction until some point in the future. On appeal, the appellate court affirmed. The appellate court determined that the record did not indicate that any of the properties of the petitioner휩s corporation had been abandoned and the Tax Court휩s finding as such was not clearly erroneous. The corporation still had the intent to develop and sell the properties it owned. The corporation휩s properties still had mortgage debt reduction value. Tucker v. Comr., No. 16-11042, 2016 U.S. App. LEXIS 20782 (11 th Cir. Nov. 21, 2016), aff휩g., T.C. Memo. 2015-185.

Posted November 28, 2016

Exchange With Subsidiary Was Not a Qualified Deferred Exchange. The petitioner was a real estate leasing company that attempted to structure a deferred exchange with its subsidiary in an attempt to avoid the application of the I.R.C. §1031(f) related party rules. The transaction was conducted by using a party related to the petitioner that retained the cash proceeds. That had the effect of making irrelevant the use of the qualified intermediary. It also didn휩t matter that the taxpayer claimed it did not have a prearranged plan and claimed to have sought a replacement property that an unrelated party held and only used its subsidiary when the deadline to complete the deferred exchange was upon it. The court also found it immaterial that the petitioner acquired the replacement property from a related person only after it had already engaged a qualified intermediary. The court viewed that as functionally equivalent to the acquisition of replacement property from a related person before the hiring of a qualified intermediary. The court also determined that the petitioner did not show that avoidance of federal income tax was not one of the principal purposes of the exchange. The court also noted that a 흉cashing-out흩 feature of the exchange was apparent. As a result of the transaction, the petitioner and its subsidiary were able to cash out of the investment practically tax-free because the subsidiary could offset the recognized gain with its net operating losses. This allowed the petitioner and the subsidiary (as a whole) to avoid tax without basis shifting. The Malulani Group, Limited and Subsidiary, T.C. Memo. 2016-209.

Posted November 15, 2016

For Grant Purposes, Tax Basis in Wind Facility Tied to Purchase Price. The plaintiffs own six wind generation facilities near Los Angeles, CA, and claimed that the federal government underpaid them by over $206 million via a grant under Sec. 1603 of the American Recovery and Reinvestment Act of 2009 (ARRA). ARRA is known as the 2009 흉stimulus흩 bill. Sec. 1603 authorized 흉renewable흩 energy cash grants to owners of 흉renewable흩 energy facilities equal to 30 percent of the basis of 흉specified energy property.흩 The plaintiffs sold five of the facilities in sale-leaseback transactions and one in an outright sale. All of the sales were to unrelated parties. The plaintiff sought grants, but the government challenged the plaintiffs휩 basis determinations and reduced the Sec. 1603 grants accordingly. The government argued, under the cost segregation theory, that more tax basis should have been allocated to intangible property (ineligible for Sec. 1603 grants), the investment tax credit and 5-year MACRS depreciation. The government also argued that peculiar circumstances existed in the sales transactions that required the basis to be less than the nominal purchase price. The court rejected the government휩s arguments. The court determined that no goodwill or going concern value could attach to the wind generation facilities because the facilities had not yet begun selling power under power purchase agreements. While the location of the facilities added to their value, the court held that the added value was part of the basis of the tangible assets rather than a separate intangible asset, citing Tech Adv. Memo. 9317001 (Apr. 30, 1993) and its conclusion that no part of a satellite transponder휩s purchase price was associated with an intangible asset. The court also opined that turnkey value is the value of a facility valued at the time it is ready for immediate use after purchase. That value, the court determined, is part of the property휩s basis and is not a separate intangible asset citing Tech. Adv. Memo. 200907024 (Nov. 10, 2008) and the caselaw referenced therein. The court also concluded that because each power purchase agreement was specified to a specific facility and noted that each agreement could not be assigned or transferred. Thus, the value of the power purchase agreement was part of the basis of the tangible assets involved and was not a separate intangible asset. The court also determined that the purchase price allocation of the plaintiffs was reasonable insomuch that it allocated costs consistent with the majority of cost segregation studies which allocated indirect costs among the assets on a pro rata basis in accordance with the direct costs of both eligible and ineligible property. Also, the court determined that no 흉peculiar circumstances흩 existed that would require anything other than the purchase price to be used for computing basis. The court noted that the government failed to present evidence that the sale-leaseback transactions had been adjusted to inflate the purchase price as the government had claimed via pre-payments of rent. Relatedly, the court held that the Sec. 1603 grant indemnities (seller agrees to indemnify buyer for shortfalls of the Sec. 1603 grant) did not alter the purchase price as basis determination. The court also disqualified the government휩s expert witness on the basis that he lied about his credentials by failing to disclose articles that he wrote for Marxist and East German publications and that he had been an editorial board member and a contributing editor to a publication of Marxist though and analysis that touted itself as 흉the longest continuously published Journal of Marxist scholarship in the world, in any language.흩 Alta Wind I Owner-Lessor C v. United States, No. 13-402T, 2016 U.S. Claims LEXIS 1593 (Fed. Cl. Oct. 24, 2016).

Posted November 12, 2016

Casualty Loss To Farmland From Tornado For One Tract But Not the Other. The petitioners, a married couple, sustained damage to two separate tracts of land. One tract contained the couple휩s residence and barns and the husband testified as to the value of the property before it was damaged by a tornado and the value after the tornado. The court viewed the husband휩s testimony to be credible, and allowed a deduction for a casualty loss after making adjustments for the tract휩s income tax basis and the net amount of reimbursement that the couple received from insurance for the loss. As to a second tract, however, the court upheld the IRS determination of no deductible loss because the pre-tornado value was based on the value of the property as undeveloped woodland and the post-tornado value was based on the tract being grazing land. Also, as to the second tract, the court held that the petitioners failed to establish their basis in the tract. While the husband claimed that he purchased the second tract from his mother, he could not establish the purchase price or when he purchased the tract from her. Coates v. Comr., T.C. Memo. 2016-197.

Subscription Packages Weren휩t Qualified Film For DPAD Purposes. The taxpayer was a multi-channel video programmer distributor and a question arose as to whether such subscription packages qualified for the domestic production activities deduction (DPAD) of I.R.C. §199 under I.R.C. §199(c)(6) or Treas. Reg. §1.199-3(k)(1). The IRS determined that the packages didn휩t qualify for the DPAD under those provisions, because they didn휩t qualify as property under I.R.C. §168(f)(3) or Treas. Reg. §1.199-3(k)(1), but that a portion of the taxpayer휩s gross receipts from the subscription packages could qualify as DPGR under I.R.C. §199(c)(4)(A)(i)(III) and Treas. Reg. §1.199-3(k) to the extent the receipts were derived from individual film included in packages that was qualified film, and where each film that the taxpayer produced is considered to be an 흉item흩 under Treas. Reg. §1.199-3(d)(1)(ii). Tech. Adv. Memo. 201646004 (Aug. 5, 2016).

Posted November 6, 2016

Improper Retained Right in Easement Deed Ruins Multi-Million Dollar Deduction. The plaintiff donated a permanent easement on a building to a qualified charity and claimed a $4 million charitable deduction. Under I.R.C. §170(h)(4)(B) the donated interest must include a restriction that preserves the entire exterior of the building (including the front, sides, rear, and height of the building), and bar any change in the exterior of the building which is inconsistent with the historical character of the exterior. The easement deed contained language that allowed the plaintiff to conduct additional construction on the donated building if the donee approved. The donor wanted to add two or three floors to the roof of the building and possibly extend the ground floor. The IRS asserted that this reserved right permitted changes to the building exterior and denied the entire deduction. The court agreed with the IRS noting that I.R.C. §170(h)(4)(B)(i)(l) requires that the contributed property must be 흉exclusively for conservation purposes흩헩 and must include a restriction which 흉preserves the entire exterior of the building (including the front, sides, rear and height of the building)헩흩. The court noted that there is no qualification of this language and does not allow for a restriction that could allow construction above the roof or new construction that does not extend vertically beyond the highest point of the building. The entire exterior of the building must be preserved. The plaintiff argued that the retained right did not impact the front, sides, rear and height of the building, but the court noted that the word 흉including흩 did not limit the exterior solely to those features. Partita Partners, LLC, et al. v. United States, No. 1:15-cv-02561, 2016 U.S. Dist. LEXIS 147904 (S.D. N.Y. Oct. 25, 2016).

Posted October 13, 2016

Multi-Million Dollar Deduction Allowed In Conservation Easement Case. Due to the inability to develop his property because of nesting bald eagles, a wildlife corridor and wetlands on the property, the plaintiff donated a permanent conservation easement on the tract - 82 acres of Florida land. The land was being used as a public park and conservation area, and was preserved as open space. IRS claimed that the easement was worth approximately $7 million and, as a result, the claimed $24 million deduction (pre-easement value of $25.2 million based on highest and best use as residential development, and post-easement value of $1.2 million) resulted in a 40 percent accuracy-related penalty. The IRS based it's before/after valuation on its claim that the tract should be valued in accordance with its present zoning (limited residential development) based on prior zoning problems and likely opposition to a zoning change that would allow a higher-valued use such as multi-family housing. The plaintiff valued the before-easement value of the tract based on the ability to obtain a zoning change that would allow multi-family housing on concentrated parts of the tract which left the environmentally sensitive areas as open space. The Tax Court determined that there was a reasonable possibility that the tract could be rezoned to the higher valued use, but then adjusted the plaintiff's valuation downward to reflect the downturn in the real estate market. The Tax Court determined that the easement had a value of almost $20 million, reflecting the pre-easement value of $21 million and the post-easement value of $1 million (reflecting a reduction in the property's value of slightly over 95 percent). On appeal, the Circuit court affirmed the Tax Court휩s determination of the tract휩s highest and best use, but reversed as to the Tax Court휩s determination of value. The appellate court found that the Tax Court erred by reducing the proposed pre-easement value of the tract from $25.2 million to $21 million to account for a decline in property values in 2006 and departing from comparable sales data as well as relying on evidence outside the record to value the tract. The Tax Court, on remand, dealt with the issue of whether the petitioner휩s valuation should be reduced because of a declining real estate market in 2006 based on instructions from the appellate court that were to take into account evidence of comparable sales or other evidence in the record. The plaintiff휩s expert made a qualitative adjustment associated with the comparable uncontrolled price method, but IRS did not base their adjustment on sales data. Thus, the plaintiff휩s proposed method as provided by its expert resulted in the plaintiff휩s value that was claimed at trial being sustained. Palmer Ranch Holdings, Ltd. v. Comr., T.C. Memo. 2016-190, on remand from 812 F.3d 982 (11th Cir. 2016), aff휩g. in part and rev휩g., in part and remanding T.C. Memo. 2014-79.

Posted October 1, 2016

Taxpayer Was Not Away From Home and Couldn휩t Deduct Travel Expenses. The petitioner and his family lived north of Sacramento and he worked alternate weeks in areas just north of Los Angeles, some 440 miles away. On his off-weeks, the petitioner traveled home to be with his family. While his employer reimbursed him for his hotels stays during his work weeks, it did not reimburse mileage or meals and other incidental costs incurred during his work weeks. The petitioner deducted the mileage he incurred from his residence to the hotel where he stayed while working, and the meal and incidental costs for the days he was working. The IRS disallowed the deductions because he was not temporarily away from home due to the employment situation exceeding a year. Thus, his tax home became his place of business and he was not 흉away from home흩 when he paid expenses for meals, incidentals and automobile trips between his hotel and work sites. Thus, the petitioner휩s deductions for mileage, meals and incidentals were non-deductible under I.R.C. §162(a)(2). Collodi v. Comr., T.C. Memo. 2016-57.

Posted September 25, 2016

Taxpayer Was A Developer With Land Sale Gains Taxed As Ordinary Income. The petitioner was a self-described real estate real estate professional that received income from the sale of land. The petitioner reported the income as capital gain, but the Tax Court held that it was ordinary income because the petitioner held the property primarily for sale to customers in the ordinary course of the petitioner's real estate business. The court noted that the issue of whether the petitioner was a developer (ordinary income treatment) or an investor (capital gain treatment) was fact dependent, and that the facts supported developer status. The petitioner held his business out to customers as a real estate business and engaged in development and frequent sales of numerous tracts over an extended period of time. In prior years, the petitioner had reported the income from sales as ordinary income and had deducted the expenses associated with the tracts. On appeal, the appellate court affirmed. Boree v. Comr., No. 14-15149, 2016 U.S. App. LEXIS 16682 (11th Cir. Sept. 2, 2016), T.C. Memo. 2014-85.

Posted September 5, 2016

Car Donation Charity Loses Exempt Status. A tax-exempt charity handled car donations and became the subject of IRS scrutiny. The IRS determined that the charity didn휩t operate exclusively for an exempt purpose as required by I.R.C. §501(c)(3), but operated in substantial part to facilitate the selling of automobiles for a fee. The IRS noted that the charity did not maintain sufficient records to substantiate that it actually engaged in any program of granting of funds to charitable organizations or for charitable purposes. There was no documentation to support the charity휩s claim that funds were used for the exempt purpose of providing 흉middle and lower income families with emotional and financial assistance while they care for hospitalized family members.흩 The IRS also noted that the deduction for donors is limited to the fair market value of the donated car, rather than full used value in a used car pricing guide and is tied to the sales price the charity receives. UIL 201635006 (Jun. 1, 2016).

Penalty Tax Imposed For Improper IRA Withdrawals. The petitioner needed cash to pay for a medical procedure that he had to pay $11,000 for. So, he canceled an annuity contract and received the cash surrender value of $140,088.84. He paid a surrender fee of $20,618.04. No federal tax was withheld. Because he felt that additional medical procedures would be required, the petitioner retained the remaining funds and didn휩t roll them over into an IRA with 60-days from the distribution. On his tax return, the petitioner reported only $16,199 as the taxable amount of the distributions, and treated the balance as a non-taxable rollover amount. As a result, the IRS imposed the 10 percent early distribution penalty and also noted that the full amount of the distribution was taxable. A 20 percent underpayment penalty was also imposed. Peterson v. Comr., T.C. Sum. Op. 2016-52.

Computer Purchase Does Not Qualify American Opportunity Tax Credit (AOTC). The petitioner was enrolled in college and traveled to Algeria where he bought a computer at a retail store that he used in his coursework. A letter from an instructor indicated that most of the work for an English class could be performed on library computers, but that the library had limited operational hours. The petitioner claimed that the $1,288 computer cost qualified for the AOTC. The IRS disallowed the credit because it was not purchased from an educational institution, and the institution did not require him to buy the computer as a condition of enrollment. Mameri v. Comr., T.C. Sum. Op. 2016-47.

Rollover Limitations For IRAs Apply to Coverdell ESAs. In accordance with the Tax Court휩s opinion in Bobrow v. Comr., T.C. Memo. 2014-21, the IRS has determined that once a taxpayer has completed a rollover from a Coverdell Education Savings Account, the taxpayer must wait 12-months before completing another rollover from the same Coverdell ESA to another Coverdell ESA. Program Manager Technical Advice 2016-10 (Dec. 14, 2015).

Grouping of Activities Not Appropriate With Result That Passive Income Netted Against Passive Losses. The petitioner was a medical doctor that was a partner in a partnership with other doctors. The partnership owned an interest in a second partnership which provided outpatient surgery facilities for qualified licensed physicians including the petitioner. The petitioner also sustained losses from a rental property and netted the losses with his income from the second partnership on his return. On audit, the IRS disallowed the losses on the basis that the partnership income should be grouped with the income from the petitioner휩s medical practice. Such grouping made the partnership income non-passive due to the petitioner휩s material participation in the medical practice, thereby disallowing the partnership income from being netted against the petitioner휩s passive rental losses. The National Office of IRS, on review, determined that the forced grouping was not appropriate because the petitioner did not enter into the partnership to bypass the passive activity loss rules. Tech. Adv. Memo. 201634022 (Apr. 5, 2016).

Buy-Back of S Corporate Stock Means No S Election for Five Years. The petitioner owned 100 percent of the stock in an S corporation and sold it to another corporation. The sale terminated the S corporation휩s S status, resulting in the corporation being a C corporation. Less than five years later, the petitioner bought the stock back from the buyer. The IRS determined that the petitioner, in accordance with I.R.C. §1362(g) could not make another S election until the five-year period from the date of the first election. Priv. Ltr. Rul. 201636033 (Jun. 6, 2016).

Posted August 27, 2016

S Corporation Not Required To Pay Reasonable Compensation In Loss Situation. The petitioner, an S corporation, operated a business servicing, repairing and modifying recreational vehicles. The petitioner established a $224,000 home equity line of credit in 2006, but the petitioner휩s sole owner had quickly drawn on the entire line and advanced the funds to the corporation. The owner refinanced his home mortgage and established another line of credit for $87,443 and advance the full amount to the corporation. In 2008, the sole owner established a general business line of credit for $115,000 and advanced the funds to the corporation. The sole owner also borrowed $220,000 from his mother (and her boyfriend) and advanced the funds to the corporation in 2007 and 2008. The total amount advanced to the corporation between 2006 and 2008 was $664,443. All of the advances were reported as loans to the corporation and were treated as such on the corporation휩s general ledgers and Forms 1120S. No promissory notes between the corporation and the owner were executed, and no interest was charged, and no maturity dates were imposed. The owner borrowed another $513,000 from 2009 through 2011, with the corporation reporting a $103,305 loss for 2010 and another $235,542 for 2011. In those years, the corporation paid the owner휩s personal creditors $181,872.09. The corporation treated the payments as non-deductible repayment of shareholder loans. The IRS claimed that the sole owner was an employee that should be paid a reasonable wage subject to employment tax (plus penalties). The basic IRS argument was that the advanced funds were contributions to capital and the corporate payments made on the owner휩s behalf were wages. The Tax Court disagreed. The court noted that the corporation reported the advanced as loans on its books and Forms 1120S and showed the advanced as increases in loans and the expenses paid on the owner휩s behalf as repayments of shareholder loans. Thus, the court reasoned that the parties intended to form a debtor/creditor relationship and that the corporation conformed to that intent. This was supported by the fact that the corporate payments were made when the corporation was operating at a loss. Thus, the S corporation was not forced to pay a wage to the owner/employee while it was suffering losses. Scott Singer Installations, Inc. v. Comr., T.C. Memo. 2016-161.

NOL Disallowed Due to Lack of Substantiation. The petitioner operated his business in the S corporate form. He claimed that the S corporation sustained a $518,088 net operating loss (NOL) carryforward and continual S corporate losses. The $518,088 loss was allegedly sustained in tax years 1999-2002 and would have been available to offset the petitioner휩s taxable income beginning with tax year 2007. However, the petitioner did not maintain sufficient records to substantiate the NOL carryover or establish that they were not absorbed from 1997-2006. The petitioner relied solely on tax returns to establish the NOLs, but the court held that tax returns alone to not establish that there was a loss. The court also determined that the Forms 1120S did not provide sufficient information to establish the petitioner휩s basis in the S corporate stock. The court also noted that the petitioner had stipulated that he was compensated exclusively via distributions rather than wages or salary and that he used the S corporate checking account to pay substantial expenses for tax years 2007-2011. Thus, the court held that the petitioner휩s stock basis was zero. The court also upheld a 20 percent accuracy-related penalty. Power v. Comr., T.C. Memo. 2016-157.

Posted August 19, 2016

Start-Up Expenses Denied and $5,000 Election Not Made. The petitioner, a retired military pilot was nearing retirement from a major airline and purchased a small jet in late 2010 and had additional equipment put in it. She intended to use the plane in her new business. Late in 2010, the petitioner took an acquaintance, as a potential client, for a flight in the jet. The petitioner did not invoice the acquaintance for the flight, and the acquaintance moved out-of-state and a business relationship did not develop. The petitioner flew the jet two more times in 2010 and drafted a business plan for her new business, but had no revenue or customers in 2010. The petitioner claimed over $13,000 in Schedule C deductions associated with the business for the 2010 tax year. The IRS disallowed the deductions on the basis that the business activity had not yet begun in 2010 and, thus, deductions were not allowed under I.R.C. §162 as an ordinary and necessary business expense or I.R.C. §212. Instead, the IRS determined that the petitioner휩s expenses were 흉start-up흩 expenses. The court agreed with the IRS, noting that the petitioner휩s business had no clients in 2010 and did no formal advertising in 2010 that she was open for business, and had no gross receipts from business operations. The petitioner also did not elect under I.R.C. §195(b) to deduct up to $5,000 in the year the business begins with the balance deductible over 180 months. Thus, the start-up costs had to be capitalized. Tizard v. Comr., T.C. Sum. Op. 2016-42.

Bank Deposit Method Used to Reconstruct Income. The IRS believed that the petitioner had unreported income, and the petitioner claimed the amounts were reimbursements from an estate for his work as the executor. The petitioner had receipts, but couldn휩t explain the relationship of the receipts to the estate or his business. The IRS used the bank deposit method to reconstruct the petitioner휩s income. The court upheld the IRS position, finding that the petitioner intentionally evaded payment of a known tax obligation. The court imposed a civil fraud penalty. Schwartz v. Comr., T.C. Memo. 2016-144.

Abnormal 흉Reverse Exchange흩 Allowed. The petitioner estate operated a drugstore chain and sought a new drugstore before it sold the store that was presently being operated. An intermediary took title to the land on which the new store was being built. The petitioner leased the store from the intermediary until the store it was operating was sold, and used the sale proceeds to buy-out the intermediary. The transaction took place in 1999, before the IRS issued Rev. Proc. 2000-37 where IRS said it would not challenge reverse exchanges if the intermediary holds the property for 180 days or less. The intermediary held the property for more than 180 days in any event. The IRS disallowed tax-deferred exchange treatment, but the Tax Court disagreed. The court noted that caselaw established no fixed limit on which an intermediary can hold title to the exchange property. Estate of Bartell, 147 T.C. No. 5 (2016).

Posted August 12, 2016

Credible Testimony Carries the Day in Passive Loss Case. The petitioner bought and leased residential properties. Her ventures were not financially successful and she sustained losses from 2005-2009, deducting the losses for those years on Schedule E. The IRS asserted that the petitioner was not a real estate professional and the losses were, therefore, passive. The petitioner did not elect to group all of her rental activities as a single activity for purposes of the 750-hour test. IRS claimed that she failed to materially participate in each of her rental activities, and the petitioner did not maintain any log or calendar documenting the time she spent in each activity. The Tax Court, however, held that the petitioner啹s testimony was persuasive in satisfying the facts and circumstances test of Treas. Reg. §1.469-5T(a)(7). The court found it convincing that the petitioner did not have other employment and spent well in excess of 40 hours per week doing work related to the rental properties. The court concluded that the petitioner啹s testimony established that she materially participated in each rental activity and met the 750-hour test. Thus, the petitioner was a real estate professional and the losses from the rental activities were not passive. Hailstock v. Comr., T.C. Memo. 2016-146.

Posted August 7, 2016

Real Estate Pro Lacked Material Participation 噩 Passive Loss Rules Apply. The petitioners, a married couple, consisted of a husband that was a corporate executive and his wife that was a real estate agent. They sustained losses on two rental real estate properties that they owned. The wife啹s status as a real estate agent meant that she was a real estate professional. Thus, the rental losses were not automatically per se passive (which is the case for non-real estate professionals). The IRS denied the deductibility of the losses on the basis that the petitioners did not materially participate in the rental activities. The petitioners, however, asserted that they did materially participate in the rental activities on the basis of grouping the wife啹s real estate agent activities with the rental activities. The trial court agreed with the IRS, citing Treas. Reg. §1.469-9(e)(3) which provides that a qualifying taxpayer cannot group a rental real estate activity with another type of real estate activity. Thus, for real estate professionals, grouping of real estate activities with real estate rental activities is not allowed for purposes of determining material participation. Consequently, the losses from the petitioner啹s real estate rental activity were disallowed. On appeal, the appellate court affirmed on the basis that the petitioners could not meet a material participation test under I.R.C. §469. Gragg v. United States, No. 14-16053, 2016 U.S. App. LEXIS 14270 (9th Cir. Aug. 4, 2016), aff啹g., No. 4:12-cv-03813-YGR (N.D. Cal. Mar. 31, 2014).

Posted July 25, 2016

Year-End Bonus Paid to Taxpayers啹 Children Disallowed Along With Some Expenses Associated With Cattle and Deer Activity. The petitioners, a married couple, bought 176 acres of agricultural land on which to raise cattle. However, they changed their minds and decided to use the property for a deer hunting preserve rather than cattle raising. Upon learning of their legal liability issues associated with a hunting preserve they scrapped the plans for the preserve. They also enrolled 22.5 acres of the tract in a Federal conservation program (probably the CRP, but unclear from the opinion) that barred crop production activities. The petitioners later improved the tract for the purposes of creating a resort. While substantial improvements were made, the petitioners did not market the resort and had only limited and occasional income from camping sights they had created on the tract. They filed Schedule F for the years in issue, reporting their income from the entire 176 acres on Schedule F. They incurred a loss from the activity on the 176-acre tract which the IRS disallowed on the basis that the activity was not conducted with profit intent in accordance with a preponderance of the factors contained in Treas. Reg. §1.183-2(a). Specifically, the court determined that the activity was not conducted in a businesslike manner due to the lack of recordkeeping, no deer or cattle were raised, and the petitioners had no prior experienced in operating a resort or raising deer or cattle. The court also noted that the petitioners did not devote much time to the activity, little-to-no income was produced from the activity, and the petitioners enjoyed the activity and they had substantial income from other sources. The petitioners also failed to substantiate their claimed charitable deductions with receipts and appraisals. The petitioners also could not claim a deduction for unreimbursed travel for charitable purposes that was undocumented. The petitioners also claimed a deduction for wages paid to their children during the tax year for work done in the family embroidery business. While the court upheld deductions for the amounts paid during the year (the first eleven months), the Court disallowed a bonus paid to the children at year-end due to the lack of documentation of the hours of work performed. The amounts paid throughout the year (which were much smaller and were rounded) were substantiated under the rule set forth in Cohan v. Comr., 39 F.2d 540 (2d Cir. 1930) which allowed the court to estimate the amount allowable. The petitioners were unable to establish that an unrelated party would have been paid a similar bonus, which made up the largest portion of the children啹s wages. In addition, there was no written plan in place at the beginning of the year setting forth the conditions for a bonus to be paid at year end. Embroidery Express, LLC v. Comr., T.C. Memo. 2016-136.

Ownership of Oil and Gas Interests Not Required For Deducting Survey Costs. The petitioner didn啹t own any oil or gas interests, but did conduct marine surveys of the outer continental shelf of the Gulf of Mexico in an attempt to detect where oil and gas deposits were located. The petitioner gathered the data, and then licensed its use to customers on a non-exclusive basis. Those customers then used the data identifying deposits to drill for oil and gas. The petitioner deducted the cost associated with the surveys under I.R.C. §167(h) as geological and geophysical expenses incurred in connection with the exploration for, or development of, oil and gas. The IRS disallowed the deduction because the plaintiff did not own the oil and gas interests, but the Tax Court allowed the deduction. The Tax Court determined that the deduction under I.R.C. §167(h) is not limited to taxpayers that own the oil and gas interests being surveyed because all that I.R.C. §167(h) requires is that the expenses were incurred in connection with the exploration for, or development of, oil and gas. CGG Americas, Inc. v. Comr., 147 T.C. No. 2 (2016).

Posted July 23, 2016

Credit for Producing Fuel From Landfill Gas Largely Denied. The petitioner is a tax matters partner for Delaware statutory trusts that were engaged in the production and sale of landfill gas to a third party that had entered into landfill license agreements with the owners and operators of 24 landfills. One trust claimed I.R.C. §45K credits for producing fuel from a nonconventional source (landfill gas) that was produced from 23 landfills in 2005-2007. Another trust claimed the same credits producing fuel from landfill gas from one landfill in 2006 and 2007. The court noted that the landfills had various types of equipment, monitoring capabilities and production levels, and that the documentation of gas rights and sales varied as did the operation and maintenance agreements between the trusts and the third party. The court also noted that the documentation of landfill gas production and expenses for which the trusts claimed deductions varied. While untreated landfill gas is a 喹qualified fuel嗹 under I.R.C. §45K, the court determined that the trusts could not claim the credits due to the lack of substantiation of production and sale of landfill gas except with respect to one landfill each and only for the time period during which gas-to-electricity equipment was running at those particular landfills. In Green Gas Delaware Statutory Trust, Methane Bio, LLC, Tax Matters Partner, 147 T.C. No. 1 (2016).

Posted July 16, 2016

No Casualty Loss For Wall Collapse That Suffered Progressive Deterioration. The petitioner suffered a collapse of a retaining wall at the taxpayer's cooperative housing complex and claimed a casualty loss associated with the collapse of the wall. The wall separated the housing complex from public roads. The taxpayer, as a shareholder, was assessed a portion of the damage and claimed a casualty loss. The IRS denied the deduction because the collapse was gradual in nature and did not result from an event that was of a sudden, unusual or unexpected nature. The Tax Court upheld the IRS position and granted summary judgment on the basis that the collapsed wall was on property owned by the cooperative rather than the shareholder. As a result, the taxpayer did not have sufficient property rights in common areas under I.R.C. §165(c)(3), and no "equitable easement" was present. On appeal, the appellate court noted that state (NY) law recognized that the petitioner had a right to use the cooperative啹s common areas, and such right was a property interest in the grounds that satisfied the 喹property嗹 element of I.R.C. §165(c)(3). As such, the court vacated the Tax Court啹s opinion and remanded the case for a determination of whether the loss was a 喹casualty嗹 loss. On remand, the Tax Court determined that the evidence showed that the wall had been suffering deterioration for approximately 20 years before the collapse occurred. Thus, the casualty loss deduction was properly denied. Alphonso v. Comr., T.C. Memo. 2016-130, on remand from 708 F.3d 344 (2d Cir. 2013), vacating and remanding, Alphonso v. Comr., 136 T.C. 247 (2011).

Farming Activity Not Conducted With Profit Intent. The plaintiff was born and raised on a ranch until he left for college. He did not return to the ranch, but instead became an architect. After about a decade, the plaintiff bought 40 acres of pasture to start a ranch and took a year to clean the property up and buy equipment. He then began raising hay for sale. The hay sales were not profitable so he stopped selling hay, but continued to raise hay for his own animals. He started a horse breeding business, but it was not successful and he discontinued the business but continued to deduct expenses associated with the horses. A few years later he bought an 80-acre tract with a house. In 2011, he had $242,240 in gross receipts from his architecture business, but only $6,000 in gross receipts from farming and about $50,000 in farm-related expenses. The state department of revenue disallowed the farming loss due to the lack of a profit motive, using the same factors contained in Treas. Reg. §1.183-2(b). The state tax court affirmed on the basis that the plaintiff did not operate the farming operation in a businesslike manner, had no expectation in an increase in asset values, had no prior business success, had 16 consecutive years of losses and the losses offset substantial non-farm income. Horton v. Department of Revenue, No. TC-MD, 150399D, 2016 Ore. Tax LEXIS 85 (Ore. Tax Ct. Jun. 14, 2016).

No Deductions For Expenses Related To Hop Crop Because No Business Conducted. The petitioners, a married couple, had an S corporation with an office in Virginia. The husband was also an employee of the S corporation. The husband worked full time in the oil industry, but bought a 79-acre tract in North Carolina in 2004 and completed the construction of a warehouse on part of the property. The warehouse was built to store hops for distribution to local breweries. In 2008 and 2009, the husband planted hop seeds, but weather problems stalled crop growth and no hops were harvested or sold during these years. During this time, the husband also called local breweries to determine their interest in buying hops. The petitioners deducted business losses on Schedule C for both 2008 and 2009 related to the hop crop. The court upheld the IRS denial of Schedule C deductions because the court determined that the North Carolina activity was not functioning as a going concern in either 2008 or 2009 due to the petitioners failing to engage in the activity with the requisite continuity and regularity, and with the primary purpose of deriving a profit. However, the court agreed with the IRS that some related expenses were deductible as personal expenses related to their investment in the North Carolina property. The S corporation also claimed deductions for health insurance benefits paid on the husband啹s behalf that were upheld due to the husband holding more than two percent of the S corporate stock. Those amounts were included in the husband啹s taxable income. The Tax court also held that the S corporation failed to adequately substantiate the business of three vehicles used in the S corporation啹s business. On appeal, the appellate court largely affirmed, but did modify some of the deductions allowed/disallowed. Powell v. Comr., No. 15-1851, 2016 U.S. App. LEXIS 10928 (4th Cir. Jun. 14, 2016), aff啹g., in part, vacating in part and remanding, T.C. Memo. 2014-235.

Posted July 9, 2016

喹Unexpected嗹 Birth of Child Results in Allowance of Reduced Gain Exclusion. Married taxpayers had one child at the time that they purchased their first residence. The residence had two small bedrooms and two baths. The child啹s bedroom also served as the home office for the husband as well as a guest room. The couple had a second child and sold the residence before residing in it as their principal residence for two years. They sought to exclude a portion of the gain attributable to the sale of the residence under I.R.C. §121(c)(2)(B) on account of the pregnancy of the wife and the birth of the second child being an 喹unforeseen circumstance.嗹 Based on the taxpayers啹 facts, the IRS determined that the pregnancy qualified as an unforeseen circumstance and was the primary reason why they sold the residence before residing in it for two years. Priv. Ltr. Rul. 201628002 (Apr. 11, 2016).

Posted July 8, 2016

Cancelled Income Is Not Taxable Due to Insolvency Exception. The petitioner had a deficit in his bank account in 2008. The bank issued the petitioner a Form 1099-C in 2011 reporting $7,875 in cancelled debt which the taxpayer did not report on his 2011 return. The court determined that the petitioner had cancelled debt income in 2011, but that the petitioner had established that he was insolvent at the time of the discharge to the extent of $14,500. Accordingly, none of the discharged debt was taxable. Newman v. Comr., T.C. Memo. 2016-125.

Posted July 5, 2016

Oil and Gas Investment Generated Self-Employment Taxable Income. The petitioner was a CEO of a computer company with no knowledge or expertise in oil and gas. In the 1970s, the petitioner acquired working interests in several oil and gas ventures of about 2-3 percent each. The ventures were not part of any business organization, but were established by a purchase and operating agreement with the actual operator of the interests. The operator managed the interests and allocated to the petitioner the income and expense from the petitioner's interests. The petitioner had no right to be involved in the daily management or operation of the ventures. Under the agreement, the owners of the interests elected to be excluded from Subchapter K via I.R.C. §761(a). For the year at issue, the petitioner's interests generated almost $11,000 of revenue and approximately $4,000 of expenses. The operator classified the revenues as non-employee compensation and issued the petitioner a Form 1099-Misc. (as non-employee compensation). No Schedule K-1 was issued and no Form 1065 was filed. The petitioner reported the net income as "other income" on line 21 of Form 1040 where it was not subject to self-employment tax. The petitioner believed that his working interests were investments and that he was not involved in the investment activity to an extent that the income from the activity constituted a trade or business income, and that he was not a partner because of the election under I.R.C. §761(a) so his distributive share was not subject to self-employment tax. The IRS agreed with the petitioner啹s position in prior years, but chose not to for 2011, the year in issue. The IRS claimed that the income was partnership income that was subject to self-employment tax. The Tax Court agreed with the IRS because a joint venture had been created with the working interest owners (of which the petitioner was one) and the operator. Thus, the petitioner's income was partnership income under the broad definition of a partnership in I.R.C. I.R.C. §7701(a)(2). The trade or business was conducted, the court determined, by agents of the petitioner, and simply electing out of sub-chapter K did not change the nature of the entity from a partnership. Also, the fact that IRS had conceded the issue in prior years did not bar IRS from changing its mind and prevailing on the issue for the year at issue. On appeal, the Tenth Circuit affirmed, noting that the petitioner did not hold a limited partner interest which would not be subject to self-employment tax pursuant to I.R.C. §1401(a)(13). The Tenth Circuit also noted that the fact that the IRS had conceded the self-employment tax issue in prior years did not preclude the IRS from pursuing the issue in a subsequent tax year. Methvin v. Comr., No. 15-9005, 2016 U.S. App. LEXIS 11659 (10th Cir. Jun. 24, 2016), aff啹g., T.C. Memo. 2015-81.

Posted July 4, 2016

IRS Determination Illustrates Care Must Be Taken in Naming IRA Beneficiaries. The taxpayer and spouse lived in a community property state at the time of the spouse啹s death. The spouse named their child as the sole beneficiary of three IRAs. After the spouse died, the taxpayer (surviving spouse) filed a claim in the estate seeking her one-half community property that they owned, including the IRAs. The taxpayer entered into a settlement with the estate, which the state probate court approved, that ordered the IRA custodian to assign an amount to the taxpayer as a spousal rollover IRA. The taxpayer asked the IRS to rule that the settlement amount be designated as the taxpayer啹s community property interest and that the taxpayer be treated as the payee of the inherited IRAs. The taxpayer also asked the IRS to rule that the distributed amount of the IRA to the spouse be treated as a spousal rollover such that it would not be taxable. The IRS ruled against the taxpayer on all of the requests. The IRS noted that I.R.C. §408(d)(3)(C) bars rollovers from non-spousal inherited IRAs and that the rule applies irrespective of state community property laws. However, the IRS refused to rule on whether the settlement amount was community property because that issue was a matter of state law. The IRS also pointed out that the child was the named beneficiary of the IRA and it had been retitled in the child啹s name and community property law didn啹t matter. Consequently, the taxpayer could not rollover anything from the IRAs. That meant that any amount that was assigned to the taxpayer would be a taxable distribution. Priv. Ltr. Rul. 201623001 (Mar. 3, 2016).

Structured Deal Doesn啹t Avoid Corporate Income Tax. The shareholders of a C corporation wanted to liquidate the corporation and entered into a transaction with an intermediary to reduce or avoid the tax liability that the liquidation would trigger. The court determined that the transaction lacked economic substance and had no effect other than the creation of a loss. As such, the transferees were liable for the corporate tax triggered on the liquidation. In addition, the transaction was classified as a listed transaction that required disclosure. Estate of Marshall, et al. v. Comr., T.C. Memo. 2016-119.

Posted June 26, 2016

Lack of Substantiation Costs Charitable Deductions. The taxpayer claimed a charitable deduction for non-cash donations to charity. The amounts exceeded $25,000 for 2006-2009 and $79,000 for 2010, $90,000 for 2011, $80,000 for 2012, $36,000 for 2013 and $52,000 for 2014. Of those amounts, the taxpayer claimed $56,600 for clothing. The taxpayer did not substantiate the deductions with any evidence of purchases or acquisition dates. There also was no written acknowledgement. The taxpayer also did not have any qualified appraisals. Payne, T.C Sum. Op. 2016-30.

Posted June 25, 2016

Failure to Properly Substantiate Costs Charitable Deductions. A couple each made $20 contributions to their respective churches each week. They did not provide any documentation to substantiate their cash contributions. They claimed a $2,000 deduction for the cash donations, but had no written acknowledgment from either church and had no records to substantiate the amounts donated. The court sustained the IRS denial of the deduction. The couple also claimed a charitable donation for non-cash contributions of various household items to the Salvation Army including clothing, furniture and kitchenware. The couple attached form 8283 to their return and used 喹comparative sales嗹 to determine the fair market value of the donated items. On a supplemental schedule, they assigned a value of $2,082 to the clothing and $1,087 to donated furniture and kitchenware. They didn啹t receive a contemporaneous written acknowledgement for the non-cash donations and they didn啹t maintain any written records. However, the IRS allowed a $250 deduction for the non-cash donated items. The court sustained the IRS $250 deduction. Haag v. Comr., T.C. Sum. Op. 2016-29.

Sale of Business Interests Were Non-Taxable As Incident To Divorce. A married couple started a dance school in 1989 for which they reported the income on Schedule C. They incorporated the business in 1996 with the wife established as the sole shareholder. They created an LLC in 1997 for the sale of dancewear and related accessories with each of them being equal 50 percent shareholders and both of them operating the business equally. They formed a real estate LLC in 1999 that was taxed as a partnership which held and leased real estate. The wife was a 49 percent owner and the husband a 51 percent owner. They divorced in 2007 and pursuant to the divorce agreement, they equalized their ownership interests in the entities. After the transfers were complete, they each owned 50 percent of each entity. Later in 2007, the ex-wife sued the ex-husband for alleged mismanagement of the dancewear/accessory business and sought an order requiring him to sell his shares either to the corporation or to her. They entered into a settlement agreement in 2008 under which he sold all of his interests in the entities to her for $1.58 million and that amount was allocated among the businesses. The IRS claimed that the sale triggered taxable gain, but the ex-husband claimed it was non-taxable under I.R.C. §1041 as being incident to a divorce. The IRS asserted that the 2007 divorce agreement resolved all of the issues between the couple and that the later lawsuit was a separate business dispute that was not brought in family court. The court noted that I.R.C. §1041 did not limit its application to a single division of marital property, and that Treas Reg. §1.1041-1T(b) established a presumption that that non-recognition provision does not apply to any transfer pursuant to a divorce or separation agreement, but that it can be rebutted by a showing of a transfer to effect the division of property owner by former spouses at the time of the divorce. The court noted that the couple had made unsuccessful attempts to divide the businesses and there was nothing in I.R.C. §1041 that limited it from applying to sales or business-related property. The court also determined that the type of court the lawsuit was filed in was immaterial. Belot v. Comr., T.C. Memo. 2016-113.

Posted June 14, 2016

New Rules on Qualified Real Property Debt. The IRS has provided guidance on debt forgiveness with respect to property that is used in a taxpayer啹s trade or business. Under the fact scenario presented, an individual borrowed $10 million from a bank to build an apartment building that would be used in the taxpayer啹s rental business. Before the loan maturity date, the taxpayer had paid down $2 million of loan principal, but failed to pay off the balance in a timely manner. At the time of maturity, the fair market value of the apartment building was $5 million and the taxpayer啹s adjusted basis in the building was $9.4 million. The lender agreed to accept $5.25 million in return for forgiving the $8 million outstanding loan balance. At the time of loan forgiveness, the taxpayer was not insolvent or in bankruptcy. Accordingly, the taxpayer chose to exclude $2.75 million of debt forgiveness as qualified real property business debt under I.R.C. §108(a)(1)(D). The IRS agreed, and the taxpayer啹s basis in the building would be reduced by the amount of the debt forgiven in accordance with I.R.C. §1017. Under another fact scenario, the taxpayer borrowed $10 million for the construction of a residential community which the taxpayer then subdivided and held for resale. Assuming the same set of facts as the first situation, the indebtedness was not qualified real property business debt because the property was held primarily for sale to customers in the ordinary course of business. Thus, the forgiven debt could not be excluded from income. Rev. Rul. 2016-15.

Posted June 7, 2016

Cancelled Insurance Policy Triggers Income. The petitioner bought a modified single premium variable life insurance policy in the 1980s. Under the policy, if the invested premium makes money the cash surrender value and cover increases. Otherwise, the petitioner would have to pay the actuarial value of any loss or lose the entire investment. The value increased significantly and the petitioner borrowed heavily against the policy, to an extent that the borrowings plus unpaid accrued interest exceeded the cash value. The petitioner failed to pay the interest on the borrowed amounts. The insurer cancelled the policy, treating the eliminated debt and interest as a distribution under I.R.C. §72 and issued the petitioner a 1099-R. The petitioner啹s wife wrote a note to the IRS on the 1099 stating that they didn啹t know how to compute the tax and seeking IRS guidance. However, the note was sent in with a late-filed return, and it was revealed at trial that the IRS had provided the petitioner with regularly issued statements concerning the policy and the loans, and informing the petitioner that any unpaid interest would be capitalized. The court determined that the interest was nondeductible personal interest. The court also held that because the amount borrowed was nontaxable, that when the insurer wrote them off the write-off constituted income to the petitioner. The court also imposed late filing and accuracy-related penalties. Mallory v. Comr., T.C. Memo. 2016-110.

Posted May 16, 2016

AOTC Inapplicable When Tuition Paid with Tax Subsidies. The petitioner啹s tuition and related expenses were paid directly to the educational institution. The court determined that while the petitioner was an eligible student, the tuition and related expenses were not qualified because they were paid directly to the educational institution by the U.S. Department of Veterans Affairs as tax-free educational assistance under the Post-9/11 G.I. Bill. Lara v. Comr., T.C. Memo. 2016-96.

Employees of Homecare Provider Were Independent Contractors. The plaintiff sought to recover $4,000 in employment taxes it had paid for tax years 2008 through 2012, plus costs and attorney啹s fees. The IRS claimed that the plaintiff had improperly classified its non-medical homecare service providers as independent contractors rather than employees. The plaintiff, however, claimed it had a reasonable basis for treating the workers as independent contractors under the 喹Section 530嗹 safe harbor provisions. But, the IRS claimed that prior audits did not provide reasonable reliance because those audits were not employment tax audits. But, while the purpose of the prior IRS audit involved an analysis of the personal tax problems of the plaintiff啹s owner, the IRS did review numerous documents involving the contracts with independent contractors. Thus, the court determined that it was reasonable for the plaintiff to interpret the silence of the IRS on the worker classification issue as acquiescence. Thus, the plaintiff had a reasonable basis to classify the workers as independent contractors. The plaintiff was entitled to relief. Nelly Home Care, Inc. v. United States, No. 15-439, 2016 U.S. Dist. LEXIS 61524 (E.D. Pa. May 10, 2016).

Posted May 11, 2016

Taxpayer Entitled to AOTC Even Though 1098-T Inaccurate. The petitioner was enrolled as a full-time student at a University during 2011, having registered for the spring 2011 semester during the fall of 2010. She was billed $2,340 for the spring 2011 classes in late 2010, and on Jan. 10, 2011, the university billed to her account additional tuition of $1,230 on the basis of her final course selections for that semester. The petitioner啹s student loans in the amount of $10,199 were disbursed to the University on Jan. 20, 2011, which accredited her account and the excess over tuition and fees were refunded directly to her. The University filed Form 1098-T for 2011 with no entry in Box 1 (payments received) and an entry of $1,180 in Box 2 representing amounts billed for qualified tuition and related expenses. The petitioner claimed an American Opportunity Tax Credit (AOTC) of $2,500 on her 2011 return. The IRS disallowed the AOTC because the University reported a zero amount in Box 1. However, an account statement from the University showed an itemized schedule of the petitioner啹s tuition charges for the spring 2011 semester that reflected net charges to the petitioner exceeding $2,500 in 2011. The court determined that the petitioner could claim a $2,410 AOTC equating to $2,000, plus 25 percent of the $1,640 balance of tuition and related charges that she paid in 2011. While the University charged a portion of the spring 2011 tuition in 2010, the loan proceeds weren啹t disbursed and credited to her account until 2011 which meant that the petitioner was treated, for purposes of the AOTC of paying the qualified expenses in 2011. The court determined that the evidence showed what the petitioner actually paid in 2011 and that the 1098-T was inaccurate. Terrell v. Comr., T.C. Memo. 2016-85.

Posted May 9, 2016

Mortgage Not Subordinated at Time of Donation 噩 No Charitable Deduction for Conservation Easement. The petitioner made a charitable contribution a permanent conservation easement on two private golf courses in the Kansas City area in 2003 valued at $16.4 million. The IRS challenged the charitable contribution deduction on numerous grounds, and in an earlier action, the petitioner conceded that the donation did not satisfy the open space conservation test, granting the IRS summary judgment on that issue, with other issues remaining in dispute. At the time of the donation, two banks held senior deeds of trust on the land at issue. Subordination agreements were not recorded until approximately three months after the donation stating that they were effective at the time of the donation. In addition, the petitioner had no power or authority to enforce the easement with respect to a portion of the property due to its lack of ownership of the property. The Tax Court cited Mitchell v. Comr., 775 F.3d 1243 (10th Cir. 2015) and Minnick v. Comr., 796 F.3d 1156 (9th Cir. 2015) as precedent on the issue that the donor must obtain a subordination agreement from the lender at the time the donation is made. Here, the court held that the evidence failed to establish that the petitioner and the lenders entered into any agreements to subordinate their interests that would be binding under state (MO) law on or before the date of the transfer to the qualified charity. As a result, the donated easement was not protected into perpetuity and failed to qualify as a qualified conservation contribution. RP Golf, LLC v. Comr., T.C. Memo. 2016-80.

Wearing Expensive Clothing Doesn啹t Necessarily Make Them Tax Deductible. The petitioner啹s employer, a Ralph Lauren retail outlet, required him to wear Ralph Lauren clothing while at work. As a result, the petitioner purchased Ralph Lauren clothing and deducted the cost as an unreimbursed employee expense on his 2010 and 2011 returns. The IRS denied the deductions on the basis that the clothing purchases could be worn for everyday usage. The Tax Court upheld the IRS determination noting that for the cost of the clothing to be deductible the clothing must satisfy three tests 噩 (1) be required or essential as a condition of employment; (2) be unsuitable for everyday wear; and (3) not be worn outside the workplace. The Tax Court noted that simply wearing Ralph Lauren clothing, while distinctive, is insufficient to make the clothing deductible. The clothing at issue was suitable for everyday use and, therefore, non-deductible. Barnes v. Comr., T.C. Memo. 2016-79.

Posted April 27, 2016

Conservation Easement Not Protected in Perpetuity; Deduction Lost. The petitioner contributed a conservation easement on a tract of land to two qualified organizations. The easement provided that if the conservation purpose was extinguished because of changed circumstances surrounding the donated property, the that donees were entitled to a proportionate share of extinguishment proceeds. If extinguishment occurred, the donees were entitled to receive at least the amount allowed as a deduction to the donor for federal income tax purposes over the fair market value of the property at the time of the contribution. The plaintiff claimed a charitable contribution for the year of the contribution and carried forward the remaining balance to tax years 2006-2008. Under Treas. Reg. §1.170A(g)(6)(i), when a change in conditions extinguishes a perpetual conservation restriction, the donee, on later sale, exchange or conversion of the property, must be entitled to a portion of the proceeds at least equal to that proportionate value of the perpetual conservation restriction. Because the easement at issue provided that the value of the contribution for purposes of the donees啹 right to extinguishment proceeds is the amount of the petitioner啹s allowable deductions rather than the fair market value of the easement, the court determined that the easement violated the Regulation and was not protected in perpetuity under I.R.C. §170(h)(5)(A). The court also imposed an accuracy-related penalty. Carroll, et al. v. Comr., 146 T.C. No. 13 (2016).

Posted April 25, 2016

Proposed Income Exclusion for Sale or Exchange of Student Farmer啹s Qualified Property. S.2774, proposed on April 11, 2016, would exclude from the income of a 喹student farmer嗹 the gain from 喹qualified dispositions嗹 not exceeding $5,000 per tax year. Under the proposal, a 喹student farmer嗹 is defined as an individual under age 19 who is enrolled in a program established by the National FFA, a 4-H club or other program established by 4-H, or any student ag program similar in nature which is under the guidance of an ag educator, advisor or club leader. A 喹qualified disposition嗹 is a sale or exchange of qualified property by or on behalf of a student farmer (as of the date of the sale or exchange) that occurs during an ag exposition or fair (as defined by I.R.C. §513(d)(2)(B) or (D)) or occurs under the supervision of a National FFA program of 4-H club or other 4-H program. 喹Qualified property嗹 is defined as personal property, including livestock, crops and ag mechanics or shop projects produced or raised by the student farmer by or on behalf of whom the sale or exchange is made, and is made under the supervision of National FFA program or 4-H club or other 4-H program. S.2774, 喹Agricultural Students Encourage, Acknowledge, Reward, Nurture Act,嗹 sponsored by Moran (R-KS) and introduced on Apr. 11, 2016 and referred to the Senate Finance Committee on the same day.

Posted April 22, 2016

You Can Take it With You 噩 Your Carried-Over Credits, That Is. The petitioner was a surviving spouse that utilized an unused I.R.C. §53 minimum tax credit carryover from her deceased spouse. The deceased spouse had exercised incentive stock options (ISOs) in 1998 (when married to a different spouse) which triggered alternative minimum tax for the year of $708,181 and also gave rise to the credit. However, the pre-deceased spouse did not have sufficient regular tax liability for the year to use the credit, and the credit carried forward. The deceased spouse divorced that spouse and then married the petitioner in 2002. Apparently, there was no question that the divorce allocated the credit carryover amount to the deceased spouse. On the 2003 joint return (filed while both spouses were alive), the Form 8801 attached to the return claim an AMT of zero and an AMT credit carryforward of $304,442. The petitioner啹s husband died in 2004 and the petitioner filed a joint return as a surviving spouse for the year. No portion of the AMT credit carry forward was claimed until an amended return was filed for 2007 claiming $29,172 of credit which the IRS refunded. More AMT credit carryforward was claimed in 2008 in an amount exceeding $150,000. The IRS disallowed the credit. The same occurred for the 2009 tax year. The court agreed with the IRS disallowance of the AMT credit, pointing out that deduction carryovers allocable to a deceased spouse 喹die嗹 to the extent they cannot be used on the final joint return. While the case involved a credit and not a deduction, the court concluded that the tax treatment was the same, citing Rev. Rul. 74-175 and Treas. Reg. §1.170A-10(d)(4)(iii). The court also cited net operating loss cases for the proposition that a taxpayer could not deduct for a post-marital year an NOL incurred by the other spouse during the marriage. No accuracy-related penalty was imposed because the petitioner had filed Form 8275 with the original claim for refund. Vichich v. Comr., 146 T.C. No. 12 (2016).

Posted April 20, 2016

Business Engaged in With Profit Intent, But Expenses Not Substantiated. The petitioner operated a hair braiding business in a booth at a mall under a five-year lease with the mall that had an automatic renewal clause. When the lease was up, it was in the midst of the financial crisis in 2009 and the business was doing poorly, but the petitioner renewed the lease out of fear of damaging her credit rating. The landlord renewed the lease for three years. The petitioner never reported a profit from the business for any year. The petitioner maintained a website, kept distinct business records and a separate business bank account from 2004-2010. The petitioner also had a full-time job making over $80,000 annually and worked the booth at nights and on weekends. The petitioner believed the business failed because of the financial crisis, the non-interest in hair braiding and a saturated market. The petitioner was also not licensed to provide associated salon services. For the year at issue, the petitioner reported $82.503 in income from her employment, and gross receipts of $325 from the hair braiding business with associated expenses of $16,131. The court believed that the petitioner was engaged in the activity with a profit intent based on an analysis of the nine factors contained in the I.R.C. §183 regulations. However, the petitioner failed to substantiate $1,441 of her expenses. The court imposed a 20 percent accuracy-related penalty on the portion of the underpayment of tax attributable to the unsubstantiated expenses. Delia v. Comr., T.C. Memo. 2016-71.

Partnership Income Must Be Reported Even If Not Distributed. The petitioner created a financially successful blog and created a partnership to further its success. The petitioner had a 41 percent interest in the partnership. The partnership filed its return by the extended due date, but didn啹t issue a Form K-1 to the petitioner for the petitioner啹s share of partnership income. The petitioner did not report his share of partnership income and the IRS asserted a deficiency. The court, agreeing with the IRS, noted that a partner must report his share of partnership income whether or not a distribution is received. In addition, the court pointed out that the petitioner actually filed a return before the partnership filed its return and could have requested an extension of time to file. The court did not impose an accuracy-related penalty. Lamas-Richie v. Comr., T.C. Memo. 2016-63.

Posted April 19, 2016

From Strip Club to Horses 噩 Appellate Court Says Profit Intent Present For All of the Years Involved. The petitioner bought an abandoned restaurant building in the late 1960s and operated it successfully until a kitchen fire shut it down. The petitioner later reopened the business as a bar which eventually became a strip club. The petitioner sold that business for moral reasons and opened a pizza parlor about five miles away. He later reclaimed the strip club because the buyer defaulted on payments. He continued to operate the club (having apparently jettisoned his prior moral concerns) successfully and opened other strip clubs and restaurants and participated in strip club trade organizations. In the late 1980s, petitioner bought farmland adjacent to the strip club and bought additional farmland in the late 1990s near the strip club on which a stable was located. With the purchases, the petitioner created a 95-acre contiguous plot. Petitioner relinquished control of the strip club businesses to his children and started an insulation business and used car dealership. He ultimately terminated involvement in both of those businesses, and turned the 95-acre tract into a horse training facility to support his interest in horse racing. He expanded the business and obtained a trainer's license. The petitioner got crosswise with county officials with respect to building codes and his horse activities and ultimately sold the 95-acre tract in 2005 to an unrelated party for $2.2 million in a part-sale part like-kind exchange transaction. The next year, petitioner bought a 180-acre parcel 16 miles from his home for horse-related activities, where he built a first-class training facility. Petitioner was deeply involved in the activities, but due to mishaps in the early years involving, in part, disease and death of numerous horses, and his deductions for the four years in issue far exceeded his income from horse-related activities with cumulative losses just shy of $1.5 million. The court determined that the taxpayer conducted the horse activities in a business-like manner, consulted experts, but significant time into the activities, had a legitimate expectation that the new property would appreciate in value, had successfully conducted other activities that were relevant to an expectation of profit in horse activities, was neutral on the history of loss issue, had a legitimate expectation of future profit, was not an "excessively wealthy" individual and had elements of personal please or recreation for only the first two of the four tax years under review, and while initially started the horse activities without profit objective, turned that intent into one with a profit objective. As a result, the petitioner had the requisite profit intent for the last two years at issue, but not the first two. Accuracy-related penalty not imposed, but petitioner liable for addition to tax for one of the tax years under review. On appeal, the Seventh Circuit reversed. The court stated that the Tax Court啹s conclusion was untenable inasmuch as the Tax Court opinion amounted to saying that a business啹s start-up costs are not deductible business expenses and amounted to saying that every business starts up as a hobby and becomes a business only when it achieves a level of profitability. The appellate court stated that the Tax Court啹s finding that the petitioner啹s land purchase and improvements were irrelevant to the issue of profit motive until he began using the new facilities is 喹unsupported and an offense to common sense.嗹 Thus, the petitioner had a profit intent for 2005 and 2006 also. Roberts v. Comr., No. 15-3396, 2016 U.S. App. LEXIS 6865 (7th Cir. Apr. 15, 2016), rev啹g., T.C. Memo. 2014-74.

Posted April 16, 2016

Inflation-Adjusted Percentages for 2016 Announced for Schoolteacher Deduction and Expense Method Depreciation. The IRS has provided inflation-adjusted amounts for several tax provisions.  For tax years beginning in 2016, the deduction for certain expenses of elementary and secondary school teachers cannot exceed $250.00, the maximum I.R.C. §179 deduction will be $500,000 and will be reduced dollar-for-dollar for qualified property placed in service during 2016 that exceeds $2,010,000. Rev. Proc. 2016-14.

Posted April 11, 2016

IRS Explains Contributing to an HSA in the Year of Medicare Enrollment. Contributions to a Health Savings Account (HSA) cannot be made by otherwise eligible individuals starting with the first month the individual becomes eligible for Medicare. I.R.C. §223(b)(7). Simply turning age 65 is insufficient, by itself, to become eligible for Medicare. Registration is required. Thus, an individual who is 65 and has Medicare equivalent coverage remains eligible to make an HSA contribution. IRA, in two Information Letters, has addressed the issue of HSA contributions in the year of Medicare eligibility. One situation involved a married couple where each spouse had an HSA with one taxpayer having family coverage at the beginning of the year. The other spouse enrolled in Medicare on May 1. Then, the spouse with family coverage turned 65 after that and enrolled in Medicare on October 1. The IRS stated that, assuming the couple otherwise qualified to make HSA contributions during the year, they could contribute 1/3 of the maximum amount allowed, reflecting January-April and the spouse turning 65 and enrolling in Medicare on May 1 could make and additional catch-up contribution of one-third of the maximum catch-up amount. The spouse turning 65 later in the year and enrolling in Medicare on October 1 could make an additional contribution of 5/12 of the maximum amount (reflecting May-September), and a catch-up contribution of 75 percent of the maximum amount for a catch-up contribution reflecting the months of January-September. In the other Information letter, the IRS dealt with the situation of a single person that enrolled in Medicare on October 1. The IRS stated that the individual would be entitled to a contribution of 75 of the maximum annual amount (reflecting the months of January through September) and a catch-up contribution of 75 percent of the maximum catch-up amount for the year. IRS Info. Ltrs. 2016-0003 (Jan. 29, 2016) and 2016-0014 (Feb. 17, 2016).

Posted April 4, 2016

Paying Tuition In Different Tax Year Than Academic Semester Begins Blows AOTC. The petitioner paid his college tuition for the Spring 2012 semester in December of 2011. He graduated in May of 2012. On this 2012 return, he claimed an American Opportunity Tax Credit. The IRS disallowed the credit, except for the $247.47 in textbook rental that the petitioner incurred in 2012. The court upheld the disallowance based on the statutory requirement of I.R.C. §25A that the credit is only allowed for payment of qualified tuition and related expenses for an academic period beginning in the same taxable year as the payment is made. The limited exception of I.R.C. §25A(g)(4) did not apply because the taxpayer did not claim the credit on his 2011 return. McCarville v. Comr., T.C. Sum. Op. 2016-14.


No IRS Guidance, So S Corporations Can Still Reimburse Health Insurance Costs of More Than Two Percent Shareholders. In response to an inquiry by a member of the Congress, the IRS stated in an information letter that an S corporation can continue to reimburse a more than 2 percent S corporation shareholder for the cost of health insurance premiums the shareholder incurs where the reimbursement is included in the shareholder啹s income and deducted under I.R.C. §162(l), assuming all other criteria for eligibility are satisfied. The information letter noted that IRS has not issued additional guidance beyond that specified in Notice 2015-17, which specified that such reimbursement did not violate Obamacare and would continue to be permissible until IRS said that it wasn啹t sometime in the future. Thus, taxpayers can continue to rely on Notice 2008-1, 2008-2 I.R.B. 1. IRS Info. Ltr. 2016-0021 (Feb. 22, 2016).

Posted April 1, 2016

For ACA Medical Reimbursement Purposes, IRS Confirms that One is Less Than Two. A Congressional Representative wrote a letter to the IRS on a constituent啹s behalf seeking the IRS position on whether the constituent could continue to reimburse health insurance premiums for his only employee without violating Obamacare and incurring the $100/day penalty of I.R.C. §4980D. The question arose because the IRS, in Notice 2014-53 said that, in general, employer reimbursement of individual health insurance plans violate Obamacare啹s ban on annual and lifetime limits on benefits because the payment of premiums would be limited. But, Notice 2014-53 also noted that the Obamacare rules exempted a group health plan that has fewer than two participants who are active employees. So, the IRS responded to the inquiry by noting that the constituent啹s situation was exempt from the penalty. Thus, the employee can obtain health insurance with the employer paying the policy premiums via the reimbursement approach. But, it is still not a good idea for an employer to reimburse one employee啹s health insurance premiums while covering other employees under a group plan. IRS could construe that situation as involving one plan with the option of providing group premiums and another option of providing coverage for non-group premiums. In that case, the $100/day penalty would apply. IRS Info. Ltr. 2016-0005 (Feb. 8, 2016).


Using IRA Funds To Invest in Personal Business Results in Tax and Penalties. The petitioners, a married couple, bought an unincorporated business using their retirement funds after being advised to do so by an investment broker. They then rolled the retirement funds into IRAs and had the IRAs buy the stock of a C corporation that they formed to acquire the unincorporated business. They then had the transaction involving the acquisition of the unincorporated business structured such that it included a loan from them that they personally guaranteed. The petitioners treated the transfer of funds from their IRAs as tax-free rollovers and did not disclose their personal guarantee. Seven years later, the IRS deemed the distributions to be prohibited transactions and sought a deficiency related to unreported IRA distributions of $431,500 and an additional 10 percent penalty for premature distributions. The Tax Court agreed with the IRS that the petitioners had engaged in a prohibited transaction under I.R.C. §4975(c)(1)(B). The six-year statute of limitations on assessment was triggered because the unreported income exceeded 25 percent of the amount reported on the petitioners啹 2003 return. Thiessen v. Comr., 146 T.C. No. 7 (2016).


Scrap Steel Sales Totaling $317,000 Over 7 Years Not S.E. Taxable. The petitioner incorporated a steel company in 1997, but got into trouble with the IRS over employment taxes and was impacted by the stock market drop in 2000. In 2004, a Chapter 7 bankruptcy trustee took over the company to manage its liquidation. As part of winding up the bankruptcy, the trustee abandoned a large pile of scrap steel. From 2004 through 2010, the petitioner sold scrap steel up to twice a month to steel wholesalers for a total of just over $317,000. The IRS claimed that the scrap steel sale income was subject to self-employment tax, but the petitioner had reported it as miscellaneous income not subject to self-employment tax. The court first noted that to be s.e. taxable, the income had to derive from a trade or business that the taxpayer conducted, and that 喹trade or business嗹 was defined as an activity that the taxpayer engaged in for income or profit with continuity and regularity (citing the Supreme Court啹s Groetzinger decision of 1987). The court then determined that the s.e. question hinged on whether the petitioner was holding the scrap steel primarily for sale in the ordinary course of a trade or business. On that issue, the court used the multi-factor test utilized in Williford v. Comr., T.C. Memo. 1992-450. As for the frequency and regularity of sales, the court determined that this factor was in the petitioner啹s favor because he sold the scrap steel slowly over time. While the sales were substantial in total, they were sporadic and generated large profits with little effort. Thus, this factor was neutral. Because he held the scrap steel for seven years, the court believed that the petitioner was not holding it for sale in the ordinary course of business. As to whether the petitioner segregated the scrap from business property, the court held the factor was neutral because he had a single pile of scrap. There also were insufficient facts to determine when and why the petitioner acquired the scrap -whether he took possession of it after determining it had value or whether he immediately took possession of it thinking that it might be useful someday. Because the sales took little effort to market the scrap, the factor was neutral, as was the factor involving the time and effort that the petitioner put into researching scrap wholesalers and contacting them to arrange sales. The petitioner also didn啹t use the sale proceeds to replace his inventory of scrap, which weighed in his favor. Accordingly, the court determined that the petitioner did not hold the scrap primarily for sale to customers in the ordinary course of business because the sales were not part of a trade or business. Ryther v. Comr., T.C. Memo. 2016-56.


Ag Chemicals Security Credit Only Partially Available. At issue was the availability to the taxpayer of the agricultural chemicals security credit of I.R.C. §45O. That provision says that eligible agricultural businesses can claim a 30 percent credit for qualified chemical security expenditures for the tax year, with certain limitations. Qualified expenditures generally relate to expenses the business incurs to ensure that their ag chemicals will be secure on the premises and that employees are properly trained in using them. However, the expenses must be incurred with respect to any fertilizer commonly used in agricultural operations and any pesticide that is customarily used on crops grown for food, feed or fiber and is a listed pesticide in section 2(u) of the Federal Insecticide, Fungicide and Rodenticide Act (FIFRA). Here, the taxpayer manufactures and distributes various chemicals, and claimed the I.R.C. §45O credit associated with its security expenditures related to the chemicals. The taxpayer manufactured and stored three chemicals for which it claimed the credit against the security expenditures. However, the taxpayer could only provide documentation that one of the chemicals was registered with the EPA as a pesticide as required by the credit statute. Thus, the credit could only be claimed for the security expenditures related to the one chemical. The taxpayer also asserted that its processing centers, storage tanks and transportation units should be viewed as separate facilities for purposes of the 喹per facility嗹 limit on the credit. In rejecting the taxpayer啹s reasoning, the IRS cited Tech. Adv. Memo. 201532034 where the IRS concluded that an eligible facility is one that can locomote itself, and also referenced congressional history which indicated that the Congress was attempting to incentivize on-site security rather than security costs related to transportation units. Thus, only the taxpayer啹s facilities that were used to process and store qualified chemicals qualified as a 喹facility嗹 under I.R.C. §45O. F.A.A. 20161102F (Nov. 4, 2015).


FBAR Fines Don't Count Towards Whistleblower Awards. Under I.R.C. §7623(b)(5)(B), a person can receive an award from the IRS for providing information about a taxpayer that leads to tax, penalties, interest, additions to tax and additional amounts that exceed $2,000,000. In this case, the petitioner was participating with the U.S. Department of Justice and the IRS criminal investigation Division in regards to two Swiss bankers. One of the bankers plead guilty and pay a Foreign Bank and Financial Accounts (FBAR) penalty in excess of $2,000,000. The petitioner claimed that he was entitled to a "whistleblower" award. The IRS refused to pay the award on the basis that I.R.C. §7623(b) only requires the IRS to pay an award if the "additional amounts" for purposes of determining whether the $2 million threshold has been satisfied are imposed under the I.R.C. Because FBAR civil penalties are not imposed or collected under the IRC, the court agreed. Instead, FBAR civil penalties are imposed and collected under 31 U.S.C. §5321 rather than the IRC. Whistleblower 22716-13W v. Comr., 146 T.C. No. 6 (2016).


Lack of Contemporaneous Written Acknowledgement Blows Conservation Easement Deduction. The petitioner attempted to make a charitable contribution of a permanent conservation easement to a qualified charity. The easement was valued at $350,971, but the IRS denied the entire charitable deduction on the basis that the petitioner did not have a contemporaneous written acknowledgment that specified that the petitioner did not receive anything in return for the contribution. The court agreed with the IRS, noting that the deed transferring the easement failed to include any provision stating that it constituted the entire agreement of the parties. Thus, the court said that the IRS couldn't be assured based on a review of the deed that the petitioner did not receive anything in exchange for the donated easement. Thus, the deed transfer did not satisfy the contemporaneous written acknowledgement rules of I.R.C. §170(f)(8)(B)(ii). French v. Comr., T.C. Memo. 2016-53.


Horse Training Activity Not Engaged in With Profit Intent; Deductions Limited. The petitioner operated a financial consulting and insurance business out of her home. She also conducted a horse training activity. She started training horses in 2005, but was injured in a car accident that year which severely hampered her training activities that year. She had recovered by 2009 and starting riding horses again. She also purchased carriage horses to train and then sell. She was again injured in a car accident in 2010 and bedridden. She spent no time training horses in 2010 and little time in 2011, and sent her horses to a professional trainer. She was able to give some lessons in 2011, but otherwise ceased her training activity and shifted to the creation of a website designed to educate children about animals. She projected that the website would become operational in 2016 and generate at least $100,000 in income for 2016. She never kept separate books and records for her horse training activity, simply keeping track of expenses on a notepad. She tried selling or giving away her horses, but couldn't find suitable (to her) transferees. Her barn was damaged by flooding in 2007. For 2008 through 2014, the expenses related to the horse training activity exceeded gross receipts each year. For the years in issue, 2010 and 2011, the petitioner netted her six-figure income from financial planning and insurance against the losses from the horse training business. The IRS disallowed the loses on the basis that the horse training activity was not engaged in for profit in accordance with I.R.C. Sec. 183. The court agreed. The court did not even need to go through the nine-factor analysis of the I.R.C. Sec. 183 regulations because the petitioner had no evidence that the horse training activity was conducted in a businesslike manner, years of losses, spent little time in the training activity, used the losses to offset income from her other business, and received personal pleasure from the activity. An accuracy-related penalty was imposed. Kaiser v. Comr., T.C. Sum. Op. 2016-13.


Trust Beneficiaries Liable For Income Tax After Statute of Limitations Expired. The petitioner啹s father created a revocable trust during his lifetime and named the trust the beneficiary of several of his IRAs. At his death in 2001, $228,530.44 was distributed to the trust from the IRAs. Later in 2001, the trust distributed that amount to two children, one of which is the petitioner (what was also the trustee of the trust). The trust filed Form 1041 for 2001 reporting the distributed amount as gross income and also deducting that amount as an income distribution, resulting in no net income. The beneficiaries each reported $114,265 on their individual returns for 2001. The IRS audited the trust and, in 2004, and the petitioner allowed the IRS to extend the statute of limitations from April 2005 to April of 2006. The IRS disallowed the deduction for the distribution of trust income, determining that the trust owed the tax on the distributions instead of the beneficiaries. The trust tax rates were higher than the rates applicable to the beneficiaries. The IRS asserted a deficiency of $80,302 for the trust, and also removed the trust distributions from the gross income of the beneficiaries and issued them refunds based on adjusted 2001 individual returns. The trust made partial payment of the deficiency in early 2005 and later in 2005 the beneficiaries used their refunds to pay the balance of the trust liability. In 2006, the trust filed an amended 2001 return seeking a refund by again claiming a distribution deduction for the trust. The IRS accepted the refund claim in 2008 and refunded the taxes in 2009 that were paid based on the disallowance in 2004. In the fall of 2008, the IRS sent deficiency notices to the beneficiaries for 2001 that included the distributed amounts in the beneficiaries啹 gross income. The 2008 assessments came after the expiration of the normal three-year from the date of filing of the return statute of limitations which had expired in 2005, and, as a result, the beneficiaries claimed that the IRS could not adjust their individual returns. However, the IRS claimed that the mitigation provisions of I.R.C. §§1311-1314.4 allowed the late assessments to bar the beneficiaries from receiving a windfall. The mitigation provisions allow the IRS to correct errors made in a closed tax year by extending the statute of limitations for a year from the date a final determination is made. The mitigation provisions allow the correction of an error in a closed tax year where the same item was erroneously included or excluded from income or where the same item was allowed or disallowed as a deduction. The court agreed with the IRS, noting that all four requirements for mitigation were satisfied 噩 a determination had been made in accordance with I.R.C. §1313(a); the determination caused an error (as described in I.R.C. §1312); an adjustment to correct the error is barred by operation of law on the date of the determination; and the determination adopted a position that a party maintained that was inconsistent with the error. Specifically, the court held that mitigation applied because there had been a determination of tax which caused an error. In this case, the court noted that the allowance of the trust啹s refund claim allowed a deduction to the trust, but the corresponding inclusion of the income of the distribution income was erroneously excluded from the beneficiaries啹 gross income, and the statute of limitations would otherwise prevent the income from being assessed to the beneficiaries. That inconsistency between the allowed trust deduction and the erroneous non-taxation of the beneficiaries triggered the mitigation provision of I.R.C. §1312 and allowed the late assessment against the beneficiaries. Costello v. Comr., T.C. Memo. 2016-33.


Brokering Financial Services Is Not 喹Real Estate嗹 For Passive Loss Purposes. The petitioner operated a mortgage brokerage, real estate brokerage and tax preparation business. The petitioner had an accounting background and was an IRS enrolled agent. The business incurred rental losses and claimed that the business constituted a real estate trade or business such that the rental losses were not automatically passive and limited in deductibility by the passive loss rules (to the extent of passive income) if the petitioner spent at least 750 hours during the tax year in the business and spent more time working in the business than on non-real estate activities. However, the court determined that the mortgage brokerage activity was not a real property trade or business as defined by I.R.C. §469(c)(7)(C). In addition, the court noted that during the years in issue, the petitioner was not brokering real estate. The court also determined that the petitioner did not satisfy the 750-hour test without including the time spent brokering mortgages. As such, the petitioner啹s rental real estate losses were passive and were disallowed. Guarino v. Comr., T.C. Sum. Op. 2016-12.


Auto Dealerships Are Separate Activity From Horse Activity Under Hobby Loss Rules. The petitioner was a third-generation auto dealer with successful dealerships, and his family has been involved in horse-related activities since the 1960s. The petitioner started his own horse activity in 1993. For various reasons, the horse activity lost money for the years in issue, but the petitioner argued that the auto dealerships and the horse activity constituted a single activity for purposes of I.R.C. Sec. 183. The court held, however, that the activities were separate. Based on the evidence, the court noted that the activities were not conducted in the same locations and there was no relationship between the customers of the horse activity and the customers of the auto dealerships. In addition, there was minimal cross-advertising between the activities and there was no leasing of assets between the two activities. The court also noted that the activities were not similar in nature. On appeal, the Third Circuit affirmed in a short, non-precedential opinion. The court noted that the activities were separate and that the nine-factors contained in the regulations were in the governments favor. Price v. Comr., T.C. Memo. 2014-253, aff啹d., 117 AFTR 2d 2016-933 (3rd Cir. Mar. 7, 2016).


Trust Gets Charitable Deduction for Distribution of IRA To Charity. The decedent established a trust and named the trust the successor beneficiary of an IRA. The trust terms specified that that the IRA was to be distributed to a charity. If the amount distributed to charity was paid out of the trust啹s gross income, the trust could claim a charitable deduction for the distribution in accordance with I.R.C. §642(c)(1). The IRS noted that while the Uniform Principal and Income Act specifies that a payment from an IRA contained in a trust (or an estate) is allocated 10 percent to income and 90 percent to principal to the extent it represents a minimum required payment from the account and 100 percent to principal to the extent it exceeds the minimum or if there is no current minimum required distribution, the limit is only on the gross income and the trust can claim a deduction for the full amount paid without the deduction being limited to a percentage of income limitation. Priv. Ltr. Rul. 201611002 (Dec. 7, 2015).


Income From Gift Cards is Partially Deferrable. Under the general rule, accrual method taxpayers account for income from 喹advance payments嗹 from gift card sales in the year they receive the income. However, the IRS issued a Rev. Proc. In 2004 (Rev. Proc. 2004-34) that allows the portion of the advance payment not recognized for financial accounting purposes in the year of receipt to be deferred until the next year. Treas. Reg. §1.451-5 allows an additional year of deferral for advance payments for the sale of goods, including the sale of gift cards, if certain conditions are met. That longer period is available if the consumer can redeem the gift cards for goods, even if the gift card may be redeemed for 喹non-integral嗹 services. Under this interpretation of the regulation, the retailer will aggregate all gift cards that are outstanding at the end of the tax year in which the cards were sold, and then allocate between the portion that is reasonably expected to be redeemed for merchandise and the portion reasonably expected to be redeemed for non-merchandise purposes. The portion reasonably expected to constitute sales of merchandise in the future is eligible for the two-year deferral period. The IRS noted that the use of the longer deferral period is accomplished by filing Form 3115, and the taxpayer will recognize the resulting tax benefit entirely in the year of change via an I.R.C. §481 adjustment. Tech. Adv. Memo. 201610017 (Aug. 28, 2015).


No Deduction for Job-Related Clothing Expenses. The petitioner, a bartender at a high-end restaurant in New York City, claimed a deduction for the cost of clothing related to his job. The IRS denied the deduction and the Tax Court agreed with the IRS. The court noted that the petitioner啹s employer did not require him to wear any particular type of clothing and what he purchased to wear for his job was adaptable to wearing when he was not at work. Thus, the expenses were non-deductible personal expenses. It was immaterial that the petitioner believed that it was necessary that he wear the clothing at issue in order to look his best at work. Beltifa v. Comr., T.C. Sum. Op. 2016-8.


Real Estate Sold By REIT Was Not a Prohibited Transaction. A real estate investment trust (REIT), through various subsidiaries, owned and leased residential real estate to third parties. A limited partnership owned most of the stock of the REIT and owned all of the REIT啹s voting common stock. The limited partnership needed to wind its business down and dissolve. The REIT planned to liquidate by disposing of all of its real property that it owned. The REIT initially acquired the properties with the intent to own them for a long time and to profit from capital appreciation and by renting the properties out. At the time of the proposed sale of the properties, the REIT will have held each of them at least two years. The REIT proposed to use at least one independent third party broker to dispose of the properties. The issue was whether the REIT held the real estate primarily for sale to customers in the ordinary course of business under I.R.C. §1221(a)(1) and, thus, the sale of the property would be a prohibited transaction under I.R.C. §857(b)(6)(B). While the IRS does not ordinarily issue rulings on whether property is held primarily for the purpose of sale to customers in the ordinary course of the taxpayer啹s trade or business, the IRS determined that the taxpayer had satisfied the 喹unique and compelling嗹 test for justifying a ruling. Accordingly, the IRS ruled that the proposed transaction would not constitute a prohibited transaction under I.R.C. §857(b)(6)(B). Priv. Ltr. Rul. 201609004 (Nov. 12, 2015).


No Deduction For Unsubstantiated Charitable Deductions. The petitioners, a married couple, claimed itemized deductions of over $51,000 on income of slightly over $50,000. The husband pastored a church and claimed deductions for medical insurance premiums and charitable contributions. The IRS allowed about 20 percent of the claimed charitable deductions but disallowed a medical expense deduction because the substantiated amount did not exceed 7.5 percent of the petitioners啹 AGI. At trial, the IRS conceded a deduction for about 70 percent of the claimed health insurance premiums attributable to the wife啹s portion of health insurance premiums deducted from compensation. The balance was not deductible due to lack of substantiation. The court upheld the IRS determinations, otherwise. On the claimed charitable deduction, the court noted that the petitioners failed to substantiate their contributions and did not have contemporaneous receipts or bank records. Brown v. Comr., T.C. Memo. 2016-39.


Refundable State Tax Credits Are Income. The petitioners, a married couple, were New York residents that created a business and elected S corporate status. The corporation was a certified Empire Zone business under the NY Empire Zone Program. For the 2008-2010 tax years, the business qualified under the NY EZ Program. The wife owned 100 percent of the business during 2008, and the husband owned 100 percent of the business after that. For 2008, the corporation claimed an Empire Zone Wage Tax Credit of $17,250 and an Empire Zone Investment Tax Credit f $58,827. For 2008, the wife claimed the credits against the couple啹s NY income tax, and could receive 50 percent of the excess credit as an overpayment of NY income tax which could be refunded. The use of the credits eliminated the petitioners啹 state income tax liability and generated a refund of a NY income tax overpayment of $30,935. The petitioners did not report any of the state refund as taxable on their federal return. The petitioners received credits again in 2010 and 2011 and which generated refunds for those tax years which the petitioners did not report on their federal return for each year. The IRS asserted a deficiency and the court upheld the deficiency on the basis of prior rulings. In one of those earlier cases, the petitioners got a refund of $54,507 in state (NY) income tax in 2008. The refund was attributable to refunded state income tax credits which were based on state real property taxes that entities paid in which the petitioners had an ownership interest. The property tax was paid and deducted at the entity level which decreased the entity income that ultimately passed through to the taxpayers, resulting in a lower tax liability. The Court, agreeing with the IRS, determined that the petitioners received a tax benefit from the credits and, as such, the credits were income to them. The court cited its prior decision in Maines v. Comr., 144 T.C. No. 8 (2015), which involved similar facts. Elbaz v. Comr., T.C. Memo. 2015-49. The citation for this case is Rivera v. Comr., T.C. Memo. 2016-35.


Advance Payments Count Towards Basis of Partnership Interest. Under I.R.C §752, if a partner啹s share of partnership liabilities increases or the partner啹s own liabilities increase by assumption of the partnership liabilities, then the increase is to be treated as a contribution of money by the partner to the partnership. Distributions to a partner can be made without taxable gain to the extent the partner has income tax basis in their interest. Also, basis in the partnership interest allows a partner to deduct their allocable share of losses to the extent of basis, and basis will reduce the amount of gain realized when a partnership interest is sold. Liabilities that increase basis include promissory notes, mortgages and, in general, booked partnership liabilities. Here, a partnership received 喹notice to proceed嗹 payments from customers before the partnership began a construction project. The payments were not fully included in income upon receipt because the partnership utilized the percentage of completion method. Thus, the payments were for services to be rendered in the future. The IRS reasoned that the payments counted as a basis-increasing liability (to the extent they had not yet been included in income) under I.R.C. §752 because the partnership would be liable if it didn啹t perform the work for which it had already been paid. Priv. Ltr. Rul. 201608005 (Nov. 11, 2015).


Wrong Entity Claims Expense With Non-Deductible Result. A married couple formed a corporation and a year later the husband formed a second corporation that he solely owned. The second corporation held the name of a hand washing system to be used in the other corporation啹s food handling process that it was developing via a machine which would use radio frequency identification (RFID) tags. The idea of the system was that an employee could have their hands scanned to verify that the employee had washed their hands as required by food handling rules. However, the second corporation had been dormant for 11 years but the first corporation had hired employees to develop the RFID machine. Ultimately, it was determined that the RFID machine would not be developed and an attempt was made to develop a voice-activated machine. The second corporation hired an employee as a computer technician to develop the hand washing system. The first corporation paid approximately $130,000 per year for two years to the second corporation and deducted the payments as contract payments to develop the voice-activated machine. The IRS denied the deduction on the basis that the first corporation lacked an ownership interest in the second corporation啹s machine. The court agreed with the IRS, denying the deduction for any payment paid for the hand washing machine. The court noted that the husband failed to present any evidence that he owned the voice-activated hand washing machine and the employee was an employee of the second corporation. Also, the court noted that the first corporation did not receive any benefit from the payment to the second corporation. Key Carpets, Inc. v. Comr., T.C. Memo. 2016-30.


Federal Court Upholds Colorado Law Subjecting Out-of-State Retailers to Sales and Use Tax Notification and Reporting Requirements 噩 Implications For Online Retailers. In 2010, the Colorado legislature enacted Colo. Rev. Stat. §39-21-112(3.5)(c)(I) requiring retailers that do not collect Colorado sales taxes (e.g., out-of-state retailers) to send a 喹transactional notice嗹 to purchasers informing them that they may be subject to Colorado啹s use tax. The notice requirement applied to out-of-state retailers having gross sales to CO customers in excess of $100,000 in the prior calendar year. Covered retailers also had to report CO purchase information to the CO Department of Revenue. In addition, purchase summaries had to be provided on an annual basis to CO customers who bought goods from a covered retailer in excess of $500 for the prior calendar year. The plaintiff challenged the law on constitutional grounds, claiming that the law contravened the U.S. Supreme Court啹s decision in Quill Corporation v. North Dakota, 504 U.S. 298 (1992). In that case involving a state啹s attempt to require a mail order office supply vendor to collect taxes on its sales to residents of the state where the vendor had no physical presence, the Court ruled that the state cannot impose the same tax obligations on out-of-state retailers having no physical presence in the state as they impose on retailers with a physical presence in the state. In this case, the plaintiff claimed that the CO law violated the Commerce Clause by discriminating against and 喹unduly burdening嗹 interstate commerce. The trial court agreed and issued a permanent injunction against the law啹s enforcement. Direct Marketing Association v. Huber, No. 10-cv-01546-REB-CBS, 2012 U.S. Dist. LEXIS 44468 (D. Colo. Mar. 30, 2012). On appeal, the appellate court determined that could not review the trial court啹s ruling because the Taxpayer Injunction Act (TIA) divested the trial court of jurisdiction over the plaintiff啹s claims and because the case involved an attempt to bar CO from exercising sovereign power to collect revenues. The court held that state law provided procedures to challenge use tax notice and reporting requirements that, after administrative remedies were exhausted, the plaintiff could proceed to state court and ultimately to the U.S. Supreme Court. As such, the appellate court remanded the case for dismissal of the Commerce Clause claims and dissolution of the permanent injunction. Direct Marketing Association v. Brohl, et al., 735 F.3d 904 App. (10th Cir. Aug. 2013). The U.S. Supreme Court agreed to hear the case in 2014 (134 S. Ct. 2901 (U.S. 2014)), and in 2015 the Supreme Court held that federal law (28 U.S.C. §1341) did not bar the lawsuit challenging the enforcement of the law from proceeding. Thus, the Supreme Court reversed the 10th Circuit啹s decision and remanded the case. Direct Marketing Association v. Brohl, 135 S. Ct. 1124 (U.S. 2015). On remand, the Tenth Circuit held that the statute did not violate the dormant Commerce Clause because it did not discriminate against or unduly burden interstate commerce. The court distinguished Quill on the basis that Quill applied only to sales and use tax collection. The court noted that discrimination wasn啹t present because the statute imposed differential treatment based on whether the retailer collected CO sales and use tax, not on the location of the retailer as in-state or out-of-state. The court also held that the statute did not create any competitive advantage for in-state retailers because CO customers are to pay sales or use tax when they purchase goods. Likewise, there was no undue burden on interstate commerce because it did not require out-of-state retailers to assess, levy or collect tax on behalf of CO. Direct Marketing Association v. Brohl, No. 12-1175, 2016 U.S. App. LEXIS 3037 (10th Cir. Feb. 22, 2016).


IRS Can Sell Farmland of Tax Protestor To Pay Tax Debt. The defendant is a self-employed farmer who hasn啹t filed a federal tax return or paid federal taxes since at least 1991 on the belief that he has no obligation to pay taxes on his income. The IRS asserted that his tax liability for the tax years 1991-1997 was $441,845.75, including penalties and interest through the end of 2015, and sought a judgment for that amount. The IRS also sought a judgment that the defendant啹s tax liabilities constitute a valid lien on the defendant啹s property including farmland. that IRS could enforce via foreclosure and sale. The court noted that the defendant did not cooperate with the IRS throughout the audit process. As a result, the IRS estimated his income and expenses based on USDA data for the years at issue. After the audit began, the defendant transferred his personal and real property to various 喹pure嗹 trusts. Under the trusts terms, the trusts held title to the property contained in the trusts and the defendant had no right to manage the trust property. The IRS filed liens against the farmland that had been placed in trust. The court determined that the defendant could not object to the IRS estimates of his tax liability because he failed to cooperate with the IRS during the audit process. The court also held that the defendant retained ownership rights to the farmland transferred to the trusts thereby allowing the IRS to seize the farmland and sell it to pay the defendant啹s tax debt. The court noted that the trusts were simply the defendant啹s nominee. Indeed, at least with respect to one of the trusts, the defendant was the sole trustee and the sole beneficiary. The defendant retained possession and control of the farmland and continued to derive income for the farmland. The court also noted that the defendant啹s legal counsel had been suspended for six months for making frivolous tax arguments on behalf of himself and clients. United States v. Sanders, No. 11-CV-912-NJR-DGW, 2016 U.S. Dist. LEXIS 19691 (S.D. Ill. Feb. 18, 2016).


No Iowa Capital Gain Deduction For Sale of Inherited Farmland. In this administrative ruling, the petitioner sold farmland and claimed the capital gain deduction on the Iowa return. The farmland was acquired by the petitioner啹s parents in 1968 and they farmed it through 1976. From 1977 through 1979, the petitioner farmed the land for his parents. From 1980 through 2008, the farmland was farmed by one of petitioner啹s brothers as a tenant under a lease with the petitioner啹s parents. The petitioner啹s father died in 1986 and his mother passed away in 2008. The petitioner sold the property later in 2008, triggering a gain to the petitioner of $75,087.00. The petitioner claimed the Iowa capital gain deduction for that amount. The Iowa Department of Revenue (IDOR) denied the deduction due to the petitioner啹s failure to satisfy the 10-year material participation requirement. The petitioner challenged that position on the basis that he had inherited his parents啹 material participation as a lineal descendant. The administrative law judge upheld the IDOR啹s position. While the petitioner argued that he was attributed his parents啹 material participation under I.R.C. §469(h)(3) (note 噩 the IA capital gain deduction rules use the material participation rules of I.R.C. §469) which says material participation is present in a farming activity if paragraph (4) or (5) of I.R.C. §2032A(b) would cause the requirements of I.R.C. §2032A(b)(1)(C)(ii) to be met with respect to real property used in such activity if the taxpayer had died during the tax year. The judge noted that I.R.C. §2032A(b)(4) relates to decedents who are retired or disabled and that I.R.C. §2032A(b)(5) sets forth rules for surviving spouses. Neither of those provisions applied to the petitioner, a lineal descendant. Those provisions also apply to a 喹farming activity,嗹 an activity that had ceased in 1980 as far as the parents were concerned. From that time forward, they were engaged in a rental activity. There was no support in the statute for the petitioner啹s argument that he inherited his parents啹 material participation for purposes of excluding gain on sale on the Iowa return. The judge also noted that the Iowa capital gain deduction provision (Iowa Code §422.7(21)) did not incorporate the active management provision of I.R.C. §2032A(b)(7)(B). Thus, the petitioner could not treat his active management as material participation. In re Weis, No. 15201055, IA Dept. of Inspection and Appeals (Sept. 4, 2015).


No Income From Stock Purchased By IRA. The petitioner sought to buy stock for his IRA, which was not a prohibited transaction. Even though the stock purchase was not a prohibited transaction, the trustee would not complete the transaction. Thus, the petitioner, had the trustee wire the purchase price directly to the corporation with the corporation issuing the stock certificate to the petitioner啹s IRA 喹for the benefit of嗹 the petitioner. The trustee claimed that the stock certificate was received in the following tax year and attempted to mail it on two occasions to the petitioner. The trustee asserted, however, that the petitioner received the stock certificate in the year following the year of the transaction. The trustee issued the petitioner a Form 1099-R for the year of the transaction equal to the purchase price. The petitioner didn啹t report the income and the IRS asserted a deficiency. However, the court determined that the petitioner did not have income from the transaction because no funds actually passed through his hands. The court noted that an IRA owner can direct how the IRA funds are invested without giving up the tax benefits of the IRA. Here, the court noted, the funds the IRA used to buy the stock 喹went straight to the investment and resulted in the stock shares啹 being issued straight to the IRA.嗹 The petitioner had no claim of right to the funds, merely serving as a conduit, and was not in constructive receipt of the funds. McGaugh v. Comr., T.C. Memo. 2016-28.


Income Triggered from IRA Distribution. The petitioner sought to invest in a company that was developing a liquefied natural gas plant in Colombia. To facilitate the investment, the petitioner transferred $125,000 from his IRA (maintained by Edward Jones) to his Edward Jones account that he held jointly with his wife. The petitioner then transferred the funds to his account at a bank. He then loaned the funds to the individual that was soliciting investors for the natural gas plant. The petitioner received a 1099-R for $125,000 indicating that the entire amount was taxable, but reported the amount as a nontaxable rollover into an account that held funds of the investing company. The court disagreed, noting that the petitioner was not merely a conduit for the funds, but had control over them and would have a claim of right to the funds. Vandenbosch v. Comr., T.C. Memo. 2016-29.


Emotional Distress Damages Taxable. The petitioner was a Postal Service employee and suffered back and neck injuries in an auto accident while on the job. As a result, the petitioner accepted a new position with the Postal Service in which would not have to carry mail, but could work at a desk answering phones and providing window assistance. Thirteen years after the accident, the petitioner was reassigned to again carry mail. However, the petitioner soon again began experiencing pain and her supervisor started retaliating against her when the petitioner requested medical accommodations and generally creating a hostile work environment. The petitioner filed complaints against the Postal Service with the Equal Employment Opportunity Commission (EEOC). The EEOC judge awarded the petitioner $70,000 in damages for emotional distress, and specifically found that the petitioner啹s damages did not relate to any physical pain that her employer caused. The Postal Service paid the petitioner $70,000 in 2011 which the petitioner did not report, believing the damages to not be includible in income under I.R.C. §104(a)(2). The IRS claimed that the damages were not excludible, and the Tax Court agreed with the IRS. The court noted that the award of damages were emotional distress damages and were not for physical distress or pain attributable to discriminatory actions of the Postal Service. As such, the damage award was for emotional distress attributable to discrimination and were not excluded under I.R.C. §104 in accordance with Treas. Reg. §1.104-1(c). Barbato v. Comr., T.C. Memo. 2016-23.


Donated Coin Collection Required Qualified Appraisal. While cash that is donated to a charity normally need not be accompanied by a qualified appraisal because cash is 喹readily valued property嗹 under I.R.C. §170(f)(11)(a)(ii), if the cash is collectible coins and the claimed charitable contribution deduction exceeds the face amount of the coins, an appraisal must be obtained if the contribution exceeds $5,000. In that situation, the exception to the appraisal requirement for 喹cash嗹 does not apply. C.C. A. 201608012 (Feb. 5, 2016).


Tax Court Case Illustrates Difficulty In Valuing Art For Estate Tax Purposes. The decedent died in mid-2009 during a time of market decline for many art pieces, with the market recovering shortly thereafter. In early 2010, the estate sold a Picasso at auction for almost $13 million, but reported the value for estate tax purposes at $5 million in accordance with an appraisal report that pegged the date-of-death value at that amount. The IRS asserted a $10 value by discounting the selling price to reflect the market conditions as of the date of death. The court agreed with the IRS approach, rejecting the estate啹s argument that the price received at auction was a 喹fluke.嗹 The estate also contained a Motherwell painting that the IRS claimed was worth $1.5 million based on a comparable Motherwell piece that sold in late 2010 for $1.4265 million. The court, however, agreed with the estate that the market had rebounded sufficiently by late 2010 such that the sale of that piece at that time did not properly reflect the value of the estate啹s piece. As such, the court determined the date-of-death value of the Motherwell piece to be $800,000, agreeing with the estate. The estate also contained a Dubuffet piece that the IRS valued higher than a comparable Dubuffet that had sold in late 2007 that had sold at $825,000. The court noted that the market had soured after 2007 and, as a result, the estate啹s use of the Sotheby啹s appraisal value for the piece of $500,000 was correct. Estate of Newberger, et al. v. Comr., T.C. Memo. 2015-246.


No Tax-Exempt Status For Farmer啹s Market. A farmer啹s market operated a marketplace where farmers and others could sell products directly to the public. The market also set-up special events where local craft vendors could sell goods, do cooking demonstrations and conduct educational programs. Its stated purpose was to strengthen the natural products economy, contribute to healthy lifestyles and support other charities. The IRS denied the market啹s I.R.C. §501(c)(3) application on the basis that the market provided space at the market for private businesses to sell their products in violation of Treas. Reg. §1.501(c)(3)-1(d)(1)(ii). Thus, the market was organized for the substantial purpose of providing private benefit to vendors of products at the market which violated its charitable tax status. The IRS determined that the facts involved were basically the same as those mentioned in Rev. Rul. 71-395. Priv. Ltr. Rul. 201601014 (Oct. 7, 2015).


IRS Can Foreclose Lien On Couple啹s Community Property To Pay One Spouse啹s Tax Debt. A married couple resided in the state of Washington, a community property state, and the husband incurred tax liabilities for unpaid taxes in years 1999-2004. Married taxpayers in a community property state who don啹t file as MFJ must report one-half of the total community income that they earn during the tax year, unless an exception contained in I.R.C. §66 applies. But, the IRS can tax a spouse啹s entire income if the spouse acted as if they were solely entitled to the income and didn啹t notify their spouse of the income before filing. In such a situation, innocent spouse relief could apply. In a prior action, the court determined that the IRS had valid tax liens on all of the couple啹s property and the IRS moved to foreclose it liens on the couple啹s community property home. However, the wife claimed that the IRS couldn啹t satisfy her husband啹s tax debt with her share of the home because state (WA) community debt doctrine didn啹t apply. But, the court disagreed, noting that all debt acquired during marriage is presumed to be community debt and that the wife had not provide clear evidence to the contrary. The court also rejected the wife啹s claim that she should have been sent a deficiency notice, finding that was a non-issue because the tax liability was only assessed against her husband. The court also held that the wife was not entitled to innocent spouse relief because her husband did not act as if he were entitled to all of the income or that he failed to notify her of that notion, and because she was aware of his income. United States v. Smith, No. 3:14-cv-05952-RJB, 2016 U.S. Dist. LEXIS 15249 (W.D. Wash. Feb. 8, 2016).


Receipt of Payment to Remain Monogamous Could Constitute Gross Income. The petitioner, 54, was involved in a romantic relationship with a 72-year-old man for just over a year. The couple never married, but the man transferred to the petitioner property worth almost $750,000 which included various items, cash and a Corvette. After almost a year into the relationship, the parties entered into a written agreement that was designed to confirm their commitment and provide her with financial security. The agreement also specified that they 喹shall respect each other and shall continue to spend time with each other and shall refrain from engaging in intimate or other romantic relations with any other individual.嗹 Under the agreement, the man was required to pay the petitioner $400,000 at the time of execution. The man made the payment and then the relationship soured and the parties separated. The day after the petitioner moved out of the house they shared, he gave her notice of termination of the agreement. He also determined that she had been unfaithful during the time the agreement was in force. Soon thereafter, he filed suit against the petitioner in state court seeking to have the court nullify the agreement, have his Corvette returned along with a diamond ring and also order the return of cash and other items that he had transferred to the petitioner 噩 in essence, the property worth almost $750,000. He also claimed that he had been fraudulently induced into the agreement. Also, he filed a Form 1099-Misc with the IRS reporting a transfer to the petitioner of almost $750,000. As a result, the IRS asserted a deficiency and the petitioner filed a Tax Court petition. About two months later, the IRS learned of the state court action and requested copies of depositions, filing and motions related to the Form 1099-Misc. and the fraudulent inducement claim. In the Tax Court action, the petitioner sought a continuance to which the IRS did not object and the Tax Court granted. The state court ruled for the man on his fraudulent inducement claim and ordered the petitioner to pay $400,000 to his estate (he died during the action). The Corvette, ring and cash gifts of approximately $275,000 were held to be gifts that the petitioner could keep. The estate executors then filed an amended Form 1099-Misc that reported $400,000 of income. The petitioner filed a motion in Tax Court seeking summary adjudication claiming that about $375,000 of property transferred to her constituted gifts rather than income, and that the IRS was estopped by the state court opinion from denying that these items were gifts. The Tax Court ruled that IRS was not estopped because it kept informed of the state court action, and it was not bound to the state court action by not opposing the continuance. However, the Tax Court denied the summary adjudication motion, which means that the Tax Court will later decide whether any portion of the nearly $750,000 is gross income to the petitioner. The petitioner will be able to argue that the amounts received were gifts. Blagaich v. Comr., T.C. Memo. 2016-2.


Rollover Period Waived Due to Emotional Distress. The taxpayer啹s spouse died owning an IRA that named his estate as the beneficiary. The couple served as trustees of a trust and the taxpayer became the sole trustee and beneficiary when the spouse died and had the authority to distribute the IRA to herself. Within the 60-day rollover period, the taxpayer requested a lump sum distribution from the IRA, and on that same day, the estate received a distribution from the IRA in the same amount. Within the rollover period, the taxpayer deposited the amount in a non-IRA account in the name of the decedent啹s estate that was maintained by a financial institution. Long after the expiration of the 60-day rollover period, the taxpayer put the IRA funds into her own IRA. The taxpayer sought a waiver of the 60-day rollover period and the IRS granted it because even though the IRS treated the taxpayer as having received the proceeds from the trust and not from the decedent, the IRS said the rule doesn啹t apply where the surviving spouse is the sole trustee of the decedent啹s trust and has the sole authority and discretion under the trust language to pay the IRA proceeds to herself. Those facts applied in this instance and the relief was granted. Priv. Ltr. Rul. 201606032 (Nov. 9, 2015).


Corporate Documents Created Second Class of S Corporation Stock. A corporation amended its articles of incorporation to provide that the corporation could issue stock in various classes. Under the amendment, there were to be no preferences, distinctions or special rights with respect to any particular class of stock. However, the articles of incorporation said that the corporation and its shareholders could enter into a written agreement and specify the manner in which the corporate assets would be distributed in the event of a liquidation, dissolution or winding up of the corporation. The shareholders and the corporation entered into a binding agreement that permitted potentially different rights of the shareholders to proceeds of liquidation. The agreement also stated that the net proceeds on liquidation would be distributed in accordance with a plan is distribution if approved by a certain percentage of corporate shareholders. If no plan was approved, the proceeds would be distributed in a way that could vary by class by the length of a shareholder啹s employment with the corporation. The corporation then elected S corporate status at a time that the agreement and articles were in effect. The different rights on liquidation created a second class of stock that terminated the S election. However, because the corporation amended the articles to provide for only a single class of stock and remove the differing rights among the shareholders to liquidation proceeds, the IRS granted relief. Priv. Ltr. Rul. 20105002 (Oct. 16, 2015).


Personal and Business Use Asset Is A Single Asset for Exchange Purposes. The taxpayer owned an aircraft that the taxpayer used in his business and also for personal purposes. The taxpayer exchanged the aircraft for a replacement aircraft and sought to defer the gain under I.R.C. §1031. On the issue of whether the transaction qualified for deferral treatment, the IRS determined that the aircraft was to be considered a single property. The IRS did make mention that addition facts were to be considered, and also noted that the low percentage of business-related flights in the tax year at issue indicated that the aircraft would not qualify for deferral treatment under I.R.C. §1031. The IRS said that a 50 percent use test was an appropriate measure for determining a property啹s intended use. C.C.A. 201605017 (Oct. 19, 2015)


Taxpayer Not In Real Estate Business With Result That Losses Not Ordinary. The petitioner啹s business plan was to acquire properties and tear the structures on the properties down and then build single and multi-unit residences for resale or rent the units out. However, from 2003-2007 the petitioner bought only one rental property and two other properties on which he tore down the existing structures. On one of the 喹tear down嗹 tracts, he constructed a two-condominium building and then sold it. On the other 喹tear down嗹 property he incurred developmental costs, borrowing money to do so. However, the petitioner defaulted on the loan and the property was foreclosed on. The petitioner attempted to deduct his loss on the property as a fully deductible ordinary loss from being engaged in the real estate trade or business. The IRS and the court disagreed. The court determined that the intent to develop property is not enough, by itself, to be in the real estate trade or business. The court also held that sales activity, to get ordinary loss treatment, must be frequent and continuous rather than sporadic. Also, the court determined that inadequate properties were involved and that the petitioner啹s primary source of income was not from real estate activities. In addition, the court noted that the petitioner did not keep good business records. Evans v. Comr., T.C. Memo. 2016-7.


Failure To Deliver Deed Dooms Charitable Deduction. The petitioner, a partnership, made a charitable contribution of an 喹Open Space and Architectural Façade Conservation Easement嗹 to the National Architectural Trust (NAT). The easement protected for perpetuity the façade of a certified historic structure that the petitioner owned. The petitioner claimed a $2.21 million deduction for the contribution, but the IRS denied the deduction and moved for partial summary judgment that the deduction was properly disallowed. The court granted the motion because the deed wasn啹t recorded in the tax year at issue. While the deed was recorded in the following year, it was only effective in the year recorded under state (NY) law thereby negating the deduction for the year claimed. The petitioner claimed that the easement wasn啹t created under state law so as not to be subject to the state statute and was merely a common law restrictive covenant, but the court said that the facts showed that the parties clearly intended to create an easement that fit within the parameters of the state statute. The court also rejected the petitioner啹s argument the recordation was only required to make the easement enforceable against subsequent purchasers. Also, the court held that Treas. Reg. §1.170A-13(c)(3)(i) was not satisfied (60-day requirement. Mecox Partners, LP v. United States, No. 11 Civ. 8157 (ER), 2016 U.S. Dist. LEXIS 11511 (S.D. N.Y. Feb. 1, 2016).


Self-Rental Rule Applies to S Corporation Lessor - Passive Rents Recharacterized As Non- Passive. The petitioners, a married couple, owned an S corporation that held real estate. They also owned a medical C corporation. The husband worked full-time for the C corporation and materially participated in its business activity. The couple did not, however, materially participate in the S corporation and they were not engaged in a real estate trade or business. For the years at issue, the S corporation leased commercial real estate to the C corporation. The S corporation had rental income of about $50,000 in each of the two years at issue, which the petitioners reported as passive income, not subject to self-employment tax. They also offset the rental income with passive losses from other S flow-through entities they owned as well as losses from other rental properties that they owned. While rental income is normally passive regardless of the level of activity by the taxpayer in managing the activity and rental income will offset passive losses generated by other activities, the IRS viewed the rental income as non-passive under Treas. Reg. Sec. 1.469-2(f)(6) (the "self-rental" rule) and disallowed passive losses that exceeded adjusted passive income for the years at issue. The petitioners, argued that I.R.C. Sec. 469 did not apply to S corporations and was invalid. The Tax Court disagreed even though I.R.C. Sec. 469, on its face, does not say that it applies to S corporations. The Tax Court held that because it need not identify S corporation due to the S corporation shareholders being the taxpayers to whom I.R.C. Sec. 469 actually applies. In addition, the Tax Court ruled that Treas. Reg. §1.469-4(a) validly interpreted "activity" as used in I.R.C. Sec. 469. Thus, the rental activity was subject to I.R.C. §469. The Tax Court also rejected the petitioners' argument that the self-rental rule didn't apply because the S corporation, as lessor, didn't participate in the C corporation's trade or business. Thus, the Tax Court upheld the IRS啹 determination that the rental income was properly recharacterized as non-passive and couldn't be used to offset passive losses. On appeal, the court affirmed. The court agreed that the statute need not refer to S corporations because S corporations do not pay taxes directly. The court also rejected the petitioners claim that the because the S corporation (as lessor) did not materially participate in the lessee啹s trade or business the self-rental rule did not apply. The court said there was no basis for reading the regulations in that manner. The S corporation was not the taxpayer for I.R.C. §469 purposes. As a result, the proper focus was on the petitioners. Viewed in that light, the self-rental rule applies and the rental income was non-passive. Williams v. Comr., No. 15-60341, 2016 U.S. App. LEXIS 1756 (5th Cir. Feb. 5, 2016), aff啹g., T.C. Memo. 2015-76.


Multi-Million Dollar Deduction Will Be Allowed In Conservation Easement Case. Due to the inability to develop his property because of nesting bald eagles, a wildlife corridor and wetlands on the property, the plaintiff donated a permanent conservation easement on the tract - 82 acres of Florida land. The land was being used as a public park and conservation area, and was preserved as open space. IRS claimed that the easement was worth approximately $7 million and, as a result, the claimed $24 million deduction (pre-easement value of $25.2 million based on highest and best use as residential development, and post-easement value of $1.2 million) resulted in a 40 percent accuracy-related penalty. The IRS based it's before/after valuation on its claim that the tract should be valued in accordance with its present zoning (limited residential development) based on prior zoning problems and likely opposition to a zoning change that would allow a higher-valued use such as multi-family housing. The plaintiff valued the before-easement value of the tract based on the ability to obtain a zoning change that would allow multi-family housing on concentrated parts of the tract which left the environmentally sensitive areas as open space. The Tax Court determined that there was a reasonable possibility that the tract could be rezoned to the higher valued use, but then adjusted the plaintiff's valuation downward to reflect the downturn in the real estate market. The Tax Court determined that the easement had a value of almost $20 million, reflecting the pre-easement value of $21 million and the post-easement value of $1 million (reflecting a reduction in the property's value of slightly over 95 percent). On appeal, the Circuit court affirmed the Tax Court啹s determination of the tract啹s highest and best use, but reversed as to the Tax Court啹s determination of value. The appellate court found that the Tax Court erred by reducing the proposed pre-easement value of the tract from $25.2 million to $21 million to account for a decline in property values in 2006 and departing from comparable sales data as well as relying on evidence outside the record to value the tract. Palmer Ranch Holdings, Ltd. v. Comr., No. 14-14167, 2016 U.S. App. LEXIS 1930 (11th Cir. Feb. 5, 2016), aff啹g. in part and rev啹g., in part and remanding T.C. Memo. 2014-79.


No Deductions for Management Fee Expenses and Losses Subject to Passive Loss Rules. The petitioner and his wife jointly owned a dental practice and got involved in an ESOP, a retirement plan that would be funded by stock in the petitioner啹s separate corporation. The petitioner paid the corporation a management fee to operate the petitioner啹s dental practice. However, the corporation did not provide any management services and the management fee was decided by the petitioner and was not based on hours or value of services. The IRS disallowed deductions for management fees and the Tax Court agreed, also upholding accuracy-related penalties. Also, the Tax Court determined that the petitioner啹s claimed losses from the dental practice were subject to the passive loss rules. On appeal, the court affirmed. Elick DDS, Inc. v. Comr., No. 13-73071, 2016 U.S. App. LEXIS 767 (9th Cir. Jan. 15, 2016), aff啹g., Elick v. Comr., T.C. Memo. 2013-139.


Another Horse Breeding and Training Activity Not Engaged in With Profit Intent. A married couple operated numerous Steak 'n Shake franchises, but later also began breeding and training Tennessee Walking Horses and formed an S corporation for the horse activity. They owned a farm personally that they rented to the S corporation to conduct the horse activities on. After the husband died in a 2003 house fire, the surviving spouse became President of the corporation that ran the franchises and was very involved in the franchise businesses. They ran up substantial losses from the horse activity from 1994 to 2009, losing money every year except 1997 when they made a profit of $1,500. The only way the horse activity was able to continue was by virtue of about $1.5 million in personal loans from the couple. The IRS examined years 2003-2005 that had total losses of about $430,000 which they attempted to deduct. The IRS denied the deductions and the surviving spouse paid the tax and sued for a refund. The court upheld the IRS determination. The court noted that under the multi-factor analysis the taxpayers (and later the widow) didn't substantially alter their methods or adopt new procedures to minimize losses, didn't get the advice of experts and continued to operate the activity while incurring the losses. The court noted that the losses existed long after the expected start-up phase would have expired. Profits were minimal in comparison and the taxpayers had substantial income from the franchises. Also, the court noted that the widow had success in other ventures, those ventures were unrelated to horse activities. The widow moved to amend the judgment to reduce the couple啹s taxable income by the amount of rental income that they received from the S corporation. The court denied the motion. On appeal, the court affirmed, noting that none of the nine factors of Treas. Reg. §1.183-2(b) favored the couple. The court also ruled that the inability to deduct the losses that the S corporation sustained did not alter the fact that an S corporation is a separate entity from its shareholders. Thus, the inability of the couple to deduct the losses from the S corporation啹s horse activities did not entitle them to exclude the rental income from their personal return. Estate of Stuller v. United States, No. 15-1545, 2016 U.S. App. LEXIS 1233 (7th Cir. Jan. 26, 2016), aff啹g., 55 F. Supp. 3d 1091 (C.D. Ill. 2014).


Taxpayers Not Entitled To Tax Credit for Home Purchase. In 2004, the petitioner bought a house, obtaining a mortgage to finance its purchase. The house was to serve as the petitioner啹s second home. The petitioner met his future wife in 2005, and she later that year leased an apartment for a one-year term. At the end of the lease, she moved into the petitioner啹s house and the parties were married one-month later. The couple lived in the house until mid-2007 when they moved to another home that they leased until early 2008. They then moved to another leased home and lived there until later in 2008. In September of 2008, the couple bought a home. The petitioner used the address of the home purchased in 2004 on his tax returns for 2004-2007 and claimed mortgage interest deductions on those returns attributable to that home. The couple received mail and tax documents at the address of the home purchased in 2004. The petitioner also claimed a homestead exemption with respect to the home purchased in 2004 for years 2005-2008. On their, 2008 return, the couple claimed a first-time homebuyer tax credit (FTHBTC) attributable to the home purchased in 2008. The IRS disallowed the credit on the basis that the petitioner owned and used another residence as a principal residence in the three years before the purchase of the home for which the credit was claimed, and imposed an accuracy-related penalty. The petitioner claimed that the 2004 home was not a 喹qualified principal residence嗹 because the other homes were his principal residences and that he actually intended to rent the 2004 home. The court upheld the IRS determination because the facts favored classification of the 2004 home as the petitioner啹s principal residence. The court did not uphold the accuracy-related penalty. Blackbourn v. Comr., T.C. Summary Op. 2016-5.


Ninth Circuit Again Says That Stock Received Upon Demutualization Has No Basis. Following up its late 2015 decision in Dorrance v. United States, No. 13-16548, 2015 U.S. App. LEXIS 21287 (9th Cir. Dec. 9, 2015), the U.S. Court of Appeals for the Ninth Circuit has again held that stock received pursuant to an insurance company demutualization does not have any income tax basis in the shareholder啹s hands. Under the facts of the case, the taxpayers (husband and wife) created an irrevocable trust in 1989 and the trust bought an insurance policy from a mutual life insurance company. The trust paid over $1.7 million in premiums over the next 10 years until the time that the company demutualized. The trust received 40,300 shares and later distributed 5,001 of the shares to the taxpayer in 2004 who sold 4,000 of them in 2005 for $160,000. On the taxpayer啹s 2005 return, the stock sale was reported with the shares having a zero basis. However, the taxpayer filed an amended return in 2008 for the 2005 tax year claiming an income tax basis in the shares consistent with the U.S. Court of Federal Claims decision in Fisher v. United States, 82 Fed. Cl. 780 (2008), and seeking a refund. The IRS rejected the refund and the taxpayer sued for a refund in federal district court. The district court upheld the IRS position and the appellate court affirmed. The trial court had determined that the open transaction doctrine utilized by the Fisher court did not apply to stock received upon demutualization. Reuben v. United States, No. 13-55240 (9th Cir. Jan. 5, 2016).


Conservation Easement Deduction Fails Due to Lack of Qualified Appraisal. The taxpayers (who were not represented by legal counsel) were a married couple who lived in a 1898 home in a Chicago north side historic district. In 2007, they donated a façade easement and $10,800 to a qualified charity. The IRS did not challenge the cash donation, but disallowed the deduction associated with the easement that was claimed to be worth $108,000 on the basis that the appraisal was not a 喹qualified嗹 appraisal in accordance with I.R.C. Sec. 170(f)(11)(A) and (C) and because the taxpayers had not included an 喹appraisal summary嗹 on IRS Form 8283 with their return (which was prepared by a CPA in his mid-80s). The IRS claimed that the easement donation should have been valued at no more than $35,000. The court agreed with the IRS, finding that the failure to include a copy of a qualified appraisal doomed the claimed deduction. The court also upheld the IRS imposition of the 20 percent penalty under I.R.C. Sec. 6662(a) and (b)(1) and, in the alternative, the 40 percent penalty for gross valuation misstatement under I.R.C. Sec. 6662(h) (a strict liability penalty with no reasonable cause exception). Gemperle v. Comr., T.C. Memo 2016-1.


Treasury Withdraws Proposed Regulations That Would Have Tweaked Contemporaneous Acknowledgement Rules For Charitable Contributions. Under I.R.C. §170(f)(8), a taxpayer claiming a charitable contribution deduction exceeding $250.00 must substantiate that deduction with a contemporaneous written acknowledge from the donee, showing the amount of the contribution, whether any good and services were received in return for the donation and a description and good faith estimate of any goods and services provided by the donee or that the donee provided only intangible religious benefits. However, I.R.C. §170(f)(8)(D) says that the substantiation rules don啹t apply if the donee files a return including the contemporaneous written acknowledgement information that the taxpayer was otherwise supposed to report. This provision allows taxpayers to 喹cure嗹 their failure to comply with the contemporaneous written acknowledgement requirement by the donee exempt organization filing an amended Form 990. However, without any regulations, the IRS has taken the position that the statutory provision does not apply. Apparently believing that their position was weak and would not be supported judicially, the proposed regulations acknowledge the exception and allow the charitable organization to file a form (yet to be announced) on or before February 28 of the year after the year of the donation that shows the name and address of the donee, the donor啹s name and address, the donor啹s tax identification number, the amount of cash and a description of any non-cash property donated, whether the donee provided any goods and services for the contribution, and a description and good faith estimate of the value of any goods and services the donee provided or a statement that the goods and services were only intangible religious benefits. The form must be a timely filed form and cannot be filed at the time the taxpayer is under examination, and a copy of the form must be provided to the donor. In early, January of 2016, the IRS withdrew the proposed regulation. The regulation was controversial because done organizations that chose to use the procedure would have been required to obtain (and retain) the Social Security numbers of donors which could have increased the potential for identity theft. REG-138344-13 (Sept. 16, 2015); Prop. Treas. Reg. §§1.170A-13(f)(18)(i-iii); withdrawn January 7, 2016.


Ag Cooperative Joint Venture Generates DPAD Ruling. An agricultural cooperative provides various products and services to members and markets grain for its members that the members raise. The taxpayer considered combining its grain marketing function with another cooperative. To facilitate the joint marketing function, an LLC taxed as a partnership was proposed to be formed with each cooperative receiving a fixed percentage interest in the LLC. Each cooperative啹s distributive share of partnership net gain/loss were to be based on the fixed percentage. The taxpayer sought IRS guidance on the various tax aspect of the proposal. The IRS determined that the taxpayer啹s distributive share of net income/loss from the LLC that was attributable to marketed grain on behalf of members would be patronage-sourced. The IRS also determined that grain payments to members (and participating patrons) would be 喹per-unit retains paid in money嗹 (PURPIMs). In addition, the IRS determined that the taxpayer would qualify for an I.R.C. Sec. 199 deduction with respect to grain it purchased from its members and participating patrons, and that the deduction would be computed without regard to any deduction for the grain payments made to members and participating patrons. Priv. Ltr. Rul. 201601004 (Sept. 28, 2015).


Losses Associated With Farming Activity Not Deemed To Be Passive. The petitioner is a lawyer that also purchased a 1,300-acre farm. The petitioner entered into a crop-share arrangement with a tenant under which the tenant had responsibility for farming decisions. The petitioner spent time during the tax years in issue performing maintenance activities on the farm including cutting vegetation, maintaining fences and shooting wild hogs. Based on the petitioner's reconstructed records, the court was convinced that the petitioner put in more than 100 hours into the activity and that no one else put in more hours than the petitioner. Thus, the petitioner was deemed to materially participate in the activity and the losses from the activity were not limited by the passive loss rules. Leland v. Comr., T.C. Memo. 2015-240.


No Conservation Easement Deduction For Protecting Sand Traps Instead of Venus FlyTraps. This case involved the donation of two permanent "conservation" easements inside a gated residential development on developed golf courses in North Carolina that were expanding with the stated purpose to protect a "natural habitat" or provide "open space" to the public. The sole issue in the case was whether the conservation purpose of I.R.C. Sec. 170(h) had been satisfied by virtue of the easements protecting the natural habitat of various plant and animal species, including the Venus Flytrap. The donated easements at issue generated claimed deductions of approximately $8 million. The court noted that while the easements did include some stand of longleaf pine, the easement terms allowed the pines to be cut back from the fairways and the surrounding housing development. Also, the court opined that the easement did not contain any requirement that an active management plan be followed to mimic the effects of prescribed burning that would allow the pines to mature in a stable condition. Also, the court stated that the I.R.C. Sec. 170 regulations concerning a "compatible buffer" that contributed to the viability of a conservation area were not satisfied. While the mere fact that a golf course was involved did not negate the possibility of a valid conservation easement donation deduction, the fact that the golf course was in a gated community eliminated the argument that the donation was to preserve "open space" for the general public. The court, while denying the claimed deductions, however, did not uphold the imposition of penalties. Atkinson v. Comr., T.C. Memo. 2015-236.


No Income Tax Basis in Stock Received Upon Demutualization. The plaintiff obtained shares of stock upon demutualization of an insurance company. The plaintiff later sold some of the shares of stock and the defendant asserted that the plaintiff's income tax basis in the stock was zero triggering 100 percent gain on the sale of the shares. The trial court rejected the defendant's position, and set forth the computation for calculating basis in stock shares received upon demutualization. The court grounded the computation of stock basis in the same manner in which the insurance company determined the value of demutualized shares for initial public offering (IPO) for purposes of determining how many shares to issue to a policyholder. Based on that analysis, the court noted that the company calculated a fixed component for lost voting rights based on one vote per policy holder and a variable component for other rights lost based on a shareholder's past and anticipated future contributions to the company's surplus. The court estimated that 60 percent of the plaintiff's past contributions were to surplus and 40 percent was for future contributions to surplus which the plaintiff had not actually yet paid before receiving shares and are not part of stock basis; thus, plaintiff's basis in stock comprised of fixed component for giving up voting rights and 60 percent of the variable component representing past contributions to surplus the end result was that the plaintiff's stock basis was slightly over 60 percent of IPO value of stock. On further review, the U.S. Court of Appeals for the Ninth Circuit reversed in a split opinion. The court determined that the plaintiffs didn't pay any additional amount for the mutual rights and that treating the premiums as payment for membership rights was inconsistent with how tax law treats insurance premiums. The court noted that under the tax code gross premiums paid to buy a policy are allocated as income to the insurance company and no portion is carved out as a capital contribution.

Conversely, the policyholder can deduct the "aggregate amount of premiums" paid upon receipt of a dividend or cash-surrender value. No amount is carved out as an investment in membership rights. Because of that, the court held that the plaintiffs couldn't have a tax-free exchange with zero basis and then an increased basis upon later sale of the stock. Accordingly, the court held that the trial court erred by not determining whether the plaintiffs paid anything to acquire the mutual rights, and by estimating basis by using the stock price at the time of demutualization instead of calculating basis at the time of policy acquisition. Thus, because the taxpayers did not prove that they paid for their membership rights as opposed to premiums payments for the underlying insurance coverage, they could not claim any basis in the demutualized stock. Dorrance v. United States, No. 13-16548, 2015 U.S. App. LEXIS 21287 (Dec. 9, 2015), aff'g., No. CV-09-1284-PHX-GMS, 2013 U.S. Dist. LEXIS 37745 (D. Ariz. Mar. 19, 2013).


Gross Valuation Overstatement Penalty Imposed For Charitable Easement Donation. The petitioner, a banker, and spouse contributed a permanent conservation easement on more than 80 acres to a land trust, valuing the easement at $1,418,500 million. They claimed a phased-in deduction over several years. The IRS, on audit, proposed the complete disallowance of the deduction and sought a 20 percent penalty or a zero valuation of the easement and a 40 percent penalty for gross overvaluation of the easement. IRS Appeals took the position that the 40 percent penalty should apply due to a zero valuation of the easement, and that if that weren't approved judicially a 20 percent penalty for valuation misstatement should apply. The parties stipulated to a easement valuation of $80,000 and that the petitioner had no reasonable cause defense to raise against the 40 percent penalty, but that the defense could apply against the 20 percent penalty. The court upheld the 40 percent penalty. The IRS also conceded, in order to clear the table for the penalty issue, that the petitioner, a non-farmer, was not subject to self-employment tax on CRP rental income for years 2007, 2008, 2009 and 2010. The concession was made after the IRS issued it's non-acquiescence to the Morehouse decision in the 8th Circuit in which the court determined that CRP rents in the hands of a non-farmer were not subject to self-employment tax. Legg v. Comr., 145 T.C. No. 13 (2015).


Repair Regulation Deminimis Safe Harbor Raised. In an attempt to decrease the administrative burden imposed by the repair and capitalization regulations, the IRS has increased the deminimis safe harbor for taxpayers without an applicable financial statement (AFS) from $500 to $2,500. The safe harbor establishes a floor for automatic deductibility for costs associated with tangible personal property acquired or produced during the tax year that are ordinary and necessary business expenses associated with the taxpayer's trade or business. The safe harbor provides for automatic deductibility for amounts up to $2,500 for the acquisition or production of new property or for the improvement of existing property which would otherwise have to be capitalized. The IRS Notice points out that deductibility is available for repair and maintenance costs irrespective of amount. The higher threshold on the safe harbor is effective for costs incurred during tax years beginning on or after January 1, 2016, however, the IRS will not raise on exam the issue of whether a taxpayer without an AFS can use the $2,500 safe harbor if the taxpayer otherwise satisfies the requirements of Treas. Reg. Sec. 1.263(a)-1(f)(1)(ii). In addition, if a taxpayer is under exam concerning the $500 safe harbor and the amount or amounts in issue do not exceed $2,500 per invoice, the IRS will not further pursue the matter. IRS Notice 2015-82


Sports Memorabilia Activity Not Engaged in With Profit Intent. The petitioner operated a sports memorabilia activity that he claimed occupied 12 hours of his time daily, seven days a week. The court didn't believe him because he had a different full-time job. The court also noted that the petitioner didn't have any expertise in the sports memorabilia business. Similarly, the petitioner did not follow accepted business practices, did not insure his inventory and didn't operate the activity in a business-like manner. Akey v. Comr., T.C. Memo. 2015-227.


The Peril In Using IRA Funds To Start A New Business. In this private ruling from the IRS, the taxpayer sought to use his IRA funds to buy a partnership interest. The paperwork was prepared and the partnership interest was purchased with the IRA funds, with the result that the IRA held the partnership interest. However, the advisor that prepared the paperwork failed to realize that the custodian could not hold the partnership interest (while other custodians could), and the IRA custodian reported a distribution by issuing Form 1099-R. The taxpayer sought relief from the 60-day rollover provision based on the bad advice received. The IRS denied relief on the basis that the IRA funds were used to start a business venture rather than being rolled-over exclusively for retirement purposes. Thus, a taxable distribution occurred along with any earnings on the distributed amount. Priv. Ltr. Rul. 201547010 (Aug. 26, 2015).


No Tax Credit Because Vehicle Not Timely Placed in Service. In these companion cases, the taxpayers sought to acquire a low-speed electric vehicle (LSEV) by the end of 2009 to be able to offset it's cost with the credit then available through 2009 under I.R.C. Sec. 30D. The taxpayers ordered and paid for a LSEV by the end of 2009, and title passed to them in 2009. However, neither taxpayer actually received delivery of the LSEV until mid-2010. I.R.C. Sec. 30D required that, to get the credit, the LSEV must have been placed in service by the end of 2009. The court held that because the actual date of production occurred after 2009 and the taxpayers didn't actually take delivery of the vehicles under after 2009, that the credit was not available because the vehicles had not been placed in service as they were not available for the taxpayers' personal use by the end of 2009. Trout v. Comr., T.C. Sum. Op. 2015-66 and Podraza v. Comr., T.C. Sum. Op. 2015-67.


Advances to Family Business That Fails Do Not Result in Bad Debt Deduction. The petitioner made advances during the year in issue totaling $808,000 to a family-owned business that the petitioner was a part owner of. The petitioner later claimed a bad debt deduction of $808,000 upon not being repaid. The note called for 10 percent interest, but no collateral was required and the line of credit remained unsecured. The Tax Court determined that the petitioner failed to prove that the advances were loans. There was no proof of repayment expectation or an intent to enforce collection. In addition, there was no documentation of the business's credit worthiness. The petitioner's conduct was inconsistent with that of an outside third party lender. Also, the petitioner did not prove that the advances were worthless in 2009, the year for which the deduction was claimed. The business had not filed bankruptcy even by mid-2011. Thus, no default occurred in 2009 and the court denied the bad debt deduction. On appeal the court affirmed. Shaw v. Comr., No. 13-73687, 2015 U.S. App. LEXIS 20563 (9th Cir. Nov. 18, 2015), aff'g., T.C. Memo. 2013-70.


Court Says IRS Wrong on Numerous Points Concerning Passive Loss Rules. The IRS, in this case, reclassified a significant portion of the taxpayers' (a married couple) income from non-passive to passive resulting in an increase in the taxpayers' tax liability of over $120,000 for the two years at issue - 2009 and 2010. The husband had practiced law, but then started working full-time as President of a property management company. He was working half-time at the company during the tax years in issue. He also was President of a company that provided telecommunications services to the properties that the property management company managed. The couple had minority ownership interests in business entities that owned or operated the rental properties and adjoining golf courses that the property management company managed, and directly owned two rental properties, two percent of a third rental property and interests in 88 (in 2010) and 90 (in 2009) additional entities via a family trust. They reported all of their income and losses from the various entities as non-passive, Schedule E income on the basis that the husband was a real estate professional under I.R.C. Sec. 469(c)(7) and that they had appropriately grouped their real estate and business activities. The IRS claimed that the husband was not a 5 percent owner of the property management company, thus his services as an employee did not constitute material participation. IRS also claimed that the husband was not a real estate professional and that the activities were not appropriately grouped. The court agreed with the taxpayers, determining that the husband was a real estate professional on the basis that he owned at least 5 percent of the stock of the property management company. The court determined that he had adequately substantiated his stock ownership and he performed more than 750 hours of services for the property management company - a company in the real property business. The court also determined that the taxpayers had appropriately grouped their rental activities, rejecting the IRS argument that real estate professional couldn't group rental activities with non-rental activities to determine income and loss. The court held that that Treas. Reg. Sec. 1.469-9(e)(3)(i) only governs grouping for purposes of determining material participation, and doesn't bar real estate professional from grouping rental activity with non-rental activity when determining income and loss (as the IRS argued). Accordingly, the taxpayers had appropriately grouped their renal activity with the activities of the telecommunications company and the adjacent golf courses as an appropriate economic unit. As such, the grouped non-rental activities were not substantial when compared to the aggregated rental activity. The activities were under common control and, under Treas. Reg. Sec. 1.469-9(e)(3)(ii), the husband could count as material participation everything that he did in managing his own real estate interests - his work for the management company could count as work performed managing his real estate interests. Note - in CCA 201427016 (Apr. 28, 2014), the IRS said that the aggregation election under Treas. Reg. Sec. 1.469-9(g) has no bearing on the issue of whether a taxpayer qualifies as a real estate professional and the 750-hour test is not applied as to each separate activity. This was not involved in the case. Stanley v. United States, No. 5:14-CV-05236, 2015 U.S. Dist. LEXIS 153166 (W.D. Ark. Nov. 12, 2015).


Offer-In-Compromise Properly Rejected Where Taxpayer Dissipated Assets. The petitioner had an unpaid tax liability exceeding $600,000 and submitted an offer-in-compromise (OIC) at a collection due process (CDP) hearing. The OIC was for $2,938. The IRS rejected the OIC on the basis that the petitioner had withdrawn over $400,000 from his retirement accounts and that the reasonable collection potential exceeded over $500,000. The court held that the IRS did not abuse its discretion in rejecting the OIC. Chandler v. Comr., T.C. Memo. 2015-215


No Deductions Due to Lack of Documentation. The petitioner claimed deductions for meals and entertainment, parking fees, tolls and transportation-related expenses, cost-of-goods sold for solar panels and a home office. As for the solar panels, the only documentation provided was a quote for 1,000 units. Concerning the home office, the only substantiation was the petitioner's testimony and the floor plan and area used for the office. No business interest deduction was allowed because there was no evidence that the use of the loan proceeds was for something other than personal purposes. The court agreed with the IRS position on the deductibility of the expenses (some were allowed, but most denied). Smith v. Comr., T.C. Memo. 2015-214.


IRS Calculation of Business Use Upheld. The petitioner was a surgeon that had a private practice in one location and also was an 喹on-call嗹 surgeon at a hospital about 25 miles away from his private practice location. At the hospital he had to work a 24-hour period three days monthly and had to be available during emergencies. He had various medical conditions and bought a motor home that he could park near the hospital that he could use for rest and sleep during the 24-hour shifts. He reviewed patient charts in the motor home and referred to his medical books and other information while in the motor home. He did maintain mileage logs that separated out the business and personal use of the motor home. On audit, the IRS allocated the allowable depreciation (including expense method) between his business and personal use. The petitioner claimed that he used the motor home for business purposes 85% of the time during his 24-hour work days. The court upheld the IRS position, noting that the motor home was used only 27 days for business in 2008 and 36 days in 2009. The petitioner啹s own logs showed that his business use was approximately 20 percent for the two tax years in issue. Cartwright v. Comr., T.C. Memo. 2016-212.


Delivery to IRS of Notice of Non-Judicial Sales is No Good. In the facts of this ruling, the question arose as to whether notices of a non-judicial sale could be delivered to the IRS by private delivery services such as United Parcel Service (UPS) or FedEx. The IRS noted that under I.R.C. §7425(c), the notice of sale must be given in writing, by registered or certified mail or by personal service, not less than 25 days prior to sale. The fact that the IRS actually received the documents does not matter. Delivery by private delivery service such as FedEx or UPS didn啹t count. C.C.A. 201545025 (Jun. 12, 2015).


Real Estate Professional Rules Not Satisfied and Rental Losses Disallowed. The petitioner was a licensed real estate appraiser and director of real estate valuation at two national CPA firms, but did not own an equity interest in either businesses. After getting married, the petitioner had three condominiums that he and his wife rented out. He claimed that he put in more than 750 hours in managing the rental activities and that he spent most of his time on rental activities, but did not provide any log to document his time. His wife had some notes, but nothing that carefully substantiated the time she spent on rental activities. However, she did construct an activity log after the IRS selected their return for audit. For the year at issue, the petitioner and spouse claimed about $40,000 in losses from the rental activity. The IRS denied the losses due to failure to satisfy the real estate professional exception to rents being passive. The court agreed, and noted that the petitioner's work for the CPA firms did not count toward the750-hr test because he didn't have an ownership interest in those businesses. The evidence also did not support the argument that petitioner's wife met the 750-hr requirement. The court upheld the imposition of an accuracy-related penalty. Calvanico v. Comr., T.C. Sum. Op. 2015-64.


Charitable Deduction of Trust Not Limited To Adjusted Basis in Donated Property. The settlors created a dynasty trust in 1993 with terms authorizing the trustee to make charitable distributions out of the trust's gross income at the trustee's discretion. The trust wholly owned a single-member LLC and in 2004, the LLC donated properties that it had purchased to three charities. Each property had a fair market value that exceeded basis. The LLC received the funds to buy the properties from a limited partnership's distribution to the trust in which the trust was a 99 percent limited partner. The limited partnership owned and operated most of the Hobby-Lobby stores in the U.S. The IRS claimed that the trust could not take a charitable deduction equal to the full fair market value, but should be limited to the trust's basis in each property. The trust claimed a charitable deduction in excess of $20 million on Form 1041 for 2004, and later filed an amended Form 1041 increasing the claimed charitable deduction to just shy of $30 million, and seeking a tax refund of over $3 million. The IRS denied the refund, claiming that the charitable deduction was limited to cost basis. The trust paid the deficiency and sued for a refund. On the trust's motion for summary judgment, the parties agreed that the donated properties were acquired by the trust with funds coming from gross income from a pre-2004 tax year. Thus, according to the trust, I.R.C. Sec. 642(c)(1) allowed the charitable deduction to be computed based on the donated property's fair market value. The court agreed, noting that I.R.C. Sec. 642(c)(1) allowed a deduction without limitation contrary to the basis limitation contained in I.R.C. Sec. 170, and that charitable deduction provisions are to be construed liberally in the taxpayer's favor. The court noted that the donated properties were all acquired with distributions from the limited partnership to the trust, and each distribution was part of the LLC's gross income for the year of distribution. Thus, the donated properties were clearly bought with funds traceable to the trust's gross income and were donated under the terms of the trust. The court noted that the IRS admitted that there was no caselaw or other substantial authority that supported the government's position. The court granted summary judgment for the trust. Green v. United States, No. CIV-13-1237-D, 2015 U.S. Dist. LEXIS 151539 (W.D. Okla. Nov. 4, 2015).