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 producers, agricultural businesses and rural landowners.

Posted June 5, 2023

IRS Focuses on Wrong Issues – Loses Hobby Loss Argument. The Oklahoma ranch at issue was originally owned by the petitioner’s grandmother and then inherited by petitioner’s mother. In 2009, as part of a family succession plan, the petitioner’s mother transferred the ranch to a revocable trust. Under the trust’s terms, if the mother died and was predeceased by the petitioner’s stepfather, the ranch would pass equally to the petitioner and her brother. If the petitioner’s stepfather were alive at the time of the mother’s death, the ranch would remain in trust for his life and then distribute equally to the petitioner and her brother upon the stepfather’s death. The petitioner and her mother executed two separate agreements in 2013 and 2016 whereby the petitioner agreed to contribute financially to the ranch and that the petitioner and her mother would jointly agree about the amount, if any, of cash distributions from ranch earnings would be made to the petitioner. From 2014 to 2019, the petitioner paid the ranch expenses, but the mother reported on her return the income from cattle sales. The petitioner did not receive any cash distributions from ranching activities and as a result did not report ranch income. The petitioner’s children participated in rodeos, and the income from the rodeo activities were reported on the petitioner’s Schedule F under “livestock activities.” For 2017, the petitioner’s Schedule F reported gross income of $2,741 and deductions of $128,990 from the ranching activity. For 2018, the petitioner’s Schedule F reported gross income of $8,063, including $1.867 of compensation for labor services performed by the children for local ranches and $6,196 for the childrens’ rodeo competition winnings. Expense deductions claimed on Schedule F were $133,929. From 2014-2019, the petitioner reported cumulative losses of $502,742 on Schedule F which far exceeded the cumulative Schedule F gross income and largely offset the ordinary income of the petitioner and her husband (primarily wage income). IRS audited and determined that the Schedule F activity was rodeo and not ranching, ignoring the fact that the Schedule F expenses were predominantly from the ranching activity. As a result, the IRS determined that the rodeo activity was not engaged in with the requisite profit motive and disallowed all Schedule F deductions for 2017 and 2018. The Tax Court determined that the IRS had focused improperly on the rodeo activity rather than the ranching activity, noting that the petitioner had credibly testified that the Schedule F activities primarily related to the ranch and not to rodeos. As such, the losses related to the ranching activity and not the rodeo activity, and the IRS failed to challenge the profit motive of the ranching activity. The Tax Court refused to allow the IRS to refocus its challenge to the Schedule F deductions on the ranching activity, holding that the IRS had waived its right to do so. Thus, the activity reported on Schedule F for 2017 and 2018 was deemed to be engaged in for profit. Carson v. Comr., No. 23086-21S (U.S. Tax Ct. Mar. 22, 2023).

Note:It could be expected that the IRS would question the arrangement between the petitioner and her mother. What was not anticipated is that the IRS would focus solely on the Schedule F income that resulted solely from the rodeo activity of the children. The arrangement between the petitioner and her mother was more akin to that of a partnership, and the fact that the ranch was in a revocable trust meant that the mother could revoke the trust at any time possibly leading to an IRS argument that there really wasn’t a trade or business activity being conducted. Indeed, the expenses the petitioner paid were really the trust’s expenses. It was the trust that was conducting the trade or business activity. Clearly, the arrangement was designed to prevent the petitioner from recognizing any income. But the IRS made the mistaken assertion that the primary purpose of the business was to fund the rodeo activities of the children, and failed to acquire and analyze relevant information about the nature of the ranching activity.

Posted June 5, 2023

Tax Court Draws Line on Trade or Business Deductible Expenses. The petitioners, husband and wife, were equal shareholders in a wholly owned S corporation. The husband was also employed by three different software development companies. As the S corporation business grew, he phased out his other work. He also formed an LLC the rented office space. The S corporation served as the LLC’s operating manager. The LLC ultimately failed. On their return for 2011, the petitioners reported losses from the S corporation and income from the LLC for a total loss of $60,491. On the S corporation return for 2011, the S corporation reported itemized expenses and “other deductions” that included auto, travel, gifts, supplies, home office rent and other expenses. The 2012 return was similar as was the 2013 return. The IRS challenged the deductions and LLC basis issues. The Tax Court determined that because the expenses were not incurred for the purposes of protecting the husband’s interest in the S corporation but were incurred to help him conduct his trade or business as an S corporation employee, all of the expenses were unreimbursed ordinary and necessary employee expenses deductible to the extent they exceeded two percent of the petitioners’ adjusted gross income. (Under current law, none of the expenses would be deductible). In addition, the petitioners failed to establish that the S corporation had an accountable plan satisfying Treas. Reg. §1.62-2(d)-(f). Thus, the expenses incurred personally in connection with his employment with the S corporation were unreimbursed employee expenses. The petitioners also failed to substantiate their basis in the LLC and were limited to the deductions the IRS allowed. The Tax Court upheld the IRS imposition of penalties. Simpson v. Comr., T.C. Memo. 2023-4.

Posted June 5, 2023

Value of Employer-Provided Housing Not Excludible from Income. The petitioner was an Air Force veteran and engineer who accepted an offer of employment with a defense contractor to work as an engineer in Australia. He was given options for housing - 1) a furnished house for which he would have to report the fair rental value on his return; or 2) a payment to compensate him for the cost or owning or renting housing. He accepted company-provided housing approximately 11 miles from his work location. After eight years of living in the company-provided housing, the company ceased providing housing and he had to find housing on his own. For 2016 and 2017, the petitioner reported the value of the housing provided to him on his return, but then filed amended returns that claimed an offsetting deduction for “employee benefit programs.” On his 2018 return he reported the value of the housing but also claimed a deduction for “employee benefit programs.” The IRS disallowed the deductions. The Tax Court noted that certain conditions must be satisfied to exclude the value of employer-provided lodging from income under I.R.C. §119 – the lodging must be furnished for the convenience of the employer; furnished on the business premises; and the employee must be “required to accept the lodging as a condition of employment. The Tax Court determined that the lodging was not furnished on the business premises. The petitioner’s occasional business activities at the home were not sufficient enough to establish that the housing was integral to the employer’s business activities and the housing was not necessary for the performance of his duties. Smith v. Comr., T.C. Memo. 2023-6.

Posted May 5, 2023

Constructive Dividends, Imputed Wages and Fraud Penalty. The petitioners, a married couple, were the sole shareholders and only officers of a day care center organized as a corporation. The wife oversaw and supervised employees and made the hiring and firing decisions a managed the day care’s directors at the six locations. The employees, which include petitioners’ children, reported to her. The husband was the secretary and treasurer and handled the accounting and finance side of the business. The husband also worked as an electrician and reported Schedule C income. The petitioners were also the sole owners of an S corporation, and a limited liability company. The petitioners collectively actively participated in the day care’s daily operation 50-60 hours per week. For the tax years in issue, they did not receive a salary or wage, but the day care paid a management fee to the S corporation which then paid wages to the petitioners and their children. But the petitioners’ children were not employees of the day care during the years at issue. The petitioners and their children used credit cards to make purchases necessary to operate the daycare centers, but they also regularly used them to pay personal expenses. During 2004 through 2007 the petitioners and their children charged thousands of dollars in personal expenses on the day care’s credit card account, as well as their own credit cards, all of which the day care paid. The children continued to make personal purchases with the cards even though they were not employees of either the day care or the S corporation. The day care also provided the petitioners and their children with vehicles with the day care paying the notes on the cars and claiming depreciation on the vehicles. The IRS issued notices of deficiency to the day care and challenged the worker classification. In prior opinions, the Tax Court determined that the petitioners were both employees of the day care, disallowed the deductions. The Tax Court also disallowed the petitioners’ I.R.C. §45A tax credit (Indian employment tax credit) because the day care was owned 51 percent by an Indian. The Tax Court also held that the petitioners received constructive dividends and imputed wages from the day care center. The Tax Court also upheld the civil fraud penalty of I.R.C. §6663 that IRS had imposed. The Tax Court determined that the IRS “clearly and convincingly demonstrated for each year at issue that petitioners failed to report income from various sources” and had fraudulent intent based on the presence of numerous “badges of fraud” that were evident from the facts. Hacker v. Comr., T.C. Memo. 2022-16.

Posted May 5, 2023

IRS Obsoletes R&A Revenue Ruling. Effective July 31, 2023, the IRS has obsoleted Rev. Rul. 58-74, 1958-1 CB 148 that allowed taxpayers using the expense method of accounting for research and experimental expenditures under I.R.C. §174(a) pre-2018 to deduct on an amended return research and experimental expenditures that were not deducted in a prior year. The IRS said the reason for obsoleting Rev. Rul. 58-74 was not because of the TCJA amendments but because Rev. Rul. 58-74 lacked enough facts "to properly analyze whether the taxpayer's failure to deduct certain research or experimental expenditures, such as the cost of obtaining a patent, when it deducted other research or experimental expenditures, constituted a method of accounting or an error." The IRS noted that if a taxpayer failed to deduct the expenditures because of a change in method of accounting, relying on Rev. Rul. 58-74 to file an amended return, refund claim, or administrative adjustment request would conflict with the "statutory requirement that a taxpayer must secure the consent of the Commissioner to change a method of accounting" and would be inconsistent with "the IRS's position that a taxpayer may not, without prior consent, retroactively change from an erroneous to a permissible method of accounting by filing amended returns." IRS noted that taxpayers have until July 31, 2023, to file a refund claim, an amended return, or an administrative adjustment request in reliance on the ruling if their claim falls under certain parameters. Rev. Rul. 2023-08, 2023-18 IRB 801.

Posted May 5, 2023

Safe Harbor Language Provided for Conservation Easement Deeds. Under Section 605(d)(1) of the SECURE 2.0 Act, which was enacted as part of the Consolidated Appropriations Act, 2023, P.L. 117-328, the IRS was required to provide safe harbor language for extinguishment and boundary line adjustment clauses in conservation easement deeds by April 28, 2023. IRS issued this Notice on April 24, 2023, providing the safe harbor language and triggering a 90-day period for a donor to amend an easement deed to substitute the safe harbor language for the corresponding language in the original deed. Thus, under Section 605(d)(2) of the Secure Act 2.0, donors are allowed, but not required, to amend their deeds to include this language. Donors wanting to make the change must do so by July 24, 2023. Any amendment will be treated as effective as of the date of the recording of the original easement deed. IRS points out in the Notice that an amendment cannot be made for any easement deed relating to any contribution that was part of a reportable transaction or was a transaction that was not treated as a qualified conservation contribution by reason of I.R.C. §170(h(7); a transaction for which a charitable deduction contribution had been disallowed by the IRS and the donor was contesting the disallowance in federal court before the amended deed was recorded; or a transaction for which a claimed charitable deduction for the contribution resulted in an underpayment and a penalty under I.R.C. §6662 or §6663 had been finally determined. Notice 2023-30, 2023-17 IRB 766.

Posted May 5, 2023

Substantiation of Expense Deductions at Issue.The petitioners, a married couple, claimed various business-related deductions for the tax years at issue (2015 and 2016) as well as Schedule A deductions. The wife was an account executive with a copying company, and she also operated her own insurance business selling supplemental insurance policies. Her job required her to travel to client sites in central Florida from her home in Jacksonville. The husband was an area manager for a courier service with a service area from Vero Beach, FL to Key West, FL, and he was required to deliver on-demand packages to clients in that area. He traveled from his employer’s warehouse weekly and sometimes stayed overnight in hotels. The petitioners claimed Schedule A deductions for vehicle expenses, meals and entertainment, tool and supply expenses, uniform expenses, medical expenses and other business expenses. They also claimed Schedule C deductions for business use of the home, meals and entertainment, supplies, repairs and maintenance, legal and professional services, insurance, utilities, office, car and truck expenses, travel and mortgage interest. No bank records or statements, itemized receipts, or credit card statements substantiated the Schedule C expenses. The only substantiation of Schedule A expenses were contemporaneous mileage logs while traveling, certain bank statements and receipts, and receipts for certain medical expenses. The IRS disallowed all Schedule A deductions for 2015 and about $20,000 of deductions for 2016. The IRS disallowed all Schedule C deductions for both years. The IRS also imposed an accuracy-related penalty for both years. The Tax Court allowed Schedule A deductions for vehicle mileage for miles driven on behalf of the petitioners’ employers for each year but denied all other Schedule A deductions due to lack of substantiation. The Tax Court upheld the disallowance of Schedule C deductions and upheld the accuracy-related penalty. Patitz v. Comr., T.C. Memo. 2022-99.

Posted April 26, 2023

Corporation Separate Entity from Shareholders.The petitioners operated a farm individually and through several related entities including an S corporation and a partnership. The petitioners were shareholders of an S corporation and they paid property taxes and utility expenses on behalf of the S corporation in proportion to their respective ownership interests and deducted the amounts on their personal returns. The IRS denied the deductions and the Tax Court agreed. The Tax Court noted that a taxpayer cannot deduct expenses paid on behalf of another taxpayer. Deputy v. du Pont 308 U.S. 488 (1940). That rule extends to corporations and their shareholders. Westerman v. Comr., 55 T.C. 478 (1970). A shareholder cannot deduct as a personal expense an expense that furthers the corporation’s business. Kahn v. Comr., 26 T.C. 273 (1956). While there is a limited exception allowing a deduction by a shareholder on behalf of a corporate taxpayer for an expenditure the corporation is financially unable to pay to "protect or promote" the business (see, e.g., Lohrke v. Comr. 48 T.C. 679 (1967)), the exception did not apply in this case. The Tax Court pointed out that although S corporate income or loss eventually flows through to the shareholders a corporation “remains a separate taxable entity [from its shareholders] regardless of whether it is a subchapter S corporation or a subchapter C corporation.” Russell v. Comr., T.C. Memo. 1989-207. Thus the business expenses of the S corporation could not be disregarded at the corporate level for purposes of I.R.C. §162. The income of the S corporation had to be matched at the corporate level against the S corporation’s expenses that were incurred to produce that income before the net income or loss amount can flow through to the shareholders. I.R.C. §1366(a)(2). The partnership bought two semi-trucks and included the expense as part of its claimed repairs and maintenance expense deduction on Schedule F of its Form 1065 which the IRS disallowed. The Tax Court upheld the IRS determination, noting that the partnership had not made an I.R.C. §179 election on its return for the truck expenses. Vorreyer, et al. v. Comr., T.C. Memo. 2022-97.

Transfer of Patent to Related Entity Triggers Capital Gain; No Carryover NOL Allowed.The petitioner had numerous patents and transferred his rights in the patents to a related entity. While the sale of a patent normally produces capital gain, the Tax Court agreed with the IRS that the transfer to a related entity disqualified the transaction for capital gain treatment. The Tax Court also held that the amount the petitioner received on the transfer to the related entity was subject to self-employment tax. The Tax Court also determined that the petitioner was not entitled to a carryover of a net operating loss from an involuntary conversion that that petitioner claimed occurred when the state of California allegedly infringed on his patent thereby reducing the value of his shares in the corporation holding the patent. The Tax Court based its conclusion on the fact that a mere loss in value doesn’t establish a net operating loss and because he neither sold nor exchanged his shared in accordance with I.R.C. §165(f) nor shown that they were rendered useless during the tax year under I.R.C. §165(g). The petitioner’s alternative argument that a Fifth Amendment taking by “inverse condemnation” resulting in a casualty loss also failed because the casualty loss rules, the Tax Court determined, didn’t apply to shares that were part of a trade or business and patent infringement does not constitute a Fifth Amendment taking and/or because there had been no finding of patent infringement in the first place which would give the Tax Court jurisdiction over the issue. On appeal, the Ninth Circuit affirmed, and the U.S. Supreme Court declined to hear the case. Filler v. Comr., T.C. Memo. 2021-6, aff’d., No. 21-71080, 2022 U.S. App. LEXIS 19356 (9th Cir. Jul. 13, 2022), cert. den., No. 22-784, 2023 U.S. LEXIS 1166 (Mar. 20, 2023).

Posted April 18, 2023

Innocent Spouse Relief Granted.The petitioner divorced her husband in 2016, but they had failed to file joint tax returns for 2010 and 2015. While the Tax Court held that the couple could not deduct unreimbursed employee expenses in 2010 that he incurred while traveling away from home to work on construction sites, the Tax Court did grant her innocent spouse relief attributable to the understatements of tax for 2010 and 2015 because, based on the facts, she neither knew nor had reason to know of the items giving rise to the understatements. Todisco v. Comr., T.C. Sum. Op. 2021-35.

No Trade or Business in Existence.The decedent was a real estate developer than went into receivership in 2009. In late 2008, the decedent had formed a single-member LLC through which he would conduct a search for another trade or business. He spent all of his time working for the LLC. He hired employees and consultants to help him find new business opportunities. He also continued to be involved with other entities that he had formed in prior years. He claimed losses from these other entities for the years in issue and net operating losses (NOLs) arising from prior years. The IRS denied the loss deduction on the basis that none of the decedent’s activities constituted a trade or business for the years in question. The IRS maintained that all of the claimed expenses were either start-up expenses under I.R.C. §195 or non-deductible personal expenses under I.R.C. §262. The decedent claimed that he was merely continuing his existing homebuilding business, such that I.R.C. §195 did not apply. The Tax Court, disagreed, noting that the decedent had not abandoned his old business at the time the receiver took control. But, the appointment of the receiver caused, based on the facts, the decedent to no longer be in the homebuilding business. The petitioner also claimed that he was, through his LLC, in the trade or business of finding another trade or business. Again, the Tax Court disagreed. A general business search does not constitute the “carrying on a trade or business” requirement of I.R.C. §162. The Tax Court determined that the “business investigation expenses” that the decedent incurred in 2012 met the definition of start-up expenses under I.R.C. §195, but because the decedent didn’t acquire a new business by the end of 2012, not business was deemed to have begun during 2012. Thus, the decedent had no current operating business during 2012 resulting in no deductions under I.R.C. §162 and no start-up costs to be capitalized under I.R.C. §195. Estate of Morgan v. Comr., T.C. Memo. 2021-104.

No Tuition Deduction for Amounts Paid For Daughter’s Boyfriend.The petitioner as a commercial painting contractor with stock owned by a married couple. Their daughter’s boyfriend took a course in coding at Northwestern University. The boyfriend had no coding experience before taking the course, but had worked in the construction industry. The petitioner paid the tuition for the course and claimed it as a deductible business expense under I.R.C. §162 because the boyfriend used what he learned in the course to update the petitioner’s website (for which he was not paid). The Tax Court disallowed the deduction under I.R.C. §262. While the petitioner claimed that the boyfriend received the tuition in exchange for the web services he later provided, the Tax Court found other factors indicating that the expense was personal in nature and was merely paid through the petitioner. The boyfriend provided free services to the petitioner; was not an employee of the petitioner; and the petitioner paid the tuition without any expectation of a return. The only real link, the Tax Court noted, that the boyfriend had with the company was that he was dating the owners’ daughter. The boyfriend had no legal obligation to provide the web services to the petitioner. Sherwin Community Painters, Inc. v. Comr., T.C. Memo. 2022-19.

IRS Issues Proposed Regulations on SECURE Act Changes.The SECURE Act made significant changes to rules related to inherited IRAs. But, the biggest changes were made to distributions to designated beneficiaries. For non-designated beneficiaries, the rules remain largely unchanged. The IRS has now issued proposed regulations addressing the changes that the SECURE Act made. REG-105954-20, Fed. Reg. Vol. 87, No. 37, February 24, 2022.

Sole Shareholder Responsible for Corporation's Tax Debt.The petitioner formed a corporation to run used-car lots. The petitioner was the sole director, office and shareholder. He had complete control over the corporation. The IRS claimed that the corporation owed almost $2 million in federal taxes, and asserted that the petitioner, his wife and the corporation were responsible for the deficiency. The petitioner liquidated his corporation and various non-exempt assets to pay the tax and sued for a refund. The trial court determined that the corporation was the petitioner’s alter ego and, as such, the petitioner was personally responsible for the tax. The petitioner appealed and the appellate court affirmed. The appellate court noted that under applicable Texas law a court may disregard the corporate “fiction” when it has been used as an unfair device to achieve an inequitable result – including use as a taxpayer’s alter ego. There was no doubt, the appellate court concluded, that the facts established a unity between the corporation and the petitioner. The appellate court noted that the petitioner failed to observe certain corporate formalities; loaned substantial sums to the corporation; and made payments from the corporate bank account to service personal loans. United States v. Lothringer, No. 20-50823, 2021 U.S. App. LEXIS 30283 (5th Cir. Oct. 8, 2021), cert. den., 21-1189, 2022 U.S. LEXIS 1827 (U.S. Sup. Ct. Apr. 4, 2022).

Evidentiary Issues Sink Taxpayer.The petitioners, a married couple operated a medical funding and real estate business through a wholly-owned S corporation. Inc. The husband was the sole shareholder. On its 2013 Form 1120S, the S Corporation reported gross receipts of $1,829,524. For the 2013 tax year, the IRS determined a $923,280 deficiency and accuracy-related penalties, under section I.R.C. §6662(a), in the amount of $184,676. The petitioners claimed that they overstated the S corporation’s gross receipts for the 2013 taxable year by $955,599, and that there was sufficient basis in one of the S corporation’s subsidiaries to deduct pro rata shares of a loss for the 2013 taxable year. None of the agreements related to the S corporation’s operations were presented to the IRS, and the record was void of any evidence of income that the S corporation received from the operations. The petitioner testified that he altered the QuickBooks computer files on multiple occasions after the S corporation returns were prepared, including during the IRS audit, and due to a computer crash, computer files for the S corporation and its subsidiaries were destroyed. However, the evidence did show that the S corporation made and received money transfers to and from its many disregarded subsidiaries, and those transfers—and evidence of the many bank accounts used by the S corporation for the transfers—were at issue. But the petitioners, after engaging an accountant to reconstruct the S corporation’s books, believed that the S corporation’s income was overstated when he signed and filed the S corporation’s return and their personal returns. The reconstruction expert prepared and sought to admit summaries of the S corporation’s bank statements, some of which were near 60 pages in length. The Tax Court held the petitioners liable for $923,000. They failed to prove they had overreported their income or that they were entitled to a deduction for pass-through losses. The petitioners did not provide rental statements and invoices that would have corroborated the recalculation of their 2013 gross receipts. The pass-through loss deduction was denied due to lack of proof of sufficient basis in the S corporation. Kohout v. Comr., T.C. Memo. 2022-37.

Value of Airline Tickets Included in Gross Income.The petitioner is a retired airline pilot that participated in United Airline’s Retiree Pass Travel Program (RPTP). In 2016, United, through the RPTP, provided free airline tickets to the petitioner, his wife, daughter, and two adult relatives. The petitioner did not include the value of the free tickets two “enrolled friends” (likely relatives) in income on their 2016 tax return on the basis that it was a de minimis fringe benefit. United Airlines issued Form 1099-Misc. to the petitioner for the relatives’ ticket values and the IRS determined that the value of the tickets provided to the two adult relatives was required to be included and issued a notice of deficiency containing an adjustment for the omitted income. Total tax due was $2,862.00. The Tax Court agreed with the IRS’ position and granted summary judgment. The Tax Court noted that the petitioner failed to allege any facts or legal argument to counter the IRS position. The Tax Court determined that the value of the relatives’ tickets was not excludible under I.R.C. §132(a)(1) as a “no-additional-cost services” because the relatives were not the petitioner’s dependent children. The tickets were also not exludible under I.R.C. §132(a)(4) as a “de minimis fringe” because the tickets had a value high enough that accounting for their provision was not unreasonable or administratively impracticable. Mihalik v. Comr., T.C. Memo. 2022-36.

Company Founder Was Employee.The petitioner was formed in 1980 to serve as a vehicle for one of its officers to conduct seminars on real estate development. The petitioner was granted I.R.C. §501(c)(3) status. The officer in question also was a member of the board of directors of the petitioner. The petitioner was inactive for almost all years from 1980 to 2010 and offered the officer’s seminars only in 1980 and 1990. In 2010, the petitioner offered an online course to the public. The office exercised complete control over the petitioner’s online course, often working 60 hours per week with the course and its students. The petitioner’s sole source of income was derived from tuition associated with the online course, and the officer was paid by the petitioner based on enrollment from the course. For the petitioner’s 2015 tax year, the petitioner reported total revenue of $255,605 on Form 990 and salaries, other compensation and employee benefits of $91,918. The petitioner issued the office a Form 1099-Misc. for the $91,918 and did not file Form 941 for any of the periods at issue. No employer tax returns reporting payments to the officer as salary or wages were filed. Upon audit, the IRS sought additional information concerning the treatment of the officer as an independent contractor, and information on whether the petitioner met the requirements for Section 530 employment tax relief. In response, the petitioner claimed that the officer was never an employee and Section 530 relief was inapplicable. IRS determined the officer to be an employee for employment tax purposes and that the petitioner was not entitled to Section 530 relief. The IRS assessed employment tax liabilities and penalties under I.R.C. §6656. The Tax Court agreed with the IRS, noting that the officer had a hand in every aspect of the petitioner’s business and that, as a result, his work as a corporate officer was more than minor and didn’t qualify for Section 530 relief. REDI Foundation, Inc. v. Comr., T.C. Memo. 2022-34.

Easement Donation Case Heads to Trial.The petitioner sought a readjustment of partnership items after the IRS disallowed the petitioner’s $26 million deduction for the donation of a syndicated conservation easement and assessed penalties. The IRS claimed that the deed granting the easement on 232 acres of farmland near Birmingham, Alabama, failed to protect the easement in perpetuity as I.R.C. §170(h)(5)(A) requires. The IRS moved for summary judgment. The Tax Court analyzed the language of the deed granting the easement and first noted that it did not specify the point in time at which the fair market value of the donee’s property right in the farmland was to be calculated. Also, the Tax Court noted that the deed language did not address the possibility that the easement might be extinguished in a future judicial proceeding. While the deed stated that the parties intended that there would not be future event that would result in extinguishment of the easement and that nothing could happen that would cause the easement donation to fail as a qualified contribution under I.R.C. §170(h). While the deed indicated that the easement could be terminated by the exercise of eminent domain, it did not clearly specify how any proceeds were to be allocated. The Tax Court noted that Treas. Reg. §170A-14(g)(6)(i) establishes a formula for determining the allocation of proceeds between the donor and donee upon the extinguishment of the easement. However, the Tax Court reasoned that the deed’s general language that I.R.C. §170(h) would not be violated gave the petitioner a reasonable argument that it hadn’t violated the requirement that the easement be protected in perpetuity or the “extinguishment” regulation. Accordingly, summary judgment for the IRS on the “protected in perpetuity” requirement was denied. However, the Tax Court granted summary judgment to the IRS on the penalty issue finding that the petitioner’s claim that the Revenue Agent may have communicated information regarding an assessment to the petitioner failed to introduce a fact issue. Morgan Run Partners, LLC v. Comr., T.C. Memo. 2022-61.

IRS Properly Denied Installment Agreement.The IRS may consider a taxpayer as qualified for an installment agreement to pay an outstanding tax obligation upon the satisfaction of six requirements: 1) the taxpayer files any delinquent returns; 2) if applicable, the taxpayer files any outstanding employment tax returns; 3) if applicable, the taxpayer makes all current payroll tax deposits; 4) the taxpayer completes Form 433-B with the financial information (supported by documentation) needed to negotiate a payment arrangement to satisfy the delinquent taxes; 5) the taxpayer provided the financial information to the IRS agent working the case and requests and installment agreement in writing specifying the amount per month intended to be paid, the date the payments will begin and the tax periods the installment agreement covers; and 6) the taxpayer must comply with IRS deadlines for providing additional documentation or information. In this case, the IRS denied the petitioner’s request for an installment agreement because the petitioner was not current on her Federal tax filings and didn’t supply financial information on Form 433-A. The petitioner also didn’t provide the IRS with a specific proposal for the installment payments. The Tax Court upheld the denial by the IRS. Roberts v. Comr., T.C. Memo. 2021-131.

Penalties Imposed on Donated Conservation Easement Transaction.The petitioner donated a conservation easement to a qualified charity and claimed a $25.5 million charitable donation deduction. The IRS challenged the valuation of the easement and its validity in an earlier decision, the Tax Court agreed, disallowed the deduction and imposed a 40 percent penalty for gross overvaluation of the easements. The deduction was disallowed because the easements were not protected in perpetuity due to a provision in the deeds granting the easements to the charity that reduced the charity’s proportionate share of the sale proceeds by in impermissible carve-out for donor improvements upon a judicial extinguishment of the easements. In the present case, the IRS sought an additional 20 percent penalty for negligence due to the petitioner’s substantial understatement of tax under I.R.C. §6662(a) and (b)(1)-(2). The 20 percent penalty would apply to the portion of the underpayment resulting from the Tax Court’s decision in the prior case that the petitioner was not entitled to a charitable deduction. The Tax Court did not allow the 20 percent accuracy-related penalty because the petitioner had reasonable cause and acted in good faith with respect to the claimed charitable deduction corresponding to the correct valuation of the easements. Plateau Holdings, LLC, Waterfall Development Manager, LLC, Tax Matters Partner, T.C. Memo. 2021-133.

Jewelry Gift Not Properly Substantiated.In 2014, the petitioner donated approximately 120 pieces of Native American jewelry to a museum, a qualified charity. The museum executed a “Deed of Gift” which specified, in part, that “all rights, titles, and interests” in the jewelry were transferred from the donor to the donee upon donation unless otherwise stated in the Gift Agreement. The petitioner claimed a charitable deduction for the donation on her 2014 return and supported the claimed deduction by submitting the “Deed of Gift” documentation. The IRS denied the deduction on the basis that the “Deed of Gift” documentation did not meet the substantiation requirements of I.R.C. §170(f)(8)(B) that require a description of the donated item(s), whether the donee provided any form of consideration in exchange for the donation, and a good faith estimate of the value of the donation. The IRS pointed out that the “Deed of Gift” documentation from the museum did not state whether the museum provided any goods or services in return for the donation. In addition, the terms of the “Deed of Gift” documentation with the museum referred to a superseding agreement, “the Gift Agreement,” which left open the question of whether the donor retained some title or rights to the donation, and also indicated that the petitioner’s documentation did not include the entire agreement with the done. The Tax Court agreed with the IRS and held that the petitioner did not comply with the substantiation requirements of I.R.C. §170(f)(8)(B) and denied the charitable deduction. Albrecht v. Commissioner, T.C. Memo. 2022-53.

Fact Issues Remain on Reason for Sale of Home.The petitioners, a married couple, bought a home in 2005. The wife was diagnosed with cancer later that year and underwent costly treatments. They resided in the home until 2009 and then rented out the home and resided in another home the husband owned. The sold the first home in 2015. They filed joint returns for tax years 2010 through 2015. During those years, they reported income from the lease of the Mercer Island house on Schedule E. They reported that they used the home for personal purposes for 14 days in 2010 and zero days in 2011 through 2015. Their depreciation schedules mirrored the number of fair rental days reported for the property on their Schedule E. On their 2015 return, they reported the sale of the Mercer Island house but excluded the gain from gross income. The IRS audited and asserted that the income from the sale of the home should have been reported and moved for summary judgment. The Tax Court granted summary judgment to the IRS on the issue of whether the petitioners used the home as their principal residence for at least two of the last five years immediately preceding the sale as I.R.C. §121 requires. They did not. However, the Tax Court determined that issues of material fact remained on whether the wife’s health problems were the primary reason for the sale such that the gain might be excludible because the sale was on account of health or other unforeseen circumstance in accordance with I.R.C. §121(c)(2)((B). Webert v. Comm’r, T.C. Memo. 2022-32.

No Substantiation of Expenses.The petitioner was a business consultant and reported gross income from consulting of $174,956 and business expenses of $174,829 resulting in taxable income of $127. The taxpayer's business expenses included, $73,651 of travel expenses, $43,117 of car and truck expenses, $28,689 of "other" expenses, $7,255 of supplies, and $6,322 of meal and entertainment expenses. The IRS disallowed the deductions for lack of substantiation and the Tax Court agreed. The Tax Court did not sustain the imposition of an I.R.C. §6673 penalty, but warned the petitioner that the would not be the case in the future if the petitioner appeared in Tax Court again and tried the same frivolous arguments. Williams v. Comr., T.C. Memo. 2022-7.

Lack of Substantiation Dooms Expense Deductions.The petitioner filed a joint return for 2016, the year of his wife’s death. The petitioner was the executor of his wife’s estate and also conducted consulting activities for the tax years in issue, 2016-2017. The petitioner did not maintain a separate checking or credit card account for the consulting activities. The Schedule C filed with the return for each year claimed numerous business expenses, including car and truck expenses; travel costs; cell phone expenses; scanning software; mapping; postage and freight; and expenses associated with miscellaneous payments for services rendered. The IRS disallowed most of the claimed Schedule C expenses for lack of substantiation. The Tax Court upheld the IRS disallowance noting that the petitioner (and the estate) failed to substantiate through adequate records the car and truck expenses, travel expenses and expenses associated with rendering services. For auto-related expenses, the petitioner was required to substantiate the amount of each expense; the mileage for each business use and the total mileage for all vehicle uses during the tax year; the date of each business use; and the purpose of each business use. The Tax Court pointed out that generalized testimony in the form of mileage logs and calendars was insufficient to establish each element of the substantiation requirements. For travel expenses, I.R.C. §274(d)(1) required the petitioner to prove the amount of the expenses for traveling away from home; the date of departure and return for each trip and number of days spent on business; the destination or locality of travel; and the business reason for the travel or expenditure. The Tax Court also concluded that “none of the purported consulting projects… bore a logical nexus with…a state purpose.” The petitioner was not liable for an accuracy-related penalty for 2017 because the IRS examining agent did not receive written supervisory approval to impose a penalty. Wolpert v. Comr., 2022-70.

Deduction for Full Amount of C Corporate Shareholder Compensation Not Deductible.A married couple were the sole shareholders of the petitioner, a corporation engaged in the construction business that graded and prepared land. The petitioner’s growth was irregular from 2000 on. The principal took a relatively modest salary between 2000 and 2012 but took a big increase in the years 2013 to 2016, ostensibly to compensate for earlier years. The company had an outside consulting firm perform an analysis to determine what the principal's compensation should be. The IRS challenged the amount in 2015 and 2016. The Tax Court examined the usual factors considered in such a case including the employee's qualifications; the nature, extent, and scope of the employee's work; the size and complexities of the business; a comparison of salaries paid with gross income and net income; the prevailing general economic conditions; comparison of salaries with distributions to stockholders; the prevailing rates of compensation for comparable positions in comparable concerns; and the salary policy of the taxpayer as to all employees. The Tax Court denied a deduction for the full amount of the compensation. In addition, the IRS assessed an accuracy-related penalty for both years. The taxpayer was able to show that he relied in good faith on the advice of the accounting firm and the Tax Court did not sustain the penalty. However, for the second year the taxpayer could not substantiate its reliance on the outside adviser. Clary Hood, Inc. v. Comr., T.C. Memo. 2022-15.

Early Distribution “Penalty” is a “Tax” and Does Not Require Supervisor Approval.The petitioner borrowed money from her pension account at age 42. She received an IRS Form 1099-R reporting the gross distributions from the pension of $9,025.86 for 2015. She didn’t report any of the amount as income in 2015. The IRS issued her a notice of deficiency for $3,030.00 and an additional 10 percent penalty tax of $902.00. The parties later stipulated to a taxable distribution of $908.62 and a penalty of $90.86. The petitioner claimed that she was not liable for the additional penalty tax because the IRS failed to obtain written supervisory approval for levying it under I.R.C. §6751(b). The Tax Court determined that the additional 10 percent tax of I.R.C. §72(t) was a “tax” and not an IRS penalty that required supervisor approval before it would be levied. The Tax Court noted that I.R.C. §72(t) specifically refers to it as a “tax” rather than a penalty and that other Code sections also refer to it as a tax. The appellate court affirmed. Grajales v. Comr., No. 21-1420, 2022 U.S. App. LEXIS 23695 (4th Cir. Aug. 24, 2022), aff’g., 156 T.C. 55 (2021).

IRS Questions Farming Practices, But Tax Court Allows Most Deductions.The petitioners, a married couple, farm in southwest Iowa. The wife worked off-farm at a veterinary clinic, and the husband was a full-time delivery driver for United Parcel Service (UPS). He purchased his first farm in 1975 four years after graduating high-school and started a cow-calf operation. The petitioners lived frugally and always avoided incurring debt when possible by purchasing used equipment with cash with the husband doing his own repairs and maintenance. The petitioners were able to weather the farm crises of the early-mid 1980s by farming in this manner. Ultimately, the petitioners owned five tracts totaling 482 acres. The tracts are noncontiguous and range anywhere from six to 14 miles apart. On the tracts, the petitioners conduct a row-crop and cow-calf operation. He worked on the farms early in the mornings before his UPS shift and after his shift ended until late into the night. Over the years, the petitioners acquired approximately 40 tractors with 17 in use during the years in issue (2013-2015). The tractors had specific features or used a variety of mounted implements to perform the various tasks needed to operate the various farms. Certain tractors were dedicated to a particular tract and attached to implements to save time and effort in taking the implements off and reattaching them. The petitioners also have several used pickup trucks and a machine shed that was used to store farm equipment. The petitioners’ tax returns for 2013-2015 showed farm losses each year primarily due to depreciation and other farm expenses. The IRS disallowed significant amounts of depreciation and other farm expense deductions largely on its claim that the petitioners were not engaged in a farming business, but rather were engaged in a “nostalgic” activity with an excessive and unnecessary amount of old tractors. The IRS imposed a substantial understatement penalty of over $25,000 for the years combined The IRS took the position that the petitioners’ pickups and other vehicles were subject to the strict substantiation requirements of I.R.C. §274(d). The Tax Court disagreed as to the trucks that had been modified for use on the farm and were only driven a de minimis amount for personal purposes but agreed as to one pickup that was used to travel from farm to farm and to the UPS office. As to the disallowed depreciation on certain tractors, the IRS asserted that the tractors were not used in the petitioners’ farming business because, according to the IRS, the husband was a collector of antique tractors and that the acquisition and maintenance of 40 tractors, most of them more than 40 years old served no business purpose and involved an element of “nostalgia.” The Tax Court disagreed, noting that the husband had sufficiently detailed his farming practices – avoidance of debt and personally repairing and maintaining the tractors and other farm equipment so as to avoid hiring mechanic work – and that this was an approach that worked well for them. The Tax Court also noted that the IRS failed to account for petitioners’ noncontiguous tracts which meant that it was necessary to have various tractors and implements located at each farm to save time moving tractors from farm to farm and assembling and disassembling various attachments. As such, the Tax Court concluded that the items of farm machinery and tractors were used in the petitioners’ farming business and, as such, it was immaterial whether the purchase of the various farm tractors and implements constituted ordinary and necessary expenses. The Tax Court also determined that the machine shed was a depreciable farm building. As to various other farming expenses, the Tax Court allowed the petitioners’ claimed deductions for utilities, insurance, gasoline, fuel, oil and repair/maintenance expenses. The Tax Court upheld the accuracy-related penalty with respect to the underpayment related to depreciation on assets that had previously depreciated, but otherwise denied it. Hoakison v. Comr., T.C. Memo. 2022-117.

Mortgage Interest Deduction Disallowed.The petitioner claimed a mortgage interest deduction for 2012 associated with a home that his brother purchased for $1,525,000 in 2005. The purchased was financed with a bank loan. The brother and his wife were listed as the borrowers on the loan. The brother (and wife) and another brother also took out a $1,200,000 construction loan. Both loans were secured by the home. The construction loan was used to build a separate guest house on the property. In 2010, one brother executed a quit claim deed in favor of the petitioner with respect to the property. During 2012, the petitioner didn’t make any loan payments and was not issued a Form 1098 for the year. While the petitioner lived in the guest house for part of 2012, he did not list the property as being his place of residence or address. On his 2012 return, the petitioner claimed a $66,354 deduction for one-half of the total mortgage interest paid for the year as reported on Form 1098 that was issued to his brother and his brother’s wife. The IRS disallowed the deduction and the Tax Court agreed. The petitioner failed to prove that the debt on the property was his obligation, did not show ownership (legal or equitable) in the property, and the quitclaim deed did not convey title to him under state law. The Tax Court also determined that the petitioner failed to establish that the residence was his “qualified residence.” Shilgevorkyan v. Comr., T.C. Memo. 2023-12.

Business-Related Expenses Denied for Lack of Substantiation.The petitioner claimed continuing education expense deductions, most of which were for travel and meals that are subject to strict substantiation requirements. His documentation was a mere listing of the expenses. He also claimed a home office deduction but did not provide any records as to how the deduction was calculated. The IRS denied the deductions as well as other expenses for lack of proof of a business purpose or explanation. The Tax Court upheld the IRS determinations and stated it could not use the Cohan rule to estimate the expenses due to lack of records to base an estimate on. The Tax Court also upheld an accuracy-related penalty. Elbasha v Comr., T.C. Memo. 2022-1.

Net Operating Loss Couldn’t Be Carried Forward.The petitioner sustained a loss from the disposition of a condominium he owned as a rental property. He reported the date of the loss as August 2013, but a mortgage lender had foreclosed on the condo in May 2009 and the taxpayer lost possession on that date. The IRS denied the deduction on the basis that the petitioner had not claimed the loss on either an original or amended return which meant that there was no loss that could be carried forward. The Tax Court agreed with the IRS noting that the I.R.C. §165 Regulations provide that a loss is treated as sustained during the tax year in which the loss occurs as evidenced by a closed and completed transaction and fixed by identifiable events occurring in such taxable year. A loss resulting from a foreclosure sale is typically sustained in the year in which the property is disposed of and the debt is discharged from the proceeds of the foreclosure sale. Thus, the Tax Court determined that the loss had occurred in 2009 and should have been claimed at that time where it could have then been carried forward. Villanueva v. Comr., T.C. Memo. 2022-27.

Retained Ownership of Minable Surface Negates Conservation Easement Deduction. The Chief Counsel’s office of IRS has taken the position that a conservation easement donation is invalid if the donor owns both the surface estate of the land burdened by the easement as well as a qualified mineral interest that has never been separated from the surface estate, and the deed retains any possibility of surface mining to extract subsurface minerals, conservation easement doesn’t satisfy I.R.C. §170(h). The IRS said the result would be the same even if the donee would have to approve the surface-mining method because the donated easement would not be donated exclusively for conservation purposes in accordance with I.R.C. §170(h)(5). The IRS pointed out that Treas. Reg. §1.170A-14(g)(4) states that a donated easement does not protect conservation purposes in perpetuity if any method of mining that is inconsistent with the particular conservation purposes of the contribution is permitted at any time. But the IRS pointed out that a deduction is allowed if the mining method at issue has a limited, localized impact on the real estate and does not destroy significant conservation interests in a manner that can’t be remedied. Surface mining, however, is specifically prohibited where the ownership of the surface estate and the mineral interest has never been separated. On the specific facts involved, the IRS determined that the donated easement would not be treated at being made exclusively for conservation purposes because the donee could approve surface mining of the donor’s subsurface minerals. C.C.A. 202236010 (Sept. 9, 2022).

IRS Questions Farming Practices, But Tax Court Allows Most Deductions. The petitioners, a married couple, farm in southwest Iowa. The wife worked off-farm at a veterinary clinic, and the husband was a full-time delivery driver for United Parcel Service (UPS). He purchased his first farm in 1975 four years after graduating high-school and started a cow-calf operation. The petitioners lived frugally and always avoided incurring debt when possible, by purchasing used equipment with cash with the husband doing his own repairs and maintenance. The petitioners were able to weather the farm crises of the early-mid 1980s by farming in this manner. Ultimately, the petitioners owned five tracts totaling 482 acres. The tracts are noncontiguous and range anywhere from six to 14 miles apart. On the tracts, the petitioners conduct a row-crop and cow-calf operation. He worked on the farms early in the mornings before his UPS shift and after his shift ended until late into the night. Over the years, the petitioners acquired approximately 40 tractors with 17 in use during the years in issue (2013-2015). The tractors had specific features or used a variety of mounted implements to perform the various tasks needed to operate the various farms. Certain tractors were dedicated to a particular tract and attached to implements to save time and effort in taking the implements off and reattaching them. The petitioners also have several used pickup trucks and a machine shed that was used to store farm equipment. The petitioners’ tax returns for 2013-2015 showed farm losses each year primarily due to depreciation and other farm expenses. The IRS disallowed significant amounts of depreciation and other farm expense deductions largely on its claim that the petitioners were not engaged in a farming business, but rather were engaged in a “nostalgic” activity with an excessive and unnecessary amount of old tractors. The IRS imposed a substantial understatement penalty of over $25,000 for the years combined. The IRS took the position that the petitioners’ pickups and other vehicles were subject to the strict substantiation requirements of I.R.C. §274(d). The Tax Court disagreed as to the trucks that had been modified for use on the farm and were only driven a de minimis amount for personal purposes but agreed as to one pickup that was used to travel from farm to farm and to the UPS office. As to the disallowed depreciation on certain tractors, the IRS asserted that the tractors were not used in the petitioners’ farming business because, according to the IRS, the husband was a collector of antique tractors and that the acquisition and maintenance of 40 tractors, most of them more than 40 years old served no business purpose and involved an element of “nostalgia.” The Tax Court disagreed, noting that the husband had sufficiently detailed his farming practices – avoidance of debt and personally repairing and maintaining the tractors and other farm equipment so as to avoid hiring mechanic work – and that this was an approach that worked well for them. The Tax Court also noted that the IRS failed to account for petitioners’ noncontiguous tracts which meant that it was necessary to have various tractors and implements located at each farm to save time moving tractors from farm to farm and assembling and disassembling various attachments. As such, the Tax Court concluded that the items of farm machinery and tractors were used in the petitioners’ farming business and, as such, it was immaterial whether the purchase of the various farm tractors and implements constituted ordinary and necessary expenses. The Tax Court also determined that the machine shed was a depreciable farm building. As to various other farming expenses, the Tax Court allowed the petitioners’ claimed deductions for utilities, insurance, gasoline, fuel, oil, and repair/maintenance expenses. The Tax Court upheld the accuracy-related penalty with respect to the underpayment related to depreciation on assets that had previously depreciated, but otherwise denied it. Hoakison v. Comr., T.C. Memo. 2022-117.

Neither Spouse Satisfies 750-Hour Test Under Passive Loss Rules. The petitioners, a married couple, owned two properties that they rented out through the husband’s LLC during 2013 and 2014. They performed various activities with respect to the rental properties such as communicating with prospective renters and preparing the properties for new tenants. They filed joint returns for 2013 and 2014 a claimed a deductible loss on the rental properties. During 2013, they put a combined 557 hours of service into the rentals and during 2014 a combined 107 hours. The IRS denied the loss deduction under the passive loss rule of I.R.C. §469 asserting that the petitioners did not meet the definition of a “real estate professional.” Under I.R.C. §469(c)(7), a real estate professional is a taxpayer: (1) who performs more than one-half of all personal services rendered during the tax year in real property trades or businesses in with the taxpayer materially participates; and (2) performs more than 750 hours of services in real property trades or businesses in which the taxpayer materially participates. The petitioners filed a joint return; thus the definition of a real estate professional could be met if either spouse separately satisfied both requirements. The IRS claimed that neither spouse satisfied the 750-hour test of I.R.C. §469(c)(7)(B). The Tax Court agreed, noting that even if the petitioners’ non-contemporaneous logs were accepted as true, neither spouse satisfied the 750-hour test. Sezonov v. Comr., T.C. Memo. 2022-40.

Loss on Sale of Real Estate was Capital Loss.The petitioner had been involved in real estate ventures since the mid-1980’s. In 2005, the petitioner and his business partner formed an LLC. In 2006, the LLC bought four unimproved lots for $1 million and re-platted them into nine lots. The terms of the sale agreement included certain guarantees-of-resale-within-one-year, allocation of ownership of the nine lots between the parties with the seller allocated five lots. The sales agreement also included buy-back provisions and other conditions related to development and sale of the lots. The seller was to complete improvements on some of the lots. The petitioner financed the purchase of the lots via a loan from a bank. In 2007, the real estate market collapsed, and due to no improvements and lack of sales, the LLC sued the seller. To settle the suit, the seller transferred his partially improved lots to the petitioner. The LLC made no further improvement to those lots. The bank’s later appraisals indicated that the lots were not known to be for sale. The LLC divided up the lots and the existing debt and distributed four of the lots to the petitioner. Within four months, the petitioner sold the lots at a loss of $1,022,726 and reported a Schedule C deduction of $1,022,726 as cost of goods sold. The IRS disagreed, characterizing the loss as a capital loss because the lots were, in the IRS view, capital assets. The Tax Court agreed with the IRS that the lots were capital assets and did not meet the definition of stock in trade under I.R.C. §1221(a)(1) that would either be held in inventory or held primarily for sale to customers in the ordinary course of business. The Tax Court noted that the distinction between a capital asset and one held for sale to customers in the ordinary course of business is a fact question. Those factors in the Fourth Circuit (the Circuit to which the case would be appealable) include: 1) the purpose for which the property was acquired; 2) the purpose for which the property was held; 3) improvements, and their extent, that the taxpayer made to the property; 4) the frequency, number and continuity of sales; 5) the extent and substantiality of the transaction; 6) the nature and extent of the taxpayer’s business; 7) the extent of advertising of lack thereof; and 8) the listing of the property for sale directly through a broker. The Tax Court noted that no single factor is determinative, but that the factors overwhelmingly favored the IRS. The Tax Court also noted that the reason the taxpayer holds real estate can change by the taxpayer developing investment property to prepare it for sale, and that I.R.C. §735(a)(2) provides that gain or loss on the sale or exchange by a distributive partner of inventory items distributed by a partnership is ordinary income/loss if the items are sold or exchanged within five years from the date of distribution. Musselwhite v Comr., T.C. Memo. 2022-57.

Posted February 22, 2022

IRS Reconstructed Income From Bank Records. The petitioner operated an autobody shop as his primary income source. He also owned numerous rental properties, and had loans on them as well as loans on various vehicles. Upon audit, the petitioner claimed that he had only one business account and that his only source of income was from the body shop. On his 2011 return he reported a net profit from business of $28,799. His itemized deductions included home mortgage interest of $11,950 and taxable income of $114. He also told the auditor that he owned no rental properties and understated the number of vehicles that he owned. The petitioner lacked adequate records and the IRS reconstructed his income from bank deposit records, including checks for work the body shop did that were deposited directly in an account to pay the loans on the petitioner’s various vehicles. The Tax Court allowed the IRS use of the bank deposit method to reconstruct the petitioner’s income, and noted that during the years at issue the taxpayer reported adjusted gross income of $58,000 while repaying 15 vehicle loans for $173,250 and $180,600 on real property loans. The Tax Court determined that the petitioner had sufficient financial sense to run his own business and manage multiple rental properties. The Tax Court also determined that the petitioner tried to deceive the IRS agent which indicated that he understood the situation and the purpose of the audit. The Tax Court upheld the IRS position and sustained the imposition of a fraud penalty for the years at issue. Clark v. Comr., T.C. Memo. 2022-114.

Posted February 21, 2022

Unreimbursed Employee Expenses Properly Substantiated. The petitioner was a construction worker that worked for various employers over the tax years in issue. His work required him to leave home for significant “chunks of time.” He sought to deduct unreimbursed expenses for meals and entertainments, lodging, vehicle and other unreimbursed expenses that he incurred during his employment. The IRS disallowed a portion of the claimed deductions. The Tax Court upheld the petitioners deductions, noting that he had properly substantiated his travel, meals and lodging while away from home. He corroborated the amount, time, place and business purpose for each expenditure as I.R.C. §274(d) and Treas. Reg. §1.274-5T(b)(2)(ii)-(iii) requires. He also substantiated the auto expenses by documenting the business use and total use by virtue of a contemporaneous log. He also was “away from home” because his employment was more than simply temporary or only for a short period of time. The petitioner also proved that the dd not receive or have the right to receive reimbursement from his employer. Harwood v. Comr., T.C. Memo. 2022-8.

No Dependency Exemption Allowed. The petitioner’s former spouse had custody and control of their children, although the petitioner had visitation rights. The petitioner claimed a dependency exemption for one of the children as well as a dependent-related earned income credit, but did not include Form 8332 with the return that was signed by the former spouse indicating that the former spouse had released or revoked any right to claim the exemption for the child as the custodial parent. The IRS asserted a deficiency and the Tax Court agreed with the IRS. The Tax Court noted that the petitioner failed to present any evidence that any of the children met the definition of “qualifying child” during the tax year in issue and had failed to include a declaration signed by the custodial parent via Form 8332. Ola-Buraima v. Comr., T.C. Sum. Op. 2022-2.

Posted February 18, 2022

Business Deductions Properly Denied. The petitioners, a married couple, both had sources of income. The husband operated a music studio from a shed in their backyard. They used an electronic application to track their business expenses and receipts. On their joint 2017 return, they reported $247,201 in income from Form W-2. They claimed Schedule C deductions of $47,385, resulting in a business loss of $28,835. The deductions included amounts for travel expenses; air fare; meals and entertainment; bank charges; batteries; books and publications; a briefcase; credit card interest and fees; camera parts; costume cleaning; stage costumes; catering for special events; labor; office supplies; fees for physical training; postage/shipping; personal hygiene products; prop expenses; “research” admission fees; cable fees; Apple Music and Spotify subscriptions; Netflix subscriptions; studio supplies; cell phone expense; tools; and legal services. The IRS disallowed $37,800 of the deductions which included $11,713 of travel expenses; $5,763 of meal and entertainment expenses; and $20,324 of other expenses. The Tax Court agreed with the IRS. Personal care expenses were properly denied. The credit card and annual fee expenses involved multiple personal transactions and weren’t substantiated as business expenses. The stage costume expense was not deductible because the husband testified that the shoes and clothes could also be worn as personal wear. The catering expenses were not properly substantiated, and the physical training expenses were also determined to be personal in nature as were the hygiene products. The research expenses were determined to be inherently personal. The cell phone expense was properly disallowed - some of the expense had been allowed. Other expenses were also disallowed for lack of substantiation – bank charges; batteries; books and publications; briefcase; camera parts; office supplies; and legal services. The claimed travel expenses were properly disallowed for failure to meet the heightened substantiation requirements of I.R.C. §274(d). Still other expenses were properly disallowed as both personal and unsubstantiated, including: costume cleaning; labor; props; studio supplies; tools; and postage/shipping. Sonntag v. Comr., T.C. Sum. Op. 2022-3.

Posted February 8, 2022

No WOTC For “Weed” Business. The taxpayer is a business that is engaged in the trade or business of trafficking marijuana. Under federal law, marijuana is a Schedule I controlled substance under the Controlled Substances Act. The taxpayer hires and pays wages to employees from one or more targeted groups provided under I.R.C. §51, and is otherwise eligible for the Work Opportunity Tax Credit (WOTC). The IRS noted that I.R.C. §280E bars a deduction or credit for a business that traffics in controlled substances as defined by state or federal law. Thus, the taxpayer was not eligible for any WOTC attributable to wages paid or incurred in carrying on a business of trafficking in marijuana. C.C.A. 202205024 (Nov. 30, 2021).

IRS Email Approval of Supervisor Penalty Blessed. Under I.R.C. §6751, when an IRS agent makes an initial determination to assess penalties against a taxpayer, the agent must obtain “written supervisory approval” before informing the taxpayer of the penalties via a “30-day” letter. Here, the IRS agent received written supervisory approval of the penalty recommendation in an email from his supervisor before issuing the 30-day letter to the taxpayer. The taxpayer sought to have the IRS remove of the tax lien securing penalties imposed for his failure to furnish information on reportable transactions on the basis that IRS had failed to comply with I.R.C. §6751. The taxpayer claimed that such failure made the penalties invalid and required the lien to be released. The IRS Chief Counsel’s Office disagreed, finding that the IRS had complied with I.R.C. §6751. The Chief Counsel’s Office noted that the U.S. Tax Court has held that compliance with the supervisory approval requirement doesn’t require written supervisory approval to be given on a specific form and that an email satisfied the statute, if not the Internal Revenue Manual. C.C.A. 202204008 (Sept. 13, 2021).

Posted February 7, 2022

ESOP Didn’t Shield Taxpayer From Income. The petitioner, a CPA and an attorney, was also the fiduciary of an Employee Stock Ownership Plan (ESOP). He placed restricted S corporate stock in the ESOP for his own benefit. The petitioner claimed that the ESOP met the requirements of I.R.C. §401(a) such that the related trust was exempt from income tax under I.R.C. §501(a). The IRS claimed that the stock value was to be included in his income because he (and the other control person) failed to enforce employment performance restrictions, and “grotesquely” failed to perform fiduciary duties associated with the ESOP. The petitioner testified that he was not aware of his duties as a fiduciary, but the court didn’t believe the testimony. The court noted that the petitioner waived the stock restrictions and breached his fiduciary duties which revealed an effort to avoid enforcement of the restrictions. As such, there was no way he could lose control over the S corporation. As a result, there was no substantial risk of forfeiture associated with the stock, and the value of the stock was properly included in the petitioner’s income in accordance with Treas. Reg. §1.83-3(a)-(b). The court also upheld the denial of deductions for claimed business expenses incurred and paid by the S corporation. Larson v. Comr., T.C. Memo. 2022-3.

Posted February 6, 2022

Valuation Misstatement Penalties Upheld. The petitioner claimed a $10,425,000 charitable deduction for the donation of a conservation easement to a qualified land trust, plus a $3,475.000 charitable deduction for the donation of a fee simple interest in real estate associated with the easement. The IRS disallowed the deductions and assessed valuation misstatement penalties. The petitioner moved for partial summary judgment on the basis that the IRS has failed to comply with I.R.C. §6751(b)(1) which says a penalty cannot be assessed unless the initial determination of the assessment is personally approved in writing by the immediate supervisor of the individual making the determination (or a higher-level official if the Treasury Secretary may designate). The penalties were approved by the agent’s immediate supervisor. A new Territory Manager later discovered that the agent had not executed a new Form 11247, so he prepared one confirming that a new acting team manager had been appointed. The petitioner claimed that the appointment of a new team manager rendered the penalties meaningless. The Tax Court disagreed, noting that the “immediate supervisor” is the person who supervises the agent’s substantive work on an examination.” The penalties were properly approved. Long Branch Land, LLC v. Comr., T.C. Memo.

Posted February 1, 2022

Car Expense Deductions Denied. In 2017, the petitioner conducted a ridesharing business but was hit by another driver while operating his business vehicle. He kept his business receipts in the vehicle, but the car was owned title in his wife’s name. She sold the car after it was repaired, but he had not retrieved his receipts from the car before it was sold. The couple filed a joint return for 2017 with a Schedule A claiming various medical expenses of $121,136 and miscellaneous expenses of $13,300 consisting of attorney fees and accounting fees of $9,700 and lottery tickets of $3,600. They claimed a $13,853 refund. Upon audit, the IRS disallowed the Schedule C ridesharing deductions, other expenses, utilities, supplies car and truck expenses and depreciation. The IRS also disallowed $110,366 of medical expenses and miscellaneous deductions of $13,300. The Tax Court upheld the IRS determination with respect to the ridesharing business deductions – the petitioner couldn’t substantiate them with a printed spreadsheet with merely the dates and miles driven with no stated business purpose and origination and end of trip. The Tax Court also upheld the IRS determination with respect to the denial of substantially all medical expenses. Eze v. Comr., No. 17486-19S (Jan. 21, 2022).

IRS Procedures for Determining Employee Status. In general, whether a worker is an employee is determined in accordance with common law rules based on control and direction of the worker in the details of the work and the means of performance. If a worker is determined as an employee and is not treated as such, the employer can be liable for employment taxes and penalties but may obtain relief in specified circumstances under Section 530 of the Revenue Act of 1978. The IRS has specified when and how the IRS will issue a notice of its employment status determination under I.R.C. §7436 and how the person to whom the notice is issued may seek Tax Court review in light of SECC Corp. v. Comr., 142 T.C. 225 (2014) and American Airlines, Inc. v. Comr., 144 T.C. 24 (2015). In those cases, the Tax Court held that an I.R.C. §7436 notice is not a jurisdictional requirement and even in the absence of the issuance of notice, a taxpayer may petition the Tax Court on an IRS worker reclassification or Sec. 530 relief determination to the extent that the determination meets the requirements the Tax Court has established. Thus, the IRS states it has jurisdiction if it conducts an examination in connection with an audit and as part of the audit determines that one or more individuals performing services for the person are employees for purposes of worker reclassification, or the person is not entitled to Sec. 530 relief; there is an “actual controversy” involving the determination as part of an examination; and the person for whom the services at issue were performed files an appropriate pleading in the Tax Court. Rev. Proc. 2022-13, 2022-6 I.R.B. ____ (Jan. 19, 2022), eff. Feb. 7, 2022.

Court Upholds IRS Certification of Delinquent Tax Debt. The IRS determined that the petitioner had delinquent tax debt in excess of the statutory amount under I.R.C. §7345. As a result, the IRS notified the Secretary of State which resulted in the revocation of his passport. The petitioner claimed that the IRS failed to send him statutory notices of deficiency for five of the six tax years underlying the IRS’s certification of his delinquencies. Thus, the petitioner claimed that he owed no tax for those years and his remaining tax debt was insufficient to constitute “seriously delinquent tax debt.” He also claimed that he had a fundamental right to international travel and that I.R.C. §7345 was unconstitutional. The Tax court held that the petitioner was precluded from arguing that the IRS did not send him deficiency notices for the five years in question, and also held that the IRS did not err in certifying that he has a seriously delinquent tax debt. The Tax Court did not address the constitutional question, and ordered the petitioner to show cause why it should not sanction him under I.R.C. §6673(a) for advancing the groundless argument that the IRS had not sent him deficiency notices. Kaebel v. Comr., T.C. Memo. 2021-109.

Posted January 23, 2022

Airplane Used to Find Stray Livestock Not Exempt From Sales Tax. The taxpayer’s farm was on hilly terrain and, as a result, the taxpayer planned on using an antique airplane to monitor locations of the taxpayer’s cattle and goats and spot strays. The airplane, the taxpayer claimed, would make it easier to locate missing animals. The taxpayer sought an exemption from state sales tax under R.S. Mo. §144.030.2(22) that exempts “farm machinery” from sales tax. The exemption was denied on the basis that the airplane did not qualify as farm equipment/machinery because it would not be used for the aerial application of agricultural chemicals on crops in accordance with R.S. Mo. §144.047. Ltr. Rul. No. 8171 (Mo. Dept. Rev. Dec. 23, 2021).

IRS Guidance on “Substantially Equal Periodic Payment.” There is no 10 percent penalty tax for an early distribution from an annuity, qualified retirement plan or IRA if the distribution is part of a series of substantially equal periodic payments that are paid at least annually and are calculated using the taxpayer’s life expectancy or the joint life expectancy of the taxpayer of the taxpayer and the designated beneficiary. IRS provides three methods for determining whether such a distribution meets the test – 1) the RMD method; 2) the fixed amortization method; or 3) the fixed annuitization method. The IRS has now updated the Uniform Life Table which can be used to determined whether distributions are substantially equal periodic payments under the RMD and fixed amortization methods. The IRS has also updated the interest rate that may be used with the fixed amortization or fixed annuitization methods. In addition, the IRS has provided guidance on how to determine an account balance, special rules for distributions from an IRA and making a one-time change from the fixed amortization or fixed annuitization method to the RMD method. IRS Notice 2022-6, 2022-5 I.R.B., effective for a series of payments beginning in 2022.

Posted January 4, 2022

Extinguishment Regulation Invalid - Conservation Easement Protected In Perpetuity. The petitioner owned farmland and deeded a conservation easement on a portion of the property to a qualified charity under I.R.C. §170(h)(3). The petitioner continued to own a large amount of agricultural land that was contiguous with the easement property, and he continued to live on the land and use it for cattle ranching. The petitioner claimed a charitable contribution deduction for the donation of $2,788,000 (the difference in the before and after easement value of the property) which was limited to $57,738 for the tax year 2012 – the year of donation. The petitioner claimed carryover deductions of $1,868,782 in 2013 and $861,480 in 2014. He could not determine his basis in the property and, upon the advice of a CPA firm, attached a statement to Form 8283 explaining his lack of basis information. The deed stated that its purpose was to preserve and protect the scenic enjoyment of the land and that the easement would maintain the amount and diversity of natural habitats, protect scenic views from the roads, and restrict the construction of buildings and other structures as well as native vegetation, changes to the habitat and the exploration of minerals, oil, gas or other materials. The petitioner reserved the right to locate five one-acre homesites with one dwelling on each homesite. The deed did not designate the locations of the homesites but required the petitioner to notify the charity of when the petitioner desired to designate a homesite. The charity could withhold building approval if it determined that the proposed location was inconsistent with or impaired the easement’s purposes. The deed provided for the allocation of proceeds from an involuntary extinguishment by valuing the easement at that time by multiplying the then fair market value of the property unencumbered by the easement (less any increase in value after the date of the grant attributable to improvements) by the ratio of the value of the easement at the time of the grant to the value of the property, without deduction for the value of the easement at the time of the grant. The deed also stated that the ratio of the value of the easement to the value of the property unencumbered by the easement was to remain constant. The charity drafted the deed and a CPA firm reviewed it and advised the petitioner that it complied with the applicable law and regulations such that he would be entitled to a substantial tax deduction. The IRS denied the carryover deductions for lack of substantiation and assessed a 40 percent penalty under I.R.C. §6662(h) for gross valuation misstatement and, alternatively, a 20 percent penalty for negligence or disregard of the regulations or substantial understatement of tax. The petitioner bought additional land that he held through pass-through entities that would then grant easements. The petitioner recognized gain of over $3.5 million on the sale of interests in the entities to investors who then claimed shares in the easement deductions. The IRS claimed that these entities overvalued the easements for purposes of the deductions. Individuals in the CPA firm invested in the entities and claimed easement deductions. The Tax Court determined that the deed language violated the perpetuity requirement of I.R.C. §170 because of the stipulation that the charity’s share of proceeds on extinguishment would be reduced by improvements made to the land after the easement grant. The Tax Court did not uphold the penalties. On further review, the appellate court reversed on the basis that the extinguishment regulation of Treas. Reg. §1.170A-14(g)(6)(ii) that bars the subtraction of the value of post-donation improvements to the easement property from the proceeds allocated to the donor and done in the event of judicial extinguishment is arbitrary and capricious under the Administrative Procedure Act (APA) for failing to comply with the APA’s procedural requirements. Thus, the regulation was invalid. The APA requires the Treasury to incorporate into a new rule a concise general statement of its basis and purpose, and must rebut “vital relevant” or significant comments. During the notice and comment period, the Treasury received more than 700 pages of comments with some comments expressing concern that the allocation formula of the proposed regulation was not workable. The Treasury did not respond to the comments about the unworkableness of the allocation formula. The appellate court determined such failure violated the APA’s procedural requirements. The Treasury’s statement that it considered “all comments” was inadequate. The appellate court reversed the Tax Court’s order disallowing the petitioner’s carryover charitable deductions as to the donation of the conservation easement and remanded the case. Hewitt v. Comr., No. 20-13700, 2021 U.S. App. LEXIS 38555 (11th Cir. Dec. 29, 2021), rev’g., T.C. Memo. 2020-89.

Posted December 31, 2021

Bankruptcy Debtor’s Tax Returns May Be Disclosed to Bankruptcy Trustee. Pursuant to I.R.C. §6103(e)(5)(A), upon written request to the IRS the tax return of a debtor in a voluntarily filed bankruptcy, for the tax year in which the case was filed or any preceding tax year, may be disclosed to the bankruptcy trustee. Return information may also be disclosed without the requirement of a written request. In the case of an involuntarily filed bankruptcy, court approval is required before tax return information can be disclosed to the bankruptcy trustee. C.C.A. 202150016 (Jul. 23, 2021).

Posted December 29, 2021

American Eagle Coins Must Be Held by Custodian. The petitioner set up a self-directed IRA via a single-member LLC that would be used to hold IRA funds through the purchase of membership interests. She instructed the IRA custodian to have the LLC buy gold and silver American Eagle coins. But, according to the custodian’s website, an LLC owned by an IRA could invest in the coins and the IRA owner could hold the coins at their home without tax consequences or penalties so long as the coins were titled in an LLC. Based on the website information, the petitioner instructed the coins be transferred directly to her at her home for storage there in a safe. The petitioner funded the IRA by transferring funds from an annuity and an employer-sponsored Sec. 401(k) profit-sharing plan. She did not report either transfer as taxable. She then used the funds to buy membership interests in the LLC via the IRA. The IRA purchased membership interests on three occasions in 2015 and 2016, and each time the petitioner instructed the custodian to transfer the purchase price of the membership interests from the IRA to the LLC’s bank account. In turn, the petitioner, as the LLC’s manager, had the LLC use the funds to buy American Eagle coins from an authorized coin dealer. The funds to buy the coins were transferred from the LLC’s bank account to the dealer’s account. The dealer invoices listed the LLC as the buyer, but the shipping label was addressed to the petitioner individually or along with her IRA. The coins were shipped to the petitioner where she stored them in a safe at her home. The dealer provided annual valuations for the gold coins, but not for the silver coins. The IRA trustee valued the IRA via a year-end IRA asset valuation provided by the petitioner, but the valuations omitted the LLC bank account balance and the value of the silver coins. The custodian filed Form 5498 with IRS for 2015 and 2016 reporting the IRA’s fair market value of $349,856 and $388,247 respectively. A CPA prepared the tax returns, but was not consulted on the self-directed IRA and was not informed concerning how the coins were being held. Upon audit, the IRS determined that the petitioner received taxable distributions in both 2015 and 2016, and assessed an accuracy-related penalty for both years. The IRS took the position that the coins were actually held under the petitioner’s control rather than the LLC – she was the LLC manager and had physical possession of the coins that were purchased with IRA funds. As such, a qualified custodian or trustee was not responsible for the management and disposition of the property in the self-directed IRA as required by Treas. Reg. §1.408-2(e). A custodian is required to maintain custody of the IRA assets, maintain the required records, and process transactions that involve IRA assets. I.R.C. §408(h) and (i) and Treas. Reg. §1.408-2(e)(4) and (5)(i)(2). The Tax Court agreed with the IRS, finding that the petitioner had complete and unfettered control over the coins and could use them in any manner she wished. The Tax Court determined that the existence of the LLC was irrelevant because it was being treated taxwise as a disregarded entity, even though the Tax Court also said this didn’t matter because the petitioner had complete control over the coins in any event. Thus, she had received taxable distributions that should have been included in her gross income. The Tax Court also determined that the exemption contained in I.R.C. §408(m)(3) allowing coins and bullion to be held in an IRA did not negate the requirement of physical possession by a trustee as a condition of the IRA owning coins and bullion. The Tax Court also determined that the petitioner had violated I.R.C. §408(a)(5) barring commingling of IRA assets (the storing of the coins in a safe with non-IRA assets) with other property except in a common trust fund or common investment fund. Simply labeling the coins as having been purchased with IRA funds was not enough and, in any event, she had physical possession and control over the coins. The Tax Court upheld the accuracy-related penalties because even though a CPA prepared the returns, the petitioner did not seek advice from the CPA and never disclosed the facts regarding where the IRA’s assets were being held. The website was where the petitioner got her “research” leading her to conclude that the structure was acceptable. The website was not an unbiased source of information. McNulty v. Comr., 157 T.C. No. 10 (2021).

Check to U.S. Treasury Denoted “Deposit” Was a Deposit and Not a “Payment.” The petitioner was involved in litigation with his family involving the division of wealth from an oil company. The matter settled and the petitioner was ordered to assign a multi-million-dollar asset to trusts for the benefit of his children. The asset had an aggregate value of $30,675,000. The assignment was made in 2011 and the petitioner wrote a check to the U.S. Treasury for $10.3 million to cover potential gift tax on the assignment. In subsequent communications with the IRS about a week later, the petitioner’s representative wrote a letter to the IRS designating the check as a “deposit” satisfying the requirements of I.R.C. §6603(a) – “Deposits Made to Suspend the Running of Interest on Potential Underpayments.” The IRS acknowledged the check, but indicated that no corresponding tax return had been received. Thus, the IRS credited the $10.3 million to the petitioner’s “Form 709 account for [2011].” The IRS urged the petitioner to submit Form 709 as soon as possible so that the IRS would then “apply the credit to the tax you owe and refund any overpayment.” The petitioner’s representative replied by letter again referring to the $10.3 million as a “deposit” that should be applied to 2012 rather than 2011. The petitioner submitted Form 709 in 2014 reporting a gift tax liability of zero on the basis that the gift was incomplete as of the end of 2012 because entitlement to the funds was still in litigation. In the accompanying cover letter, the petitioner’s representative again reiterated that the “deposit” should be refunded to the taxpayer.” The IRS conducted a gift tax examination in 2015 focusing on whether the assignment (an installment payment obligation) was a taxable gift and, if so, when the gift was made. The settlement was reached in 2010, the assignment was executed in 2011 and the funds were transferred to the children’s trusts in 2015. Because there was no gift tax liability for 2012, the $10.3 million could not be applied to any gift tax liability for that year, so the IRS told petitioner that he “must request in writing that the funds be applied to a different tax year in accordance with Rev. Proc. 2005-18. The IRS issued a 30-day letter proposing alternative gift tax deficiencies for 2010, 2011 and 2015. The petitioner objected, requesting that the IRS apply the “deposit” to any liabilities for 2010, 2011 and 2015. IRS issued a notice of deficiency and litigation started eventually leading to a stipulation of a gift tax deficiency of $6.8 million for 2011. In a stipulated decision, the parties agreed that the $10.3 million would be applied to the petitioner’s 2011 gift tax liability. In early 2010, the IRS issued the petitioner a check for $3.5 million – the difference between the deficiency of $6.8 million and the $10.3 million check. The IRS check did not include any interest, so the petitioner filed a motion to redetermine interest. The IRS conceded that the petitioner was allowed interest, but because the petitioner paid a “deposit,” the IRS computed the interest on the excess deposit using the Federal short-term rate without the three percentage point increase set forth in I.R.C. §6603(d)(4) for overpayments. The result was $1.1 million less than petitioner sought. The petitioner motioned for a redetermination of interest. The Tax Court noted that I.R.C. §6603 provides for the payment of a cash deposit to pay any tax which has not been assessed at the time of the deposit. Under this provision, the IRS must return to the taxpayer any amount of the deposit that the taxpayer requests in writing. Any return of a deposit is treated as a payment of tax for any period to the extent it is attributable to a disputable tax for that period. The Tax Court also determined that there was a deficiency in gift tax due from the petitioner for 201, but no deficiencies or overpayments due for 2010 or 2015. Because the Tax Court found that the petitioner had not made an overpayment, the Tax Court lacked jurisdiction over the plaintiff’s motion. Ultimately, however, the Tax Court determined that the petitioner could not have made an “overpayment” for 2011 because no payment had been made because the $10.3 million was termed a “deposit.” A deposit is not a payment of tax before the time the deposited amount is used to pay a tax. Hill v. Comr., T.C. Memo. 2021-121.

Not Enough Information Provided for a Whistleblower Award. The petitioners claimed their former landlord owned other properties and collected rents from them but and did not report the income. The claim was based on the landlord boasting about owning other rental properties that were rented on a cash-only basis to avoid paying income tax. The petitioners gave this information to the IRS along with a list of possible alias that the landlord might be using and 50 addresses that could be associated with the landlord. The petitioners sought a whistleblower award for providing the information. The IRS reviewed the information and determined from a database that the landlord only owned one property and had properly reported the income from the property. The IRS determined that the petitioners’ information was neither specific nor credible. The Tax Court held that the IRS had not abused its discretion in rejecting the claim, noting that the Tax Court cannot compel the IRS to investigate a claim further or seek additional information and the IRS is not obligated to do so. Wai-Cheung, et al. v. Comr., T.C. Memo. 2021-106.

Posted December 28, 2021

No Foreign Earned Income Exclusion For Pilot. The petitioner was a U.S. citizen residing in Thailand that worked as a pilot for a company headquartered in Tulsa, OK that had a contract with the U.S. Department of Defense. He transported primarily military personnel and cargo. He spent most of his days off in Thailand and would also visit Thailand on a temporary transit and nonimmigrant visa that would expire in 30 days. His wife resided in Thailand. He did not pay any taxes to Thailand. His wages were direct deposited into his bank account of a bank headquartered in California. His employment agreement required him to have a home base which he chose as San Jose, CA because his parents and brother lived near there. He listed Campbell, CA as his mailing address. He did not own or lease a residence in the U.S. during the years in issue, but shopped for groceries several times in Campbell and paid for haircuts in a nearby town and went to the eye doctor in San Jose. All of his training was done in the U.S. For the years in issue, he never spent a majority of the days of the year in Thailand. He filed his returns for the years in issue listing his filing status as “single” and his father’s Campbell, CA address. He claimed a Foreign Earned Income Exclusion to his Form 1040 for each year in issue, reporting his entire salary as foreign earned income and claiming the maximum exclusion for each year. The IRS disallowed the exclusion in its entirety for each year on the basis that the petitioner failed to establish either a bona fide residence or physical presence in a foreign country. The Tax Court agreed with the IRS on the basis that the petitioner failed to meet his burden of proof that the income he earned was eligible for the exclusion. His designation of a home base in CA and a gateway travel airport also in CA made him ineligible for the exclusion. The appellate court affirmed on the basis that the Tax Court had properly determined that the petitioner did not meet his burden of proof that he was entitled to the exclusion. Cutting v. Comr., T.C. Memo. 2020-158, aff’d., No. 21-70235, 2021 U.S. App. LEXIS 37928 (9th Cir. Dec. 22, 2021).

Posted December 26, 2021

Roberts Tax Not a Priority Claim in Bankruptcy. The debtor filed Chapter 11 and the IRS filed a proof of claim for unsecured excise and income taxes totaling $5,071.79. IRS laster amended its proof of claim reducing the income tax claim to zero and the unsecured excise tax to $1,540.59. The IRS later further amended its claim as to the unsecured priority claims totaling $1,451.59 based on an unpaid Roberts Tax. The bankruptcy trustee objected to the IRS claim, but the IRS asserted that the Roberts Tax is a “tax” under 11 U.S.C. §507(a)(8)(E). The trustee asserted that the Roberts tax is a penalty that is not entitled to priority. The court determined that the Roberts Tax did not arise out of a transaction that the debtor engaged in and, as such, were not an excise tax on a transaction for purposes of 11 U.S.C. §507(a)(8)(E) and, as such, were not entitled to priority. As to whether the Roberts Tax is an income tax, the court noted that the Ninth Circuit had not resolved the issue. The IRS claimed that it was measured, in part, by the taxpayer’s income. However, the court found In re Juntoff, No. 19-17032, 2021 Bankr. LEXIS 995 (Bankr. N.D. Ohio Apr. 15, 2021) persuasive. In In re Juntoff, the court held that the Roberts Tax is not an income tax based on numerous non-income factors that are relevant in determining the amount of the “tax,” and that income was not relevant for everyone subject to the “tax.” In addition, the court noted, the Roberts Tax is listed as “Other tax” on Form 1040 and not as an income tax. The Internal Revenue Code also lists the Roberts Tax as a “Miscellaneous Excise Tax” under Subtitle D and not an income tax under Subtitle A. Accordingly, the court also held that the IRS’s claims were not for income taxes that are entitled to priority under 11 U.S.C. §507(a)(8)(A). Thus, the Roberts Tax is not a penalty, but an excise tax that is not levied on a “transaction.” Thus, it is not entitled to priority under 11 U.S.C. §507(a)(8)(E), nor is it an income tax entitled to priority under 11 U.S.C. §507(a)(8)(A). In re Vallejo, No: 2:20-bk-01372-DPC, 2021 Bankr. LEXIS 3239 (Bankr. D. Ariz. Nov. 23, 2021).

Posted December 25, 2021

Horse Breeding Activity Not Engaged in With Profit Intent. The petitioners were co-owners of an LLC taxed as a partnership. The LLC was engaged in breeding horses. The LLC incurred considerable losses despite a business plan anticipating a future gain from the activity. The losses continued through the 2010-2013 period under examination. The LLC did not produce any gain until 2016 when it sold its breeding rights in one of its horses. One of the LLC co-owners provided nominal supervision of employees, but was not involved int the daily operation of the breeding activity. The other co-owner had no direct involvement in the breeding operation. The petitioners deducted the losses on their personal returns. The IRS denied the deductions on the basis that the petitioners lacked a profit intent. The Tax Court agreed with the IRS. The Tax Court noted that the petitioners could not use the safe harbor by showing that the activity showed a profit for any two of seven consecutive years ending with the year at issue. That meant that the nine-factors of the regulations under I.R.C. §183 applied. In analyzing those factors, the Tax Court determined that even though the petitioners consulted experts, the petitioners did not conduct the activity in a business-like manner; failed to commit sufficient time in direct operation of the activity; had no intent to profit from an increase in value of the breeding activity, and lacked evidence of potential appreciation of the horse; lacked expertise in horse breeding; had multiple years of continuous losses; generated significant losses and only a small profit in 2016; had substantial income from other sources; and derived personal pleasure/recreation from the activity. As such, the Tax Court held that the petitioners were not engaged in the horse breeding activity with a profit intent. Net operating losses from prior years were also disallowed due to lack of evidence of existence of the net operating losses in previous years. Skolnick v. Comr., 2021-139.

No Trade or Business Means No Business-Related Deductions. The petitioner bought 10 acres in the Mojave Desert in 2012/2013, about a mile away from any road. He intended to develop the property’s natural resources and then rent the parcels to farmers for organic farming. He devised a business plan under which he would build a barn-like structure; obtain USDA certification that the property complied with organic farming standards; install an irrigation system on the property; and build an access road to the property. By 2015, the petitioner had partially installed a water tank and rainwater collection system on the property, explored and mapped the property, and experimented with growing certain plants on the property. He also used the property for recreational activities. The petitioner started the construction of a barn-like structure in 2015. He purchased building materials, rented a commercial truck and tractor-trailer to transport materials to the property, created an unpaved road to access the property, and hired workers to assist in building the structure. The petitioner accomplished this work on weekends. He was a full-time engineer. On his 2015 return, the petitioner’s Schedule C reported no gross income and claimed deductions for car and truck expense, travel expense, start-up costs and amortization. The IRS disallowed the deductions. The Tax Court agreed with the IRS on the basis that the petitioner was not engaged in a trade or business in 2015, but was merely in the stage of setting up a trade or business and didn’t produce any evidence that he was actively engaging with potential customer to rent the property during 2015. The Tax Court also denied any deductions for start-up costs and amortization expenses because there was no active trade or business in 2015. Antonyan v. Comr., 2021-138.

Posted December 22, 2021

Ass Breeding Business Engaged in With Profit Intent. The petitioners, a wealthy married couple, formed a partnership in 2004 for “agricultural and equestrian or equine purposes, including, without limitation, breeding and raising animals.” The husband also owned an asset management company in which he would, among other things, buy underperforming companies in various industries and turn them into profitable ventures and then sell them for a healthy return. The asset management company took a long-term perspective with respect to its investments. In 1987, the petitioners purchased 31.35 acres in New Jersey subject to a conservation easement that permitted most equestrian and agricultural uses. In 1990, the petitioners bought an adjacent 7.5 acres for their daughter who then lived there with her husband. The petitioners lived on their acreage under 2013. Sometime before 2010, the petitioners began to investigate potential uses for their acreage, consulting with a friend whose line of business was eggs. The friend also had extensive experience in successfully breeding miniature asses and agreed to assist with the activity if the petitioners determined to pursue it. The petitioner then had his asset management firm research miniature ass breeding, nutrition and husbandry. The research was extensive and involving consultations with various experts in numerous states. In 2010, the petitioners moved forward with the breeding of miniature asses and develop a herd with attractive genetic attributes that could become self-perpetuating. The driving factor in engaging in the activity was to boost the income of the petitioners’ daughter. The petitioners’ belief was that the ass breeding and raising operation could be turned over to the daughter once it became profitable. The partnership ran the ass breeding and raising activity, maintaining its own bank account and business filings. It also maintained a registry of each miniature ass and a website. The activity did not show a profit for any year from 2010 through 2017. The IRS examined years 2013 and 2014 and denied losses associated with the activity on the basis that the partnership was not carrying on a trade or business with a profit intent. The Tax Court disagreed with the IRS position based on an analysis of the factors. The petitioners, the Tax Court determined, conducted the activity in a business-like manner; followed a detailed business plan; kept good records (but didn’t use the records to analyze the activity’s profitability which neutralized this factor); modified the activity to adopt new techniques and abandon ones not working; engaged experts to assist with the activity; employed competent and qualified people to carry on the activity given the petitioners’ limited amount of time available for the activity; showed past success in turning unprofitable ventures into profitable ones; had years of losses, but the years under exam were less than five years into the breeding operation and were not indicative of a lack of profit motive; and sought to create a profitable venture for their daughter. The petitioners did not have, however, a reasonable expectation that the value of the activity would appreciate in value. The Tax Court pointed out that its determination was only focused on the years in issue – 2013 and 2014 – and did not address whether the petitioners continued to have an actual and honest profit objective in later years. Huff v. Comr., No. 22604-17, 2021 U.S. Tax Ct. Memo. LEXIS 184 (U.S. Tax Court, Dec. 21, 2021).

Posted December 21, 2021

No Claim of Right Deduction Associated with Restricted Stock Sale. The plaintiffs, a married couple, created a revocable living trust in 2004 and amended it in 2012. The trust was created under Wisconsin law and named a bank as trustee with a different bank as successor trustee. The trust language gave the trustee broad discretion to invest, reinvest, or retain trust assets. However, the trust barred the trustee from doing anything with the stock of two companies that the trust held. The trustee apparently did not know of the prohibition and sold all of the stock of both companies in late 2015, triggering a taxable gain of $5,643,067.50. The sale proceeds remained in the trust. Approximately three months later, in early 2016, the trustee learned of the trust provision barring the stock sale and repurchased the stock with the trust’s assets. The grantors then revoked the trust later in 2016. On their 2015 return, the plaintiffs reported the gain on the stock sale and paid the resulting tax. On their 2016 return, the plaintiffs claimed a deduction under I.R.C. 1341 for the tax paid on the stock sale gain the prior year. The IRS denied the deduction and the plaintiffs challenged the denial and the IRS motioned to dismiss the case. The plaintiffs relied on the “claim of right” doctrine of I.R.C. §1341– they reported the income and paid the tax, but could be entitled to a deduction if and when their claim to the income is defeated. Under I.R.C. §1341, the plaintiffs had to: (1) establish that they included the income from the stock sale in a prior tax year; (2) show that they were entitled to a deduction because they did not have an unrestricted right to the income as of the close of the earlier tax year; and (3) show that the amount of the deduction exceeds $3,000. If the requirements are satisfied, a taxpayer can claim the deduction in the current tax year or claim a credit for the taxes paid in the prior year. The IRS claimed that the plaintiffs could not satisfy the second element because the plaintiffs were not actually required to relinquish the proceeds of the stock sale. The court agreed, noting that once the stocks were sold the plaintiffs had the unrestricted right to the proceeds as part of the revocable trust, as further evidenced by them revoking the trust in 2016. The court noted that neither the trustee nor the plaintiffs had any obligation to repurchase the stock. The court also noted that under Wisconsin trust law, the plaintiffs could have instructed the trustee to do anything with the proceeds of the stock sale, and that they had the power to consent to the trustee’s action of selling the stock. In other words, they were not duty-bound to require the trustee to buy the stock back. Accordingly, the court determined that I.R.C. §1341 did not provide a remedy to the plaintiffs, and that any remedy, if there was one, would be against the trustee. Heiting v. United States, 16 F.4th 242, (7th Cir. 2021), aff’g., 2020 U.S. Dist. LEXIS 10967 (W.D. Wisc. Jan. 23, 2020).

No Exclusion for Principal Residence Debt; Trade or Business Not Established. The petitioners, a married couple, claimed deductions for the wife’s alleged consulting business. She was a marketing executive and her husband was an investment advisor. She claimed that she engaged in a consulting business that gave rise to numerous business deductions. Also, as part of her marketing job, the wife was required to move to where the company was located. The company agreed to provide her an interest free loan to help finance the purchase of a nearby home and provide her with six months of temporary housing in a furnished executive apartment and reimburse some travel and moving expenses. Ultimately, the petitioners bought a home in the area of the company. $385,993 of the company’s loan traced to being used to acquire the residence. The wife soon lost her position with the company and she had to repay the company’s loan. Thus, the petitioner’s sold the home and hired an attorney to negotiate a settlement with the company. The company offered to cancel half of the loan amount in lieu of a cash severance payment. Ultimately, the parties settled for the company forgiving $220,000 of the loan and making a cash payment to the petitioners of $30,000. The petitioners signed a new promissory note for $280,000 to be paid from the proceeds of the sale of the home. The company forgave another $35,000 of the $280,000 loan and the house ultimately sold for $1,665,000. $200,000 of the loan was paid off from the sale proceeds with the balance to be paid in two equal installments. The petitioners defaulted on the first installment and the parties ultimately reached a settlement whereby the company would forgive another $30,000 and the petitioners would pay $15,000. The petitioners reported $255,000 as excludible cancelled debt income under the provision for the discharge of qualified principal residence debt under I.R.C. §108(h)(2). The IRS disallowed the exclusion and also denied the allegedly business-related deductions. On the exclusion for qualified principal residence debt issue, the Tax Court determined that the initial loan used for acquiring the residence was not secured by the residence but was unsecured debt. As such it was not “acquisition indebtedness” in accordance with I.R.C. §163(h)(3)(B)(i). Thus, the initial $220,000 forgiven did not qualify for exclusion as qualified principal residence debt. Also, the subsequent $280,000 loan, while it was recorded to secure a lien against the house, was not used to acquire, construct, of substantially improve the home. Accordingly, it also failed to constitute excludible qualified principal residence debt. The same result occurred for the $245,000 loan because its repayment was condition on the sale of the home. The debt being refinance was not qualified debt which meant that the refinancing also was not qualified principal residence debt in accordance with I.R.C. §163(h)(3)(B). The Tax Court also upheld the IRS position on non-deductibility of business expenses for lack of proof that the wife was actually engaged in the trade or business for purposes of I.R.C. §162. The Tax Court pointed out that she had either no gross receipts or merely nominal gross receipts from consulting for the years in issue while simultaneously working full time for another company. In any event, the Tax Court noted that she failed to substantiate any of the alleged expenses including automobile travel expenses, meals and entertainment, computer and phone expenses. She also had unreliable mileage logs and phone bill excerpts. Other documentation, the Tax Court concluded, did not sufficiently differentiate between personal and business expenses. Her claimed expenses also appeared to be related to her employment with the company she was working for and not the consulting business. Weiderman, et ux. v. Comr., T.C. Memo. 2020-109.

Short Sale of Real Estate Generated Capital Loss. The petitioner owned a historic waterfront mansion and was in the process of restoring it with plans to rent it. The restoration turned out to be more costly and take longer than originally anticipated. The petitioner never actually rented the property even though a listing agent did talk to prospective renters that expressed interest in renting it. Ultimately the petitioner abandoned attempts to rent the property due to economic issues, and entered into a short-sale of the property for $6.5 million. On the petitioner’s 2009 return, the seven-figure loss on sale was reported as a capital loss, which limited the ability to offset income other than capital gains to $3,000 per year. Later, the petitioner met with an estate planner that questioned the tax treatment of the loss on the 2009 return. As a result, the petitioner hired another tax preparer to file an amended 2009 return to treat the sale as the sale of an I.R.C. §1231 asset. The result was that the loss was ordinary in nature, which also triggered a large net operating loss that the petitioner carried back to 2004 and forward to 2010. The IRS issued a refund, but later examined the 2009 return and determined that the loss was not an I.R.C. §1231 loss, but instead involved the sale of a capital asset generating a capital loss. The Tax Court agreed with the IRS, noting that for property to be treated as property that is used in a taxpayer’s trade or business, the taxpayer must be engaged in the activity on a basis that is, “continuous, regular, and substantial” in relation to the management of the property as part of the rental activity. The Tax Court noted that there was never any rental activity that was engaged in in any meaningful or substantial way. Thus, the IRS was correct to disallow the NOL carryover and carryback. The Tax Court also sustained the imposition of an accuracy-related penalty for the petitioner’s failure to rely on the advice of a professional. The Tax Court noted that the petitioner knew that a rental activity had never been engaged in. On appeal, the appellate court affirmed, noting that the petitioners did not engage in “regular and continuous” rental activities because they didn’t ever engage in a rental activity in a meaningful or substantial manner. They didn’t advertise the mansion online, they didn’t sign a tenant to a lease, they didn’t furnish the property for rent after occupancy was ready or receive any rental payments or security deposits. The made mere limited attempts to rent the property while making continuous attempts to sell it. In addition, the appellate court noted that the petitioner pursued a tax credit that was not contingent on renting the property while being aware of the availability of a credit if they rented the property. Keefe v. Comr., 966 F.3d 107 (2d Cir. 2020), aff’g., T.C. Memo. 2018-28.

Posted December 5, 2021

Taxpayer Entitled to Foreign Earned Income Exclusion. The petitioner owned a home in Texas and spent a short amount of time there during the year in issue. However, she spent most of the year living and working in Afghanistan. After the petitioner was discharged from the military, she spent a short time working in Texas, but had spent most of the past decade working abroad. She claimed the foreign earned income exclusion on her return and the IRS denied it on the basis that she was not a “qualified individual” because she was neither a bona fide resident of one or more foreign countries or was not physically present abroad for a sufficient amount of time, and failed to prove that her tax home was other than in the United States. The Tax Court disagreed, noting that the facts and circumstances sufficiently established the petitioner’s entitlement to the exclusion. Woods v. Comr., T.C. Memo. 2021-103.

Posted December 2, 2021

EIP Not Exempt From Garnishment. The plaintiff was sentenced to five years in prison with five years of supervised release and ordered to pay restitution in early 2021. As of August of 2021, the plaintiff still owed the full amount. The government moved to garnish his bank account containing $3,982.23. The plaintiff claimed that $1,700 contained in the bank account was from a stimulus payment (“Economic Impact Payment”) paid under the Coronavirus Aid, Relief, and Economic Security Act ("CARES Act") and was exempt from garnishment as an unemployment benefit to provide relief from “economic challenges” faces as a result of the virus. The court noted that the statutory language providing for the payment classified it as a “recovery rebate” taking the form of a tax credit, and did not refer to it as an “unemployment” benefit. It was not conditioned on the lack of employment. The court held that the payment was also not properly classified as unemployment insurance, but was separate and distinct from unemployment insurance. Accordingly, the payment was not protected from garnishment under 18 U.S.C. §3613(a)(1) and 26 U.S.C. §6334. United States v. Ruiz, No. EP-19-CR-03035(1)-DCG, 2021 U.S. Dist. LEXIS 217327 (W.D. Tex. Nov. 10, 2021).

Early Distribution Penalty is a “Tax.” The petitioner, at age 42, took out loans in connection with her pension plan. The pension plan custodian sent her a Form 1099-R reporting gross distributions of $9,026. The petitioner did not report any of the retirement plan distributions on her return for the year. The IRS issued a notice of deficiency for the non-reporting of the distributions and added on the 10 percent additional tax on early distributions under I.R.C. §72(t) for $90.26. Ultimately, the parties agreed that only $908.62 of distributions were taxable as early distributions. However, the petitioner contested the penalty of $90.86 on the basis that the penalty was assessed without the examining agent receiving written supervisory approval required under I.R.C. §6751(b)(1). The IRS claimed that no written supervisory approval was required because the additional $90.86 amount was a “tax” and not a “penalty,” “addition to tax” or “additional amount” within the meaning of I.R.C. §6751(b)-(c). The Tax Court agreed with the IRS, noting that I.R.C. §72(t) is captioned “10-percent additional tax on early distributions from qualified retirement plans,” and that I.R.C. §72(t)(1) refers to a 10 percent “tax.” The Tax Court also cited a number of its prior opinions construing I.R.C. §72(t) in contexts other than the penalty context where it determined the provision provided for a “tax” and declined to reconsider its analysis set forth in those opinions. Grajales v. Comr., 156 T.C. 55 (2021).

No Deduction For Excess Rent – Bad Valuation. The petitioner, a drug store in a rural town in northeast Montana, claimed rent deduction for the main floor of the building it rented. The petitioner estimated the value of the main floor at $25 per square foot. Upon audit, the IRS rejected the petitioner’s valuation and pegged the value at $7.17 per square foot. The Tax Court rejected both valuations and determined that the rental value was $15.90 per square foot. As a result, the petitioner couldn’t claim approximately $40,000 in deductions attributable to “excess” rent. In addition, the rents paid exceeding the $15.90 per square foot threshold were non-deductible constructive dividends to the building owners. The Tax Court also rejected the IRS imposition of penalties under I.R.C. §6662. The Tax Court noted that real estate data are not publicly available in Montana which complicates efforts to appraise property values and reasonable rents. Plentywood Drug, Inc., et al. v. Comr., T.C. Memo. 2021-45.

Posted November 25, 2021

IRS Legal Advice Lacks Force of Law. The petitioner received distributions from three different pension or retirement plans. Each of the plans sent Form 1099-R to the IRS and to the petitioner indicating that the entire distribution was taxable and that it was a “normal distribution.” The petitioner filed his return for the year reporting the total amount of distributions, but that the “taxable amount” was far less. The IRS issued a CP12 Notice advising the petitioner that there were errors on the return and that the overpayment amount that he reported and that the refund due him was much less than he reported on the return. The petitioner did not respond to the Notice, thereby agreeing to its calculations. Later, the IRS relied on the various Forms 1099-R and issued the petitioner a notice of deficiency notifying the petitioner that the full amount of the distributions was taxable. The petitioner timely filed for a redetermination on the basis that he followed the advice of the IRS helpline representative with respect to the reporting of the distributions. He also claimed that the CP12 Notice confirmed his entitlement to a refund. The Tax Court rejected the petitioner’s arguments, noting that IRS employee legal advice has no force of law and cannot bind the IRS or the Tax Court. The Tax Court also determined that a CP12 Notice is not a settlement agreement and does not limit the IRS in assessing additional tax to be found due. Peak v. Comr., T.C. Memo. 2021-128.

For PTC Purposes, MAGI Includes Social Security Benefits. The petitioners, a married couple, reported nearly $60,000 of Social Security benefits for 2015. During 2015, they also received $7,332 in advance premium tax credit (APTC) payments. They did not file Form 8962 for 2015 to reconcile the APTC with their eligible premium tax credit (PTC) at the end of the year. The IRS issued a Notice of Deficiency that the full $7,332 had to be paid back and that an accuracy-related penalty was due in the amount of $1,466. The Tax Court, citing its prior decision in Johnson v. Comr., 152 T.C. 121 (2019), held that, for purposes of determining PTC eligibility, the petitioners’ Social Security benefits were required to be included in their modified adjusted gross income, including their lump-sum amounts relating to prior years which they elected to exclude from gross income. By including such amounts in MAGI, the petitioners’ MAGI exceeded 400 percent of the federal poverty level thereby making them ineligible for the PTC. Knox v. Comr., T.C. Memo. 2021-126.

“Immediate Supervisor” is Person Who Actually Supervised Exam. Under the Code, an IRS examining agent must obtain written supervisory approval to the agent’s determination to assess a penalty on any asserted tax deficiency. Under I.R.C. §6751(b)(1), the approval must be from the agent’s “immediate supervisor” before the penalty determination if “officially communicated” to the taxpayer. In a partnership audit case under TEFRA, supervisory approval generally must be obtained before the Final Partnership Administrative Adjustment (FPAA) is issued to the partnership. See, e.g., Palmolive Building Investors, LLC v. Comr., 152 T.C. 75 (2019). If an examiner obtains written supervisory approval before the FPAA was issues, the partnership must establish that the approval was untimely. See, e.g., Frost v. Comr., 154 T.C. 23 (2020). In this case, the IRS opened a TEFRA examination of the petitioner’s 2015 return. The IRS auditor’s review was supervised by a team manager. While the audit was ongoing, the agent was promoted and transferred to a different team, but continued handling the audit still under the supervision of the former team manager. Ultimately, the agent asserted an accuracy-related penalty against the petitioner and the former team manager signed the approval form. The next day, the auditor sent the petitioner several documents indicating that a penalty might be imposed. Two days later the new team manager also signed the auditor’s penalty approval form. The petitioner challenged the imposition of penalties because the new team manager hadn’t approved the penalty assessment before the auditor sent the penalty determination to the petitioner. The Tax Court held that the supervisor who actually oversaw the agent’s audit of the petitioner was the “immediate supervisor” for purposes of the written supervisory approval requirement of I.R.C. §6751(b)(1). There was no evidence that the new team manager had any authority to supervise the agent’s audit of the petitioner. Sand Investment Co., LLC v. Comr., 157 T.C. No. 11 (2021).

Sole Shareholder Responsible for Corporation's Tax Debt. The petitioner formed a corporation to run used-car lots. The petitioner was the sole director, office and shareholder. He had complete control over the corporation. The IRS claimed that the corporation owed almost $2 million in federal taxes, and asserted that the petitioner, his wife and the corporation were responsible for the deficiency. The petitioner liquidated his corporation and various non-exempt assets to pay the tax and sued for a refund. The trial court determined that the corporation was the petitioner’s alter ego and, as such, the petitioner was personally responsible for the tax. The petitioner appealed and the appellate court affirmed. The appellate court noted that under applicable Texas law a court may disregard the corporate “fiction” when it has been used as an unfair device to achieve an inequitable result – including use as a taxpayer’s alter ego. There was no doubt, the appellate court concluded, that the facts established a unity between the corporation and the petitioner. The appellate court noted that the petitioner failed to observe certain corporate formalities; loaned substantial sums to the corporation; and made payments from the corporate bank account to service personal loans. United States v. Lothringer, No. 20-50823, 2021 U.S. App. LEXIS 30283 (5th Cir. Oct. 8, 2021).

Farming Activity Not Conducted With Profit Intent. The petitioner claimed deductible losses associated with a farming activity. The Arkansas Department of Revenue determined that the losses were not deductible because the petitioner failed to establish a profit motive for the activity. An administrative law judge agreed with the state’s position. The judge determined that the petitioner failed to meet eight of the nine factors used to establish whether an activity is engaged in for profit. The judge also determined that the petitioner failed to establish the accuracy of the claimed expenses listed on the returns. Nos. 22-108 through 111, Ark. Dept. of Finance and Administration.

Posted November 19, 2021

No Sales Tax Exemption on Purchase of Farm Equipment. The plaintiff bought farm equipment and sought a sales tax exemption because he was going to use it on his farm to assist with fixing fences and spraying fence rows. The state Department of Revenue denied the exemption because the equipment wasn’t used exclusively or directly to produce food or fiber. The Administrative Law Judge, on further review, agreed and noted that simply operating the equipment on a farm does not entitle the owner to the state’s tax exemption for farm machinery or equipment. The ancillary activities of the plaintiff did not qualify the equipment for the exemption. Instead, the equipment must be used directly for the production of food or fiber as a business. No. 22-186, Ark. Dept of Finance and Administration.

Meal Portion of Per Diem Allowance Eligible to be Treated As Attributed to a Restaurant. Under I.R.C. §274(n)(1) and Treas. Reg. §1.274-12, a deduction of any expense for food or beverages generally is limited to 50 percent of the amount otherwise deductible (i.e., as an ordinary and necessary business expense that is not lavish or extravagant under the circumstances). However, the Consolidated Appropriations Act, 2021, provides that that the full cost of such an expense is deductible if incurred after Dec. 31, 2020, and before Jan. 1, 2023, for food or beverages "provided by a restaurant." The IRS has specified that a taxpayer may treat the meal portion of a per diem rate or allowance paid or incurred after Dec. 31, 2020, and before Jan. 1, 2023, for meals purchased while traveling away from home as being attributable to food or beverages provided by a restaurant. IRS Notice 2021-63, effective for expenses incurred by an employer, self-employed individual or employees described in I.R.C. §62(a)(2)(B) through (E) after December 31, 2020 and before January 1, 2023.

Posted November 18, 2021

Excluded PPP Loan Forgiveness Is Gross Receipts for Some Purposes; Timing Issues Clarified. Forgiven PPP loans are tax-exempt income that is included in gross receipts for purposes of the gross receipts test for a “small business taxpayer” eligible to use cash accounting contained in I.R.C. §448(c). It is also included in gross receipts for the return filing requirement thresholds for tax-exempt organizations under I.R.C. §6033. For taxpayer’s using the safe harbor of Rev. Proc. 2021-20, eligible expenses will be treated as being paid or incurred in the immediately subsequent tax year after the taxpayer’s 2020 taxable year in which the expenses were actually paid or incurred. Rev. Proc. 2021-48.

Posted November 6, 2021

Innocent Spouse Relief Granted. The petitioner divorced her husband in 2016, but they had failed to file joint tax returns for 2010 and 2015. While the Tax Court held that the couple could not deduct unreimbursed employee expenses in 2010 that he incurred while traveling away from home to work on construction sites, the Tax Court did grant her innocent spouse relief attributable to the understatements of tax for 2010 and 2015 because, based on the facts, she neither knew nor had reason to know of the items giving rise to the understatements. Todisco v. Comr., T.C. Sum. Op. 2021-35.

Owner Personally Liable For Corporate Taxes. The petitioner was the sole director, officer and shareholder of his corporation which ran used-car lots. The corporation got behind on taxes and the IRS sued the petitioner and his wife as well as the corporation for the unpaid tax debt of almost $1.8 million. The trial court determined that the petitioner was personally liable for the corporation’s tax debt because it was his alter ego. The appellate court agreed, noting that the petitioner was the sole shareholder, officer, director and owner of the corporation, and exercised complete dominion and control of the corporation and failed to observe certain corporate formalities. The appellate court also noted that the petitioner loaned substantial sums to the corporation and made payments from the corporate bank account to service personal loans. United States v. Lothringer, No. 20-50823, 2021 U.S. App. LEXIS 30283 (5th Cir. Oct. 8, 2021).

Posted October 10, 2021

No Deduction for Expenses Not Obligated For. The petitioners paid their daughter’s alimony which meant that the daughter could not deduct it because she did not pay it. In addition, the court upheld the disallowance of Schedule F deductions for lack of substantiation. Some of the disallowed Schedule F expenses were rent and utilities that required “normal” substantiation, while others were car and truck expenses that were subject to heightened substantiation. The court also upheld the disallowance of certain amounts of income for particular tax years due to the failure to show that the income was received. It was likely that the petitioners’ alleged farming activity was a hobby. Berger v. Comr., T.C. Memo. 2021-89.

Posted October 6, 2021

Portion of Court Award Excludible From Income. The petitioner sued her employer for damages arising out of a hostile work environment. She received an $82,500 settlement payment from her (now former) employer in 2014 and sought to exclude $55,000 of the amount from gross income as being paid to her on account of emotional distress attributable to personal physical injuries or physical sickness. The Tax Court disagreed, noting that the settlement agreement said that the $82,500 payment was in return for a general release against the former employer. There was not specific reference that the payment was for emotional distress tied to physical injuries. But she could exclude $6,980 of the amount from income as attributable to bills for psychotherapy. Tressler v. Comr., T.C. Sum. Op. 2021-33.

No Deduction For Travel Expenses. The petitioner worked jobs as an electrician and would travel during the week in his RV to work sites. He had a home in Texas with his family. He claimed travel-related deductions as unreimbursed employee expenses. The IRS denied the deductions and the Tax Court agreed. The Tax Court noted that he failed to substantiate his mileage and because his home in Texas was not his tax home. While unemployed during the summer, he did not attempt to find work near his residence, and his only tie to the home was his family. Vasquez v. Comr., T.C. Sum. Op. 2021-32.

For Pre-TCJA Years, Deductions Allowed Under Hobby Loss Rules Are Miscellaneous Itemized Deduction Subject to 2 percent Floor. The petitioners, a married couple, engaged in a boat chartering activity during tax years 2014 and 2015. They reported the activity’s income on Schedule C for each year. The IRS determined that the petitioners lacked a profit motive for the activity and recharacterized the Schedule C income as non-Schedule C “other income” and the Schedule C expenses as miscellaneous itemized deductions to the extent allowed under I.R.C. §183. The petitioners sought a redetermination of the deficiency and penalty. Two years later, the petitioners requested the Tax Court to hold as a matter of law that the deduction provided under I.R.C. §183(b) for activities not engaged in for profit are not subject to the 2 percent floor on miscellaneous itemized deductions of I.R.C. §67(a). The Tax Court denied the request, noting that I.R.C. §63(d) defines itemized deductions as deductions other than those allowed in computing AGI and the deduction for personal exemptions allowed under I.R.C. §151. I.R.C. §183(b)(2) is not identified as a deduction allowable in computing AGI. Thus, if an itemized deduction (such as I.R.C. §183(b)(2)) is not identified on the list provided under I.R.C. §67(b), it is a miscellaneous itemized deduction and subject to the restriction of I.R.C. §67(a). It is important to note, however, that the issue in this case is not applicable for tax years 2018 through 2025. Gregory v. Comr., T.C. Memo. 2021-115.

Petitioner Properly Not Allocated Tax Credits. The petitioner and her husband filed jointly for 2005 and elected to apply the overpayment shown on the return to their estimated tax for 2006. The husband made additional estimated payments for 2007 and also made a payment with a request for an extension of time to file a 2006 return. The couple divorced in early 2007 and the ex-husband died in 2008. The petitioner filed a separate return for 2006 claiming credit for half of the 2005 overpayment. She also claimed credit for the estimated tax payments the husband made in 2006 and early 2007 and the husband’s extension payment. The IRS issued a Notice of Federal Tax Lien to collect the unpaid tax for 2006. After a hearing, IRS said it would release the lien because the petitioner was entitled to credit for the payment shown on her return. IRS then issued another Notice of Intent to Levy for the 2006 tax year which led to another hearing. The decedent’s estate claimed credit for the full amount of the payments in issue. IRS continued then issued a notice of determination to the petitioner upholding the proposed levy action. The Tax Court determined that the IRS was not obligation to refrain from collection with respect to the 2006 tax year. The Tax Court held that the issuance of Form 12257 after the hearings did not bind IRS to that particular determination. Equitable estoppel also did not apply because IRS had not duty to inform the petitioner of the estate’s efforts to secure credit for the payments in issue and the petitioner had not detrimentally relied on the failure of the IRS to inform her of those facts. But, because the evidence did not support an IRS finding that the husband intended the estimated payments that he made to have been for his own account, the appellate court reversed the Tax Court on this point. Richlin v. Comr., No. 20-72392, 2021 U.S. App. LEXIS 28573 (9th Cir. Sept. 21, 2021), aff’g. in part and rev’g., in part, T.C. Memo. 2020-60.

Posted October 4, 2021

Lack of Documentation Leads to Receipt of Constructive Dividends. The petitioner was the sole shareholder of a C corporation in which he housed his motivational speaking business. The fees he earned were paid to the corporation. The corporation paid him a small salary which he instructed the corporation not to report as income to him. In addition, he also paid many personal expenses from a corporate account. The IRS claimed that the distributions from the corporation to the petitioner constituted dividends that the petitioner should have included in gross income. The Tax Court noted that if the corporation has sufficient earnings and profits that the distribution is a dividend to the shareholder receiving the distribution, but that if the distribution exceeds the corporation’s earnings and profits, the excess is generally a nontaxable return of capital to the extent of the shareholder’s basis in the corporation with any remaining amount taxed to the shareholder as gain from the sale or exchange of property. The Tax Court noted that the petitioner’s records did not distinguish personal living expenses from legitimate business expenses and did not provide any way for the court to estimate or determine if any of the expenses at issue were ordinary and necessary business expenses. Thus, the court upheld the IRS determination that the petitioner received and failed to report constructive dividends. The appellate court affirmed noting that there was ample evidence to support the Tax Court’s constructive dividend finding and that the petitioner had failed to rebut any of that evidence. Combs v. Comr., No. 20-70262, 2021 U.S. App. LEXIS 28875 (9th Cir. Sept. 23, 2021), aff’g., T.C. Memo. 2019-96.

Posted October 3, 2021

Acting Activity Not a Hobby. The petitioner began acting after retiring from Mary Kay. She secured roles in feature-length films; spent 35-45 hours each week researching, applying or auditioning for other roles; trained to enhance her skills by taking acting and voice lessons; retained an assistant and an agent to help her obtain new roles; and otherwise conducted the activity in a businesslike manner. The petitioner did not generate a profit for the years in issue and the IRS denied deductions for losses from the activity on the basis that she was not engaged in it with the requisite profit intent. The Tax Court rejected the IRS position based on the facts. However, the petitioner’s side business involving jewelry sales was not engaged in for profit. The petitioner only devoted 10 hours weekly to the jewelry activity, didn’t seek expert help or advice, and didn’t make a sustained effort to sell to the general public. In addition, the petitioner only had intermittent sales to former Mary Kay associates. Gaston v. Comr., T.C. Memo. 2021-107.

Independent Contractor in Trade or Business. The petitioner was an independent contractor that performed services for two different clients during the tax year at issue. He didn’t report any of the income from the services even though we was issued 1099s totaling approximately $123,000. The IRS introduced evidence of the petitioner’s unreported income, and the petitioner failed to prove, by a preponderance of the evidence that the IRS statutory notice of deficiency was arbitrary or erroneous. In addition, the petitioner admitted to receiving the income, but claimed he was not participating in a trade or business. The Tax Court disagreed, and determined that the petitioner misrepresented the definition of a trade or business, and his income was subject to self-employment tax. Delgado v. Comr., T.C. Memo. 2021-84.

No Whistleblower Award. The petitioner claimed entitlement to a whistleblower award in a matter where the IRS had neither initiated an administrative or judicial action nor collected an proceeds from the targeted taxpayer on the basis of information that the petitioner furnished to the IRS. The Tax Court rejected the petitioner’s argument that the IRS mistakenly failed to pursue the targeted taxpayer, noting that the Tax Court did not have the authority to compel the IRS to initiate any action. In addition, the Tax Court noted that the IRS had denied the petitioner’s claim on the basis that the statute of limitations had expired. Peterfreund v. Comr., T.C. Memo. 2021-83.

Suing Ex-Wife Not a Trade or Business. The petitioner divorced his wife in 1977 and then sued her in state court in 1998 over debts she owed associated with two real estate purchases and credit cards, as well as penalties she owed the petitioner for not providing him with financial statements in a timely manner. During the pendency of the lawsuit in 2020, he sued her two more times in state court and sued her attorneys in federal court. The federal litigation involved losses from trading agreements the petitioner entered into with her involving a futures and options trading method she created. Ultimately, she owed the petitioner about $384,000 for trading losses incurred with funds he deposited into a commodities brokerage account. The petitioner deducted $267,000 in legal fees on his 2014 return and the IRS rejected the deduction, tacking on an accuracy-related penalty. In 2019, the Tax Court disallowed the legal expenses under I.R.C. §162(a), but allowed a deduction for legal costs incurred that were associated with trading agreement losses as production of income expenses under I.R.C. §212(1). The Tax Court also upheld the accuracy-related penalties. On appeal the appellate court largely affirmed the Tax Court, find that the petitioner didn’t prove that his lawsuit to recover the trading agreement losses was related to his work with a trade or business. Also, the appellate court upheld the Tax Court finding that the petitioner didn’t have a profit motive in suing his ex-wife which was required for a deduction under I.R.C. §212(1). However, the appellate court held that the Tax Court erred in concluding that the petitioner lacked some justification for claiming deductions under I.R.C. §162(a) for legal fees relating to the trading agreement losses. As such, the appellate court remanded the penalty issue to the Tax Court. Ray v. Comr., No. 20-6004, 2021 U.S. App. LEXIS 27614 (5th Cir. Sept. 14, 2021).

Posted September 9, 2021

No Trade or Business in Existence. The decedent was a real estate developer than went into receivership in 2009. In late 2008, the decedent had formed a single-member LLC through which he would conduct a search for another trade or business. He spent all of his time working for the LLC. He hired employees and consultants to help him find new business opportunities. He also continued to be involved with other entities that he had formed in prior years. He claimed losses from these other entities for the years in issue and net operating losses (NOLs) arising from prior years. The IRS denied the loss deduction on the basis that none of the decedent’s activities constituted a trade or business for the years in question. The IRS maintained that all of the claimed expenses were either start-up expenses under I.R.C. §195 or non-deductible personal expenses under I.R.C. §262. The decedent claimed that he was merely continuing his existing homebuilding business, such that I.R.C. §195 did not apply. The Tax Court, disagreed, noting that the decedent had not abandoned his old business at the time the receiver took control. But, the appointment of the receiver caused, based on the facts, the decedent to no longer be in the homebuilding business. The petitioner also claimed that he was, through his LLC, in the trade or business of finding another trade or business. Again, the Tax Court disagreed. A general business search does not constitute the “carrying on a trade or business” requirement of I.R.C. §162. The Tax Court determined that the “business investigation expenses” that the decedent incurred in 2012 met the definition of start-up expenses under I.R.C. §195, but because the decedent didn’t acquire a new business by the end of 2012, not business was deemed to have begun during 2012. Thus, the decedent had no current operating business during 2012 resulting in no deductions under I.R.C. §162 and no start-up costs to be capitalized under I.R.C. §195. Estate of Morgan v. Comr., T.C. Memo. 2021-104.

Posted September 8, 2021

No Ordinary Loss Deduction For Worthless Stock. The petitioners, a married couple, incorporated their business but never generated any gross receipts. The husband, in 2009, signed an stock subscription agreement with the company to buy 50 shares of its class C common stock. The company planned on investing in another business (LGS) to obtain rights in a process related to alternative energy. The petitioners’ company invested $125,000 in LGS with the intent of investing a total of $400,000. Funds were transferred from the husband’s bank account for the purchase of the stock. The petitioners had not claimed a deduction with respect to the corporate stock on either their 2012 or 2013 returns. Upon audit, the IRS proposed a $3,000 capital loss deduction for each of 2012 and 2013. Then, the petitioners claimed entitlement to an ordinary loss deduction of $50,000 for 2012 with respect to the worthlessness of their corporate stock under I.R.C. §1244. The IRS denied the deduction on the basis that the stock did not qualify at I.R.C. §1244 stock. The Tax Court agreed with the IRS. The Tax Court determined that the petitioners failed to establish that more than 50 percent of the corporation’s gross aggregate gross receipts were not from sources other than rents, royalties, dividends, interest, annuities, and sales or exchanges of stocks or securities. Indeed, the corporation never had any gross receipts during its existence. Thus, the requirement of I.R.C. §1244(c)(1) was not satisfied. Ushio v. Comr., T.C. Sum. Op. 2021-27.

Taxpayer Caring for Brother’s Children Entitled to Child-Related Tax Benefits. During the tax year in issue, the petitioner lived with and cared for her mother at the petitioner’s home. She received compensation for caring for her mother through a state agency. For more than one-half of the tax year, the petitioner also cared for her niece and nephews because their father (her brother) was a disabled single parent. The niece and nephews stayed with her overnight from mid-May to mid-August and on weekends during school closures and on holidays. While they were with her, she paid for their food, home utility use and entertainment. On her 2015 return she claimed dependency exemption deductions for the children and child tax credits as well as the earned income tax credit. On audit and during the examination, the brother provided a signed form 8332, but the petitioner did not attach it to her return. The IRS denied the dependency exemptions, the child tax credits and the earned income tax credit. The Tax Court, rejecting the IRS position, noted that the children stayed with the petitioner for more than one-half of the tax year and that the petitioner’s testimony was credible to establish that the children were “qualifying children” for purposes of I.R.C. §152. Because none of them had reached age 17 during the tax year, the petitioner was entitled to a child tax credit for each one. Also, because I.R.C. §32 uses the same definition of “qualifying child” as does I.R.C. §152, the petitioner was entitled to the earned income tax credit. Griffin v. Comr., T.C. Sum. Op. 2021-26.

IRS Provides Deed Language for Conservation Easement Donations. The IRS has noted that a deed language for a donated conservation easement to a qualified charity fails to satisfy the requirements of I.R.C. §170(h) if the deed contains language that subtracts from the donee’s extinguishment proceeds the value of post-donation improvements or the post-donation increase in value of the property attributable to improvements. Such language violates Treas. Reg. §1.170A-14(g)(6)(ii) unless, as provided in Treas. Reg. §1.170A-14(g)(6). The IRS has provided sample language adhering to Treas. Reg. §1.170A-14(g)(6)(ii) that would not cause the issue from arising on audit. The language specifically states that on any subsequent sale, exchange or involuntary conversion of the property subject to the easement, the done is entitled to a portion of the proceeds at least equal to the proportionate value of the perpetual conservation restriction. CCA 202130014 (Jun. 16, 2021).

Posted September 6, 2021

NOL Not Available Due to Lack of Documentation. The petitioners, a married couple, has NOLs from 1993-1997 (which could be carried back three years and forward 15 years) that were being used to offset income in 2009 and 2010. The petitioners provided their 1993 and 1994 tax returns, but the returns did not include a detailed schedule related to the NOLs. Based on the information provided, the Tax Court determined that the petitioners had, at most, an NOL of $782,584 in 1993 and $666,002 in 1992 or earlier. Consequently, $1,448,586 of the NOL had expired in 2008 and was not available to offset income in 2009 or 2010. Thus, the petitioners had a potential NOL of $257,125 for their 1994 return. The Tax Court pointed out that the petitioners bore the burden of substantiating NOLs by establishing their existence and the carryover amount to the years at issue. That requires a statement be include with the return establishing the amount of the NOL deduction claimed, including a detailed schedule showing how the taxpayer computed the NOL deduction. The petitioners also filed bankruptcy in 1998. The Tax Court determined that the $257,125 NOL for 1994 was zeroed-out in the bankruptcy. The petitioners provided some information from their 1997-2007 returns which seemed to show Schedule C losses for some years, but had no documentation. They claimed that the NOLs should be allowed because they had survived prior audits of their 20072008 and 2011-2012 returns. The Tax Court pointed out that each year stands on its own and the fact that the IRS didn’t challenge an item on a return in a prior year is irrelevant to the current year’s treatment. Due to the lack of documentation the Tax Court denied any NOL deduction for 2009 or 2010. Martin v. Comr., T.C. Memo. 2021-35.

“Roberts Tax” is Not a Tax. The court held that the “shared-responsibility” payment of Obamacare is not an income tax because it is not measured based on income or gross receipts. The court determined that it also was not an excise tax because an individual’s not purchasing minimum essential coverage was not a transaction. Thus, the payment was not on a transaction. Thus, the “Roberts Tax” was not a tax entitled to priority treatment in bankruptcy under 11 U.S.C. §507(a)(8). The court noted it’s disagreement with the holding in In re Szczyporski, No. 2:20-cv-03133, 2021 U.S. Dist. LEXIS 61628 (E.D. Pa. Mar. 31, 2021) on the same issue. In re Juntoff, No. 20-13035, 2021 Bankr. LEXIS 995 (Bankr. N.D. Ohio Apr. 15, 2021).

Losses Not Passive and Fully Deductible. The petitioner, a married couple, worked full-time as physicians. They also owned and operated a pain management clinic. During 2008-2012, they also opened five restaurants and a brewery with a 50 percent partner in the same general location as their medical practices. Each restaurant and the brewery operated in a separate LLC. For the years 2010-2012, they deducted nonpassive losses of more than $3 million from these businesses. The IRS claimed that the losses were passive and, thus, nondeductible. The petitioners couldn’t substantiate their participation, but did have some records showing trips and time spent at the various locations. They were also able to obtain sworn statements from 12 witnesses about the petitioners’ involvement in the construction and operation on a daily basis over the years. The Tax Court found the witnesses credible. The Tax Court determined that the petitioners had satisfied the material participation requirement of Temp. Treas. Reg. §1,469-5T(a)(4) because their hours in the non-medical activities exceeded the 100 hours required for each one to be considered a significant participation activity and exceeded the 500-hour threshold. The Tax Court therefore rejected the IRS argument that the restaurants and brewery were passive activities. The claimed losses were currently deductible. Padda v. Comr., T.C. Memo. 2020-154.

Posted September 1, 2021

Amounts For Repaid Loans Were Shareholder Distributions. The petitioner was engaged in the business of buying businesses and flipping loans. The petitioner controlled numerous businesses and there were many intercompany transactions involving funds transfers and loans. The business was successful until 2008. Eventually, some of the loans could not be repaid and were forgiven. The petitioner reported the amounts received as a result of the repayment of the loans were not income. The Tax Court, however, determined that there was a diminished likelihood that the loans could be repaid after 2007. That bore on the issue of whether the loans were bona fide debt. The Tax Court also noted that respect for the loan characterization and repayments gradually disappeared after 2007. As such, the Tax Court held that the transfers and other intercompany transfers were not properly characterized as loans beginning on January 1, 2008 and were taxable as shareholder distributions. Kelly v. Comr., T.C. Memo. 2021-76.

Posted August 31, 2021

Book-Related Payments Are S.E. Taxable. The petitioner is a well-known writer specializing in the macabre and violent crime genre, who has a personal fascination with the inner workings of the Manson family and states that her favorite book is Helter Skelter. She received two types of payments annually from her publisher – a nonrefundable advance and a royalty. No royalty was paid until the total computed amount for the royalty exceeded the nonrefundable advance that had been paid. The petitioner claimed that only the portion of her income related to writing should be subject to self-employment tax as reported on Schedule C, and that the other royalty portion and the portion related to her name brand benefitting a publishing house was properly reported on Schedule E where it was not self-employment taxable. The Tax Court disagreed, noting that none of the petitioner’s contracts allocated advances or royalties between writing and promotion. There were also not noncompete or exclusive option clauses. The Tax Court also noted that the payments were not designated separately for writing and for the petitioner’s brand. The tax preparer also did not have copies of the petitioner’s contracts, simply breaking out the total amount the petitioner received in accordance with the time petitioner spent actually writing. The Tax Court determined that all of the petitioner’s income was associated with the petitioner’s conduct of the petitioner’s trade or business, including the brand activities. Accordingly, all of the petitioner’s income was subject to self-employment tax. The Tax Court also rejected the petitioner’s argument that Rev. Rul. 68-499, 1968-2 C.B. 421 supported her position. That ruling involved two employees that were among five persons owning patents that the employer paid royalties to for licenses to manufacture items. The IRS determined that the royalty paid to the employees was not subject to payroll tax and were not included in their W-2 income. The Tax Court, however, viewed the Rev. Rul. as irrelevant because the issue before the court was self-employment tax where the issue in the Rev. Rul. was payroll tax. The Tax Court noted that self-employment tax was tied to the taxpayer’s conduct of a trade or business whereas payroll tax focused on the definition of wages as payment to an employee for services provided to the employer. As such, all of the petitioner’s brand activities were related to the conduct of the petitioner’s trade or business of writing books. On further review, the appellate court affirmed. Slaughter v. Comr., T.C. Memo. 2019-65, aff’d., No. 20-10786, 2021 U.S. App. LEXIS 22932 (11th Cir. Aug. 3, 2021).

Posted August 30, 2021

Unassessed Tax Liabilities Nondischargeable in Bankruptcy. The petitioners filed a voluntary Chapter 11. The IRS filed a proof of claim for tax deficiencies for several years, but not including 2003. The bankruptcy court approved the petitioners’ reorganization plan and the IRS moved to life the automatic stay so that the Tax Court could issue a decision on the petitioners’ 2003 tax year. The bankruptcy court granted the motion, and the Tax Court issued an opinion on the 2003 tax year which held that the petitioners owed deficiencies, penalties and additions to tax for 2003 as determined in the notice of deficiency that IRS has issued. The IRS later assessed the 2003 liability and issued a Notice of Federal Tax Lien for the petitioners’ 2003, 2008 and 2009 tax years. The petitioners requested a Collection Due Process hearing. The IRS partially released its lien, determining that the 2008 and 2009 tax liabilities were included in the taxpayers’ bankruptcy. However, IRS determined that the lien filing as to the 2003 liability was appropriate and collectible after the petitioners received a discharge in the bankruptcy. The Tax Court determined that the IRS did not abuse its discretion in determining that the 2003 tax debt was collectible after the bankruptcy discharge because unassessed tax liabilities are nondischargeable. Barnes v. Comr., T.C. Memo. 2021-49.

Posted August 20, 2021

Latex Dancer Fee Unconstitutional. In 2007 the Texas legislature passed and the governor signed into law a “sexually oriented business fee” (SOBF) imposing a $5 per customer charge (the so-called “pole tax”) on businesses that serve alcohol in the presence of “nude” entertainment. The law went into effect on January 1, 2008. To avoid the fee, many businesses modified their practices to require that female dancers wear shorts and opaque latex over their breasts. After sending inspectors to various establishments to see what dancers were not wearing, the Texas Comptroller, in January of 2017, promulgated a ruled clarifying that “nude” applied to dancers wearing opaque latex over their breasts, thereby subjecting the businesses to the SOBF. The Comptroller then began proceedings to collect the fee both prospectively and retroactively to 2008. The plaintiff, the state organization for member strip clubs, filed suit to challenge the rule on First Amendment and Equal Protection grounds. The defendant claimed that the suit was barred under the Tax Injunction Act (federal law barring lawsuits that could restrain collection of tax), and claimed that the law was otherwise constitutional. The trial court determined that the rule violated the plaintiff’s right to freedom of expression, right to equal protection and due process. The appellate court affirmed. While the appellate court determined that the didn’t violate equal protection because it treated all clubs the same, latex or non-latex, the appellate court held that the rule violated “latex bars” right to freedom of expression and due process. The appellate court determined that the rule was subject to strict scrutiny and, as such, was presumptively unconstitutional. The appellate court also found a due process violation because the Comptroller knew how various clubs were skirting the rule and made no attempt to enforce the rule and collect the customer charge, thus giving rise to an expectation of nonpayment. Thus, the attempt at retroactive collection violated the clubs’ due process rights. The appellate court also held that the suit was not barred by the Tax Injunction Act because the charge was a fee and not a tax. Texas Entertainment Association, Inc. v. Hegar, No. 20-50262, 2021 U.S. App. LEXIS 24871 (5th Cir. Aug. 19, 2021).

Law Limiting Deductions for Pot Shops Constitutional. I.R.C. §280E disallows deductions or credits for amounts paid or incurred in carrying on a trade or business that consists in trafficking in controlled substances prohibited by law. The petitioner challenged the constitutionality of the law and the Tax Court upheld its constitutionality, finding that the law did not violate either the Eighth or Sixteenth Amendment. Thus, the Tax Court denied the petitioner’s deductions for expenses related to the growing, producing and selling of medical marijuana products. Today’s Health Care II, LLC v. Comr., T.C. Memo. 2021-96.

No Theft Loss Deduction. The petitioner was the president, CEO and sole shareholder of an S corporation that he cofounded with Ruzendall. From about 2010 forward, Ruzendall was no longer a shareholder but continued to manage the S corporation’s books and records. The petitioner became ill in 2016 and was unable to work and relied on others to handle the taxes for the business. Upon a bookkeeper’s advice, Ruzendall was issues a Form 1099-Misc. for 2016 reporting $166,494 in non-employee compensation. In 2018, the petitioner sued Ruzendall for misappropriation of funds, alleging a loss from embezzlement. In 2019, an amended Form 1120-S was filed. The IRS denied a deduction for embezzlement and the alternative claim as a deduction for compensation. The Court looked to the definition of embezzlement under state law. One of the requirements is an intent to defraud. The taxpayer did not offer evidence the woman intended to defraud the company and denied the deduction. The Court also noted that even if a theft loss occurred it was discovered in 2017, not 2016 and, therefore, could only be deducted in the year of discovery. The Court also denied the taxpayer's alternate argument of a deduction for compensation, but on the taxpayer's claim he did not mention the woman was entitled to compensation. The Court denied the alternative argument. Torres v. Comr., T.C. Memo. 2021-66.

Posted August 3, 2021

Assignment of Income Doctrine At Issue. The petitioner and spouse owned 50 percent of an S corporation engaged in construction projects. They were also involved in drag racing. They reported the income and expenses of the racing operation on the S corporation’s books. The IRS took the position that the taxpayers merely assigned the income of the racing operation to the S corporation while in fact they were separate operations. The Tax Court upheld the IRS position that the income had to be reported on the taxpayers' personal return as other income. The S corporation also claimed an I.R.C. §179 deduction for the cost of a utility trailer and an excavator. The IRS also disallowed this deduction. The Tax Court determined that the petitioner failed to show that the trailer was used for business purposes. Instead, it was used to transport race cars. The I.R.C. §179 expense for the excavator was disallowed because all the S corporation could show with respect to the purchase was an undated bill of sale. The petitioner established that he made a cash withdrawal and purchased a money order for the purchase of the excavator, but failed to prove that the cash withdrawal was connected to the purchase. Berry v. Comr., T.C. Memo. 2021-52.

Travel Expenses Not Deductible. The petitioner lived in Georgia, but worked in Louisville, Kentucky as a nurse. She deducted over $30,000 in travel-related expenses traveling between Kentucky and Georgia. The IRS denied the deductions and the Tax Court agreed. The Tax Court determined that the petitioner’s tax home was Kentucky. She had no business ties in Georgia and her job in Kentucky was not temporary. The petitioner also rented an apartment in Kentucky, filled prescriptions there and registered her car in Kentucky. The Tax Court noted that those facts further indicated that Kentucky was the petitioner’s tax home. West v. Comr., T.C. Memo. 2021-21.

Posted July 26, 2021

Payment For Water Right is Business Expense. The IRS, in a private ruling, determined that a contractually obligated payment for part of the cost of acquiring a water right was an ordinary expense. The right, IRS determined, was used to mitigate environmental damage from a tract of real estate, not improve it. Also, because the water right was used to combat groundwater draw down was a business expense, the taxpayer was eligible to deduct the payment for tax purposes. Priv. Ltr. Rul. 202129001 (Apr. 21, 2021).

Posted July 21, 2021

Tax Treatment of Employer Leave-Based Donation Programs Extended. In Notice 2020-46, IRS said that cash payments employers make to I.R.C. §170(c) organizations in exchange for vacation, sick or personal leave that the employees elect to forego will not be treated as wages (or compensation) to the employees, or otherwise be included in the gross income of the employees. This is the result, IRS said, if the payments are made to the qualified organizations for the relief of victims of the China virus in the charity’s geographic area and the amounts are paid to the qualified charity before 2021. Employees electing to forgo leave are not treated as having constructively received wages or compensation. Thus, the amount of the qualified cash payments are not included in Box 1, 3 (if applicable) or 5 of Form W-2. Electing employees cannot claim a charitable contribution deduction under I.R.C. §170 for the value of the forgone leave. An employer may deduct the cash payments as a business expense (under the rules of I.R.C. §170 or I.R.C. §162). In mid-2021, the IRS extended the guidance issued in 2020 through 2021. I.R.S. Notice 2021-42, IR-2021-142.

Uber Driver Taxed on All Amounts on His Account. The petitioner signed on with Uber, installed the necessary IT connections and subcontracted the driving to other persons using automobiles that were registered to the petitioner and stored at his home. For tax year 2015, Uber issued a 1099-K to the petitioner in the amount of $542,420. The petitioner did not report that amount on his 2015 return. He also had established an LLC but did not file Form 8832 or Form 1065. Thus, the entity was a disregarded entity, and the Form 1099-K amount should have been reported on the petitioner’s individual return. The Tax Court allowed a deduction for amounts the petitioner paid to other drivers from his Uber-connected bank account. But, the petitioner failed to substantiate amounts paid to other drivers in cash and could not deduct those claimed amounts. The petitioner also failed to satisfy the strict substantiation requirements of I.R.C. §274 for his vehicles and the Tax Court upheld the IRS denial of vehicle-related deductions. Nurumbi v. Comr., 2021 T.C. Memo. 79.

Study Hours Don’t Count Toward 750-Hour test. The petitioners, a married couple, sustained losses on rental properties from 2008-2010 and deducted them as non-passive losses on the basis that the wife was a real estate professional in accordance with I.R.C. §469(c)(7). As such, she had to put more than 50 percent of the personal services that she performed for any given year into real property trades or businesses in which she materially participated, and perform more than 750 hours of services during the tax year in real property trades or businesses in which she materially participated. The trial court determined that the wife did not satisfy the 750-hour test because it was not permissible to count her hours spent during 2008-2009 studying for her real estate license. The appellate court affirmed on this point, and also affirmed the trial court’s finding that the wife failed to meet the 750-hour test in 2010 because the time spent working on the couple’s personal properties could not count toward the required 750 hours to be spent on real property trades or businesses. Johnson v. United States, No. 20-16927, 2021 U.S. App. LEXIS 18847 (9th Cir. Jun. 24, 2021).

Posted July 18, 2021

Alimony Deduction Tied To Former Spouse. The petitioners, a married couple paid their former son-in-law to visit their grandchildren and deducted the amounts as “alimony.” The IRS denied the deduction and the Tax Court affirmed on the basis that the deduction belongs exclusively to the former spouse, the petitioners’ daughter. The Tax Court noted that alimony obliges the former spouse, not anyone else that makes payments on behalf of an ex-spouse. The Tax Court also held that the petitioners could not deduct amounts allegedly as business expenses as rent for a greenhouse related to a cannabis business due to a lack of evidence that the amounts were spent on a business. Berger v. Comr., T.C. Memo. 2021-89.

Guidance on Use Tax Is Due on Acquisitions of Farm Personal Property (Washington). The Washington Department of Revenue (WDOR) has provided guidance to farmers, who are generally not required to register with the WDOR, about when use tax may be due on acquisitions of tangible personal property. When farmers purchase machinery and equipment from a dealer in Washington, they usually pay sales tax to the dealer who remits the tax to the WDOR. In the instances where sales tax is not paid, use tax is due. Some examples include machinery and equipment purchased from another farmer or in another state, through a mail order catalog, or through the internet, and purchases of machinery parts and labor outside the state for equipment shipped back into Washington. The WDOR also addressed credits for tax paid to another state and for equipment trade-ins. The WDOR also discussed sales and use tax exemptions available to farmers such as exist for livestock feed for feeding livestock at public livestock markets and purchases of pollen. Wash. Dept. of Rev. Informational Publication No. 06/01/2021 (Jun. 1, 2021).

Posted July 16, 2021

IRS Guidance on 2020 Business Interest Limitation Calculation. The IRS has taken the position that, to determine the amount of interest allowed as a deduction for the 2020 tax year under the business interest limitation rules of I.R.C. §163(j), a taxpayer's adjusted taxable income (ATI) under I.R.C. §163(j)(8) includes those adjustments that are required under I.R.C. §481(a) for a change in method of accounting for depreciation. Additionally, for purposes of determining ATI, the addback of the depreciation amount, including any I.R.C. §481(a) adjustment for the year of change, is allowed only for tax years beginning before January 1, 2022. C.C.M. 202123007 (May 10, 2021).

Posted July 15, 2021

Tax “Home” At Issue. The petitioner was a licensed union journeyman electrician. He owned a trailer home and a rental property in Colorado. His membership in his local union near his home gave him priority status for jobs in and around that area. When work dried up in the area near his home he traveled to jobs he could obtain through other local unions. As a result, he spent most of 2013 on jobs in Wyoming and elsewhere in Colorado. On his 2013 return, he claimed a $39,392 deduction for unreimbursed employee business expenses – meals; lodging; vehicle expenses (mileage); and union dues. He also claimed a deduction of $6,025 for “other” expenses such as a laptop computer, tools, printer and hard drive. The petitioner claimed a home mortgage interest deduction on the 2013 return for the Colorado home. He voted in Colorado, his vehicles were registered there, and he received his mail at his Colorado home. The IRS disallowed the deductions. The Tax Court noted that a taxpayer can deduct all reasonable and necessary travel expenses “while away from home in pursuit of a trade or business” under I.R.C. §162(a)(2). Home for this purpose means the vicinity of the taxpayer’s principal place of business rather than personal residence. In addition, when it differs from the vicinity of the taxpayer’s principal place of employment, a taxpayer’s residence may be treated as the taxpayer’s tax home if the taxpayer’s principal place of business is temporary rather than indefinite. If a taxpayer cannot show the existence of both a permanent and temporary abode for business purposes during the tax year, no deductions are allowed. The Tax Court cited three factors, based on Rev. Rul. 73-529, 1973-2 C.B. 37, for consideration in determining whether a taxpayer has a tax home – (1) whether the taxpayer incurred duplicative living expenses while traveling and maintaining the home; (2) whether the taxpayer has personal and historical connections to the home; and 3) whether the taxpayer has a business justification for maintaining the home. As such, the Tax Court held that the petitioner’s tax home was his Colorado home for 2013. His work consisted of a series of temporary jobs, each of which lasted no more than a few months. That meant that he did not have a principal place of business in 2013. He paid a mortgage on the Colorado home, and had significant personal and historical ties to the area of his Colorado home where he had been a resident since at least 2007. Also, his relationship with the local union near his Colorado home gave him a business justification for making his home where he did in Colorado. Thus, the Tax Court concluded that the petitioner was away from home for purposes of I.R.C. §162(a)(2). The Tax Court allowed substantiated meal expenses which were tied to a business purpose to be deducted. The court also allowed lodging expenses to be deducted to the extent they were substantiated by time, place and business purpose for the expense. The Tax Court also allowed a deduction for business mileage at the IRS rate where it was substantiated by starting and ending point. The Tax Court also allowed the petitioner’s claimed deductions for union and professional dues, but not “other expenses” for lack of proof that they were incurred as an ordinary and necessary business expense. The end result was that the Tax Court allowed deductions totaling approximately $7,500. Geiman v. Comr., 2021-80.

Unforeseen Circumstances Exception to Two-Rule Home Ownership Rule At Issue. The defendants, a married couple, bought a home in 2000 and lived there until 2005 when they sold it. They put about $150,000 worth of furniture in the home. In 2003, they bought a lot with the intent to build a home. They took out a loan an began construction on the home. They also did not get paid the full contract amount for the 2005 home sale and couldn’t collect fully on the seller finance notes. They experienced financial trouble in 2005, but moved into the new home in December of 2005 and purchased an adjacent lot for $435,000 with the intent to retain a scenic view from their new home. After moving into their new home, the defendants sought to refinance the loan to a lower interest rate, but were unable to do so due to bad credit. Thus, a friend helped them refinance by allowing them to borrow in his name. They then executed a deed conveying title to the friend. A trust deed named the friend as Trustor for the defendants as beneficiaries. The friend obtained a $1.4 million loan, kept $20,000 of the proceeds and used the balance to pay off the defendants’ loans. The defendants made the mortgage payments on the new loan. In 2006, they also executed a deed for the adjacent lot in the friend’s favor. In 2007, the friend signed a quitclaim deed conveying title of the home to the defendants. The loan on the home went into default, and the defendants then transferred title of the home to an LLC that they owned. They then sold the home in and the adjacent lot for $2.7 million later in September of 2007 and moved out. An IRS agent filed a report allowing a basis increase in the initial home for the furniture that was sold with that home, and determined that the defendants could exclude $458,333 of gain on the 2007 sale of the new home even though they had not lived there for two years before the sale. Both the IRS and the defendants challenged the agent’s positions and motioned for summary judgment. The defendants claimed that they suffered unexpected financial problems requiring the sale before the end of the two-year period for exclusion of gain under I.R.C. §121. As such, the defendants claimed that they were entitled to a partial exclusion of gain for the period that they did own and use the home. The court noted that the defendants’ motion for summary judgment required them to show that there was no genuine issue of material fact that the home sale was not by reason of unforeseen circumstances. The court denied the motion. A reasonable jury, the court determined, could either agree or disagree with the agent’s report. While the defendants were experiencing financial problems in 2005, before moving into the new home, the facts were disputed as to when they realized that they would not be able to collect the remaining $695,000 of holdbacks from the buyers of the first home. The court also denied the defendants’ motion that they were entitled to a basis increase for the cost of the furniture placed in the initial home. The defendants failed to cite any authority for such a basis increase. United States v. Forte, No. 2-:18-cv-00200-DBB, 2021 U.S. Dist. LEXIS (D. Utah Jun. 21, 2021).

Corporate Payment of Personal Expenses Not Deductible. The petitioner paid for personal expenses of its officers and their family members via credit cards issued in the petitioner’s name. The cards were also used to pay officers (and family members) personal credit card, and family members continued to make personal purchases on the petitioners’ cards even during periods when they were not employees of the petitioner. The IRS disallowed the deductions, and the Tax Court agreed. The petitioner also recorded the personal expenditures as a “Note Receivable from Officers” in multiple entries on the corporate books and maintained a running balance, indicating the personal nature of the expenses. The Tax Court also disallowed the petitioner’s I.R.C. §45A tax credit (Indian tax credit) because the petitioner was owned 51 percent by an Indian. Blossom Day Care Centers, Inc. v. Comr., 2021 T.C. Memo. 86.

Firm Marketing Tax Reduction Strategies Willfully Evaded Tax Laws. The petitioner, a tax planning company in San Diego, California, marketed tax reduction strategies. It generated more than $31 million in revenues between 2003 and 2011 that flowed through the company to a web of Wyoming limited liability companies, S corporations, employee stock ownership plans (ESOPs), ranches and other pass-through businesses. The petitioner paid zero corporate income tax between 2002 and 2011, and the owner paid only $31,000 in federal income tax during that timeframe on $1.5 million in distributions from the petitioner and associated businesses. The Tax Court determined that client fees were compensation to the petitioner for its services in creating entities and hiding the connection between itself and the fees it charged. The corporation diverted the payments through contracts and entities, and accounts and divisions within entities. The Tax Court noted that the assignment of income doctrine meant that the petitioner was the actual recent of the income for the services rendered. Ernest S. Ryder & Associates v. Comr., T.C. Memo. 2021-88.

No Like-Kind Treatment for Cryptocurrency Trades. The IRS examined trades in which taxpayers exchanged Bitcoin, Ethereum and Litecoin. The IRS took the position that none of the cryptocurrencies can qualify as like-kind to each other under the pre-TCJA rules. The IRS pointed to revenue rulings on coins and precious metals as its foundation for analyzing the nature and character of cryptocurrency. The IRS noted that Bitcoin played a fundamentally different role in the market and differed in nature and character from Litecoin. The IRS also noted that Ethereum blockchain acts as a payment network and a platform for operating smart contracts and other applications, with the currency working as the “fuel” for those features. The IRS stated that all crypto transaction must be examined independently, and that the market is changing frequently. ILM 202124008 (Jun. 8, 2021).

Taxpayer Had Trade or Business Income. The petitioner, an independent contractor, filed a zero tax return. IRS, via Forms 1099-MISC and the petitioner’s wage and income transcript and his admissions, determined that he had received payments in the amounts the Forms indicated for services that he provided to a marketing company and an agency for the tax year at issue. The Tax Court rejected the petitioner’s argument that the payments weren’t taxable to him because he didn’t participate in a trade or business within the meaning of I.R.C. §7701(a)(26). Delgado v. Comr., T.C. Memo. 2021-84.

Posted July 13, 2021

Solar Power Generation Assessed as “Farmland.” New Jersey law now provides that land on which a dual-use solar energy project is constructed and approved is eligible for farmland assessment, subject to certain conditions. To receive farmland assessment, a dual-use solar energy project must: (1) be located on unpreserved farmland that is in operation as a farm in the tax year for which farmland assessment is applied for; (2) in the tax year preceding the construction, installation, and operation of the project, the acreage used for the dual-use solar energy project must have been valued, assessed, and taxed as land in agricultural or horticultural use; (3) be located on land that continues to be actively devoted to agricultural and horticultural use, and meets the income requirements set forth in state law for farmland assessment; and (4) have been approved by the state Department of Agriculture. In addition, no generated energy from a dual-use solar energy project is considered an agricultural or horticultural product, and no income from any power sold from the dual-use solar energy project is considered income for the purposes of eligibility for farmland assessment. To be eligible, the owner of the unpreserved farmland must obtain the approval of the Department of Agriculture, in addition to any other approvals that may be required pursuant to federal, state or local law, rule, regulation, or ordinance, before the construction of the dual-use solar energy project. L. 2021, A5434, eff. Jul. 9, 2021.

South Dakota Updates Sales and Use Tax Guide for Ag. In its updated guidance related to farm machinery, attachments and irrigation equipment, the South Dakota Department of Revenue has also revised the definition of “agricultural land” in accordance with newly revised S.D. Cod. Laws §10-6-112. Under the revised statute, “principal use” means the primary use of the land as opposed to a mere secondary and incidental use. Under the revision, “ag land” for sales and use tax purposes annual gross income of at least $2,500 must be derived form the pursuit of agriculture from the land. This, however, excludes transactions between: (1) an individual and anyone with whom the individual shares a residence; (2) an individual and an entity in which the individual and anyone who shares a residence with the individual have an aggregate ownership interest of more than 50%; or (3) entities that are members of the same controlled group, as defined. South Dakota Tax Facts, No. 07/01/2021(Ag Machinery, Attachment Unit, and Irrigation Equipment).

Posted July 11, 2021

Hoop Buildings are Farm Machinery and Equipment in Missouri. A taxpayer sold hoop buildings that are designed and used for livestock production. The buildings are of a permanent nature and can be used in multiple livestock production cycles. The Missouri Department of Revenue (MDOR) determined that is a buyer used a hoop building exclusively, solely, and directly for raising livestock for ultimate sale at retail, the hoop building constitutes "farm machinery and equipment" exempt from sales and use tax under Mo. Rev. Stat. §144.030(2)(22). In addition, the MDOR concluded that the mere fact that the purchaser ultimately attaches the system to a wood or concrete foundation does not make the hoop building subject to sales and use tax. But, MDOR determined that the taxpayer's sales of hoop buildings would not be exempt from sales and use tax as farm machinery and equipment if they are used for purposes such as grain, hay, and other commodity storage, feed rations storage, sand, salt and gravel storage, and storage of equipment and machinery. The MDOR reasoned that hoop buildings used for grain storage are not used in the production of crops. Grain storage is not an agricultural purpose under Mo. Rev. Stat. §144.030.2(22). Neither is the storage of machinery and equipment. MDOR Priv. Ltr. Rul. No. LR 8152 (Jun. 29, 2021).

Drug-Induced Gambling Losses Disallowed. The petitioner was diagnosed with Parkinson’s disease in 2004 and began taking prescription medicine to help him control his movements. Over time, the medication dosage was increased. In 2008, he began gambling compulsively, and by the end of 2010 he had drained all of his bank accounts and almost all of his retirement savings. In 2009, he started selling real estate holdings for less than fair market value and used the proceeds to pay his accumulated gambling debt. In 2010, his doctor took him off his medication and his compulsive gambling ceased along with his compulsive cleanliness, and suicidal thoughts. The medication he had been on was known to lead to impulse control disorders, including compulsive gambling. On his 2008-2010 returns he reported gambling winnings and also deducted gambling losses to the extent of his winnings. He later filed amended returns characterizing the gambling losses as casualty losses. While the Tax Court determined that the compulsive gambling was a likely side effect of the medication, the Tax Court agreed with the IRS that the gambling losses were not deductible because there was no physical damage property as I.R.C. §165 requires. Also, the gambling losses over a three-year period failed the “suddenness” test to be a deductible casualty loss. In addition, the Tax Court found that the petitioner had failed to adequately substantiate the losses. On appeal, the appellate court affirmed. Mancini v. Comr., No. 19-73302, 2021 U.S. App. LEXIS 19362 (9th Cir. Jun. 29, 2021), aff’g., T.C. Memo. 2019-16.

ARPA State Tax Provision Permanently Enjoined. The American Rescue Plan Act (ARPA) provided taxpayer dollars to states burdened by the edicts of various state governors shutting non-favored businesses in reaction to the 2020 flu. However, a state’s receipt of federal funds was conditioned upon the state not using the funds, either directly or indirectly, to cut taxes. The plaintiff, state of Ohio, sought a permanent injunction barring the Treasury Secretary from enforcing the provision. The plaintiff claimed that the provision was ambiguous and violated the Spending Clause in that the Congress failed to clearly state any conditions it imposes on federal grants offered to states resulting in an impermissible federal intrusion on the States’ sovereign and indispensable authority to establish tax policy in each state. The defendant claimed that its regulations implementing ARPA clarified the contours of the provision and consequently cured any constitutional defect. The court rejected the defendant’s arguments, first noting that the Congress did not, under the terms of ARPA, authorize the Treasury Department to clarify the provision. The court also determined that the plaintiff articulated an ongoing harm arising from the ambiguity of the provision, and that the provision violated the constitution’s Spending Clause. Ohio v. Yellen, No. 1-21-cv-181, 2021 U.S. Dist. LEXIS 123008 (S.D. Ohio Jul. 1, 2021).

Posted June 27, 2021

To Recover Cost of Goods Sold, Taxpayer Must Have Gross Receipts From Sale of Goods. The petitioners passed through to their investors $160 million in mineral lease acquisition costs over two tax years. However, they had failed to drill anything except two test wells. The petitioners stipulated that the test wells were irrelevant. The petitioners generated no income from the wells. However, they characterized the passed-through amounts as costs of goods sold in the amount of $100 million for 2008 and $60 million in 2009 for drilling costs for natural gas mining. There were no gross receipts for natural gas for either 2008 or 2009. The IRS disallowed the deduction for costs of goods sold and the Tax Court agreed. The Tax Court noted that the petitioners had no receipts from the sale of goods to offset by costs. BRC Operating Company LLC v. Comr., T.C. Memo. 2021-59.

Basis Reduction Is In Same Year As Discharge of Debt. In 2009 petitioner purchased3 27 investment properties on which he assumed outstanding loans totaling $1,714,520. By 2012 petitioner was struggling to make payments on the loans. The petitioner sold 16 of the properties in 2012, with 15 of them being sold at a loss. After the sales, the lender restructured the petitioner’s debt and issued Form 1099-C for each property sold at a loss evidencing the amount of debt forgiven. The petitioner sold additional investment properties in 2013 at a loss. The lender again restructured the debt, but didn’t issue Form 1099-Cs for 2013. In late 2015, the lender noted that $493,141 was the remaining amount to be booked as a loan loss reserve recovery as of October 25, 2015. After filing an initial return for 2012, the petitioner filed Form 1040X for 2012 on January 14, 2015. The Form 4797 attached to the amended return stated that petitioner had sold 17 properties for a loss totaling $613,263. On Form 982 petitioner reported that he had excludable income of $685,281 "for a discharge of qualified real property business indebtedness applied to reduce the basis of depreciable real property" (i.e., the debt discharged from the lender). On October 15, 2014, the petitioner filed Form 1040 for 2013. On Form 4797 included with that return, petitioner reported that in 2013 he had sold six investment properties5 and his primary residence (which was also listed as an investment property) for a loss totaling $499,417 ($437,650 for the investment properties and $61,767 for his primary residence). On October 15, 2015, the petitioner filed Form 1040 for 2014. The petitioner reported a net operating loss carryforward of $423,431 from 2013. On Form 982 petitioner reported he had excludable income of $65,914 from a discharge of qualified real property business debt. A Form 1099-C shows that petitioner received a discharge of debt of $65,914 from the 2014 sale of his primary residence (the same residence reported as sold in his 2013 tax return). The IRS disallowed the loss deductions claimed on petitioner’s 2013 Form 4797. For 2014, the IRS disallowed the loss carryover deduction from 2013. The issue was whether the basis reduction as a result of the debt discharge occurred in 2012 or 2013. Also at issue was whether there was any debt discharge in 2013. The Tax Court, in a case of first impression, laid out the statutory analysis. The Tax Court noted that, in general, a taxpayer realizes gross income when a debt is forgiven under I.R.C. §61(a)(11). But, under I.R.C. §108(a)(1)(D), forgiveness of qualified real property business debt is excluded from income. However, the taxpayer must reduce basis in the depreciable real property under I.R.C. §108(c)(1)(A). I.R.C. §1017 requires the reduction of basis to occur at the beginning of the tax year after the year of discharge. But, I.R.C. §1017(b)(3)(F)(iii) provides that in the case of property taken into account under I.R.C. §108(c)(2)(B) which is related to the exclusion for qualified real property business debt, the reduction of basis occurs immediately before the disposition of the property (if earlier than the beginning of the next taxable year). The Tax Court reasoned that because the petitioner received a discharge of qualified real property debt and sold properties in 2012, he was required to reduce his bases in the disposed properties immediately before the sales of those properties in 2012. The Tax Court rejected the taxpayer’s arguments that because the aggregated bases in his unsold properties in 2012 exceeded the discharged amount, he did not need to reduce his bases until 2013. The Tax Court noted instead that selling properties from the group triggered I.R.C. §1017(b)(3)(F)(iii) with respect to the bases of the properties sold regardless of the remaining bases in the properties not sold. The basis reduction rule for qualified real property debt is an exception to the general rule of basis reduction in the year following the year of debt discharge. Hussey v. Comr., 156 T.C. 12 (2021).

Posted June 25, 2021

No Deductible Theft Loss Associated With Stock Purchase. The petitioners, a married couple, bought corporate stock from a third party’s mother after the third part “encouraged” them to do so. The petitioners lost money on the stock and deducted the losses as theft losses on the basis the they were defrauded in the purchase based on false pretenses. The IRS denied the deductions. Under state (CA) law, theft by false pretenses requires that the defendant made a false pretense or representation to the owner of property with the intent to defraud the owner of that property, and that the owner transferred the property to the defendant in reliance on the representation. The petitioners did their own investigation, confirming the information presented to them. They also provided records of communications between them and the promoter about the investments. But, they failed to provide specific evidence that the third party’s representations were false or that they were made with the intent to defraud. The Tax Court held that the taxpayer’s failed to prove the elements for theft by false pretenses and that there was no reasonable prospect of recovery. Accordingly, the Tax Court upheld the determination of the IRS. Baum v. Comr., T.C. Memo. 2021-46.

No Charitable Deduction for Donated Conservation Easement. The petitioner engaged in a syndicated easement transaction whereby it made a $6.9 million charitable contribution for an easement on 637 acres of a 652-acre parcel donated to a land conservancy. The IRS denied a charitable deduction due to the easement deed not satisfying the perpetuity requirement and imposed a 40 percent gross valuation misstatement and negligence penalties. The Tax Court agreed, determined that the actual value of the easement donation was less than 10 percent of what was originally reported on the petitioner’s return. In the process, the Tax Court gave more credibility to the approach of the appraiser for the IRS. On appeal, the appellate court affirmed the denial of the deduction and the penalties that the IRS imposed, including a 40 percent gross valuation misstatement penalty. The appellate court also noted that the deed in question would subtract any gain in value from improvement to the land after the donation if the easement were extinguished by judicial action. That, the appellate court noted, violated the formula set forth in the “extinguishment regulation” of Treas. Reg. §1.170A-14(g)(6)(ii), and contained an unenforceable savings clause. The appellate court also dismissed the petitioner’s expert opinion that the best use of the easement before the donation was as residential development because the evidence showed that the surrounding areas were unpopulated and undeveloped. As such, the appellate court determined that the Tax Court reasonably concluded that the easement’s most valuable use would have been as a recreation and timber investment property. TOT Property Holdings, LLC v. Comr., No. 20-11050, 2021 U.S. App. LEXIS 18679 (11th Cir. Jun. 23, 2021), aff’g., No. 5600-17 (U.S. Tax Court Dec. 13, 2019).

Posted June 22, 2021

Deductions Fail For Lack of Substantiation. On her 2015 return, the petitioner reported approximately $40,000 of income and claimed about $33,000 of deductions. The deductions included Schedule A deductions of $6,500 for charitable donations and $4,500 for sales taxes. Schedule C deductions were claimed for meals and entertainment; car and truck expense; utilities for a home office; legal fees; advertising; and “other” expenses. The IRS disallowed all of the Schedule C deductions and the Schedule A deductions for charity and sales taxes. The Tax Court determined that the petitioner could not meet the specific receipt requirement for the cash donations to charity or sales taxes, but used the sales tax tables to substantiate the sales tax deduction. The Tax Court determined that the petitioner could not satisfy the heightened substantiation deduction requirements of I.R.C. §274(d) or §280A for the Schedule C deductions. Chancellor v. Comr., T.C. Memo. 2021-50.

“Reward” for Services Was Income Rather Than Gift. The petitioner was an employee of an eyewear laboratory. In 2016, the lab was acquired by another company and the petitioner lost his job. The acquiring company paid the petitioner $25,000 as a “gift, a reward for his services.” The acquiring company treated the payment as a non-employee compensation and filed a Form 1099-Misc. The petitioner treated the payment as a nontaxable gift. The IRS computers caught the discrepancy and initiated an examination. The IRS took the position that the payment was taxable income and sent the petitioner a notice of deficiency. The petitioner filed a petition with the Tax Court. While officials of the acquiring company made statements that led the petitioner to believe that the amount was a gift, the Tax Court determined that the acquiring company’s dominant intent, based on objective facts, showed that there was disagreement whether to make the payment in the first place and the acquiring company paid a Form 1099-Misc. In addition, the Tax Court pointed out that the payment was made close in time to the sale of the company making it look that the payment was for the petitioner’s past services in building up the value of the company (even though the payment was also close in time to when the petitioner lost his job). The Tax Court noted that the IRS position was consistent with the acquiring company’s actions. Pesante v. Comr., No. 9107-19S, U.S. Tax Court (May 6, 2021).

HSA Inflation-Adjusted Numbers for 2022. During 2022, the annual limitation on deductions for an individual with self-only coverage under a high deductible health plan is $3,650. For those with family coverage, the limitation is $7,300. A “high deductible health plan” is one with an annual deductible of not less than $1,400 for self-only coverage or not less than $2,800 for family coverage, and where annual out-of-pocket expenses don’t exceed $7,050 (self-only) or $14,100 (family coverage). The maximum amount that may be made newly available for the plan year for an excepted benefit HRA under Treas. Reg. §54.9831-1(c)(3)(viii) is $1,800. Rev. Proc. 2021-25, I.R.B. 2021-21.

Posted June 20, 2021

Machinery and Equipment Used To Apply Fertilizer to Farmland Exempt From Sales Tax. The taxpayer was engaged in the business of manufacturing and blending of fertilizer, feed, seed, chemicals and grain for sales to farmers. The taxpayer purchased various items of machinery and equipment as well as repair or replacement parts, and sought guidance on whether its purchases were exempt from sales tax. The Mo. Dept. of Rev. concluded that to the extent the machinery, equipment and parts are used directly in the taxpayer’s blending operations they qualify for the manufacturing exemption from sales and use tax under Mo. Rev. Stat. §§144.030(2)(4)-(5). However, such items are not exempt if they are used only in the storage of beginning or ending inventory. Based upon the facts and information presented, the taxpayer's blending operations were deemed to be manufacturing. Additionally, the fertilizer is intended to be sold for final use or consumption. In addition, the taxpayer's purchases of machinery, equipment, and repair or replacement parts that are used exclusively for the custom application of fertilizer are exempt from sales and use tax if the requirements of Mo. Rev. Stat. §144.030(2)(22) are met. The Mo. Dept. of Rev. concluded, that if the taxpayer's purchases of machinery, equipment, and repair or replacement parts are used exclusively for the application of fertilizer to farmland owned or leased by its customers, then the taxpayer's purchases are exempt from sales tax if the statutory requirements are met. Mo. Dept. of Rev. Priv. Ltr. Rul. No. LR 8144 (Apr. 30, 2021).

No Research/Experimentation Credit for Clothing Designer. The petitioner was a clothing designer that developed, produced and sold women's clothing under many different brands or lines. In 2013, his company engaged alliantgroup, a tax consulting firm known for putting out misinformation on the research and development credit, to conduct a research and development tax credit study spanning 2009 to 2012. The resulting study was produced in 2014, and found that 32 of the 35 projects of the petitioner qualified for the research and experimentation credit. The petitioner claimed $426,255 of research credits via his S corporation in 2011 and $496,462 via his S corporation in 2012 and $322,700 of passthrough credits on Form 3800. These credits were consistent with the findings of the alliantgroup study. The IRS disallowed all of the claimed credits. The Tax Court upheld the IRS position noting that the petitioner’s work in developing clothing designs did not meet the requirements of the expenditures necessary for the research credit. The Tax Court noted that to be qualified research, the research must relate to a new or improved function, performance, reliability, or quality of the product or process. As a result, certain activities cannot be qualified research. Qualified research, the Tax Court noted, does not include research after commercial production; adaptation or duplication of an existing business component; market research, testing, or development; or routine or ordinary testing or inspection for quality control. Instead, the Tax Court noted that qualified expenditures must pass the tests contained in I.R.C. §Section 174 which require that the expenditures represent research and development costs in the experimental or laboratory sense. Essentially, for there to be experimental expenditures, the Tax Court held that the petitioner had to show that it did not already have information that can address a capability or method for improving the product or design of the product and that its activities were meant to eliminate those uncertainties. Max v. Comr., T.C. Memo. 2021-37.

Missouri - Large Drum Composter Exempt from Sales Tax. Under Mo. Rev. Stat. §144.030(2)(22), “farm machinery and equipment” is defined to include new or used farm tractors and other new or used farm machinery and equipment. The term also includes repair or replacement parts and any accessories for and upgrades to farm machinery and equipment used exclusively for agricultural purposes. The taxpayer, an out-of-state manufacturer and retailer of agricultural equipment, sought guidance on whether the sale of a large metal cylindrical bin that is installed above-ground in a farmyard was exempt from sales tax as farm machinery or equipment. A buyer would use the composter on its livestock and poultry farm to efficiently and safely compost dead animals The composter is also used to produce fertilizer, which a buyer would then used to produce crops for retail sale. The Mo Dept. of Rev. determined that the composter qualified as exempt farm equipment as being used exclusively for agricultural purposes. Mo. Dept. of Rev. Priv. Ltr. Rul. No. 8148 (May 28, 2021).

Posted April 26, 2021

No Deduction For Moving Expenses. The petitioners, a married couple, own a home in California and lived there as of the beginning of 2017. They were both employed. In early 2017, he was offered a job in Hawaii and moved to Hawaii to start work. The couples’ car and other household items soon followed. The wife and the couple’s child remained in California with intent to move to Hawaii later in 2017. However, the husband only worked the Hawaii job for about four months, resigned and moved back to California. He did not have a job in California upon returning. On their 2017 return, the couple claimed a $28,466 deduction for moving expenses. The IRS disallowed the deduction for failure to satisfy I.R.C. §217(c)(2)(A) which requires that during the 12-month period immediately following the taxpayer’s arrival in the general location of the new principal place of work, the taxpayer is employed full-time in that general location for at least 39 weeks. The IRS pointed out that the petitioner did not work in Hawaii for at least 39 weeks and terminated his employment voluntarily and returned to California. Thus, his reasons to end his employment were personal and not “involuntary” such that the exception of I.R.C. §217(d)(1) would apply. The Tax Court agreed with the IRS, and also held that the portion of his moving expenses allocable to returning to California were also nondeductible because he did not return to California in connection with work at a new principal place of work. Doyle v. Comr., No. 6532-20S, U.S. Tax Ct. (Apr. 14, 2021).

No Sales Tax Exemption For Purchase of Farm Machinery and Equipment. The taxpayer claimed that he purchased machinery to use to maintain an irrigation system on his farm as well as to destroy beaver dams, spray weeds and maintain trees. He claimed that he was engaged in the trade or business of farming for the year in issue. However, the taxpayer claimed no farming income or expense for the tax year on his return. Thus, the taxpayer failed to prove that he was engaged in a farming activity, a threshold requirement for claiming the sales tax exemption for purchases of farm machinery and equipment. Ark. Admin. Hearing Dec., No. 21-228 (Mar. 8, 2021).

Posted April 24, 2021

IRS Doesn’t Agree With Insolvency Calculation Decision. Upon retiring from the police force in 2005, the petitioner started receiving monthly distributions from his pension plan. The plan withheld federal income tax from the payments. The plan specified that the petitioner could not convert his interest in the plan into a lump-sum cash amount, assign the interest, sell the interest, borrow against the interest, or borrow from the plan. Upon the petitioner’s death, his surviving wife would receive payments for her life. In 2009, GMAC canceled approximately $450,000 of the petitioner’s mortgage debt that was secured by some of the petitioner’s non-residential real estate. The petitioner was not in bankruptcy in 2009. The canceled debt included $30,076 of interest. The petitioner excluded the forgiven interest from income based on I.R.C. §108(e)(2) because the petitioner had not deducted it on his Form 1040. That provision specifies that “no income shall be realized from the discharge of indebtedness to the extent that payment of the liability would have given rise to a deduction.” The IRS conceded this point. However, the IRS claimed that the petitioner’s interest in the principal amount of $418,596 that was canceled should be included in income. The petitioner claimed that the pension plan should not be considered an asset for purposes of the insolvency computation of I.R.C. §108(d)(3). Under that provision a taxpayer may exclude canceled debt from income to the extent of the taxpayer’s insolvency, defined as the extent to which the taxpayer’s liabilities exceed the fair market value of the taxpayer’s assets. But, the term “assets” is not defined. In a prior opinion, the full Tax Court determined that the value of an exempt asset could be included in the insolvency calculation if it gives the taxpayer “the ability to pay an immediate tax on income” from the canceled debt. Carlson v. Comr., 116 T.C. 87 (2001). The petitioner claimed that he couldn’t access the pension funds by its terms. The IRS did not challenge that point, but claimed the point was irrelevant. Instead, the IRS claimed that the petitioner’s right to receive monthly payments caused the plan to be considered an “asset.” The Tax Court disagreed, noting that its prior decision in Carlson only extended to assets that gave the taxpayer the “ability to pay an immediate tax on income” from the canceled debt, not the ability to pay the tax gradually over time. Schieber v. Comr., T.C. Memo. 2017-32. The IRS has announced its disagreement with the Tax Court’s opinion. A.O.D. 2021-1, IRB 2021-15.

FBAR Penalties Not Subject to “Full Payment” Rule. The plaintiff was assessed approximately $750,000 of “willful” Foreign Bank and Financial Account (FBAR) penalties. Such penalties can reach up to 50 percent of the highest account balance of the foreign account. He paid $1,000 of the penalty amount and then sued in the U.S. Court of Federal Claims under the Tucker Act to recover the $1,000 as an illegal exaction. The IRS counterclaimed, seeking the entire judgment of $750,000 plus interest. The plaintiff moved to dismiss his complaint on the basis that the court lacked jurisdiction over the illegal exaction claim on the basis of Flora v. United States, 362 U.S. 145 (1960). Such dismissal would nullify the court’s jurisdiction over the counterclaim of the IRS. Under Flora, in accordance with 28 U.S.C. §1346(a)(1), a taxpayer seeking to file a federal tax claim in federal court (other than the U.S. Tax Court) must pay the full amount of the tax before filing suit. However, the plaintiff claimed that 28 U.S.C. §1346(a)(1) only applied to “internal revenue taxes” and claims related to “internal revenue laws.” The petitioner noted that Bedrosian v. United States, 912 F.3d 144 (3d Cir. 2018) hinted that FBAR penalties may fall within the reach of 28 U.S.C. §1346(a). The court, in ruling for the plaintiff, flatly rejected the Bedrosian decision in holding that FBAR penalties are not subject to the Flora rule because they are not internal revenue laws or internal revenue taxes. The court noted that FBAR penalties are contained in Title 31 of the U.S. Code rather than Title 26 (the Internal Revenue Code), and that this placement was intentional. Title 31, the court noted, has as its purpose, the regulation of private behavior rather than the purpose of being a charge imposed for the purpose of raising general revenue. In addition, the court concluded that FBAR penalties are unlike civil penalties in that they contain no statutory cross-reference that equate “penalties” with “taxes.” The court also reasoned that the if the full payment rule didn’t apply to FBAR penalties there wouldn’t be any concern that the collection of FBAR penalties would be seriously impaired because they are enforced via a civil action to recover a civil penalty. That meant that there were no administrative collection procedures for FBAR penalties with which a partial payment illegal exaction claim would interfere. Thus, the court concluded that the Congress did not intend to subject FBAR penalty suits to the full payment rule. Mendu v. United States, No. 17-cv-738-T, 2021 U.S. Claims LEXIS 537 (Fed. Cl. Apr. 7 2021).

New Oklahoma Law Provides Forestry Service Equipment Tax Exemption. Beginning in 2022, Oklahoma will provide a state sales tax exemption through 2026 for the sales of commercial forestry service equipment, limited to forwarders, fellers, bunchers, track skidders, wheeled skidders, hydraulic excavators, delimbers, soil compactors and skid steer loaders, to businesses engaged in logging, timber and tree farming. H1588, effective Jan. 1, 2022.

Honey Bees Exempt from Sales Tax. The South Carolina Department of Revenue has issued a ruling finding honey bees should be exempt from sales tax on the basis that honey bees are domesticated and customarily raised on a farm to produce food. As such, honey bees are “livestock’ that are exempt from sales and use tax under S.C. Code Ann. §12-36-2120(4). Thus, all purchasers (e.g., a commercial honey bee retailer, a honey bee hobbyist) may purchase honey bees tax free, and an exemption certificate is not needed. South Carolina Dept. of Rev., Ruling No. 21-6 (Apr. 14, 2021).

“Roberts Tax” is a “Tax” Entitled to Priority in Bankruptcy. The debtor was required to file an income tax return in 2018, but hadn’t obtained the government-mandate health insurance resulting in the IRS assessing the Roberts Tax for 2018. In 2019, the debtor filed Chapter 13 bankruptcy and the IRS filed a proof of claim for taxes in the amount of $18,027.08 which included the Roberts Tax of $927. The IRS listed the Roberts Tax as an excise tax and the balance of the tax claim as income taxes. The debtors objected on the basis that the Roberts Tax is a penalty that is not qualify for priority treatment under 11 U.S.C. §507(a)(8). The debtor’s Chapter 13 plan was confirmed in 2020, and the IRS filed a brief objecting to the debtor’s tax treatment of the Roberts Tax. The bankruptcy court ruled that the Roberts Tax was a “tax” under the bankruptcy Code entitled to priority treatment. On appeal, the federal district court affirmed, citing National Federation of Independent Businesses v. Sebelius, 567 U.S. 519 (2012). While that decision involved facts outside of the bankruptcy context, the Supreme Court concluded that the Roberts Tax was a “tax” because it was enacted according to the taxing power of the Congress. Thus, it was either an excise or income tax, both of which are entitled to priority in bankruptcy. Here, the district concluded it was an income tax. In re Szczyporski, No. 2:20-cv-03133, 2021 U.S. Dist. LEXIS 61628 (E.D. Pa. Mar. 31, 2021).

Travel, Meal and Entertainment Expenses Denied. The petitioner was employed as a computer platform engineer and claimed unreimbursed employee expenses of $17,269 on this 2016 Schedule A. The expenses consisted of $16,900 for vehicle expenses and $1,069 of business expenses. He claimed that he drove 30,000 miles for business. He performed computer consulting, repair and sales through his S corporation. On Schedule C he claimed gross receipts of $3,000 and costs of goods sold of $3,400. He also claimed $44,608 of expenses, including $5,464 for meals and entertainment. He relied on his girlfriend to keep track of receipts and expenses, but she died in early 2017 and he was not able to access her computer. He was unable to explain why the S corporate income and expense were reported on Schedule C rather than For 1120S. He also didn’t provide Schedules K and K-1 to himself as the shareholder. He did not report the S corporate income on Schedule E, but reported it on Schedule C. The court denied the claimed deductions, including those for travel, meals and entertainment, for failure to meet the substantiation requirements of I.R.C. §274(d) as well as for failure to establish that the expenses for ordinary and necessary business expenses under I.R.C. §162. Klekamp v. Comr., No. 14517-19S, 2021 U.S. Tax Ct. LEXIS 28 (Apr. 20, 2021).

No Depreciation Deductions or Energy Tax Credits For Solar Lenses. The petitioners, a married couple with the husband being a lawyer, bought light-concentrating plastic Fresnel lenses to be mounted on towers and used as components of a system to generate electricity. The sellers (promoters of a “scheme” as the Tax Court termed the transaction) told the petitioners that they could zero out their federal tax liability by claiming energy tax credits and depreciation deductions on the lenses. From 2010-2014, the petitioners claimed depreciation and credits attributable to the lenses which had the effect of zeroing out (or nearly so) their tax liability. As a result, the petitioners sought substantial tax refunds. They used the refunds to buy more lenses and claim more deductions and credits. Ultimately, the United States Department of Justice received an injunction to shut down the sellers as operating a tax shelter, resulting in a $50 million judgment against the promoters. See, e.g., United States v. RaPower-3, LLC, 343 F. Supp. 3d 1115 (D. Utah 2018), aff’d., 960 F.3d 1240 (10th Cir. 2020). In 2006, the sellers constructed 19 towers at a testing site and represented to investors that it would install on each tower and “array” of triangular-shaped Fresnel lenses formed into a circle. By 2015, only one tower had been constructed and equipped with a full array of lenses. Although the array generated a small amount of electricity, the sellers venture never came close to commercial production. However, the venture did generate millions of dollars in revenue from investors that purchased lenses in anticipation of tax benefits. The lenses were sold for an amount far in excess of production cost with investors making a down-payment of one-third of the purchase price with the balance due when the lenses were used to produce electricity. The lenses were sold as “solar energy systems,” and the seller provide a memo from a law firm outlining the tax benefits to be derived from the investment. A buyer of lenses would buy just enough to zero out their tax liability. Prospective new members calculate the taxes they expect to pay in the current year and, as an option, add that to what they paid in federal taxes in the prior year. Once those numbers are known, the “correct” number of lenses to maximize the tax benefits is purchased. When the IRS issues the tax refund, the purchase price of the lenses is paid off with any excess retained by the taxpayer. Initially, the petitioners characterized the investment on their return as a “solar energy business” but later changed that to “equipment rental services.” The IRS denied the petitioners’ claimed deductions for depreciation and credits for each year at issue, and assessed accuracy-related penalties under I.R.C. §6662(a). The IRS later conceded the penalty issue for failing to secure timely supervisory approval for them. The IRS asserted that the deductions and credits should be denied on the basis that the solar power project never progressed beyond the research and development stage, and the lenses were never placed in service to produce energy. The Tax Court determined that the petitioners were not engaged in a trade or business with respect to the lenses because he didn’t engage in the activity with the intent to make a profit, but merely to derive tax savings. Accordingly, depreciation could not be claimed and, as a result, the lenses were not “energy property” that could generate energy tax credits. The Tax Court also determined that the petitioners’ conduct was not consistent with someone engaged in an equipment rental business, and that the lenses had never been placed in service based on a five-factor test. The petitioners merely leased the lenses back to the sellers immediately after the purchase. The Tax Court also concluded that even if the petitioners had been engaged in a trade or business and had put the lenses in service, they were engaged in a passive activity and they had no passive income, thus losses associated with deductions would have been disallowed. Olsen v. Comr., T.C. Memo. 2021-41.

Posted April 11, 2021

Settlement Proceeds Taxable Income. The petitioner was involved in a personal injury lawsuit and received a payment of $125,000 to settle a malpractice suit against her attorneys. She did not report the amount on her tax return for 2015 and the IRS determined a tax deficiency of $27,418, plus an accuracy-related penalty. The IRS later conceded the penalty, but maintained that the amount received was not on account of personal physical injuries or personal sickness under I.R.C. §104(a)(2). The Tax Court agreed with the IRS because the petitioner’s claims against the law firm did not involve any allegation that the firm’s conduct had caused her any physical injuries or sickness, but merely involved allegations that the firm had acted negligently in representing her against a hospital. Blum v. Comr., T.C. Memo. 2021-18.

IRS Listing of Taxpayers With Significant Tax Debt Constitutional. Section 32101, subsection (a) of the “Fixing America’s Surface Transportation” (FAST) Act created I.R.C. §7345 which authorizes the IRS to certify lists of seriously delinquent taxpayers to the Treasury Department that will then send those lists to the State Department for denial or revocation of a listed taxpayer’s passport. The petitioner had unpaid tax debt of nearly $500,000 and the IRS certified to the Treasury Department that the petitioner had a “seriously delinquent tax debt” within the meaning of I.R.C. §7345(b), giving the U.S. Secretary of State the ability to deny or revoke the petitioner’s passport. The petitioner sued for a determination that the certification was erroneous under I.R.C. §7345(e)(1) and moved for summary judgment on the basis that I.RC. §7345 violates the Due Process Clause of the Constitution and illegally infringes his right to travel internationally. The petitioner also claimed that I.R.C. §7345 violated his human rights under the Universal Declaration of Human Rights. The Tax Court held that I.R.C. §7345 is not constitutionally defective because it doesn’t restrict the right to international travel and that the IRS was entitled to judgment as a matter of law. The Tax Court noted that all passport-related decisions are left to the Secretary of State and that the authority of the Secretary of State to revoke a passport doesn’t derive from I.R.C. §7345. The Tax Court noted that the constitutionality of the authority granted to the Secretary of State by FAST Act section 32101(e) was not an issue in the case and, therefore, the Court expressed no view on that issue. Rowen v. Comr., 156 T.C. No. 8 (2021).

Posted March 31, 2021

Partnership Loans Create Debt Discharge Income. The petitioner was a partner in a four-partner LLC. One partner advanced the capital for the business and the other partners intended to repay the contributing partner for those amounts. However, the business lost money and the LLC didn’t allocate losses on the basis of the partnership interests. The partners also did not follow the operating agreement’s provisions for contributing capital or maintaining capital accounts. The Tax Court, agreeing with the IRS, determined that the allocations provided by the operating agreement lacked substantial economic effect. The partners treated the LLC’s debt as a recourse liability and allocated according to the partners’ interests in the partnership – 30 percent, 30 percent, 30 percent and 10 percent. The partners also claimed and took the tax benefit from the additional basis arising from their respective shares of the loans. They chose to reflect their economic arrangement as a recourse loan shared by all partners. The Tax Court held that once the loans were discharged, they ceased to be a partnership liability and because partnership income. Thus, the petitioner had income from the discharge of the partnership’s indebtedness. Hohl, et al. v. Comr., T.C. Memo. 2021-5.

S Corporation Payments Were Wages. The petitioner conducted her law practice as an S corporation in which she was the sole shareholder. For the three tax years at issue, the petitioner reported the net profit or loss from the S corporation on her Form 1040. In addition, for 2011, the S corporation did not treat any of the amount paid to her as wages on Form 941 and did not report any of it as income. In 2012, the petitioner reported $73,448 in payments as income, but neither she nor the S corporation reported the amounts as wages. The petitioner conceded that she was an officer of the S corporation. As such, the court concluded that payments to her were wages and the petitioner offered no evidence otherwise. The de minimis exception of Treas. Reg. §31.3121(d)-1(b) didn’t apply because as the sole shareholder she was performing services for the corporation. While the S corporation employed an associate attorney, the petitioner could have claimed that some of the firm’s net profit distributed to the petitioner attributable to the associate attorney’s efforts would not be wages. However, the petitioner provided no evidence of the value that the associate attorney added to the S corporation or whether that value exceeded the associate’s compensation. Thus, the salary payments reported to the petitioner by the S corporation were reportable as compensation. In addition, the petitioner also had canceled debt income in years when lenders discharged portions of her debt because the insolvency exception did not apply. She failed to provide sufficient evidence of her assets and liabilities for a solvency determination to be made. Ward v. Comr., T.C. Memo. 2021-32.

Posted March 28, 2021

Vet Loses on Reliance Claim and Charitable Donation Deductions. The petitioner, a self-made millionaire, was a veterinarian who developed an animal vaccine at one of his labs. He sold the lab in 2002 for $85 million and used the funds to buy numerous businesses in South Dakota that supported numerous rural economies. He utilized numerous bookkeepers for the businesses over the years. In 2008, a draft of a cost segregation study was completed for the various business investments, with a final opinion issued in 2010. The 2008 draft was used to prepare the petitioner’s returns at issue. The petitioner also made numerous charitable contributions including oil and gas projects, land and a conference center. The petitioner was not involved with his CPAs preparation of his returns. The Tax Court agreeing with the IRS, disallowed the charitable deductions for failure to attach an appraisal, upholding a tax deficiency exceeding $10 million. The Tax Court determined that the taxpayer did not have reasonable cause for failure to attach an appraisal in accordance with Treas. Reg. §1.170A-13(c)(1). The bookkeeper for the petitioner’s businesses gathered information for the preparation of the returns and visited personally with the petitioner about his returns, passing information along to the return preparer, a CPA. The petitioner never visited personally with the CPA. The bookkeeper is not a CPA or attorney or licensed tax preparer and did not have experience preparing returns. Thus, the petitioner could not reasonably rely on the bookkeeper. While the cost segregation study was relied on in good faith, the Tax Court determined that the associated deductions were properly disallowed. While the petitioner testified that no one told him he needed appraisals for the donated properties, he never met with the CPA and never reviewed his returns. The Tax Court noted that any literate person would could have determined an appraisal was required for gifts over $500,000 by examining Form 8283. Thus, any reliance of the petitioner on his CPA was not reasonable. Pankratz v. Comr., T.C. Memo. 2021-26.

Failure to Substantiate Eliminates Charitable Deduction. The petitioner made numerous charitable donations of clothing, furniture and antiques that he inherited. However, the petitioner didn’t maintain any proper receipts from the charitable donees, he didn’t keep reliable records in lieu of receipts. The petitioner also didn’t have contemporaneous written acknowledgements for his contributions exceeding $250, and didn’t satisfy the heightened record keeping and return statement requirements for contribution exceeding $5,000. Appraisals of the donated items didn’t account for the items’ physical condition and age, and didn’t include any mention of the appraiser’s qualifications or a statement that the each appraisal was prepared for income tax purposes. The petitioner also did not complete the appraisal summary on Form 8283. The Tax Court rejected the petitioner’s substantial compliance argument noting the while the petitioner provided supplemental information the supplemental information was also incomplete. The Tax Court also rejected the petitioner’s claim that he cured his defective submissions by responding to IRS's request for additional documentation within 90 days in accord with Treas. Reg. §1.170A-13(c)(4). Chiarelli v. Comr., T.C. Memo. 2021-27.

Transfer of Patent to Related Entity Triggers Capital Gain. The petitioner had numerous patents. He transferred his rights in a patent to a related entity. Normally, the sale of a patent produces capital gain. However, the Tax Court held that a transfer to a related entity disqualified the transfer for capital gain treatment. The Tax Court also held that the taxpayer had not acquired a sufficient interest in the patent and the amount he received on the transfer to the related entity was subject to self-employment tax. Filler v. Comr., T.C. Memo. 2021-6.

No Exception From Early Withdrawal Penalty for Payment of Living Expenses. The petitioner retired at age 55 and transferred his 401(k) funds to a traditional IRA. Two years later, the petitioner withdrew $37,000 from the IRA to pay for maintenance on his home and other living expenses. The IRS applied a 10 percent penalty to the amount withdrawn because the petitioner had not reached age 59.5 at the time of the withdrawal. The Tax Court agreed with the IRS, determining that the Code contains no exception to early retirement account withdrawals for payment of living expenses and/or home maintenance. Catania v. Comr., T.C. Memo. 2021-33.

Posted March 27, 2021

Conservation Easement Deduction Allowed for Donated Façade Easement. The taxpayer donated an easement on a building in a registered historic district on which the taxpayer had installed an accessibility ramp to comply with the Americans With Disabilities Act (ADA). The IRS determined that the installation of the ramp would not disqualify the taxpayer’s deduction. The IRS viewer the ramp as “upkeep” essential to the preservation of the structure. Such upkeep, if required to comply with the ADA, does not jeopardize the donor’s eligibility for a charitable deduction under I.R.C. §170(h)(4)(B) with respect to a building in a registered historic district. C.C.M. AM 2021-001 (Mar. 8, 2021).

Posted March 24, 2021

Team Roping Activity Not Engaged in With Profit Intent. The petitioner was engaged in the insurance business when he began developing a large part of his time to team roping. He lost tens of thousands of dollars roping, some of which he reported on the same Schedule C that he reported income and loss for his insurance business. The IRS disallowed the losses as personal expenses. The petitioner began competitive team roping in 1989 as a “header.” In 2009, he began reporting income and loss from roping on Schedule C when he decided to make it his “business.” His business plan was to “get better” by winning more competitions and also by selling and breeding team-roping horses. He also purchased a mare for the sole purpose of breeding, saddle and luxury horse trailer complete with living quarters. He lost over $50,000 in each of 2009-2011 on the team roping activity which he used to offset his income from the insurance business. The petitioner also did not maintain a separate bank account or records for the team roping activity and did not keep a budget for it. The petitioner claimed that he had a profit intent for the team roping activity, but the IRS disagreed noting that it was highly improbable that the petitioner could ever have a genuine profit motive. The Tax Court went through the nine factors of Treas. Reg. §1.183-2(a) to determine if a profit intent was present based on the facts and circumstances. The Tax Court noted that the petitioner did not conduct the team roping activity in a businesslike manner; lacked practical knowledge of team roping economics; did not really put in sufficient hours in the activity to disrupt his insurance business; had no realistic expectation that the horses would appreciate in value; failed to show that the insurance business experience aided him in the team roping activity; never profited from the activity and used the losses to offset his insurance business income; made large investments in the team roping activity but failed to make much money at it; was independently wealthy; and received a lot of personal pleasure or recreation from the team roping activity. Accordingly, the Tax Court held that the petitioner did not engage in the team roping activity with the primary motivation to earn a profit and denied the deductions for the tax years at issue associated with the team roping activity. Gallegos v. Comr., T.C. Memo. 2021-25.

Posted March 9, 2021

Structure for Taxing Social Security Benefits is Constitutional. The petitioner and his wife were married, but had elected under state (LA) law a Separate Property Matrimonial Regime. In 2014, the petitioner received $20,646 of Social Security benefits. His 2014 return was filed as marred filing separately. He did not report any of the Social Security benefits as taxable. The IRS determined that 85 percent of the Social Security benefits were taxable and that $17,549 of the benefits should be reported as income on the husband’s 2014 return. The Tax Court agreed with the position of the IRS, noting that the Congress enacted I.R.C. §86 in 1983 which taxed Social Security benefits as “benefits received under other retirement systems.” The statute set forth a base amount of nontaxable benefits to ensure that lower income persons would not be taxed on their benefits. The statute was later amended in 1993 to increase the amount includible in gross income to as high as 85 percent of the Social Security benefits received. The petitioner claimed that the he had been denied due process and equal protection under the 14th Amendment of the Constitution because the application of his filing status as married filing separately is discriminatory. He claimed that his base income should be one-half of the joint return amount ($16,000). The Tax Court held that the petitioner’s argument were without merit because the Tax Court had repeatedly found that I.R.C. §86 is constitutional. Kelley v. Comr., T.C. Memo. 2021-2.

Credit Card Rewards May Be Taxable. The petitioners, husband and wife, spent over $6 million on their credit card between 2013 and 2014. Nearly all of these purchases were for Visa gift cards, money orders or prepaid debit card reloads that the couple later used to pay the credit card bill. The credit card earned then five percent cash back on certain purchases after spending in $6,500 in a single calendar year. Before purchases were sufficient for them to reach the five percent level, the card earned one percent cash back on certain purchases. Rewards were issued in the form of “rewards dollars” that could be redeemed for gift cards and statement credits. In 2013, the petitioners redeemed $36,200 in rewards dollars from the card as statement credits in 2013 and $277,275 in 2014. The petitioners did not report these amounts as income for either year. The IRS audited and took the position that the earnings should have been reported as “other income.” The IRS noted that when a payment is made by a seller to a customer, it’s generally seen as a “price adjustment to the basis of the property” – the “rebate rule.” Under this rule, a purchase incentive is not treated as income. Instead, the incentive is treated as a reduction of the purchase price of what is purchased with the rewards or points. Thus, points and cashback earned on spending are viewed as a price adjustment. The petitioners cited this rule, pointing out that the “manner of purchase of something…does not constitute an accession of wealth. The petitioners claimed that the rewards would be taxable upon receipt and that taxation of the rewards would not depend on how the gift cards were later used. The Tax Court agreed that gift cards are a “product.” Thus, the portion of their reward dollars associated with gift card purchases weren't taxable. However, the Tax Court held that the petitioners’ direct purchases of money orders and reloads of cash into the debit cards using their credit card was different in that the petitioners were buying “cash equivalents” rather than a rebate on a purchase. They were not a product subject to a price adjustment and were not used to obtain a product or service. Because there was no product or service obtained in connection with direct money order purchases and cash reloads, the reward dollars associated with those purchases were for cash infusions. The Tax Court also noted that the petitioners’ practice would most often have been ignored if it had not been for the petitioners’ “manipulation” of the rewards program using cash equivalents. Thus, the longstanding IRS rule of not taxing credit card points didn’t apply. Thus, the Tax Court held that reward points become taxable when massive amounts of cash equivalents are purchased to generate wealth – buying money orders and funding prepaid debit cards with a credit card for cash back, and then immediately paying the credit card bill. The Tax Court also stated that it would like to see some reform in this area providing guidance on the issue of credit card rewards and the profiting from buying cash equivalents with a credit card. Anikeev, et ux. v. Comr., T.C. Memo. 2021-23.

Taxpayer Unable to Establish Funds Used to Cover Expenses as Loans or Gifts. The plaintiff operated a recreational marijuana business as a single-member limited liability company. The plaintiff’s business and personal expenses were largely cash based. Under the cash accounting method, the plaintiff reported on his 2015 Schedule C: gross receipts of $1,153,466; cost of goods sold of $1,100,217; and gross income of $53,249. After reviewing the plaintiff’s 2015 tax return and analyzing the plaintiff’s gross receipts using an indirect analysis, the defendant determined the plaintiff had $1,144,181 in purchases and had substantiated $287,414 in nondeductible expenses, resulting in $1,431,595 in outgoing cash. As a result, the defendant increased the plaintiff’s 2015 gross receipts by $278,129, which was the amount outgoing cash exceeded the plaintiff’s gross receipts. The plaintiff argued that the additional funds used to cover expenses were attributable to a combination of loans, gifts, and savings. Specifically, the plaintiff claimed that he received $120,000 from his father as a result of four nontaxable loans and $150,000 in nontaxable gifts from his grandfather over six years. The plaintiff also claimed to have built up a reserve of cash savings by spending less on living expenses than the defendant had determined in its indirect income analysis. The state tax court noted that taxpayers are required to keep adequate records in order to determine their correct tax liability. The court determined that the plaintiff was unable to establish that he received a loan from his father, gifts from inheritance funds, or cash savings. The plaintiff only had a handwritten note from his father and no bank statements or testimony to establish the loans or gifts existed. The court also noted that the plaintiff likely understated his annual living expenses by relying on bankruptcy standards to estimate living expenses. As a result, the court held that the defendant had properly adjusted the plaintiff’s gross receipts for 2015. Oss v. Dep’t. of Revenue, No. TC-MD 190304N, 2020 Ore. Tax LEXIS 47 (Ore. Tax Court Jul. 30, 2020).

Posted March 7, 2021

Structure for Taxing Social Security Benefits is Constitutional. The petitioner and his wife were married, but had elected under state (LA) law a Separate Property Matrimonial Regime. In 2014, the petitioner received $20,646 of Social Security benefits. His 2014 return was filed as marred filing separately. He did not report any of the Social Security benefits as taxable. The IRS determined that 85 percent of the Social Security benefits were taxable and that $17,549 of the benefits should be reported as income on the husband’s 2014 return. The Tax Court agreed with the position of the IRS, noting that the Congress enacted I.R.C. §86 in 1983 which taxed Social Security benefits as “benefits received under other retirement systems.” The statute set forth a base amount of nontaxable benefits to ensure that lower income persons would not be taxed on their benefits. The statute was later amended in 1993 to increase the amount includible in gross income to as high as 85 percent of the Social Security benefits received. The petitioner claimed that the he had been denied due process and equal protection under the 14th Amendment of the Constitution because the application of his filing status as married filing separately is discriminatory. He claimed that his base income should be one-half of the joint return amount ($16,000). The Tax Court held that the petitioner’s argument were without merit because the Tax Court had repeatedly found that I.R.C. §86 is constitutional. Kelley v. Comr., T.C. Memo. 2021-2.

Posted February 28, 2021

Lack of Economic Substance Leads to Amortization Deductions. The petitioner, a C corporation, acquired the assets of a business from a partnership. In the exchange, the petitioner issued approximately five million shares of common stock. The petitioner then redeemed 1.875 million common shares that the partnership held in exchange for $2.7 million in cash and the petitioner’s obligation to make an additional payment of $300,000 a year later. The partnership paid the cash and assigned its rights to the additional payment to one of its partners in redemption of that partner’s partnership interest. The petitioner claimed an increased basis of $3 million in intangible assets it acquired from the partnership and amortized that additional basis under I.R.C. §197(a). The IRS denied the amortization deductions. The Tax Court allowed the deductions first noting that the parties agreed that I.R.C. §351 governed the transactions. As such, the partnership recognized gain to the extent of the $2.7 million cash it received and the fair market value of its right to the additional $300,000 payment. Consequently, the basis in the assets transferred to the petitioner were increased. The Tax Court then noted that when assets are transferred in an I.R.C. §351 exchange with taxable boot constitute a trade or business, the residual method of allocation of I.R.C. §1060 applies to allocate the boot among the transferred assets. Thus, the partnership’s gain in amortizable I.R.C. §197 intangibles and the corresponding increase in the basis of assets allowed to the petitioner was to be determined by subtracting from the agreed total asset value the estimated values of those assets other than amortizable I.R.C. §197 intangibles. The Tax Court determined that the petitioner’s issuance and immediate redemption of the common shares lacked economic substance and was, therefore, to be disregarded under the step-transaction doctrine. As such, the cash and the deferred payment right were to be treated as additional consideration for the assets the petitioner acquired from the partnership. Complex Media, Inc. v. Comr., T.C. Memo. 2021-14.

Posted February 27, 2021

Some Installation Services Taxable. The plaintiff is a home improvement store that sells a variety of products and enters into installation contracts with customers to install various items that have have been purchased from the plaintiff. The contracts specifically state that the installation services do not include alterations to existing structures or installing new electrical boxes. The plaintiff invoiced customers with an itemization of the cost of the product purchased and the installation service. The plaintiff paid state sales/use tax on the cost of the products sold, but not on the labor installation services. The defendant audited and assessed sales tax on the installation labor claiming that sales tax applied as either a “carpentry” service, “electrical and electronic repair and installation” service, or “pipe fitting and plumbing” service, or a combination thereof. The court determined that the installation of vanity tops, windows and doors did not fit in the “carpentry” category because that category only taxed repairs and not installation services. However, the court determined that the installation of dishwashers, garbage disposals, faucets, toilets and sinks involved either electrical or plumbing installation (or both) and were taxable. The court also held that the installation of ceiling fans involved both carpentry and electrical services. However, the court remanded to the defendant to address the taxability under the state’s “predominant services rule.” Lowe’s Home Centers, LLC v. Iowa Department of Revenue, 921 N.W.2d 38 (2018).

Tax Court Says ‘Tis Better to Send Than Receive a CDP Notice. Under I.R.C. §6330, the IRS can’t levy before giving the taxpayer written notice of the right to a hearing at least 30 days before the levy. The notice must be given in person, or left at the taxpayer’s dwelling or usual place of business, or be sent by certified or registered mail, return receipt requested to the taxpayer’s last known address. The taxpayer must request the hearing during the 30-day period. Here, the IRS sent by certified mail a Notice of Intent to Levy (LT11) to the petitioner on July 13, 2018 that also informed the petitioner of his right to a Collection Due Process (CDP) hearing. The Notice was sent to the petitioner’s business address as his last known address. It was signed for. The address was a common address for numerous business and the signor was neither the petitioner’s employee nor was authorized to receive the petitioner’s mail. The Notice found its way to the petitioner shortly before the end of the 30-day period. The petitioner submitted a request for a CDP hearing eight days after the close of the 30-day period. The IRS provided an administrative-equivalent hearing due to the lateness of the CDP request. IRS then issued an adverse “decision letter” rather than a “determination letter.” Actual receipt is not a prerequisite to the validity of the CDP Notice. Treas. Reg. §301.6330-19i)(2); Q&A 9. The petitioner had no appeal rights. I.R.C. §6330; Treas. Reg. §301.6330-19i)(2); Q&A 16. The Tax Court determined that it had jurisdiction because the IRS issued a decision letter after a timely request for a hearing. The Tax Court noted that the IRS had properly sent the Notice to the petitioner’s last known address, and the petitioner had failed to explain how the IRS could have taken into account that multiple businesses used that address. It was the address that the petitioner had given to the IRS. The Tax Court did not impose any requirement on the U.S. Postal Service to ensure that the party signing for the certified mail was authorized to do so. Ramey v. Comr., 156 T.C. No. 1 (2021).

Posted February 10, 2021

Farming Activity Was a Hobby; Loss Deductions Denied. The petitioner had retired from the banking industry. Before he retired, in 2003 he purchased a 156-acre tract that had been a timber farm and cattle operation for 350,000. 134 acres of the tract was timber. It was not an active timber or farming operation when he bought it, but was in the Conservation Reserve Program (CRP). In 2004, he bought an additional 26 contiguous acres. That tract had a new (built in 2000) home on it along with a barn and a small caretaker’s house. On the advice of his long-time CPA, the petitioner created an LLC in 2004. He owned 97 percent of the LLC, his wife was a one percent owner, and their children owned the balance. He never transferred the land to the LLC. For several years, he spent about 700 hours annually maintaining the property without any formal business plan. There was no timber harvesting because of the land being in the CRP. The petitioner would occasionally “thin” the trees to allow sunlight to get through to aid the growth of pine trees which would be harvested after many years of growth. The petitioner testified that he had wanted to introduce cattle “from day one.” He had consulted with two cattle experts for advice, but he couldn’t remember when the consultations had occurred or what he had learned from those experts. In reality, however, the petitioner didn’t actually have cattle on the property until at least 2008 – soon after he learned that he was going to be audited. He also testified that many of what he claimed to be cattle-related activities were really preparatory activities so that cattle could be on the property at some future date. Those preparatory activities included the installation of fencing and barn repairs. He ran the LLC very informally, keeping no traditional accounting records such as ledgers, balance sheets, income statements, or cashflow statements. He didn’t expense the cost of insurance for the property and didn’t maintain a separate bank account or any separate banking records during the years at issue. For those years, the petitioner filed Form 1065 (partnership return) stating that the LLC’s principal business activity was a “Farm” and the principal product or service was “Cattle.” This was also how the activity was characterized on the petitioner’s Schedule F. The petitioner’s tax returns were professionally prepared by the petitioner’s CPA even though the petitioner had a “cattle farm” with no cattle, and a “tree farm” with no timber. He showed a tax loss from the property for tax years 2004-2008 on Schedule F, with the losses stemming largely from depreciation claimed on two buildings on the property. The IRS notified the petitioner in early 2008 that it was going to audit the LLC for tax year 2005. Upon receiving the audit notice, the petitioner put together a forest management plan and brought cattle to the property. The IRS later expanded the audit to include tax years 2004 and 2006-2008. The IRS disallowed the losses on the basis that the petitioner’s activity on the land was not engaged in with a profit intent. The IRS also disallowed a large charitable deduction for the petitioner’s deduction of a permanent conservation easement. The Tax Court agreed with the IRS, finding that all nine factors of the I.R.C. §183 regulations favored the IRS. This was despite the Tax Court’s recognition that the facts suggested that the petitioner was attempting to transform the property into a viable farming business. Whatley v. Comr., T.C. Memo. 2021-11.

Posted February 7, 2021

California Property Tax Changes. The California State Board of Equalization, in a news release, has advised that, effective February 16, 2021, significant property tax law changes will occur for families transferring real property between parents and children or between grandparents and grandchildren if the parents are deceased. The changes are the result of the voter approval of Proposition 19 on November 3, 2020. Under Proposition 19, a parent's primary residence can be transferred without a property tax increase if the child keeps the home as their primary residence. In addition, Proposition 19 caps the transferable amount equal to the home's taxable value at the time of transfer plus $1 million. The $1 million allowance will be adjusted annually beginning in 2023. Family farms can also be eligible. California State Board of Equalization News Release No. NR 21-01 (Feb. 1, 2021).

Posted January 31, 2021

Faulty Deed Language Causes Loss of Charitable Deduction for Donated Conservation Easement. A group of taxpayers formed a partnership to buy a parcel and then donate a conservation easement on it to a land trust. One of the partners had purchased 400 acres in 1999 for $2.4 million and planned to build a house and horse therapy center on the property. The partner’s wealth crashed with the decline of technology stocks and he became insolvent. He tried to sell the parcel, but only managed to sell 161.5 acres for $1.4 million. The balance of the property was mountainous. His attorney suggested that he and seven of his friends form a partnership to which the taxpayer would sell the property for his outstanding debt of $1.4 million. Accordingly, the partnership bought the property in 2002 for $1.4 million. The easement was valued at $5.4 million in 2003 at the time of the donation. The partners claimed flow-through charitable deductions tied to their interests in the partnership. The IRS denied the deductions on the basis that the easement value was misstated and because deed language granting the easement reduced the proceeds from any condemnation award that would go to the recipient of the land by any improvements made to the land. The deed stated, in pertinent part, that, “This Conservation Easement constitutes a real property interest immediately vested in Grantee, which, for the purposes of this Paragraph 17, the parties stipulate to have a current fair market value determined by multiplying the fair market value of the Property unencumbered by the Conservation Easement (minus any increase in value after the date of this Deed attributable to improvements) by the ratio of the value of the Conservation Easement at the time of this Deed to the value of the Property, without deduction for the value of the Conservation Easement, at the time of this Deed, according to that certain Property Appraisal Report, dated November 1, 2003 and prepared by Tennille and Associates of Boone, North Carolina, for Burning Bush Farm, LLC. The values at the time of this Deed shall be those values used to calculate the deduction for federal income tax purposes allowable by reason of this Deed, pursuant to Section 170(h) of the Internal Revenue Code of 1954, as amended. For the purposes of this Paragraph, the ratio of the value of the Conservation Easement to the value of the Property unencumbered by the Conservation Easement shall remain constant. [Emphasis added.]” The Tax Court upheld the IRS position, noting that the deed of conveyance subtracted the value of any improvements from any condemnation award before calculating what percentage of those proceeds would go to the donee. Thus, the deed failed to comply with Treas. Reg. §1.170A-14(g)(6)(ii) and the deduction was denied in full. In addition, the Tax Court determined that local (AL) law didn’t rectify the problem. The Tax Court also denied deductions for timber donations. Sells v. Comr., T.C. Memo. 2021-12.

Minnesota Addresses Taxability of Gasoline Sales to Farmers. The Minnesota Department of Revenue (MDOR) has issued a revised release on the taxability of gasoline sales to farmers. In the release, the MDOR stated that gasoline that is sold and delivered to on-farm bulk storage for farm use are tax-free. Alternative fuels are not included in the definition of “gasoline” for this purpose. Likewise, sales of undyed diesel fuel are not included in the exemption. In order for gasoline sales to be tax-free, the gasoline must be delivered to a farm for farm use; sales tickets must clearly reflect the purchaser's name and complete address; and invoices must clearly indicate that the gasoline was sold tax-free. In the release, the MDOR explains how to claim the credit; the due date for filing claims; recordkeeping; and some common misconceptions about gasoline purchased for off-highway use. Minnesota Petroleum Tax Fact Sheet No. 100, Minnesota Department of Revenue (Jan. 11, 2021).

Posted January 30, 2021

Solar Machinery and Equipment Tax-Exempt. The Arkansas Department of Revenue (ADOR) has issued a legal counsel opinion noting that certain machinery and equipment that is used in the development of a solar project would qualify for the manufacturing exemption if it is used directly in the manufacturing process. Specifically, the ADOR determined that solar panels; steel support piles; inverters; collection system electrical cables/conduit/ accessories; transformers; transmission lines; and supervisory control and data acquisition software, if used to control or measure the manufacturing process; as well as switchyard and interconnection would qualify for the exemption. A solar farm using such items in transporting and handling the product at the various stages of the manufacturing process would qualify for the exemption. Arkansas law stipulates that machinery and equipment will be exempt if it is purchased and used to create new manufacturing or processing plants or facilities within the state. Thus, the construction of a solar array would qualify as a “new manufacturing plant” under the law. Ark. Dept. of Rev. Legal Counsel Opinion No. 20201111 (Jan. 15, 2021).

Posted January 28, 2021

Lack of Trade/Business Eliminates Farm-Related Deductions. The petitioners, a married couple, were residents of California but the wife conducted a farming operation in Mexico for which she reported a net loss on Schedule F for every year from 2007 to 2014. She began raising chickens to sell for meat in 2007, but couldn’t recall selling any of the chickens through 2011 and only had one sale of anything during that timeframe – a $264 loss on the resale of livestock. She then switched to raising chickens for egg production, but soon determined that the venture wouldn’t be profitable due to an increased cost of feed. She then sold what eggs had been produced for $1,068 and switched back to selling chickens for meat in 2012. She didn’t sell any chickens in 2012 or 2013 and her plan to begin selling chickens in 2014 was thwarted when the flock was destroyed by wild dogs. Also, during 2007-2011, she attempted to grow various fruits and vegetables, but the activity was discontinued because the soil was not capable of production due to a nearby salt flat. As a result, she had no sales revenue, only expenses that she deducted. She then tried to grow peppers in 2012, but insects destroyed the crop and there was no marketable production. Later that year, she acquired three cows and three calves in hopes to “make the calves big, sell them, impregnate the mothers…repeat.” She had to sell the cows in 2013 for $4,800 because there was insufficient forage on the 6,500-acre tract. The $4,800 was the only farm activity income reported for 2013. In 2012 and 2013, the taxpayers reported deductible business expenses on their Schedules C and Schedule F, later reaching an agreement with the IRS that the Schedule C expenses should have been reported on Schedule F. The IRS disallowed the deductions, determining that the wife didn’t conduct a trade or business activity for profit and because the business had not yet started during either 2012 or 2013. The Tax Court agreed with the IRS, concluding that the farming activities never moved beyond experimentation and investigation into an operating business. Although the Tax Court reasoned that some of the wife’s farming activities could have constituted an active trade or business, costs were not segregated by activity. In addition, income from the sale of eggs, the Tax Court noted, was an incidental receipt that was only realized after the wife had abandoned that venture. Also, the there was no itemization of costs or basis in the cattle activity to allow for an estimation of any deductible loss. Costello v. Comr., T.C. Memo. 2021-9.

Easement Valuation at Issue. The petitioner donated a permanent historic façade conservation easement to a qualified charity and claimed a charitable deduction. The IRS challenged the valuation date of the donation and the value of the donation. The IRS claimed that local law had already restricted the taxpayer’s use of the property and, as such, operated to either eliminated the donated easement or severely limited it. The Tax Court disagreed with the IRS, noting that sufficient conservation value remained that gave rise to a charitable deduction contribution. Specifically, the Tax Court noted that it would take into account any effect from zoning, conservation, or historic preservation laws that already restrict the property’s potential highest and best use. In light of those facts, the tax court noted that the conservation easement added additional conservation protection beyond local law. As to the valuation date, the Tax Court noted that local law is determinate of the issue. Under local (NY) law, an instrument creating, conveying, etc. a conservation easement is not effective unless recorded. The date that the easements were recorded set the date for determining the fair market value of the easements. As to the easement’s value, the Tax Court took note of the three methods for valuing property under the “before and after” approach – the sales approach; the income capitalization approach; and replacement cost. The Tax Court determined that the income capitalization approach was appropriate. Kissling v. Comr., T.C. Memo. 2020-153.

Posted January 24, 2021

IRA Distributions Included in Income and Subject to Early Withdrawal Penalty. During 2012 and 2013, the taxpayers, a married couple, participated in a SEP-IRA. Chase Bank (Chase) was the custodian. In 2012, the husband took two distributions from the account, one of $170,000 and the other of $39,600 (the distributions). He had the bank deposit the distributions into a Chase business checking account that he had opened in the name of The Ball Investment Account LLC (Ball LLC), of which he was the sole owner and only member. Ball LLC was not a retirement account. The only information Ball provided Chase about the distributions was that they were early distributions to which no known exceptions to being taxable applied. The taxpayer used the distributed funds to make real estate loans. The first loan was repaid in April 2013 with a check payable to "the Ball SEP Account," which Ball immediately deposited into the SEP-IRA account. The second loan was paid off in installments in 2012 and 2013, again by checks payable to "the Ball SEP Account," which Ball deposited into the SEP-IRA. Chase had no knowledge of or control over the use that Ball LLC made of the distributions it deposited in the Ball LLC business checking account and never held any documents related to the loans Ball LLC made. Chase issued the taxpayer a Form 1099-R for 2012 reporting that he had received taxable distributions from the SEP-IRA of $209,600. The taxpayer, however, on his Form 1040, reported that he had received distributions of $209,600 and that none of the amount was includible in gross income. The IRS issued a CP2000 Notice to the taxpayer stating that he had failed to report the distributions from Chase Bank and that he therefore owed $67,031 in tax and a substantial-understatement penalty of $13,406. The taxpayer did not respond to the Notice, and the IRS then sent him a notice of deficiency that determined the deficiency, additional tax, and penalty due. The Tax Court determined that the taxpayer had unfettered control over the distributions, rejecting the taxpayers’ “conduit agency arrangement” argument. The Tax Court determined that Ball LLC was not acting as an agent or conduit on behalf of Chase when Ball LLC received and made use of the distributions. The Tax Court noted that Chase had no knowledge of how the distributed funds were used after they were deposited in the Ball LLC account at the taxpayer’s direction and that nothing in the record showed that taxpayer, who controlled Ball LLC, did not have unfettered control over the distributions. The Tax Court determined that the facts of his case were analogous to those in Vandenbosch v. Comr., T.C. Memo. 2016-29 and, as a result, Ball LLC was not a conduit for Chase. As a result, the distributions were included in the taxpayer’s income. In addition, the taxpayer had not yet reached age 59.5 which meant that the taxpayer was liable for the 10 percent early distribution penalty. The Tax Court also upheld the accuracy-related penalty. Ball v. Comr., T.C. Memo. 2020-152.

Posted January 15, 2021

Hockey Organization Not a Qualified Charity. The taxpayer is organized to associate and organize ice hockey officials to facilitate registration, training, and development of them for the overall improvement of the quality of amateur ice hockey officiating. The Association is to provide a forum for discussion and a medium for dissemination of information on ice hockey rules and interpretations to ensure uniformity of rules interpretation and application; to develop more efficient and effective officials; to maintain the highest standards of officiating; and to create a better understanding between officials, coaches and players.as not limited to such a situation. Membership is restricted to persons that paid dues and met registration requirements and are currently registered as an official. All revenue is from league payments for officiating services and all expenses are to remunerate members for officiating services. The taxpayer sought tax exempt status under I.R.C. §501(c)(3). The IRS determined that the taxpayer was not a qualified organization because its purpose and operations were essentially commercial in nature and not charitable. The IRS concluded that the taxpayer’s activities were like the nurses’ association in Rev. Rul. 61-170 and the school cooperative in Rev. Rul. 69-175. Priv. Ltr. Rul. 202101008 (Oct. 13, 2020).

Posted January 14, 2021

Illinois Updates Publication on Farmland Assessment. The Illinois Department of Revenue has issued an update to its Publication 122, Instructions for Farmland Assessments, to provide guidelines and recommendations for the valuation of farmland to achieve equitable assessment between counties. Updated Pub. 122 also include information on adjustment factors, guidelines for alternative uses, soil weighting and soil complex adjustments. Illinois Dept. of Rev., Pub. 122, Instructions for Farmland Assessment, Jan. 1, 2021.

Guidance on Deductibility of Government Fines and Penalties. Final regulations have been issued providing guidance on the deductibility of government fines and penalties under I.R.C. §162(f) as amended by the TCJA. The regulation also provides guidance on the reporting requirements necessary under I.R.C. §6050X. I.R.C. §162(f) disallows a deduction for the payment of fines, penalties and certain other amounts. Under I.R.C. §162(f), a deduction is not allowed for the payment of fines, penalties and certain other amounts. Under I.R.C. §162(f)(1), a taxpayer may not deduct amounts that, under court orders or settlement agreements, are paid to, or at the direction of, governments in relation to the violation of any law or the investigation or inquiry into the potential violation of any law. However, this disallowance may not apply to amounts that the taxpayer establishes, and court orders or settlement agreements identify, are paid as restitution, remediation, or to come into compliance with a law, so long as the amounts otherwise qualify as deductible under I.R.C. §162(f)(2). The final regulations define “restitution,” “remediation,” and “paid to come into compliance with a law” for purposes of I.R.C. §162(f). The final regulations also define which nongovernmental entities are treated as governmental entities subject to the reporting requirements of I.R.C. §6050X. TD 9946, RIN 1545-BO67, issued Jan. 12, 2021 and effective upon publication in the Federal Register.

Lawyer Fails to Understand Real Estate and Tax Law; No Charitable Deduction For House Donation. The plaintiffs, a married couple, bought a tract of real estate containing a house. The husband is a lawyer specializing in banking law and the representation of financial institutions. They decided to demolish the house and build a new one in its place. They entered into an agreement with a charity that salvages building materials, fixtures and furniture while providing their employees with workforce training. The charity requires donors to also make a cash donation to help cover the costs of deconstruction, with the plaintiffs still being responsible to pay a demolition company to remove any remaining debris that couldn’t be salvaged. The agreement with the charity involved a donation of the house to the charity, but not the underlying real estate. The charity explained to the plaintiffs that they could claim a charitable deduction for materials that actually made it back to the charity’s warehouse for later resale and the charity would provide the plaintiffs with a list of those items of property and the appraised value. The plaintiffs also agreed to pay $20,000 in cash over two years. The plaintiffs claimed a charitable deduction of $675,000 for the appraised value (based on valuing the house at its highest and best use, keeping it intact and moving it elsewhere) of the house as if it were moved to another lot. They also claimed a $24,206 deduction for personal property and $10,000 for the cash gift on their 2011 return. They also claimed a $1,500 charitable deduction in 2012 for a cash gift to the charity. The charity, however, disassembled some of the house, salvaged useful components and left the remainder of the house for demolition by the plaintiffs’ contractor. The IRS disallowed the deduction on the basis that the plaintiffs did not covey their entire interest in the house as I.R.C. §170(f)(3) required, and failed to provide an accurate appraisal of what the plaintiffs actually donated. The IRS also rejected the plaintiffs’ effort to amend the claimed deduction to $313,353 (based on a second appraisal based on the assumption that the house could be used for training purposes and that all of the materials could be salvaged and resold) for settlement purposes, based on an alternative appraisal of the house’s value. The trial court agreed with the IRS and denied the deduction because the plaintiffs had not donated their entire interest in the house under state (Maryland) law, and did not donate all of the components of the house itself, as some were destroyed and some were retained for demolition. The trial court noted that the plaintiffs did not properly sever the house from the property because they failed to record the transfer of the house in the county land records as Maryland law required. In essence, the trial court reasoned that the plaintiff’s donation was the same as merely granting a license to the charity to access and use the house for salvaging and training purposes. In any event, the trial court determined that both appraisals were defective as was the appraisal for personal property. The cash gifts were allowed as charitable deductions. The appellate court affirmed, finding that the plaintiffs remained the record owner of the house, and that under Maryland law “real property” includes both real estate and improvements to real estate. The appellate court also upheld the trial court’s finding that both appraisals were defective. Mann v. United States, No. 19-1793, 2021 U.S. App. LEXIS 280 (4th Cir. Jan. 6, 2021).

Posted January 12, 2021

IRS Annual Guidance on Letter Rulings, Info. Letters and User Fees. The IRS has issued its annual revenue procedure on obtaining letter rulings and information letters issued by IRS Associate Chief Counsel. The user fee schedule includes an increase in the user fee for certain requests for private letter rulings. Rev. Proc. 2021-1, 2021-1 I.R.B. 1.

Posted January 11, 2021

Policy Premiums Not Deductible As Not Connected to Trade or Business. The taxpayer, a partnership, had a member that circulated a private placement memorandum (PPM) to potential investors promoting an opportunity to invest in the member so that the member could acquire a membership interest in the taxpayer. The taxpayer would soon own real estate that would either be developed, held for investment, or have a conservation easement placed on it with the easement then donated to charity. The PPM noted that the taxpayer might purchase a “policy” in connection with the donation of a conservation easement. Ultimately, the taxpayer acquired the land and the member acquired a membership interest in the taxpayer. The taxpayer then conveyed a conservation easement on the property to a qualified charity. The taxpayer did acquire a policy that defined “loss” as excluding the costs of investigating, defending, responding to, or appealing” any issue associated with the tax treatment of the conservation easement donation. The taxpayer fled its federal tax return and claimed a charitable deduction for the donated easement and a deduction for the premium expense incurred on the policy. The IRS took the position that the amount paid for the premiums were not deductible under I.R.C. §§162(a), 212(a) or 212(2) because the premiums weren’t sufficiently related to the taxpayer’s trade or business or income-producing activities. The IRS also stated that the premiums weren’t deductible under I.R.C. §212(3). C.C.A. 202053010 (Set. 16, 2020).

Passive Loss Deduction Decreased By Pension Distribution. The petitioners, a married couple, reported a modified adjusted gross income (MAGI) of $122,948. That amount included taxable IRA distributions of $5,579, taxable pension and annuity distributions of $103,443; and total Social Security benefits of $13,828, the taxable portion of which was reported as $11,754. The petitioners deducted a passive loss of $26,877 associated with rental real estate based on their active participation in the activity. The IRS disallowed $20,913 of the loss based on the phaseout applicable when MAGI exceeds $100,000 and assessed a penalty. The IRS computed the petitioners’ MAGI as $138,072 and the deductible passive loss as $5,964. The IRS reduced the petitioners’ AGI by the taxable portion of their Social Security benefits for the year at issue, but increased by the $26,877 passive rental loss reported on Schedule E, resulting in a MAGI of $138,071. The petitioners also claimed, however, that their MAGI must be further reduced by $5,579 of IRA distributions and $100,625 of pension and annuity distributions that they received for 2014. Those adjustments would make their MAGI of $31,867 and eliminate the phaseout. The Tax Court noted that the maximum deduction allowed was $25,000 under the active participation text of I.R.C. §469(i)(3)(A), and was reduced by 50 percent to the extent the petitioners’ MAGI exceeded $100,000. The Tax Court also disagreed with the petitioners’ calculation, noting that I.R.C. §219 allows taxpayers to deduct their "qualified retirement contributions" for a taxable year, including "any amount paid in cash for the taxable year by or on behalf of an individual to an individual retirement plan for such individual's benefit" and "any amount contributed on behalf of an individual to a plan described in section 501(c)(18)." The Tax Court noted that the amount allowable as a deduction under I.R.C. §219 is subtracted from gross income when calculating AGI. Since I.R.C. §469(i)(3)(F)(iii) directs that MAGI for purposes of section 469(i) must be calculated without regard to any otherwise allowable I.R.C. §219 deduction, the effect of that provision is to increase the petitioners' MAGI by the amount of any retirement contributions for 2014 if any had been made during the year. But no contributions were made. Thus, the Tax Court determined that the IRS calculation of the petitioners’ MAGI was correct because it included the full amount of the IRA and other retirement distributions that petitioners received for 2014. The Tax Court did not uphold the penalty. Sharma v. Comr., T.C. Memo. 2020-147.

Posted December 31, 2020

Wind Energy Company Engaged in Sham Transaction. Section 1603 of the American Recovery and Reinvestment Tax Act (ARRTA) was created by the Congress and signed into law as a part of the 2009 stimulus package. The program was a system of cash grants that was implemented by the U.S. Treasury Department's "Payments for Specified Energy Projects in Lieu of Tax Credits." The purpose of payments made from the Section 1603 program were to reimburse grant recipients for a portion of the cost they incurred to install certain types of energy systems at business locations. Payments were made after the energy systems were installed. The types of energy systems that qualified for the program were biomass, combined heat and power, fuel cells, geothermal, incremental hydropower, landfill gas, marine hydrokinetic, microturbine, municipal solid waste, solar and wind. The program started in 2009 and ended in 2012. In early 2012, the plaintiff placed a qualified wind facility into service at a cost of $433,077,031. The plaintiff applied for a Section 1603 grant (in lieu of tax credits) of $129,923,109. As part of the grant application, the plaintiff submitted a development agreement that claimed to show a “proof of payment” in support of a $60 million development fee. The plaintiff, a “project company,” paid the development fee to its parent company, Invenergy, LLC. The U.S. Treasury awarded the plaintiff a grant of $117,216,098. The Treasury explained that the reason for the $12.7 million shortfall was based on the plaintiff’s excessive cost basis in the facility based on the inclusion of the development fee in the cost basis calculation. The Treasury asserted that the development fee transaction was a sham lacking economic substance shaped solely by tax avoidance motives. The court agreed. Bank records showed that money passed through the bank accounts of several entities related to the plaintiff by wire transfer and then back into the original account. The court determined that the plaintiff could not establish any business purpose or economic substance to the banking transactions. A CPA from a national firm, as the result of an audit, testified that the development agreement contained no quantifiable services. Invenergy, LLC, was not able to produce any accounting journal entries showing a business purpose for the banking transactions. Thus, the court determined that the evidence showed a development fee with no quantifiable services, circular wire transfers that started and ended in the same bank account on the same day, none of which were corroborated by independent testimony. The court denied the plaintiff reimbursement of the $12,707,011 cash grant, and the U.S. Treasury was entitled to recover an overpayment of $4,380,039. Bishop Hill Energy, LLC, et al. v. United States, 143 Fed. Cl. 540 (2019). The court also reached the same conclusion in California Ridge Wind Energy , LLC v. United States, 143 Fed. Cl. 757 (2019). The appellate court affirmed, upholding the trial court’s finding that amounts stated by the plaintiff in development agreements pertaining to the wind farms did not reliably indicate the development costs. The appellate court, on a consolidated appeal of the two cases, noted the “round-trip” nature of the payments; the absence in the agreements of any meaningful description of the development services to be provided, and the fact that all, or nearly all, of the development services had been completed by the time the agreements were executed. The appellate court also determined that the services were not quantifiable. As a result, the government could recover $10 million in cash grants from the two companies. California Ridge Wind Energy, LLC v. United States, 959 F.3d 145 (Fed. Cir. 2020).

Deed Language Granting Conservation Easement Violates Perpetuity Requirement; Charitable Deduction Denied. In 2008, an LLC that was partially owned by the petitioner’s tax matters partner, bought 22 acres of land next to a lake in Alabama for $200,000. The property was transferred to the petitioner and the tax matters partner and his wife each owned a 50 percent interest in the petitioner at the time. Five years later, the couple sold and assigned 49.75 percent of their interests in the petitioner to another LLC, and the petitioner then deeded an easement for the 22 acres to a qualified land conservancy. At the time of the conveyance of the easement, the LLC owned 99.5 percent of the petitioner and the couple owned .5 percent. The petitioner claimed charitable deduction of $6.524 million for the easement donation on its 2013 Form 1065 attaching Form 8283 reporting an adjusted basis in the easement of $200,000 and an appraised fair market value of $6.524 million. The deed contained language specifying the formula for distribution of proceeds upon extinguishment or condemnation of the easement. The IRS denied the deduction on the basis that the deed language failed to ensure that the charitable donee would receive a proportionate share of the proceeds and use those proceeds consistently with the conservation purposes underlying the original gift. To meet the requirement, the proportionate value must be set by a fraction that is equal to the value of the conservation easement at the time of the gift, divided by the value of the property as a whole at that time. Treas. Reg. §1.170A-14(g)(6)(ii). The IRS claims that the deed violated the regulation because it provides that the portion of proceeds required to be allocated to the done in the event of an extinguishment shall be reduced by the value of improvements to the land that the petitioner made after the easement was granted. In addition, the IRS claimed that merger language in the deed allowed the easement to be eliminated via merger of estates. The petitioner claimed that the regulation was satisfied because proceeds attributable to the value of improvements that the petitioner made after the donation were not immediately vested and were not part of the easement that was granted. The Tax Court noted its prior opinion in Oakbrook Land Holdings, 154 T.C. No. 10 (2020) upheld the regulation’s proportionate value approach. The Tax Court also held that the IRS was not judicially estopped from taking its position as to the language of proceeds allocation upon condemnation or extinguishment even though it had stipulated that identical deed language in a different case satisfied the regulation’s perpetuity requirement. The Tax Court noted that the IRS in that prior case had conceded the issue and settled the case rather than having the federal district court rule on it. Here, because the deed granting the easement reduced the donee’s share of the proceeds in the event of extinguishment by the value of improvements (if any) that the donor made, the petitioner had not satisfied the perpetuity requirement of I.R.C. §170(h)(5)(A). The Tax Court upheld the validity of the regulation. The petitioner’s deduction was denied. Smith Lake, LLC v. Comr., T.C. Memo. 2020-107.

Posted December 30, 2020

Settlement Payments Taxable; No Deductible Real Estate Rental Loss. The petitioner, a medical doctor, received a settlement payment from his former employer and the IRS determined that the amount was taxable income. The Tax Court agreed with the IRS on the basis that the payment addressed the petitioner’s longstanding complaint with the Equal Employment Opportunity Commission (EEOC) alleging employment discrimination and was disconnected from later-arising physical injuries that the petitioner had suffered. The appellate court affirmed, noting that the settlement payment only referenced the discrimination complaint. As such, the payment fell outside of the exclusion of I.R.C. §104(a)(2). The petitioner also owned at least six rental properties during the tax year in issue. He claimed a Schedule E loss on the basis that he performed more than 750 hours in the rental activity during the tax year. However, the Tax Court sustained the IRS rejected of the loss on the basis that the petitioner failed to sufficiently document his claimed hours. The appellate court also upheld the Tax Court’s disallowance of a net operating loss carryover for failure to substantiate the underlying Schedule C expenses that allegedly gave rise to the loss. Smith v. Comr., No. 19-1050, 2020 U.S. App. LEXIS 40175 (D.C. Cir. Dec. 22, 2020), aff’g., T.C. Memo. 2018-127.

Posted December 29, 2020

No Deduction For Computer Used At Home. The petitioner was a licensed insurance agent that had retired in 2004. After retiring he started an insurance consulting business. He is also a compulsive gambler that created numerous problems in his life. He failed to file a return for 2014 and the IRS filed a substitute-for-return for that year resulting in a tax liability of approximately $46,000. The petitioner then attempted to file a 2014 return claiming $350,000 of gambling losses and a $402 deduction for a computer he claimed was used in his consulting business. The Tax Court determined that the petitioner had substantiated his gambling losses were at least $350,241. However, as “listed property,” the petitioner’s computer was subject to the strict substantiation requirements of I.R.C. §274(d). Those stricter requirements, however, do not apply if the listed property is used exclusively at the taxpayer’s business establishment. See I.R.C. §280F(d)(4)(B). While the petitioner testified that he used the computer for his consulting business and that he conducted the business from his home, the Tax Court determined that the petitioner failed to prove that he had a portion of the home set aside exclusively for business use. Thus, the heightened substantiation requirements applied. The Tax Court noted that the Petitioner supplied no records documenting business use of his laptop, and his wife could not corroborate that he used it solely for work. His only evidence was his own statement, which we found unconvincing. Thus, the Tax Court held that he failed to meet the substantiation requirements of I.R.C. §274(d) and could not claim a deduction for the computer. Coleman v. Comr., T.C. Memo. 2020-146.

Posted December 28, 2020

Taxpayer Not in Trade or Business of Farming – Expenses Must Be Capitalized. The plaintiff owned two homes, one in town where he lived, and another on a 20-acre property that also contained a barn, trailer, and well. This house he used for rest periods and bathroom breaks while he was working on the property. He rented out a one-acre trailer space at the acreage for $400/month in 2015, and had no other income from the acreage from 2012 through 2015. His first “farming” activity at the acreage was pasturing beef cows and raising hay. When those activities failed to produce sufficient income he switched to a strategy of raising organic crops sometime before 2015. Under state rules, organic certification requires 36 months, and certification must be received before organic crop production can begin. The plaintiff did some soil testing and made some progress toward gaining organic certification and lining up customers. He made weekend trips to the acreage and allowed neighbors to cut hay and keep the hay in exchange for the neighbor promising not to use any chemicals on the neighbor’s property that might leach onto the plaintiff’s property. The plaintiff anticipated that his fields would be ready to organic certification in the spring of 2019. He kept meticulous records and spent much time studying organic farming and generally improving the property He reported a $25,900 loss on his 2015 return from rental real estate. The defendant allowed $3,217 in Schedule E rental expenses and disallowed the balance of $28,679. The plaintiff did not originally file a Schedule F, but proposed doing so on audit and allocating some of the disallowed Schedule E expenses to Schedule F. The defendant determined tha $11,446 in Schedule F farm expenses must be capitalized as start-up costs because the plaintiff was not engaged in the trade or business of farming as of 2015. The plaintiff also proposed to deduct on Schedule A mortgage interest that the defendant disallowed on his Schedule E associated with the acreage. The defendant made such a determination based on the plaintiff not using the residence at the acreage as a home during 2015. The defendant pointed out that the plaintiff did not use the residence as a home more than 14 days, or more that 10 percent of the number of days that the house was rented during 2015. The state Tax Court upheld the defendant’s position on the capitalization issue. The plaintiff was not engaged in the trade or business of farming under the facts and circumstances test of I.R.C. §162. However, the court determined that the acreage residence qualified as a second residence under I.R.C. §163(h) and that the plaintiff could deduct the mortgage interest. The court held that the defendant’s requirement that the plaintiff use the house a certain number of days during 2015 under I.R.C. §280A(d)(1) didn’t apply because the plaintiff didn’t rent the residence out during 2015. The house, furthermore, contained sleeping space and toilet and cooking facilities and met the definition of a residence. Parsons v. Oregon Department of Revenue, TC-MD 200040N, 2020 Ore. Tax LEXIS 61 (Ore. Tax Ct. Nov. 23, 2020).

Posted December 25, 2020

Toilet Rentals Subject to Sales and Use Tax. The plaintiff’s business involved renting portable toilets to others. The defendant claimed that the plaintiff’s rentals were subject to sales and use tax. The plaintiff claimed, however, that it was providing nontaxable waste removal services rather than leasing tangible personal property. The court held that the plaintiff’s leases of portable toilets were subject to sales and use tax because the applicable statute levied sales and use tax on rentals of tangible personal property, which is what the court held the plaintiff was doing. The plaintiff claimed that under the “true object” test of the governing regulation, its customers were seeking nontaxable waste removal services instead of toilet rentals. However, the court determined that because the plaintiff charged a fixed price based on the number of toilets it rented and lumped its charges for delivery, rental, labor and supplies into one transaction, the true object test didn’t apply to the disputed sales. The was no separate billing for cleaning services or for servicing the toilets. There also was no evidence that the plaintiff’s advertisements and invoices indicated that the plaintiff was selling services rather than toilet rentals. The court held that Mo. Rev. Stat. §144.010 clearly resolved the dispute in the defendant’s favor. Gott v. Director of Revenue, No. SC98444, 2020 Mo. LEXIS 483 (Mo. Sup. Ct. Dec. 22, 2020).

Posted December 24, 2020

Final Regulations Defining Real Property For I.R.C. §1031 Purposes. The IRS has issued final regulations addressing the definition of real property under I.R.C. §1031 and also provides a rule addressing the receipt of personal property that is incidental to real property received in a like-kind exchange. Under the final regulations, real property includes land and generally anything permanently built on or attached to land. In general, real property also includes property that is characterized as real property under applicable State or local law. In addition, certain intangible property, such as leaseholds or easements, qualifies as real property under I.R.C. §1031. Property not eligible for like-kind exchange treatment prior to enactment of the TCJA remains ineligible. T.D. 9935 (Nov. 18, 2020 and effective for exchanges on or after Dec. 2, 2020).

Theft Loss Only Deductible in Year of Discovery. The petitioner invested funds with an individual that was actually perpetrating a fraudulent scheme based on bank, wire and securities fraud. The individual was indicted in 2010 and convicted of bank and securities fraud in 2011. The petitioner deducted a theft loss on his 2012 return in accordance with the safe harbor of Rev. Proc. 2009-20, 2009-14, I.R.B. 749 as a qualified investor that experienced a qualified loss. The safe harbor allows the taxpayer to deduct 95 percent of the investor’s qualified loss in the year of discovery. The IRS disallowed the deductions because they weren’t taken in the year of discovery which was 2010. The Tax Court agreed with the IRS and disallowed the theft loss deduction. The theft loss, to be deductible, should have been deducted in they year the taxpayer discovered the illegal scheme that gave rise to the deduction. Giambrone v. Comr., T.C. Memo. 2020-145.

Posted December 23, 2020

Court-Awarded Damages Not Taxable. The taxpayer was riding his bicycle on his way home from work when he was hit by an automobile. He was severely and permanently injured, including sustaining a traumatic brain injury resulting in his cognitive impairment. The taxpayer sued the company that employed the driver that hit him. The complaint alleged damages on account of the defendant’s negligence, recklessness and the driver’s willful and wanton acts. Damages were sought for the taxpayer’s medical bills; mental anguish; loss of enjoyment of life; disability; pain and suffering; and other injuries and damages, including loss of consortium for the taxpayer’s wife. The trial court jury found the defendant liable and awarded the taxpayer (and spouse) damages for past and future economic damages (medical bills) and for past and future non-economic damages (mental anguish). The jury also awarded the taxpayer’s wife damages for past and future loss of consortium. The IRS determined that the taxpayer’s damages were not taxable because the awarded damages were tied to the taxpayer’s physical injuries sustained as a result of the bicycle accident. Private Letter Ruling 202050009 (Sept. 10, 2020).

Proposed Regulations on Medical Care Arrangements. The Treasury has developed proposed regulations under I.R.C. §213 classifying payments for direct primary care (DPC) arrangements as deductible I.R.C. §213 medical expenses (an itemized deduction to the extent exceeding 7.5 percent of adjusted gross income). Because such payments are for medical care, a health reimbursement arrangement (HRA) provided by an employer generally may reimburse an employee for DPC arrangement payments. Also, payments for membership in a health care sharing ministry (HCSM) are treated as I.R.C. §213 expenses. Thus, an HRA may generally reimburse an employee for HSCM membership payments. A hearing on the proposed regulations was held October 7, 2020. Prop. Reg. 109755-19 (Jun. 8, 2020).

Separate DPAD Amounts For Patronage and Nonpatronage Need Not Be Computed. The petitioner, and ag co-op, sells fuel, lubricants, plant nutrients, crop protection products, seed, structures, and equipment. It also provides grain marketing assistance and other services. The petitioner is member-owned, and its members include farmer cooperatives and individual farmers. Petitioner does business with its members and certain nonmembers (patrons) on a patronage basis. Patrons are eligible to share in patronage dividends paid by the petitioner. The petitioner also does business with all other nonmembers (nonpatrons) on a nonpatronage basis, and nonpatrons are not eligible to share in patronage dividends. In completing its Form 1120-C for 2009, the petitioner allocated its domestic production gross receipts (DPGR) and the wages it reported on Form W-2 between the patronage and nonpatronage columns in its Schedule G. The petitioner did not split its business operations on the basis of patronage and nonpatronage activities, nor did it dedicate specific assets or persons to patronage and nonpatronage activities. Rather, on Schedule G, the petitioner allocated items between the patronage and nonpatronage columns on the basis of the volume of business done with members. In computing its 2010 DPAD, the petitioner did not separate any amounts as patronage and nonpatronage. Instead, it performed a single computation aggregating all amounts from the members of its expanded affiliate group. It then allocated the DPAD between the patronage and nonpatronage columns on Schedule G on the basis of its qualified production activities income. The IRS determined deficiencies of approximately $462,000 for 2009 and approximately $3 million for 2010. The Tax Court concluded that the petitioner was not required to compute separate domestic production activity deduction (DPAD) amounts for its patronage and nonpatronage activities, but that the taxpayer must allocate its aggregately computed DPAD between its patronage and nonpatronage accounts. The Tax Court also held that the taxpayer must allocate the aggregate DPAD on its Schedule G using the same method it used for other Schedule G allocations. Growmark, Inc. v. Comr., T.C. Memo. 2019-161.

Co-op Payments to Members Are PURPIM. The petitioner is a non-exempt cooperative subject to subchapter T (I.R.C. §§1381-1388). The petitioner, during the tax years 2006-2009, made soybean and grain payments to its members for products that it processed and marketed for the members. The amounts of the payments were fixed without reference to net earnings in accordance with the agreement between the petitioner and each member. The petitioner received similar payments from a separate cooperative of which it was a member. The petitioner received a private letter ruling from the IRS in 2009 in which the IRS characterized the payments as per-unit retain allocations paid in money (PURPIM) for purposes of the petitioner’s domestic production activity deduction (DPAD). Thus, the petitioner reported the payments as PURPIM in computing its taxable income and treated the payments as PURPIM in computing its DPAD for the 2009 tax year as well as the 2008 tax year. The petitioner also filed amended returns for 2006 and 2007 reporting the payments made with respect to those years as PURPIMs and treated them as such in computing its taxable income and DPAD. On audit, the IRS determined that the payments made to members did not qualify as PURPIM for 2006-2008, and also held that the petitioner had to compute two separate DPAD amounts – one for patronage activities and one for non-patronage activities. The IRS assessed deficiencies of approximately $12 million for the petitioner’s tax years ending September 1, 2006 through August 31, 2009. The Tax Court held that the payments were PURPIM, both those made to members and similar payments that it received from the cooperative of which it was a member. Thus, the petitioner must treat the payments as PURPIM when computing its DPAD. The Tax Court noted that I.R.C. §199(d)(3) does not required the petitioner to compute separate DPAD amounts for its patronage and non-patronage activities. Once the DPAD is computed under I.R.C. §199, that amount is to be allocated under the rules of subchapter T between the patronage and non-patronage accounts. The Tax Court also held that the petitioner’s DPAD could not be used to create or increase a net operating loss. Ag Processing, Inc. v. Comr., 153 T.C. 34 (2019).

Posted December 13, 2020

Conservation Easement Donation Deduction Upheld. The petitioner was a member of an LLC that was formed for the purpose of developing land. Some of the LLC’s land was subdivided and developed into luxury homes with 89 acres contributed to a land trust. The LLC claimed a charitable contribution of $4.9 million for the contribution, four percent of which flowed through to the petitioner. The IRS disallowed the deduction on the basis that the conservation easements were impermissible tax shelters. The Tax Court upheld the deduction. The Tax Court noted that the petitioner demonstrated that he was actually planning to invest and make money on the development of land and that the only question was how best to develop the land. The transactions were all arms-length transactions at fair market value with the LLC obtaining a $5 million loan from an unrelated bank that was secured by a portion of the property to be developed. The bank also did its own appraisal of the property. The petitioner reported the charitable deduction by attaching qualified appraisals to the tax return and the claimed deduction was approximately $55,000/acre whereas the local tax appraisal district valued the land at about $322,000/acre. Based on before and after valuations of the tracts at issue, the Tax Court determined that the fair market value of the donated land was $560,000 after the donation, accepting the expert’s opinion for the IRS. The “before” value of the property, the Tax Court concluded, was at least the amount necessary to support the donation value of $4.9 million. The IRS also stipulated that the donation was “exclusively for a conservation purpose” leaving the only remaining argument that the donation was not in perpetuity. The Tax Court held that an amendment provision in the deed granting the easement did not violate the perpetuity requirement. Rajagopalan v. Comr., T.C. Memo. 2020-159.

Posted December 12, 2020

Funds in Son’s Savings Account Count in Parents’ Insolvency Calculation. The petitioners, a married couple, obtained student loans to finance their son’s college education. The husband later injured his back and became permanently disabled as a result. Consequently, the husband sought to have the loans discharged because of his disability and $158,511 was discharged. The husband also received $308,105 in a nontaxable cash distribution relating to his 14.4 percent interest in an LLC. He also started engaging in erratic spending behavior and his wife took over his finances. The petitioners transferred $323,000 to the son’s savings account with the wife having the ability to transfer funds from the account. The wife regularly transferred funds from the savings account to the petitioners’ joint account to pay household bills. The petitioners claimed that the insolvency exclusion of I.R.C. §108(a)(1)(B) applied to exclude the discharged debt from income because their debts exceeded their liabilities at the time of the discharge. However, their tax preparer did not include the amount in the son’s account in the petitioners’ insolvency calculation. The IRS claimed that the amount in the account should be included in the petitioners’ insolvency calculation because the son was merely holding the account as a nominee for his parents. The Tax Court agreed, based on state (UT) law determining asset ownership. Hamilton v. Comr., 955 F.3d 1169 (10th Cir. 2020), aff’g., T.C. Memo. 2018-62.

Lack of Substantiation Dooms Various Deductions. The petitioner was the sole owner of a corporation. The petitioner owned a number of rental properties. The IRS claimed that the petitioner failed to allocate a portion of the purchase price of the property to non-depreciable land and, as a result, disallowed various depreciation deductions. The IRS also asserted that the petitioner failed to provide documentation showing that the capital expenditures the petitioner made to the property were actually incurred and that the taxpayer failed to identify the properties to which the expenditures were applied. The IRS also claimed that the corporation failed to withhold employment taxes or issue Forms W-2 relating to payments made to the petitioner. The IRS also claimed that the petitioner failed to include in gross income cancelled indebtedness and failed to report other corporate income. In addition, the IRS claimed that the petitioner had constructive dividends from the corporation, and that the corporation included in cost of goods sold amounts in excess of allowable amounts. The IRS also disallowed various amounts of officers’ compensation deductions due to lack of substantiation. The IRS also levied penalties for late filing. The Tax Court upheld the IRS positions. On the canceled debt issue, the Tax Court determined that the petitioner failed to refute the fact that the Forms 1099-C showed that the debt was recourse debt. The Tax Court also upheld the position of the IRS that the corporation had paid some of the petitioner’s personal expenses, and the taxpayer failed to prove that the expenses were for repayment of debts that the corporation owed the taxpayer. Wienke v. Comr., T.C Memo. 2020-143.

Posted November 30, 2020

Information Return Not Necessary for Home Buyer Rebate. A company provided online platforms where potential buyers could be matched with a broker for the purpose of buying a home. The company received referral fees from brokers when qualifying transactions closed. The referral fees were paid out of a broker’s commissions. Upon paying the fee, the company made a cash payment to the buyer. The company sought an IRS ruling on whether the payments it makes to a buyer are adjustments to a home’s purchase should be included in the buyer’s gross income under I.R.C. §61 triggering a requirement to furnish Forms 1099-Misc. for the payments. The IRS ruled that payments to the buyer from the company reduces the acquisition cost of the home and represents an adjustment to the home’s purchase price that is not included in the buyer’s gross income. Thus, the company has no information reporting obligation under I.R.C. §6041 (or any other Code section) with respect to the payments to the buyers. Priv. Ltr. Rul. 202047002 (Aug. 21, 2020).

Posted November 28, 2020

Safe Harbor for Trusts Holding Rental Real Estate. Under Treas. Reg. §301.7701-4(c), an arrangement with a single class of ownership interests, representing undivided beneficial interest in the trust assets, is classified as a trust if there is no power under the trust agreement to vary the investment of the beneficiaries (“power to vary”). In Rev Rul. 2004-86, 2004-2 CB 191, the IRS took the position that a Delaware statutory trust formed to hold real property subject to a lease was an arrangement classified as a trust for Federal tax purposes under Treas. Reg §301.7701-4(c). However, the trust would be a business entity and not a trust if the trustee had a power to, among other things, renegotiate the lease with the tenant, to enter into leases with other tenants, or to renegotiate or refinance the mortgage loan whose proceeds were used to purchase the real estate. Later, the IRS provided safe harbors for determining the Federal income tax status of certain securitization vehicles that hold mortgage loans. Under the safe harbors, certain modifications of mortgage loans in connection with forbearance programs described in that guidance are not treated as manifesting a power to vary. After those safe harbors were issued, the IRS received comments addressing arrangements organized as trusts under Treas. Reg. §301.7701-4(c), and Rev. Rul. 2004-86 that hold rental real property. As a result, the IRS provided additional guidance detailing actions that will not constitute a power to vary for purposes of determining whether the arrangement is treated as a trust under Treas. Reg. §301-7701-4(c) and Rev. Proc. 2020-34, Sec. 7. Section 6 of the safe harbor allows these arrangements to make certain modifications to their mortgage loans and their lease agreements and to accept additional cash contributions without jeopardizing their tax status as trusts. Specifically, the following do not constitute a power to vary in violation of the regulation: 1) modification of one or more mortgage loans that secure the trust’s real property in a CARES Act forbearance or a forbearance that the trust requested, or agreed to, between March 27, 2020, and December 31, 2020, and that were granted as a result of the trust experiencing a financial hardship due to the actions of state governments in reaction to the virus originating from China; 2) modification of one or more real property leases entered into by the trust on or before March 13, 2020, and the modifications must have been requested and agreed to on or after March 27, 2020 and on or before December 31, 2020, where the reason for the lease modification is to coordinate the lease cash flows with the cash flows that result from one or more transactions described in the Notice or to defer or waive one or more tenants’ rental payments for any period between March 27, 2020 and December 31, 2020 because the tenants are experiencing a financial hardship due to the COVID-19 emergency; and 3) the acceptance of cash contributions that were made between March 27, 2020, and December 31, 2020, as a result of the trust experiencing financial hardship due to state government conduct in reaction to the China virus. However, the contribution must be needed to increase permitted trust reserves, to maintain trust property, to fulfill obligations under mortgage loans, or to fulfill obligations under real property leases. A cash contribution from one or more new trust interest holders to acquire a trust interest or a non-pro rata cash contribution from one or more current trust interest holders must be treated as a purchase and sale under I.R.C. §1001 of a portion of each non-contributing (or lesser contributing) trust interest holder’s proportionate interest in the trust’s assets. Rev. Proc. 2020-26, I.R.B. 753; Rev. Proc. 2020-34, 2020-26 I.R.B.

Posted November 26, 2020

Lifetime Ban on Owning Firearms For Filing Tax Returns With False Statement. The plaintiff pleaded guilty in 2011 to willfully making a materially false statement on her federal tax returns. She was sentenced to three-years’ probation, including three months of home confinement, a $10,000 fine, and a $100 assessment. She also paid back taxes exceeding $250,000, penalties and interest. Her conviction triggered 18 U.S.C. §922(g)(1), which prohibits those convicted of a crime punishable by more than one year in prison from possessing firearms. The plaintiff’s crime was punishable by up to three years’ imprisonment and a fine of up to $100,000. As originally enacted in 1938, 18 U.S.C. §922(g)(1) denied gun ownership to those convicted of violent crimes (e.g., murder, kidnapping, burglary, etc.). However, the statute was expanded in the 1968. Later, the U.S. Supreme Court recognized gun ownership as an individual constitutional right in 2008. District of Columbia v. Heller, 554 U.S. 570 (2008). In a split decision, the majority reasoned that any felony is a “serious” crime and, as such, results in a blanket exclusion from Second Amendment protections for life. The majority disregarded that the offense was non-violent, was the plaintiff’s first-ever felony offense, and was on offense for which she received no prison sentence. The majority claimed it had to rule this way because of deference to Congressional will that, the majority claimed, created a blanket, categorical rule. The dissent rejected the majority’s categorical rule, pointing out that the plaintiff’s offense was nonviolent, and no evidence of the plaintiff’s dangerousness was presented. The dissent also noted that the majority’s “extreme deference” gave legislatures the power to manipulate the Second Amendment by simply choosing a label. Instead, the dissent reasoned, when the fundamental right to bear arms is involved, narrow tailoring to public safety is required. Because the plaintiff posed no danger to anyone, the dissent’s position was that her Second Amendment rights should not be curtailed. Likewise, because gun ownership is an individual constitutional right, the dissent pointed out that the Congress bears a high burden before extinguishing it. Post-2008, making a categorical declaration is insufficient to satisfy that burden, according to the dissent. It is likely that the case will be headed to the U.S. Supreme Court. Folajtar v. The Attorney General of the United States, No. 19-1687, 2020 U.S. App. LEXIS 37006 (3rd Cir. Nov. 24, 2020).

Posted November 25, 2020

Reserved Right to Build Does Not Disqualify Charitable Deduction for Donated Conservation Easement. The petitioner acquired a tract and later donated conservation easements in 2005-2007 on small portions of the property to a qualified land trust, intending to claim a tax deduction for the value of the contribution pursuant to I.R.C. §170. Each easement set forth a defined area that was to be perpetually restricted from being developed and also specified where “building areas” could occur, all with the stated purpose of protecting natural habitats of fish and wildlife and preserve open space to provide scenic enjoyment to the public. However, the easement donated in 2006 did not delineate the location of the building areas, and the easement donated in 2005 allowed the petitioner (with the consent of the qualified land trust), to shift the building areas to another location within the conservation area. The 2005 easement also reserved the right in the petitioner to build in the conservation area such things as barns, riding stables, scenic overlooks, boat storage buildings, etc. The petitioner claimed charitable deductions for the easements which the IRS denied on the basis that the easements weren’t qualified real property interests under I.R.C. §170(h)(1)(A) and were not used exclusively for conservation purposes under I.R.C. §170(h)(1)(C), and that the fair market value of the easements were overstated, and that they were granted in perpetuity under I.R.C. §170(h)(2)(C). A majority of the full Tax Court agreed with the IRS as to the 2005 and 2006 easements because the easements did not restrict development on a specific, identifiable piece of property and it appeared that the petitioner could take back the conserved areas and use it for residential development that were not subject to the conservation easements. As such, the Tax Court determined that the easements did not constitute “a restriction (granted in perpetuity) on the use which may be made of the real property…”. The Tax Court, however, pointed out that the easement conveyed in 2007 did cover a specific, identifiable tract and was granted in perpetuity and was made exclusively for conservation purposes and did not reserve in the petitioner any right to construct structures appurtenant to residential development. In addition, the Tax Court noted that the language in the 2007 easement providing for amendments did not disturb the qualified nature of the easement because any amendment had to be “not inconsistent with the conservation purposes of the donation.” The Tax Court, in denying the charitable deduction for the 2005 and 2006 easements followed its decision in Belk v. Comr., 140 T.C. 1 (2013) which the Fourth Circuit affirmed. Belk v. Comr., 774 F.3d 221 (4th Cir. 2014). The Tax Court also determined that the acceptable boundary modification provisions present in the easements involved in Bosque Canyon Ranch II, L.P. v. Comr., 867 F.3d 547 (5th Cir. 2017) were distinguishable from those in Belk because they didn’t allow any the exterior boundaries of the easements or the acreages to change. On further review, the appellate court reversed the Tax Court as to the 2005 and 2006 easements and affirmed as to the 2007 easement. As to the 2005 and 2006 easements, the appellate court held that the easements imposed a perpetual restriction and nothing in the grants would cause the easements, either automatically or upon the happening of some event, to revert back to the petitioner or its successors. The appellate court noted that an easement granted in perpetuity over a defined conservation area is all that is required even if it reserves targeted development rights for homesite constructions. Because the Tax Court had not addressed the perpetuity requirement as to the 2005-2006 easements, the appellate court remanded on that issue.  Pine Mountain Preserve, LLLP v. Comr., 978 F.3d 1200 (11th Cir. 2020), rev’g. in part and aff’g. in part, 151 T.C. 247 (2018).

No Charitable Deduction – Judicial Extinguishment Proceeds Allocation Rule Violated. The petitioner donated a conservation easement over 1,313 acres of undeveloped land to a land conservancy (a qualified charity) and claimed a $17.5 million charitable contribution deduction. However, the deed granting the easement subtracted any value attributable to post-easement grant improvements from any proceeds received upon judicial extinguishment of the easement before determining the donee’s share. The IRS took the position that this deed language violated Treas. Reg. §1.170A-14(g)(6) and the Tax Court agreed. However, the petitioner could deduct the amount of a cash donation that it paid to a settlement agent who, in turn, transmitted the funds to the land conservancy because the petitioner had relinquished control of the funds upon paying them to the agent at closing, and because there was only a negligible chance that the agent wouldn’t turn the funds over to the conservancy. Glade Creek Partners, LLC v. Comr., T.C. Memo. 2020-148.

Posted November 6, 2020

Payments Received By CPA Were Wages and Not S.E. Income; Deductions Disallowed. The petitioner acquired a partial interest in an accounting firm and ultimately became the sole owner of the firm that he operated as a sole proprietorship. The petitioner later went into business with another accountant pursuant to two contracts. One contract purported to be a partnership agreement and the second contract “restated” the first contract. The plaintiff provided accounting services to the firm and also brought his own clients to the firm. He later sold his interest back to the business under an agreement stating that he didn’t retain any management or supervisory role in the business. During the year of sale of his interest and the following year (2010 and 2011), the business made bi-weekly payments to the petitioner for accounting services. The business issued Schedules K-1 reporting the payments as guaranteed payments to a limited partner with no withholding. The petitioner did not receive any paid sick leave or paid vacation time. The business had a professional liability policy that included the petitioner. The petitioner received a letter from the Department of Justice requesting the records of a client and the petitioner responded to the letter without informing the business. That ultimately resulted in the business locking the petitioner out, barring him from the computer network and placing him on administrative leave and his relationship with the business being terminated. The petitioner reported his income for 2010 and 2011 as self-employment income allowing him to claim deductions for deposits into his SIMPLE IRA and for health insurance premiums that he paid as well as for one-half of his self-employment tax liability. The IRS disallowed the deductions, recharacterizing the income as wages. That resulted in his expenses being treated as unreimbursed employee expenses deductible only as miscellaneous itemized deductions subject to the two-percent of adjusted gross income floor. Likewise, the petitioner’s health insurance deductions were only deductible as a medical expense deduction and the SIMPLE IRA deduction was disallowed. The IRS also imposed accuracy-related penalties. The Tax Court agreed with the IRS position, concluding that the petitioner and the other accountant did not intend to carry on a business together or share profit and loss. Thus, they never formed a partnership. The 2010 agreement, the Tax Court determined resulted in an at-will employment arrangement with the petitioner having no management authority. The issuance of the Schedules K-1 were not controlling, but merely a factor in determining the existence of a partnership. The Tax Court also held that the petitioner was not an independent contractor because of the longstanding relationship of the petitioner and the other accountant. The accountant/firm retained the right to fire the petitioner and provided him with professional liability insurance, office space and tax prep software. The firm also retained control over the details of his work and he did not have any opportunity for profit or loss independent of the business. The IRS-imposed penalties were upheld. Thoma v. Comr., T.C. Memo. 2020-67.

Posted November 2, 2020

Lack of Economic Performance Dooms Accrual-Based Deduction. The petitioner provided bulk-packaged tomato products to food processors and customer-branded finished products to the food service and retail trades. The petitioner’s operation accounted for about 25 percent of the California processed tomato production and it supplied approximately 40 percent of the United States ingredient tomato paste and diced tomato markets.” The petitioner operated around-the-clock during tomato harvest season, and operated under numerous state and federal food safety/cleanliness regulations. Any violations (or even alleged violations) of those requirements could shut down the petitioner’s operation causing losses due to spoilage and contract defaults with growers and buyers. Specifically, after the end of a tomato harvest season, the petitioner engaged in extensive clean-up. If the petitioner didn’t engage in this meticulous post-harvest cleaning and the tomato line were to become contaminated all of the tomato products in the processing line would have to be dumped, the line sterilized at a large cost, and all had to be inspected by federal and state agricultural agencies. In addition, farmer-sellers would have to be paid for their tomato crops and the petitioner would be in breach of the covenants contained in the credit lines (that required the petitioner to maintain its licenses and keep the equipment in good repair) with its lenders as well as its delivery contracts for processed tomatoes. The petitioner incurred costs to restore, rebuild, and retest the manufacturing facilities for use during the next production cycle. The accrued production costs included amounts to be paid for goods and services. The petitioner also maintained reserves to account for future costs associated with restoring, rebuilding, and retesting the manufacturing facilities for use during the next production cycle. The production accrual reserve accounts tracked amounts for production labor, boiler fuel, electricity, waste disposal, chemicals and lubrication, production supplies, repairs and maintenance, lease, production wages, and administration wages. The accrued production costs were recurring, and the amounts set aside in the reserves covered the costs with reasonable accuracy. IRS did not challenge the accuracy of the reserves. The petitioner also documented the economic efficiency reasons why it delayed some of the restorative work as well as retesting and rebuilding work until near the beginning of the next production cycle. The petitioner deducted its clean-up costs (good and services, etc.) after a tomato harvest season in that tax year, even though the clean-up work actually occurred in the following tax year. Economic performance of the production accrual liabilities didn’t occur until the petitioner’s next tax year. At least that was the position of the IRS. It claimed that the petitioner could not include the accrued costs in the cost of sales for the current year due to the economic performance requirement of I.R.C. §461(h)(3). In particular, the IRS asserted that the petitioner couldn’t increase its COGS for the amount of the accrued production costs because the petitioner had not shown that all events had occurred to establish the fact of the liabilities. Economic performance had not occurred with respect to the liabilities to qualify for accrual for the years claimed – the third prong of the “all events” test. The petitioner claimed that it was entitled to the deduction because it had bilateral contracts for goods and services to recondition its manufacturing facilities, and that all events had occurred during the tax years in issue to establish the fact of the liabilities for the accrued production costs. The petitioner also took the position that its credit agreements and multiyear contracts to supply customers with tomato products obligated them to incur the accrued production costs to restore, rebuild, and retest the manufacturing facilities. The Tax Court disagreed. The Tax Court pointed out that under the accrual method, an item allowable as a deduction, cost or expense (liability) for federal income tax purposes is incurred if: 1) all of the events establishing the liability have occurred; 2) the amount of the liability is determinable with reasonable accuracy; and 3) economic performance has occurred. The Tax Court noted that the credit agreements did not specifically set forth the petitioner’s obligations to provide a comparably sufficiently fixed and definite basis. Instead, the Tax Court concluded that the credit agreements included nonspecific text and generalized obligations that merely required to maintain its licenses and permits, and secure governmental approvals. The agreements also also contained general language requiring the petitioner to comply with ‘all laws’, and ‘keep all property useful and necessary in its business in good working order and condition’. That language, the Tax Court concluded, didn’t specify which laws or regulations had to be complied with. It also didn’t identify with any precision which property must be kept in good working order. The generalized obligations, the Tax Court reasoned, did not establish the petitioner’s liabilities for the accrued production costs for the years in issue. In addition, the Tax Court determined that the petitioner’s inclusion of the production costs in COGS for the years in issue result in a more proper match against income than inclusion in the taxable year. The petitioner also couldn’t avoid its tax problem by using a fiscal year from October 1 to September 30. While good business reasons would have supported using such a fiscal year, I.R.C. §706 prevented it. The Morning Star Packing Company, L.P., et al. v. Comr., T.C. Memo. 2020-142.

Posted October 14, 2020

No Non-Profit Tax Status for Farm. The taxpayer was formed as a nonprofit corporation for the benefit of an I.R.C. §509(a)(1) corporation that provides residential programs, shelter care, intervention, mental health services, etc. One of the key pieces of revenue generation for the taxpayer is to be the development of pistachio orchards that will be leased to third parties. The IRS denied tax-exempt status because it was formed for the substantial non-exempt purpose of preparing and lease of a farm to a for-profit entity that the taxpayer controlled. Thus, the taxpayer failed the operational test of Treas. Reg. §1.501(c)(3)-1(a)(1) and had facts similar to those of Rev. Rul. 73-127. The IRS determined that the taxpayer was formed for the private benefit of a family through a series of transactions, and was controlled by the same persons who control the entity that will purchase the orchard land and then lease it back to the taxpayer. Priv. Ltr. Rul. 202041016 (Jul. 15, 2020).

Mississippi Tax Regulations Amended. The Mississippi Department of Revenue has added the definition of “dairy producer” and provided for a special tax rate of 3.5 percent on certain purchases that a dairy producer makes. Milking machines are also added to the definition of “farm implements” that are taxed at a reduced rate of 1.5 percent. Also added are examples of pest control services, exempt purchases, and tools and/or equipment. MS Dept. of Rev. amendments to MS Admin. Code §35.IV.9.04, effective Dec. 1, 2020.

Posted October 11, 2020

Tax Malpractice Settlement Payment Is Taxable Income. The petitioner was an independent consultant to car dealerships who hired the Grant Thornton accounting firm to advise him on tax strategy and preparation. Grant Thornton recommended that the petitioner form an S corporation wholly owned by an Employee-Owned Stock Ownership Plan (ESOP) with the petitioner as its sole beneficiary. The strategy would allow the petitioner to defer tax on the proceeds of the petitioner’s consulting business. The strategy was utilized, but Grant Thornton either failed to prepare or otherwise ensure that the ESOP was properly formed and operated. The petitioner also acquired a 25 percent interest in a GMC car dealership that was placed in a different S corporation that the ESOP wholly owned. Grant Thornton advised that the dealership’s payments to the S corporation be characterized as management fees rather than as a share of the profits. The petitioner paid no income tax for several years. Ultimately, the IRS audited and determined that the tax strategy as to the GMC car dealership was an unlawful and abusive tax shelter. The petitioner paid $2,235,429 in income taxes, interest and penalties. The petitioner sued Grant Thornton for malpractice. The petitioner alleged that Grant Thornton had failed to submit the ESOP to the IRS for a determination letter; advise the petitioner that annual and continuing contributions would have to be made to the ESOP in order to maintain its qualification on a going-forward basis; provide the petitioner with instruction regarding the timely adoption and execution of the ESOP and related trust documents; advise the petitioner regarding the requirement that the ESOP engage an independent appraiser to perform an annual appraisal; advise the petitioner to maintain annual administrative records for the ESOP; advise the petitioner regarding removal of the initial trustee; advise the petitioner regarding the non-discrimination testing requirements under the Tax Code; and provide proper ESOP documents which satisfied the qualification requirements under the Tax Code. Grant Thornton settled the suit by paying the petitioner $800,000. On its 2009 return, the petitioner deducted $419,490 in legal fees to litigate the malpractice claim and excluded the $800,000 settlement payment from gross income. The petitioner, as a result, claimed a net operating loss that was carried forward to reduce tax liability in 2010 and 2011. The IRS rejected the deductions and exclusions, recharacterizing the legal expenses as a miscellaneous itemized deduction rather than a business deduction (thus deductible only to the extent they exceeded two percent of the petitioner’s adjusted gross income). The IRS also disallowed the loss deduction and the exclusion of the settlement payment. These adjustments resulted in a tax payment of an additional $813,407 in taxes. The petitioner filed a refund claim and the IRS denied it with respect to the 2009 return and did not respond to the 2011 claim. The petitioner sued and the trial court held that the litigation expenses were not deductible business expenses because the petitioner sued Grant Thornton on its own behalf rather than on behalf of the consulting business. The trial court also held that the petitioner couldn’t claim any loss related to the ESOP transaction because of language in the 2007 settlement with Grant Thornton. The trial court, however, held that the $800,000 settlement payment was a return of capital and, as such, excludible from the petitioner’s gross income. The appellate court reversed on the issue of the taxability of the settlement payment. The appellate court noted that whether a settlement payment resolving a legal claim constitutes taxable income depends on what the damages were awarded for, and that a third party’s payment of a taxpayer’s tax liability is generally included in gross income. The appellate court determined that the settlement payment could not be deducted as a business expense under I.R.C. §162 because the litigation was personal in nature an origin and did not concern the taxpayer’s business. It was also not excludible from gross income under I.R.C. §61 because the petitioner did not satisfy the burdens of showing the entitlement to the exclusion and the amount of the exclusion. McKenny v. United States, 973 F.3d 1291 (11th Cir. 2020).

No Penalty Relief For Taxpayer With Tax Prep Experience. The petitioner was the sole shareholder of an S corporation involved in processing tax returns. The S corporation reported significant income that flowed through to the taxpayer that the taxpayer did not report on his individual return. The IRS determined that the petitioner had underreported his income and assessed an accuracy-related penalty. The petitioner argued that he shouldn’t be subject to the penalty because he relied on his accountant’s advice. The Tax Court upheld the penalty, noting that the petitioner was a lawyer with at least seven years of intensive tax experience in the business of preparing Federal income tax returns. The Tax Court also noted that the petitioner failed to keep books and records that tracked the S corporation’s income and expenses during one of the years at issue. Babu v. Comr., T.C. Memo. 2020-121.

Activity Not a “Trade or Business”; No Expense Deductions and No NOL Allowed. The petitioner was a self-employed real estate broker operating out of her home. The IRS disallowed various Schedule C deductions and made other adjustments to the return for the years in issue on the basis that the petitioner was not engaged in the real estate broker activity as a trade or business. The Tax Court agreed with the IRS position. The Tax Court noted that in determining whether an activity constitutes a trade or business depends on the presence of a profit motive and is conducted with continuity and regularity. The petitioner’s activity failed to meet those standards. The Tax Court also disallowed the petitioner’s claimed net operating loss for lack of substantiation and lac of proof that the net operating loss actually existed. The Tax Court also determined that the illness of the petitioner’s husband was insufficient to establish reasonable cause excuse for the imposition of a late-filing penalty. The petitioner was pro se. Brashear v. Comr., T.C. Memo. 2020-122.

On-Farm Sales of Processed Beef Subject to Sales Tax. The taxpayer sought a ruling from the state Department of Revenue concerning the sale of beef products from his farm. The taxpayer raises cattle, slaughters them, and then sends the beef out to be processed at a local processing plant. The taxpayer pays the processing plant for its services and then the taxpayer sells the resulting beef products to customers at his farm. The taxpayer’s question was whether the beef sales were subject to sales tax. The state Department of Revenue issued a ruling stating that the sales are subject to sales tax at the food tax rate of 1 percent. The Department of Revenue noted that 7 U.S.C. §2012, defines “food” as "any food or food product for home consumption." The taxpayer was selling raw beef at retail for home consumption. Priv. Ltr. Rul. 8115 (Mo. Dept. of Rev., Sept. 25, 2020).

Posted October 10, 2020

Vacation Properties Could Not Be Grouped For Passive Loss Purposes. The plaintiff was a real estate professional within the meaning of I.R.C. §469(c)(7) that owned 33 rental properties and elected to treat them as a single real estate rental activity. Included in the rental properties were three vacation properties (in Mexico, Colorado and Hawaii). As for the resort properties, the plaintiff entered into management agreements that gave each of three outside entities an exclusive right to rent and manage one of the properties. Under the Mexico property agreement, the plaintiff retained the right to use the property for an unlimited number of days if there was no conflicting confirmed reservation for it. Under the Colorado property agreement, the plaintiff could use the property up to 56 days in a calendar year, and more if he paid a fee, but he could not reserve it more than 365 days in advance. Under the Hawaii property agreement, the plaintiff retained the right to use the property for an unlimited number of days except that during the first six months he could only use the property for up to 30 days and at all times he was required to reserve the property at least 180 days in advance. As noted, the plaintiff sought to group the vacation rental properties with his other rental activities as a single activity for purposes of the material participation rules of I.R.C. §469. The IRS denied the grouping on the basis that the vacation rental properties were not rental properties because the average period of customer use for the vacation rentals was seven days or less for the tax year (Treas. Reg. §1.469-1T(e)(3)(ii)(A)), and because the petitioner was the “customer” rather than the management companies. Consequently, the plaintiff could not deduct the losses from the vacation properties. The trial court agreed with the IRS position on the basis that the plaintiff’s retained right to use each vacation property eliminated the management companies from having a continuous or recurring right to use the property when applying the test of Treas. Reg. §1.469-1(e)(3)(iii)(D) providing for measuring the period of customer use. As such, the facts of the case differed substantially from the contracts at issue in White v. Comr., T.C. Sum. Op. 2004-139 and Hairston v. Comr., T.C. Memo. 2000-386. Thus, the management companies were not customers with a continuous right to use the properties, but merely provided marketing and rental services for the petitioner to rent out the properties. The appellate court affirmed and interpreted “customer” under Treas. Reg. §1.469-1T(e)(3)(ii)(A) to mean the guest who actually used the rented property. The management companies, the appellate court reasoned, were simply service providers that acted as the “representatives” of the taxpayers. The appellate court did not address the trial court’s reasoning of the other two Tax Court decisions that treated a management company as the customer. The appellate court didn’t address whether it would have reached a different conclusion if the plaintiff had received fixed payments without regard to whether or not the management company secured renters. Arguably, those arrangements would be similar to a traditional lease that simply includes the right but not the requirement to sublease. Eger v. United States, No. 19-17022, 25711 (9th Cir. Aug. 13, 2020), aff’g.,405 F. Supp. 3d 850 (N.D. Cal. 2019).

Posted October 7, 2020

No Loss Deductions From Short-Term Property Rental. The petitioners, a married couple, spent the Christmas holidays at their vacation property located 100 miles north of San Francisco on the Pacific Coast, and several hours from their primary home. A management company managed the vacation property. The petitioners’ use of the vacation property did not exceed the 14-day test of I.R.C. §280A or otherwise satisfy I.R.C. §280A. As such, the IRS denied the petitioners’ passive loss deductions for lack of proof of material participation. The husband claimed that he satisfied the 100-hour test for each year in issue, his only verification of the hours was by means of a non-contemporaneous log that reconstructed the number of hours he claimed that he spent on activities at the vacation property. The Tax Court, agreeing with the IRS, determined that the petitioners had neither satisfied I.R.C. §280A nor I.R.C. §469. The Tax Court noted that the inclusion of time spent paying bills and preparing tax returns did not count as material participation hours because they amounted to investor hours. The Tax Court also concluded that commuting hours were personal expenses and that other hours for such things as grocery shopping were excessive in relation to the particular tasks described or were mixed with personal purchases. The Tax Court also concluded that the petitioners failed to show how much the property management company or others spent on the vacation property so that the a determination could be made whether the petitioners’ participation exceeded that amount. Lucero, et ux. v. Comr., T.C. Memo. 2020-136.

IRS Agent Gets Supervisor Approval to Impose Penalties. An IRS revenue agent sent the petitioner letters offering to settle the petitioner’s tax liabilities arising from a particular transaction. The settlement terms required the petitioner to accept penalties calculated at reduced rates on any related underpayment that could later be determined. The petitioner rejected the offer. The revenue agent completed the exam and obtained written approval from his acting immediate supervisor for asserting penalties at the statutory rates. The IRS sent then issued the petitioner a notice of deficiency determining the deficiencies and penalties for 2003 through 2007. The petitioner claimed that the penalties had not been properly approved in accordance with I.R.C. §6751(b)(1) for lack of supervisory approval. The Tax Court disagreed with the petitioner, holding that the settlement offers to the petitioner did not constitute "the initial determination of ... [a penalty] assessment", that required prior supervisory approval. The Tax Court also held that the supervisory approval requirement of I.R.C. §6751(b)(1) was satisfied when the revenue agent's supervisor approved the penalties, even though the immediate supervisor held the position on an interim basis. Thompson v. Comr., 155 T.C. No. 5 (2020).

Posted September 27, 2020

Property in Grantor Trust Subject to Tax Liens Against Grantor. The defendant bought residential real estate in a wealthy Denver suburb and soon thereafter transferred it to a grantor trust naming the defendant and his then-wife as beneficiaries. The defendant’s father-in-law was named as the trustee. The trust terms gave the beneficiaries the “right to participate in the management and control of the Trust Property,” and direct the Trustee to convey or otherwise deal with the title to the Trust Property. The trust terms also gave the beneficiaries the right to receive the proceeds if the property was sold, rented or mortgaged. The defendant continued to personally make the mortgage payments, pay the property taxes, homeowner association dues. In addition, the defendant personally paid the electricity, gas and water bills for the home. The defendant claimed a deduction on his personal tax return for mortgage interest and claimed a business deduction for an office in the home. While the defendant filed personal returns for 2005-2008 and 2010, he did pay the tax owed. The IRS assessed tax, penalties and interest against the defendant personally. In early 2019, the IRS notified the defendant of the balance due for each tax year and recorded a notice of federal tax lien with the county for each year at issue. The IRS also issued a lien for the Trust as the defendant’s nominee. The IRS subsequently sought to enforce its liens and a judgment that the defendant was the true owner of the trust property. The court, agreeing with the IRS, noted that the defendant’s property and rights to the property may include “not only property and rights to property owned by the taxpayer but also property held by a third party if t is determined that the third party is holding the property as a nominee…of the delinquent taxpayer.” The court examined six factor in determining that the Trust held the property as the defendant’s nominee: 1) the Trust paid only ten dollars for the property; 2) the conveyance was not publicly recorded; 3) the taxpayer resided in the property and made the property’s mortgage payments and property taxes and housing association dues payments; 4) the taxpayer enjoyed benefits from the property because he claimed mortgage interest deductions related to the property; 5) the taxpayer had a close relationship with the Trust because he created it and named himself as a beneficiary; and 6) the defendant continued to enjoy the benefits of the property transferred to the Trust. Thus, the federal tax liens against the defendant also attached to the Trust property. Thus, the IRS could seize the property in payment of the defendant’s tax debt. United States v. Cantliffe, No. 19-cv-00951-PAB-KLM, 2020 U.S. Dist. LEXIS 172253 (D. Colo. Sept. 21, 2020).

Posted September 22, 2020

No Flow-Through Loss From Corporation That Couldn’t Issue Stock. The plaintiff created a nonstock, nonprofit corporation in 2012 and was its president and one of its three directors. However, the corporation never applied for recognition of tax-exempt status with the IRS. In late 2014, the corporation mailed Form 2553 to the IRS seeking to elect S status retroactively to its 2012 incorporation date. The petitioner signed Form 2553 in his capacity as president. He also signed the shareholder’s consent statement indicating that he was the sole owner of the corporation. The corporation filed an S corporate return (Form 1120S) for tax years 2012 and 2013 on which it reported operating losses of $277,967 and $3,239 respectively, and issued Forms K-1 for the losses to the petitioner. In May of 2015, Deckard filed his Form 1040 returns for 2012 and 2013, both untimely and both claiming the losses flowed through from the corporation. The IRS denied the losses on the grounds that the S-election was invalid, and alternatively, that Deckard was not a shareholder of the corporation. On the latter point, the Tax Court noted that the petitioner was not a shareholder of record and the corporation was not authorized to issue stock. In addition, there was no evidence of any issuance of stock. The Tax Court also pointed out that a nonprofit corporation generally does not have shareholders, are not owned by third parties and there is no interest in a nonprofit corporation that is similar to that of a for-profit corporate shareholder. The petitioner also did not possess shareholder rights, had no ownership, had no right to profits, no dissolution rights and no right to corporate assets upon dissolution. In essence, the corporation was a state law nonprofit corporation controlled by a board of directors on which the petitioner only had a one out of three vote. Deckard v. Comm’r, 155 T.C. No. 8 (2020).

Posted September 11, 2020

No Deduction For Meals, Entertainment and Travel Costs. The petitioner claimed deductions for meal and entertainment costs and travel expenses. The IRS denied the deduction for lack of substantiation and the Tax Court agreed. The Tax Court concluded that the petitioner failed to provide credible evidence that the expenses were incurred in the operation of his trade or business as I.R.C. §274(d) requires, and that he failed to establish his basis in the subject property. However, the Tax Court held that the petitioner was entitled to claim deductions for business losses relating to certain loans and business properties. Late-filing and accuracy-related penalties were upheld. Franklin v. Comr., T.C. Memo. 2020-127.

Loss Deduction Denied on Liquidation of S Corporation. The petitioners, a married couple, transferred personal assets and marketable securities to a wholly-owned S corporation. Immediately after the transfer, the S corporation transferred the assets to the petitioners’ family limited partnership. Several weeks later, the petitioners liquidated the S corporation and received the partnership interest as a liquidating distribution and claimed a deductible short-term capital loss of over $2 million on Schedule E. The IRS denied the deduction and the Tax Court agreed. The Tax Court concluded that the transactions generating the loss lacked economic substance. An accuracy-related penalty for substantial understatement of tax was also upheld. Daichman v. Comr., T.C. Memo. 2020-126.

Posted September 4, 2020

No Loss Deduction on Sale of Vacation Property. The petitioners, a married couple, bought a vacation property but became unable to pay the debt on the property. They sold the property and the bank holding the obligation agreed to accept an amount of the sale proceeds that was less than the outstanding balance as full satisfaction of the debt. The debt was nonrecourse and, as such, the amount of discharged debt was included in the petitioner’s amount realized upon sale of the property and was not CODI. The petitioners claimed a loss on sale to the extent of the basis in the property exceed the amount realized from sale. However, the Tax Court noted that because the property was converted from personal use to rental use, the basis upon conversion cannot exceed the property’s fair market value for purposes of the loss computation. The Tax Court held determined that the petitioners failed to establish the basis in the property at the time of conversion. Duffy v. Comr., T.C. Memo. 2020-108.

No Deduction For Donated Conservation Easement. The petitioners were partners of a partnership that donated a permanent conservation easement to a qualified charity. The easement covered 500-acres and allowed the development of 11 single-family homes on lots of up to two-acres in size. The Tax Court, agreeing with the IRS, denied a charitable deduction for the donation on the basis that it was not a qualified real property interest under I.R.C. §170(h)(2)(C) for failing to meet the perpetual restriction requirement because the land on which the homes could be built was not a protected natural habitat of fish and wildlife. Carter v. Comr., T.C. Memo. 2020-21.

Lack of Strict Compliance With Substantiation Requirements Dooms Charitable Deduction. The petitioners donated a fractional interest in new designer eyeglass frames to charity at the suggestion of their accountant who was promoting the donation program. The associated appraisal was not a qualified appraisal because it was not for the specific share of the eyewear that the petitioners donated. The Tax Court determined that the petitioners were donating a specific number of eyewear frames rather than a fractional share and that the appraisal had to be for those specific frames. In addition, the appraisal description filed with the return was not detailed enough to determined what property was donated. Also, the contemporaneous written acknowledgement did not affirmatively state that “no consideration was provided for the contributed property.” The Tax Court noted that this language is mandatory. Campbell v. Comr., T.C. Memo. 2020-41.

No $1.4 Million NOL Carryforward. The petitioners, a married couple, carried forward a $1.4 million net operating loss (NOL) and deducted it against their income for the carryforward year. The IRS denied the deduction for failure to satisfy Treas. Reg. §1.172-1(c) which requires that a taxpayer claiming an NOL deduction must file with the return “a concise statement setting forth the…amount of the [NOL] deduction claimed and all material and pertinent facts relative thereto, including a detailed schedule showing the computation of the…[NOL] deduction.” The Tax Court agreed and noted that the regulation was in accordance with the burden of establishing both the existence of the NOLs for prior years and the NOL amounts that may properly be carried forward to the tax year at issue. The Tax Court determined that the petitioners failed to satisfy this burden because they provided no detailed information supporting the NOL – both the NOLs for the prior years and the amounts that can be carried forward. The only “proof” the petitioners had was submitted copies of tax returns on which they reported the losses. The Tax Court declined to hold that submitted copies of returns was sufficient substantiation. Gebman v. Comr., T.C. Memo. 2020-1.

Posted August 30, 2020

IRS Can’t Re-Audit NOL Carryforward Stemming From Same Issue of Prior Audit. The taxpayer, a hedge fund operator and former investment banker, bought a vineyard that also included a house, guesthouse, a caretaker’s house, and olive grove. The IRS conducted an audit resulting in the issuance of a Notice of Proposed Adjustment (NOPA) disallowing all expenses and depreciation deductions related to the Vineyard for the prior tax years under audit. The IRS took the position that the vineyard was a hobby activity under I.R.C. §183 for those years. On further review, the IRS Appeals Office determined that the taxpayer’s vineyard activity was not a hobby for those tax years based on its conclusion that all of the nine-factors contained in Treas. Reg. §1.183-2(b) were in the taxpayer’s favor and, as a result, the deductions and expenses claimed in those years were allowable which resulted in a net operating loss (NOL). The IRS again audited the taxpayer in a later year on the hobby activity issue and whether the taxpayer could deduct an NOL carryforward originating from the tax years that had previously been audited and for which IRS Appeals had determined that the vineyard activity was not a hobby and that the NOL was, therefore, proper. The taxpayer asserted that the second audit stemmed from previously audited tax years in violation of I.R.C. §7605(b) as a repetitive audit. The IRS sought guidance from the IRS Chief Counsel’s Office (CCO). The CCO noted that I.R.C. §7605 bars the IRS from conducting more than a single inspection of a taxpayer’s books of account for a tax year to prevent an “unnecessary” examination or “unnecessary annoyance.” While existing caselaw does not prevent the IRS from auditing a later year based on a taxpayer’s transactions that originated from records that had been part of a prior audit, the CCO concluded the taxpayer’s situation was different. Here, the CCO noted, the taxpayer had been previously examined and prevailed at the IRS Appeals Office level. The losses allowed in the prior years under examination were properly carried forward, and IRS was disallowing the NOL carryforward for the same reason that the IRS Appeals Office had previously considered. The CCO that this amounted to a “second examination” or “repetitive audit” that I.R.C. §7605 barred. Had the NOL carryforward been disallowed for a different reason, the CCO noted, a second examination would not have been involved. CCM 20202501F (May 7, 2020).

Kentucky Beginning Farmer Credit Guidance. The Kentucky Cabinet for Economic Development has issued a revised fact sheet explaining the beginning farmer credit (known as the “selling farmer tax credit”). The credit’s purpose is to incentivize the continued use of agricultural land in the state for farming purposes by granting a tax credit to a selling farmer who agrees to sell agricultural assets to a “beginning farmer.” The credit may be claimed against personal income tax, corporate tax, and the limited liability entity tax. The credit is non-refundable, but any unused amount may be carried forward up to five years. Selling farmers wishing to sell agricultural land and assets may be eligible for a tax credit up to 5 percent of the purchase price of qualifying agricultural assets, subject to a $25,000 calendar year cap and a $100,000 lifetime cap. Kentucky Selling Farmer Tax Credit Guidelines, Jun. 1, 2020.

Kentucky Beginning Farmer Credit Guidance. The Kentucky Cabinet for Economic Development has issued a revised fact sheet explaining the beginning farmer credit (known as the “selling farmer tax credit”). The credit’s purpose is to incentivize the continued use of agricultural land in the state for farming purposes by granting a tax credit to a selling farmer who agrees to sell agricultural assets to a “beginning farmer.” The credit may be claimed against personal income tax, corporate tax, and the limited liability entity tax. The credit is non-refundable, but any unused amount may be carried forward up to five years. Selling farmers wishing to sell agricultural land and assets may be eligible for a tax credit up to 5 percent of the purchase price of qualifying agricultural assets, subject to a $25,000 calendar year cap and a $100,000 lifetime cap. Kentucky Selling Farmer Tax Credit Guidelines, Jun. 1, 2020.

Losses Don’t Offset Income Due to Lack of Basis and Material Participation. The petitioner, a CPA with numerous business interests, sustained losses in various pass-through entities that he attempted to use to offset income on his personal return. The IRS disallowed the offset due to lack of basis. While basis can be derived from any equity investment and petitioner’s loans to the business, the Tax Court noted that one of the loans had not been fully executed and there was no evidence that a loan made nearly eight years earlier remained outstanding. The Tax Court also determined that the petitioner failed to prove that he was materially participating in the business ventures. Sellers v. Comr., T.C. Memo. 2020-84.

No Deduction for Donated Permanent Conservation Easement. The petitioner donated a permanent conservation easement to a qualified charity. The IRS denied the charitable deduction because the deed conveying the easement contained language reducing the donee’s share of the proceeds of sale in the event of a judicial extinguishment by reducing the fair market value of the unencumbered property at the time of sale by an increase in value attributable to any post-easement improvements before applying proportionate distribution percentages. The Tax Court agreed, holding that the deed language violated Treas. Reg. §1.170A-14(g)(6). The Tax Court upheld the regulation as being in line with the overarching goal of guaranteeing that, upon judicial extinguishment, the donee would receive the full share of proceeds to which it was entitled. The Tax Court also determined that the proportionate value provision of the regulation was not ambiguous. Lumpkin HC, LLC, et al. v. Comr., T.C. Memo. 2020-95.

Numerous Substantiation Mistakes Blow Charitable Contribution Deduction. The petitioner mined sand and gravel deposits on its property. It’s mining process allowed construction of water storage reservoirs. The petitioner contributed to a state subdivision an undivided interest in 20 percent of the water storage easement it held on the property entitling the grantee to use the space in, over, across, on and under the property for water storage. The petitioner filed a partnership tax return for the year of the conveyance and attached Form 8283. However, page 1 of the 8283 was not included and the second page referred to an “attached appraisal.” Form 8283 reported the “donor’s cost of adjusted basis” was “None” and that $200,000 was the appraised fair market value of the charitable contribution. Attached to the Form 8283 was a letter signed by a person who was not a licensed real estate appraiser. The Tax Court determined that the plaintiff had failed to substantiate the charitable contribution deduction due to a lack of a qualified appraisal in accordance with Treas. Reg. §1.170A-13(c)(3)(ii) and lack of strict compliance with the requirements to file a complete Form 8283. Brannan Sand & Gravel Co., LLC v. Comr., T.C. Memo. 2020-76.

More Problems with Donated Permanent Conservation Easements. I.R.C. §170(h)(5)(A) requires that an easement donated to a qualified organization to be “protected in perpetuity.” Treas. Reg. §1.170A-14(g)(6) requires that the easement grant must, upon extinguishment, result in the charity receiving a proportionate part of the proceeds when the property subject to the easement is sold. In Belair Woods, however, the deed language did not provide the charity with a proportionate part of the gross sales proceeds. Instead, it specified that the charity would receive the extinguishment proceeds reduced by any increase in value related to improvements that the donor had placed on the property. The deed language also required a reduction in the proceeds going to the charity by an amount paid to satisfy any and all prior claims regardless of whether a claim arose from the donor’s conduct. The Tax Court strictly construed the regulation and denied a charitable deduction for the donation because the grantee was not in all cases absolutely entitled to a proportionate share of the proceeds upon extinguishment sale of the property. As such, the contribution was not protected in perpetuity. The Tax Court noted that the improvements were part of the donation rather than the donation being restricted just to the underlying land. The rights to construct improvements were restricted in meaningful ways by the easement, and also enhanced the property’s value. The petitioner also claimed that the IRS had accepted deed terms comparable to the petitioner’s deed via a stipulation in a case involving a different petitioner and, as such, should be estopped from disallowing the petitioner’s deduction. The Tax Court determined that the petitioner had failed to satisfy its burden in establishing that judicial estoppel should apply because the IRS position in the other case was merely a tactical stipulation and the case was settled. In Cottonwood Place, LLC, the petitioner donated a conservation easement on land to a land trust (qualified charity), reserving the right to construct limited improvements in the area subject to the easement. The Tax Court determined that no charitable deduction was allowed because the deed language didn’t entitle the charity to a proportionate share of any easement extinguishment proceeds if a court were to extinguish the easement and order the property sold. Thus, the language violated Treas. Reg. §1.170A-14(g)(6). The Tax Court noted that the deed language specified that the charity’s share of such proceeds would be reduced by the value of improvements added to the property after the easement donation. The Tax Court rejected the petitioner’s substantial compliance argument. Belair Woods, LLC v. Comr., T.C. Memo. 2020-112; Cottonwood Place, LLC, et al. v. Comr., T.C. Memo. 2020-115.

Lack of Proof for Ag Sales Tax Exemption. For purchase of farm equipment in Arkansas to be exempt from state sales tax, the buyer provides a “Farm Exemption Certificate” to the seller so that the seller knows whether the sale of an item is exempt from sales tax because the buyer was engaged in farming and the item purchased would be used directly and exclusively in farming. Here, the question was whether livestock shade systems and mower covers qualified for the exemption. Based on the facts presented, it was determined that the taxpayer (seller) did not provide sufficient facts concerning any specific sale or transaction for a determination of exemption to be made. However, the seller could rely on the buyer’s Certificate and could accept a certification or other information from the buyer to establish that the sale was exempt. Alternatively, the taxpayer could accept a certification or other information that the buyer provided to establish that the sale was exempt. Such, other information could include the buyer certifying in writing on a copy of the invoice or sales ticket that the taxpayer would retain stating that the buyer was a farmer and that the items would be used exclusively and directly in farming as a business. Arkansas Dept. of Rev. Legal Counsel Op. No. 20200527 (Jul. 21, 2020).

Posted July 24, 2020

Short Sale of Real Estate Generated Capital Loss. The petitioner owned a historic waterfront mansion and was in the process of restoring it with plans to rent it. The restoration turned out to be more costly and take longer than originally anticipated. The petitioner never actually rented the property even though a listing agent did talk to prospective renters that expressed interest in renting it. Ultimately the petitioner abandoned attempts to rent the property due to economic issues, and entered into a short-sale of the property for $6.5 million. On the petitioner’s 2009 return, the seven-figure loss on sale was reported as a capital loss, which limited the ability to offset income other than capital gains to $3,000 per year. Later, the petitioner met with an estate planner that questioned the tax treatment of the loss on the 2009 return. As a result, the petitioner hired another tax preparer to file an amended 2009 return to treat the sale as the sale of an I.R.C. §1231 asset. The result was that the loss was ordinary in nature, which also triggered a large net operating loss that the petitioner carried back to 2004 and forward to 2010. The IRS issued a refund, but later examined the 2009 return and determined that the loss was not an I.R.C. §1231 loss, but instead involved the sale of a capital asset generating a capital loss. The Tax Court agreed with the IRS, noting that for property to be treated as property that is used in a taxpayer’s trade or business, the taxpayer must be engaged in the activity on a basis that is, “continuous, regular, and substantial” in relation to the management of the property as part of the rental activity. The Tax Court noted that there was never any rental activity that was engaged in in any meaningful or substantial way. Thus, the IRS was correct to disallow the NOL carryover and carryback. The Tax Court also sustained the imposition of an accuracy-related penalty for the petitioner’s failure to rely on the advice of a professional. The Tax Court noted that the petitioner knew that a rental activity had never been engaged in. On appeal, the appellate court affirmed, noting that the petitioners did not engage in “regular and continuous” rental activities because they didn’t ever engage in a rental activity in a meaningful or substantial manner. They didn’t advertise the mansion online, they didn’t sign a tenant to a lease, they didn’t furnish the property for rent after occupancy was ready or receive any rental payments or security deposits. They made mere limited attempts to rent the property while making continuous attempts to sell it. In addition, the appellate court noted that the petitioner pursued a tax credit that was not contingent on renting the property while being aware of the availability of a credit if they rented the property. Keefe v. Comr., Nos. 18-2357-ag, 18-2594-ag, 2020 U.S. App. LEXIS 22241 (2d Cir. Jul. 17, 2020), aff’g., T.C. Memo. 2018-28.

No Exclusion for Principal Residence Debt; Trade or Business Not Established. The petitioners, a married couple, claimed deductions for the wife’s alleged consulting business. She was a marketing executive and her husband was an investment advisor. She claimed that she engaged in a consulting business that gave rise to numerous business deductions. Also, as part of her marketing job, the wife was required to move to where the company was located. The company agreed to provide her an interest free loan to help finance the purchase of a nearby home and provide her with six months of temporary housing in a furnished executive apartment and reimburse some travel and moving expenses. Ultimately, the petitioners bought a home in the area of the company. $385,993 of the company’s loan traced to being used to acquire the residence. The wife soon lost her position with the company and she had to repay the company’s loan. Thus, the petitioner’s sold the home and hired an attorney to negotiate a settlement with the company. The company offered to cancel half of the loan amount in lieu of a cash severance payment. Ultimately, the parties settled for the company forgiving $220,000 of the loan and making a cash payment to the petitioners of $30,000. The petitioners signed a new promissory note for $280,000 to be paid from the proceeds of the sale of the home. The company forgave another $35,000 of the $280,000 loan and the house ultimately sold for $1,665,000. $200,000 of the loan was paid off from the sale proceeds with the balance to be paid in two equal installments. The petitioners defaulted on the first installment and the parties ultimately reached a settlement whereby the company would forgive another $30,000 and the petitioners would pay $15,000. The petitioners reported $255,000 as excludible cancelled debt income under the provision for the discharge of qualified principal residence debt under I.R.C. §108(h)(2). The IRS disallowed the exclusion and also denied the allegedly business-related deductions. On the exclusion for qualified principal residence debt issue, the Tax Court determined that the initial loan used for acquiring the residence was not secured by the residence but was unsecured debt. As such it was not “acquisition indebtedness” in accordance with I.R.C. §163(h)(3)(B)(i). Thus, the initial $220,000 forgiven did not qualify for exclusion as qualified principal residence debt. Also, the subsequent $280,000 loan, while it was recorded to secure a lien against the house, was not used to acquire, construct, of substantially improve the home. Accordingly, it also failed to constitute excludible qualified principal residence debt. The same result occurred for the $245,000 loan because its repayment was condition on the sale of the home. The debt being refinance was not qualified debt which meant that the refinancing also was not qualified principal residence debt in accordance with I.R.C. §163(h)(3)(B). The Tax Court also upheld the IRS position on non-deductibility of business expenses for lack of proof that the wife was actually engaged in the trade or business for purposes of I.R.C. §162. The Tax Court pointed out that she had either no gross receipts or merely nominal gross receipts from consulting for the years in issue while simultaneously working full time for another company. In any event, the Tax Court noted that she failed to substantiate any of the alleged expenses including automobile travel expenses, meals and entertainment, computer and phone expenses. She also had unreliable mileage logs and phone bill excerpts. Other documentation, the Tax Court concluded, did not sufficiently differentiate between personal and business expenses. Her claimed expenses also appeared to be related to her employment with the company she was working for and not the consulting business. Weiderman, et ux. v. Comr., T.C. Memo. 2020-109.

Posted July 6, 2020

IRS Can’t Re-Audit NOL Carryforward Stemming From Same Issue of Prior Audit. The taxpayer, a hedge fund operator and former investment banker, bought a vineyard that also included a house, guesthouse, a caretaker’s house, and olive grove. The IRS conducted an audit resulting in the issuance of a Notice of Proposed Adjustment (NOPA) disallowing all expenses and depreciation deductions related to the Vineyard for the prior tax years under audit. The IRS took the position that the vineyard was a hobby activity under I.R.C. §183 for those years. On further review, the IRS Appeals Office determined that the taxpayer’s vineyard activity was not a hobby for those tax years based on its conclusion that all of the nine-factors contained in Treas. Reg. §1.183-2(b) were in the taxpayer’s favor and, as a result, the deductions and expenses claimed in those years were allowable which resulted in a net operating loss (NOL). The IRS again audited the taxpayer in a later year on the hobby activity issue and whether the taxpayer could deduct an NOL carryforward originating from the tax years that had previously been audited and for which IRS Appeals had determined that the vineyard activity was not a hobby and that the NOL was, therefore, proper. The taxpayer asserted that the second audit stemmed from previously audited tax years in violation of I.R.C. §7605(b) as a repetitive audit. The IRS sought guidance from the IRS Chief Counsel’s Office (CCO). The CCO noted that I.R.C. §7605 bars the IRS from conducting more than a single inspection of a taxpayer’s books of account for a tax year to prevent an “unnecessary” examination or “unnecessary annoyance.” While existing caselaw does not prevent the IRS from auditing a later year based on a taxpayer’s transactions that originated from records that had been part of a prior audit, the CCO concluded the taxpayer’s situation was different. Here, the CCO noted, the taxpayer had been previously examined and prevailed at the IRS Appeals Office level. The losses allowed in the prior years under examination were properly carried forward, and IRS was disallowing the NOL carryforward for the same reason that the IRS Appeals Office had previously considered. The CCO determined that this amounted to a “second examination” or “repetitive audit” that I.R.C. §7605 barred. Had the NOL carryforward been disallowed for a different reason, the CCO noted, a second examination would not have been involved. CCM 20202501F (May 7, 2020).

Posted July 2, 2020

No Deductible Loss Triggered on Transfer to Trust. The petitioner was a real estate developer that owned three parcels of land via an S corporation. The real estate was encumbered by liabilities that exceeded the value of the parcels. The S corporation engaged in a series of transactions in late 2009 to transfer the parcels to three separate liquidating trusts for the benefit of the mortgage holders. Between 2010 and 2012, the trusts disposed of the parcels and the mortgage holders applied the proceeds of sale against the S corporation’s (and its wholly owned LLC) outstanding debt. The S corporation reported large losses in 2009 as a result of the transactions that flowed through to the petitioner’s return where it created a net operating loss (NOL). The petitioner carried the NOL back to 2006 and forward to 2012. The IRS disallowed the losses that the S corporation reported and that the petitioner claimed for the 2009 tax year. The IRS also adjusted the 2006 and 2012 NOL deductions, determining deficiencies for 2006 and 2012. The Tax Court determined that the grantor trust rules of I.R.C. §§671-679 applied because the S corporation and the LLC owned the corresponding liquidating trusts during the years in issue (which included years beyond 2009). Thus, the losses that the S corporation reported and the petitioner claimed for 2009 were not bona fide dispositions and were not evidenced by closed and completed transactions that were fixed by identifiable events that were actually sustained during that year. Thus, the deductions were properly disallowed pursuant to Treas. Reg. §1.165-1(b). Sage v. Comr., 154 T.C. 121 (2020).

Losses Were Passive With Limited Deductibility. The petitioner was a CPA/tax consultant that also operated a retail boat business via passthrough entities. The boat activity sustained losses and the petitioner deducted the losses. The IRS limited the losses under I.R.C. §469 and the Tax Court agreed. The petitioner failed to establish that he materially participated sufficiently to overcome the passive loss rules. His testimony was inconsistent, and he produced no phone or inventory records or sales invoices. While partial calendars were provided, they simply corroborated his trip dates and didn’t establish the hours he spent performing activities. In addition, the hours allocated to certain activities were pre-determined and not later adjusted to reflect the actual time spent on the activity. While he claimed the hours were for attendance at boat conferences, the petitioner did not provide any credit card records, plane tickets, hotel reservations, conference brochures, etc. which would have provided a timeframe for the conferences. The petitioner also failed to establish his bases in the passthrough entities and failed to substantiate deductions attributable to self-employed health insurance. The Tax Court upheld the imposition of accuracy-related penalties under I.R.C. §6662(a). Sellers v. Comr., T.C. Memo. 2020-84.

No State Sale Tax Exemption for ATV. The petitioner bought an all-terrain vehicle (ATV) for use on his farm where he operated a dairy and raised broiler chickens. He had recently switched farming activities to beef cattle and hay production. The petitioner claimed that the purchase of the ATV was exempt from sales tax due to its use for farming. The state revenue department denied the exemption. The petitioner (and spouse) had not filed taxes since 2011, thus there was no Schedule F to show farm income and loss. In addition, the petitioner provided no evidence of how the ATV was used. State law (Ark. Code §26-52-105(b)) required machinery and equipment to be used exclusively and directly in the business of farming to qualify for sales tax exemption. Arkansas Admin. Hearing Dec. No. 20-658 (Ark. Dept. of Finance, Jun. 22, 2020).

“Gifted” Funds Were Not Gifts and Includible in Income. The petitioner was the CEO of a business that bought and sold structured settlement payments and lottery winnings. The company would buy structured payments from lottery winners and resell the payments to investors. The petitioner had historically worked in the discounted cashflow industry and, as a result, met a Mr. Haring, a wealthy British citizen, sometime in the 1990s. Their business relationship lasted until 2007. From 2005-2007, the petitioner received wire transfers from Mr. Haring totaling $24,775,000. A lawyer “advised” the petitioner that the transfers were gifts that the petitioner didn’t have to report as taxable income. The attorney’s legal “analysis” which led him to this conclusion was a conversation he had with the petitioner and a note that he drafted for Mr. Haring stating that the transfers were gifts. The attorney also advised the petitioner of the requirements to file Form 3520 every year that he received a transfer from Mr. Haring to report the gifts from a foreign person. A CPA prepared the Form 3520 for the necessary years. The petitioner never reported any of the transfers from Mr. Haring as taxable income. The petitioner was audited for tax years 2005-2007. The IRS took the position that the transfers were not gifts, should have been reported as taxable income, and assessed accuracy-related penalties on top of the tax deficiency. The Tax Court agreed that the transfers should have been included in the petitioner’s taxable income. They were not gifts. The Tax Court noted that Mr. Haring’s intention was the most critical factor in determining the status of the transfers. The petitioner bore the burden to establish Mr. Haring’s intent by a preponderance of the evidence. However, Mr. Haring never appeared at trial and didn’t provide testimony. Instead, the petitioner tried to establish the gift nature of the transfers by his own testimony. The petitioner claimed that Mr. Haring told him during the call that Mr. Haring had a “surprise” for the petitioner. The petitioner later met with Mr. Haring’s associate and they set up the ability to receive wire transfers from Mr. Haring into the petitioner’s bank account. That’s when the attorney drafted a note to the petitioner from Mr. Haring stating that the transfers would be gifts. The Tax Court didn’t buy the petitioner’s story, finding that neither the petitioner nor the attorney were credible witnesses. The Tax Court stated that the petitioner’s testimony was self-serving and that the attorney’s testimony was “simply not credible.” There was no supporting documentary evidence. In addition, the attorney represented both Mr. Haring and the petitioner. The Tax Court also noted that the attorney was “evasive in his answers and in his selective invocation of the attorney-client privilege with regard to the legal advice provided to Mr. Haring about the transfers.” The Tax Court also doubted the authenticity and credibility of the 2005 note allegedly from Mr. Haring but drafted by the attorney regarding his desire to gift funds to the petitioner. Thus, the note carried little weight in determining whether the transfers were gifts. The Tax Court also determined that the petitioner failed to prove that the transfers were made with disinterested generosity. The record was simply devoid of any credible evidence to prove that Mr. Haring transferred the funds to the petitioner with detached and disinterested generosity. The Tax Court noted that timing of some of the transfers with liquidity events of the petitioner’s business of which Mr. Haring was an investor. That raised a question as to whether Mr. Haring was acting as the petitioner’s nominee. The Tax Court determined that the petitioner need not pay the 20 percent accuracy-related penalty because the IRS failed to satisfy its burden of production under I.R.C. §6751(b). Kroner v. Comr., T.C. Memo. 2020-73.

S.E. Health Insurance Deduction Allows For Partial PATC. The petitioners, a married couple, received an advance premium assistance tax credit under I.R.C. §36B to help offset the higher cost of health insurance acquired through the Health Insurance Marketplace as a result of Obamacare. The advance credit was received for a tax year during which the wife worked as a housekeeper and the husband worked as a driver for a transport company. The husband also operated his own tax return preparation business. The IRS determined that the entire advanced credit had to be paid back based on the petitioners’ actual income for the year as reported on the tax return. However, the Tax Court held that the repayment amount was capped under I.R.C. §36B(f)(2) when taking into account the partial self-employment health insurance deduction that lowered the petitioners’ “household income” to just under 400 percent of the federal poverty line. Thus, the petitioners were eligible for some advance credit amount under I.R.C. §36B(b)(2) rather than being completely ineligible. Abrego, et ux. v. Comr., T.C. Memo. 2020-87.

Charitable Deduction Denied For Donated Conservation Easement. The petitioner entity owned two parcels of rural land and donated two open-space conservation easements on the parcels to a land trust. The deeds were recorded the next day, and included language expressing an intent to ensure that the land “be retained forever in its current natural, scenic, forested and open land condition” and language preventing any use of the conserved area inconsistent with the conservation purpose. The petitioner claimed a $25.5 million charitable deduction for the donation. Eight days before the donation, an investor acquired nearly 99 percent ownership in the petitioner for less than $6 million. The Tax Court determined that the deed language was similar to those deemed invalid in Coal Property Holdings LLC v. Comr., 153 T.C. 126 (2019) because the grantee wouldn’t receive a proportionate amount of the full sale proceeds. The Tax Court also upheld a 40 percent penalty under I.R.C. §6662(e) and I.R.C. §6662(h) for a gross misstatement of the value of the contribution. The Tax Court noted that the petitioner valued both properties well above 200 percent with one parcel valued at 852 percent of its correct value at $10.9 million and the other easement was valued at $14.5 million, or 1,031 percent of its proper value. Plateau Holdings LLC, et al. v. Comr., T.C. Memo. 2020-93.

Conservation Easement Not Protected In Perpetuity. The petitioner owned farmland and deeded a conservation easement on a portion of the property to a qualified charity under I.R.C. §170(h)(3). The petitioner continued to own a large amount of agricultural land that was contiguous with the easement property, and he continued to live on the land and use it for cattle ranching. The petitioner claimed a charitable contribution deduction for the donation of $2,788,000 (the difference in the before and after easement value of the property) which was limited to $57,738 for the tax year 2012 – the year of donation. The petitioner claimed carryover deductions of $1,868,782 in 2013 and $861,480 in 2014. He could not determine his basis in the property and, upon the advice of a CPA firm, attached a statement to Form 8283 explaining his lack of basis information. The deed stated that its purpose was to preserve and protect the scenic enjoyment of the land and that the easement would maintain the amount and diversity of natural habitats, protect scenic views from the roads, and restrict the construction of buildings and other structures as well as native vegetation, changes to the habitat and the exploration of minerals, oil, gas or other materials. The petitioner reserved the right to locate five one-acre homesites with one dwelling on each homesite. The deed did not designate the locations of the homesites but required the petitioner to notify the charity of when the petitioner desired to designate a homesite. The charity could withhold building approval if it determined that the proposed location was inconsistent with or impaired the easement’s purposes. The deed provided for the allocation of proceeds from an involuntary extinguishment by valuing the easement at that time by multiplying the then fair market value of the property unencumbered by the easement (less any increase in value after the date of the grant attributable to improvements) by the ratio of the value of the easement at the time of the grant to the value of the property, without deduction for the value of the easement at the time of the grant. The deed also stated that the ratio of the value of the easement to the value of the property unencumbered by the easement was to remain constant. The charity drafted the deed and a CPA firm reviewed it and advised the petitioner that it complied with the applicable law and regulations such that he would be entitled to a substantial tax deduction. The IRS denied the carryover deductions for lack of substantiation and assessed a 40 percent penalty under I.R.C. §6662(h) for gross valuation misstatement and, alternatively, a 20 percent penalty for negligence or disregard of the regulations or substantial understatement of tax. The petitioner bought additional land that he held through pass-through entities that would then grant easements. The petitioner recognized gain of over $3.5 million on the sale of interests in the entities to investors who then claimed shares in the easement deductions. The IRS claimed that these entities overvalued the easements for purposes of the deductions. Individuals in the CPA firm invested in the entities and claimed easement deductions. The Tax Court determined that the deed language violated the perpetuity requirement of I.R.C. §170 because of the stipulation that the charity’s share of proceeds on extinguishment would be reduced by improvements made to the land after the easement grant. The Tax Court did not uphold the penalties. Hewitt v. Comr., T.C. Memo. 2020-89.

Premium Assistance Tax Credit Unimpacted by Suspended Personal Exemption. IRS proposed regulations clarify that the reduction of the personal exemption deduction to zero for tax years beginning after 2017 and before 2026 does not affect an individual taxpayer’s ability to claim the Premium Assistance Tax Credit (PATC), essentially adopting the guidance set forth in Notice 2018-84. The proposed regulations apply to tax years ending after the date the regulations are finalized as published in the Federal Register. Taxpayers can rely on the proposed regulations for tax years beginning after 2017 and before 2026 that end on or before the date the Treasury decision adopting the regulations as final regulations is published in the Federal Register. Prop. Treas. Reg. 124810-19.

Cash Rented Farmland Not Eligible for State Capital Gain Tax Break. The plaintiff’s father died in 1989 leaving her 93 acres of farmland and a three-acre homestead to her and her brother as tenants in common. The plaintiff and her brother used the homestead personally when visiting the farm. They cash rented the farmland to their father’s tenants. None of the family, including the predeceased father were farmers. The daughter lived six hours away from the farm and the brother lived three hours away. In 2006, the plaintiff and her brother sold the farmland to the tenants and reported the gain on sale as exempt from state level capital gain tax under Iowa Code §422.7(21) as a $93,036 deduction from gross income which includes all capital gains the taxpayer earned during the year. The state department of revenue (IDOR) denied the deduction on the basis that the plaintiff and her brother failed to materially participate in the farming activity associated with the farmland. The additional tax liability was $6,616, a penalty of $1,614.30 and interest of $296.75. The plaintiff paid the additional tax and filed a protest with IDOR. The plaintiff claimed that she and her brother were engaged in a farm rental activity in which they materially participated, rather than being passively involved in a farming rental activity via a cash lease. They claimed that their involvement concerned working with the tenants on issues, collecting rents, paying expenses and providing maintenance and care for the property. The plaintiff also claimed that she and her brother negotiated leases, maintained fences and cattle buildings, cleaned brush from fence lines, arranged tiling when needed, monitored farming practices and handled paperwork related to the farm. They estimated they spent approximately 130 hours annually. They also claimed that their participation the rental activity constituted substantially all of the participation from 1989 until 2006. However, the Administrative Law Judge (ALJ) viewed the evidence as lacking substantiation and vague. A tenant that lived one-quarter mile away testified of never seeing the plaintiff or her brother fixing fences or of any need to fix fences. He also testified that he never saw them clearing brush, but he did testify that they asked about finding someone to do tiling work and clear brush. The ALJ determined that the plaintiff and brother failed to satisfy the material participation standard regardless of which standard was utilized. The activity was not regular, continuous and substantial in terms of the nature and amount of proven activity. On appeal, the Director of IDOR affirmed. On judicial review, the trial court upheld the Director’s determination. On appeal, the state Supreme Court affirmed. The Supreme Court noted that the arrangement involved a typical cash-rent farm landlord, noting that the only change to the standard farm lease form from year to year was the per-acre rental rate. Under the lease, the tenant was responsible to keep the premises free from brush and burrs, thistles and all noxious weeds, and mowing and cutting trees near the surface of all weeds. Thus, as a cash lease, the plaintiff and her brother were not considered to be materially participating in the farming activity. They failed to show that they materially participated in the farming activity. While the governing statute did not distinguish between farm leases and other commercial leases, the Supreme Court held that the IDOR’s distinction was a valid interpretation. Christensen v. Iowa Department of Revenue, No. 19-0261, 2020 Iowa Sup. LEXIS 74 (Iowa Sup. Ct. Jun. 19, 2020).

Posted June 14, 2020

Passive Loss Real Estate Professional Test Not Satisfied. The petitioner and his wife claimed deductions for rental real estate losses. The IRS denied the deductions and the court agreed. The husband’s involvement was insufficient to meet the 750-hour test of I.R.C. §469(c)(7) and his wife didn’t qualify as a real estate professional either based on non-contemporaneous logs and the husband’s uncorroborated testimony. Larkin v. Comr., T.C. Memo. 2020-70.

Posted June 11, 2020

Conservation Easement Not Protected in Perpetuity. The petitioner donated a conservation easement to a qualified charity. The deed conveying the property contained a judicial extinguishment provision stating that the easement gave rise to a vested property right in the donee, the value of which "shall remain constant." The value of the donee's property right was defined as the difference between (a) the fair market value (FMV) of the conservation area as if unburdened by the easement and (b) the FMV of the conservation area as burdened by the easement, with both values being "determined as of the date of this Conservation Easement." The IRS took the position that the language failed to satisfy the "in perpetuity" requirement for such gifts. The petitioner pointed to the following deed language for support of the petitioner’s position that the perpetuity requirement was satisfied. That provision states that, "If any provision of this Conservation Easement is found to be ambiguous, an interpretation consistent with its purposes that would render the provision valid should be favored over any interpretation that would render it invalid." The Tax Court, however, held that the provision did not help the taxpayer because it was a cure only for ambiguous provisions and the deed was unambiguous in limiting the donee's vested property right. In addition, the Tax Court noted that a statement from the donee organization that the easement be in full compliance with the tax law was immaterial. Woodland Property Holdings, LLC v. Comr., T.C. Memo. 2020-55.

Posted June 10, 2020

Conservation Easement Deduction Allowed At Reduced Amount. The petitioner was the president of a west-central Colorado company that manufactures and sells disposable ink pans for printing presses. He purchased a ranch in 2002 for 200,000 and carved out a permanent conservation easement to Colorado Open Lands, a qualified charity. He made the donation in 2007. The easement encumbered 116.14 acres along with the water rights, leaving the remaining five acres unencumbered. The easement restricted the encumbered area from being subdivided, used as a feedlot, or used for commercial activities. It also restricted all construction within the encumbered area except for a five-acre area that was designated a “building envelope”. The deed limited constructed floor space inside the building envelope to 6,000 square feet for single residential improvements and a cumulative maximum of 30,000 square feet for all improvements. On his return for 2007, the petitioner claimed a $610,000 charitable contribution deduction for the donated easement, with carryover amounts deducted in future years. He also claimed certain farm-related expenses. The IRS denied the carryover charitable deductions in three carryover years on the basis that he had already deducted more than the easement’s value for previous tax years. The petitioner and the IRS agreed that the property’s highest and best use was for farming and a residence. The petitioner’s valuation expert used a quantitative approach by taking comparable sales adjusted by time between the time of those easement donations and when the petitioner donated his easement. The petitioner’s expert then adjusted for nearness of the encumbered property to town and size. He then factored in irrigation, topography and improvements to arrive at the value of the property before the easement. The expert did not have many post-donation comparable sales to work with in arriving at the value of the petitioner’s property after the easement donation. The valuation expert for the IRS used the qualitative approach. By comparing several characteristics for each comparable, including market conditions at the time of sale, location/access, size, aesthetic appeal, zoning, and available utilities, to evaluate the relative superiority, inferiority, or similarity of each comparable to the ranch. The expert then evaluated the overall comparability of each property to the ranch. The Tax Court preferred the approach of the petitioner’s expert, due to the IRS’s expert ignoring the quantitative factors. However, the Tax Court adjusted the value arrived at by the petitioner’s expert. Post-encumbrance nearby comparable sales were lacking, the Tax Court rejected both experts’ post-encumbrance direct comparable sales analyses. By ignoring an outlier from both of the experts, the parties were only two percent apart on value. The Tax Court split the difference between the parties and added it to the pre-easement value as adjusted to arrive at the easement’s value. Thus, the Tax Court allowed a $373,000 deduction for the easement. The Tax Court also disallowed various farming expense deductions including travel-related expenses due to the lack of substantiation. Johnson v. Comr., T.C. Memo. 2020-79.

Posted May 31, 2020

Tax Court Says Ophthalmologist Not Clearly Seeing Tax Code. The petitioner, an ophthalmologist, owned 100 percent of S corporation and was also a 99 percent partner in various partnerships. The partnerships had passthrough entities as one percent partners. The petitioner received income from one of the partnerships for refractive surgeries that he performed for another entity. The Tax Court determined that the petitioner’s income that flowed-through from the partnership was subject to self-employment tax because the petitioner could not establish that the he performed the refractive surgeries for a limited partnership as a limited partner. Joseph v. Comr., T.C. Memo. 2020-65.

Court Enjoins Discriminatory Tax Treatment by Kansas DOR. The defendant, Kansas Department of Revenue, assessed taxes on the personal and real property of the plaintiffs, various railroads for the 2020 assessment year at dramatically higher ratios than other industries – a minimum of 25 percent of true market value compared to other industries whose personal property was assessed no higher than 10 percent of true market value and no higher than 15.82 percent of true market value for real property. The plaintiffs claimed that such taxation constituted illegal discrimination of common carriers by rail in violation of the Railroad Revitalization and Regulatory Reform Act (49 U.S.C. §11501). The plaintiffs sought an injunction against the enforcement of the assessments. The court issued the injunction finding that the assessments amounted to discriminatory treatment of a common carrier under 49 U.S.C. §11501. The court ordered the defendant to assess the plaintiffs’ personal property (train cars, signals and fences) and real property (track material, tunnels and stations) within a range of 13.8 percent to 15.82 percent of true market value. The court’s order also blocked the defendant from assessing any delinquencies on any previously assessed taxes exceeding the reassessments. A non-evidentiary hearing is scheduled for June 29, 2020. BNSF Railway Company, et al. v. Burghart, No. 5:20-cv-04026-JWB-ADM (D. Kan. May 28, 2020).

Posted May 28, 2020

IRS Gives Annual Adjustment to Credit for Oil and Gas Production. In a recent Notice, the IRS published the applicable reference price under I.R.C. §45l for qualified natural gas production from qualified marginal wells for calendar year 2019. The figures are used to compute the credit that is allowed for sales of fuel produced from a nonconventional source. The applicable reference price for tax years beginning in calendar year 2019 is $2.55 per 1,000 cubic feet. The credit is $.08 per 1,000 cubic feet of qualified natural gas produced from marginal wells. IRS Notice 2020-34, 2020-21 IRB 838.

Posted May 27, 2020

Extinguishment Regulation Upheld. In 2008, the petitioner donated a permanent conservation easement to a qualified organization and claimed a charitable deduction. The easement deed specified that upon extinguishment of the conservation restriction the donee would receive a share of the proceeds equal to the fair market value of the easement as of the date of the contribution. That value, the deed specified, was to be reduced by the value of any improvements that the donor made after granting the easement. The IRS denied the charitable deduction because (inter alia) violated the extinguishment regulation of Treas. Reg. §1.170A-14(g)(6). The full Tax Court, agreeing with the IRS, upheld the validity of the regulation on the basis that the extinguishment regulation (Treas. Reg. §1.170A-14(g)(6)) had been properly promulgated and did not violate the Administrative Procedure Act. The full Tax Court also determined that the construction of I.R.C.§170(h)(5), as set forth in the extinguishment regulation, was valid under the agency deference standard set forth in Chevron, U.S.A. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984). In a related memorandum opinion, the Tax Court held that the easement deed did not create a perpetual easement because the donee’s share of the extinguishment proceeds was based on fixed historical value, reduced by the value of improvements that the donor made. It was not, as it should have been, based on a proportionate share of extinguishment proceeds that are at least equal to the total proceeds (unadjusted by the value of the petitioner’s improvements), multiplied by a fraction defined by the ratio of the fair market value of the easement to the fair market value of the unencumbered property determined as of the date of the execution of the deed. However, the Tax Court did not uphold penalties that the IRS imposed, finding that the petitioner’s position was reasonable. Oakbrook Land Holdings, LLC v. Comr., 154 T.C. No. 10 (2020); Oakbrook Land Holdings, LLC v. Comr., T.C. Memo. 2020-54.

Posted May 26, 2020

Real Estate Professional Test Not Satisfied. The petitioner claimed that he spent more than 750 hours materially participating in rental real estate activities, and that he spent more time on the rental activities than his other activities. As such, the petitioner deducted his losses from the rental activities as a real estate professional under I.R.C §469(c)(7). The IRS disallowed the losses under the passive loss rules for failure to establish the requisite hours. The Tax Court agreed with the IRS on the basis that the petitioner’s documentation failed to specify the work performed. The petitioner failed to satisfy the real estate professional test and the losses were disallowed under the passive loss rules. Hakkak v. Comr., T.C. Memo. 2020-46.

Charitable Deduction Allowed for Donated Conservation Easement. The petitioner claimed a $10.4 million charitable deduction related to the donation of a permanent conservation easement on a golf course. The IRS denied the deduction on the basis that the easement was not exclusively for conservation purposes because it didn’t protect a relatively natural habitat of fish, wildlife, or plants, or a similar ecosystem as required by I.R.C. §170(h)(4)(A)(ii). The IRS also asserted that the donation did not preserve open space for the scenic enjoyment of the general public or in accordance with a governmental conservation policy for the public’s benefit under I.R.C. §170(h)(4)(A)(iii). The Tax Court agreed with the IRS and denied the deduction. The Tax Court determined that the “natural habitat” requirement was not met – there was only one rare, endangered or threatened species with a habitat of only 7.5 percent of the easement area. In addition, the Tax Court noted that part of the golf course was designed to drain into this habitat area which would introduce chemicals into it. Thus, the easement’s preservation of open space was not for public enjoyment nor in accordance with a governmental policy of conservation. On further review, the appellate court reversed. The appellate court found that the deduction was proper if the donation was made for the protection of a relatively natural habitat of fish, wildlife, or plants, or similar ecosystem or was made for the preservation of open space for the scenic enjoyment of the general public. The appellate court noted that without the golf course, the easement would satisfy the requirements. An easement deduction is not denied simply because a golf course is included. The appellate court remanded the case for a determination of the proper amount of the deduction. Champions Retreat Golf Founders, LLC v. Comr., T.C. Memo. 2018-146, rev’d., No. 18-14817, 2020 U.S. App. LEXIS 15237 (11th Cir. May 13, 2020).

Posted May 23, 2020

HSA Inflation-Adjusted Amounts for 2021. Persons covered under a high deductible health plan (HDHP) that is not covered under any other plan that is not an HDHP, is eligible to make contribution to a health savings account (HSA) subject to certain limits. For calendar year 2021, an HDHP is a health plan with an annual deductible of at least $1,400 for individual coverage or $2,800 for family coverage, and maximum out-of-pocket expenses of $7,000 for individual coverage or $14,000 for family coverage. For 2021, the maximum annual contribution to an HSA is $3,600 for self-only coverage and $7,200 for family coverage. Rev. Proc. 2020-32, 2020-24 I.R.B.

Depreciable Deduction Significantly Reduced. The petitioners (a married couple) owned two rental properties, one of which was a condominium. The petitioners allocated one percent of the total property basis to the land, 75 percent to the five-year property and 24 percent to the residential property. The condominium was used on a transient basis and, as a result, the IRS concluded that the condominium was non-residential real property with a 39-year MACRS life. The IRS allocated 11 percent of the property basis to the land, 3.4 percent to the 5-year property and about 85 percent to the non-residential real property. As a result, the petitioners’ depreciation deduction dropped by about $420,000. The Tax Court upheld the IRS determination. In addition, the depreciation adjustment constituted an I.R.C. §481 adjustment. Pinkston v. Comr., T.C. Memo. 2020-44.

Some Schedule F Deductions Denied. The petitioner lived in California where he worked two full-time jobs making a total of approximately $200,000 annually. He bought approximately 60-acres of farmland in Mexico and hired employees to build a fence around the acreage. They also built a reservoir and barn and he purchased a tractor. He wired money to his brother in Mexico in weekly amounts ranging from $100 to $2,000. The employees conducted farming operations daily. For 2015 and 2016, the petitioner claimed itemized deductions for charitable contributions and reported unreimbursed employee expenses for his cell phone bills, buying tools and work clothing (including cleaning the work clothes). Petitioner’s 2015 Schedule F reported $27,024 for farming expenses. For 2016, petitioner’s Schedule F claimed $29,097 of farming expenses. The petitioner visited the farm once annually during his two-week vacation from his two jobs in the United States. The IRS did not question whether the farm was operated as a business. However, the court upheld the denial of Schedule F deductions for expenses other than those for the cost of cattle and supplies as well as for labor expense. The court also allowed a deduction for legal fees associated with the purchase of additional farmland incurred in 2015, but not those incurred in 2016 due to lack of substantiation. Depreciation deductions for both years were also disallowed for lack of substantiation. Some travel expenses were disallowed for failure to satisfy the strict substantiation rules of I.R.C. §274(d). The court disallowed the charitable deductions for failure to qualify as gifts to charity and for lack of substantiation. The court allowed 25 percent of petitioner’s cell phone bills to be deducted because the phone was used in-part for business purposes. Serrano v. Comr., T.C. Sum. Op. 2020-15.

Posted April 24, 2021

No Deduction for Conservation Easement Donation. The petitioner, a partnership, made a charitable donation to a qualified charity of a façade easement and airspace restrictions surrounding a historic building in Cleveland, Ohio and claimed a $15 million deduction. The Tax Court upheld the IRS denial of the deduction on the basis that it wasn’t made exclusively for conservation purposes in accordance with I.R.C. §170(h). The Tax Court noted that the donation was not a perpetual one as required because the donation agreement reserved in the petitioner the right to make various changes that could be harmful changes to the donated property whenever the done failed to act within 45 days of a proposed change. That 45-day window, the Tax Court determined was far short of perpetual and allowed the petitioner to use its retained interest in a way that was inconsistent with the conservation purpose of the donation. The petitioner’s argument that the retained rights were so remote as to be negligible was also rejected. On appeal, the appellate court affirmed. Hoffman Properties II, LP v. Comr., No. 19-1831, 2020 U.S. App. LEXIS 11730 (6th Cir. Apr. 14, 2020).

Posted April 21, 2020

Unsubstantiated Deductions and Basis Claims Doom Taxpayers. The petitioners, a married couple, owned and managed rental properties and claimed various deductions associated with the properties for irrigation supplies, plumbing services, gardening and landscaping materials and pest extermination. The Tax Court determined that many of the expenses were not substantiated or were double-counted and, thus, nondeductible. Other expenses were for capital expenditures or for personal purposes and likewise nondeductible. The wife had also purchased a separate property in which the couple lived. A contractor damaged the house and the petitioners claimed a theft loss deduction for a nonrecoverable default judgment. The IRS denied the deduction and the Tax Court upheld the denial because the petitioners failed to show that they lacked a reasonable prospect of recovery and lack of proof that sellers and realtor knowingly failed to disclose known defects. In addition, amount claimed as loss was partly product of “eccentric math” and not supportable. The Tax Court also upheld the denial of depreciation deductions due to unsupportable income tax basis figures concerning the value of repairs and improvements to the rental properties and other testimony that lacked credibility. Accuracy-related negligence or substantial understatement penalties were upheld. Littlejohn, et ux. v. Comr., T.C. Memo. 2020-42.

Posted April 7, 2020

Alimony Payments Not Deductible. The petitioner and his wife were married for 14 years and had four children together before divorcing in 2010. The divorce decree included provisions for “child support” and “alimony.” The decree ordered the petitioner to pay monthly child support of %1,795.63 per month until each child reached age 18, died, married, entered military school or became self-sufficient. The decree also ordered the petitioner to pay “permanent periodic alimony” of $1,592.50 for at least five years until either the youngest child reached age 18, the ex-wife or petitioner died, the ex-wife remarried at the five-year point or later, or the wife became self-supporting. The decree also specified that if the husband received a pay raise that half of the net increase would increase the alimony payment. The decree was later modified to reduce the monthly child support amount because the petitioner took custody of an additional child. No change was made to the alimony payment. On petitioner’s 2015 return, he claimed a $28,000 alimony deduction. The IRS disallowed the deduction as nondeductible child support because on one of the contingencies terminating payment was petitioner’s youngest child turning 18. The Tax Court upheld the IRS position. The Tax Court noted that under I.R.C. §71(c)(2)(A), the payments would count as child support until the child turned 18. Here, the decree clearly stated that the designated alimony payments would terminate on the contingency that the petitioner’s youngest child turn 18. That was a contingency relating to a child that qualifies a payment as nondeductible child support. This is the result, the court noted, even though the decree designated separate amounts for child support and alimony. The parties’ intent also was immaterial. Biddle v. Comr., T.C. Memo. 2020-39.

Posted April 3, 2020

IRS Can’t Change Code Via Administrative Notice. The petitioner received a Form W-2 reporting a difficulty of care payment under I.R.C. §131(c). However, such payments are excluded from income as a type of qualified foster care payment if made under a state’s foster care program. In Tech. Adv. Memo. 2010-007, the IRS took the position that the payment of a difficulty care payment to the parent of a disabled child to the parent was not excludible because the “ordinary meaning” of foster care excluded care by a biological payment. But, in Notice 2014-7, the IRS treated the payment as nontaxable to the recipient. The petitioner did not include the payment in income, but did include the amount as earned income in computing the earned income credit under I.R.C. §32 and in computing the refundable child tax credit under I.R.C. §24. The IRS position was that since the amount was not taxable under Notice 2014-7, the amount did not count as earned income for computing the credits. I.R.C. §32(c)(2)(A)(i) states that earned income includes wages, salaries, tips and other employee compensation that has been included in gross income for the tax year. The petitioner claimed that nothing in I.R.C. §131 allowed the IRS to treat the payment as not includible in gross income. The court agreed, with the result that the petitioner could exclude the difficulty of care payment and obtain credits on that (untaxed) earned income. Feigh v. Comr., 152 T.C. No. 15 (2019). The IRS later acquiesced in result only to the Tax Court’s decision. A.O.D. 2020-20, 2020-14 IRB 558.

Posted March 24, 2020

Co-Owned Property Subject to Forced Sale. The IRS received a default judgment against the defendant for unpaid employment taxes. The defendant did not pay the judgment and the IRS recorded a lien for the unpaid tax. The IRS then sought to foreclose the lien and sell the property to which the lien attached. The defendant’s sister intervened in the case. She owned an undivided one-half interest in the property with the defendant as a tenant in common by virtue of their father’s intestate death. The court determined that the IRS lien attached only to the defendant’s undivided one-half interest. In determining whether the lien should be foreclosed and the property sold, the court determined that property should be sold because any attempt to sell only the defendant’s undivided one-half interest would result in a lower price and prejudice the ability of the IRS to collect the tax debt. In addition, the court determined that the sister did not have an expectation that the property wouldn’t be subject to a forced sale because either the defendant or her could force a sale of the property. The court also noted that the sister didn’t live on the property and wouldn’t be forcibly relocated by a sale. In addition, the court noted that the sister would be adequately compensated by receiving one-half of the proceeds of sale. The court based its analysis of the appropriateness of the sale on the factors set forth in United States v. Rodgers, 461 U.S. 677 (1983). United States v. Dase, No. 4:18-cv-00501-ACA, 2020 U.S. Dist. LEXIS 33534 (N.D. Ala. Feb. 27, 2020).

Posted March 22, 2020

Regulations on Charitable Deduction for State Credit Swap. The IRS published final regulations governing the availability of a charitable contribution deduction when a taxpayer receives or expects to receive a corresponding state or local tax credit for the charitable contribution reversing the prior determination of the IRS in CCA 201105010 (Oct. 27, 2010). The final regulations retain the quid pro quo rule: a charitable contribution to an entity in expectation of a credit for state or local taxes results in a reduction of the charitable contribution for federal income tax purposes by the amount of the benefit of the state or local tax credit. The regulations take the position that something of value has been received in exchange for the charitable donation and, thus, the donation must be reduced by the value received. The final regulations treat a deduction differently for this purpose than a credit. If the contribution only results in a deduction in determining the taxable income for state or local income taxes, a reduction in the charitable contribution is not required (unless the state tax deduction exceeds the amount the taxpayer donates). The final regulations also allow a de minimis exception to the reduction of the charitable donation by the state or local tax credit benefit. The credit can be ignored if the state or local tax credit is 15 percent or less of the amount donated. This exception is permitted as an equivalency to the provision specifying a deduction for the contribution on the state or local tax return does not reduce the charitable contribution. Along with the Final regulations, the IRS issued Notice 2019-12 which allows the disallowed charitable deduction to be deducted as a state or local tax deduction to the extent that it is applied on the taxpayer's state or local income tax return against a tax liability. The credit treated as an income tax expense is subject to the $10,000 state and local tax deduction limitation contained in I.R.C. §164(b)(6). The rules also apply to payments made by a trust or a decedent's estate. T.D. 9864, amending Treas. Reg. §§1.170A-1, 1.170A-13, and 1.642(c)-3).

No Mortgage Interest Deduction On Short Sale of Residence. The taxpayers, a married couple, filed Chapter 7 in 2010 and were discharged of their mortgage debt on their personal residence when it was sold in a short sale in 2011. The mortgage was nonrecourse and the taxpayers were not personally liable for the outstanding mortgage of $744,993. The mortgage holder, Citibank, received $522,015 from the short sale. Unpaid interest associated with the mortgage amounted to $114,688. Citibank allocated a portion of the short-sale proceeds against the outstanding interest amount and, in turn, issued a 2011 Form 1098, Mortgage Interest Statement, to the taxpayer, showing mortgage interest paid of $114,688. The taxpayers reported and deducted the mortgage interest on Schedule A of their 2011 Form 1040. The taxpayers claimed that because a Form 1098 was issued by Citibank, they were entitled to the mortgage interest deduction. The court disagreed finding no case law supporting the notion that the IRS was "bound by a third party's Form 1098." The court ruled that since the outstanding mortgage debt exceeded the FMV of the property, no interest deduction is allowed due to the lack of "economic substance” and, as a result, there was no bona fide debt obligation. Milkovich v. United States, No. 2:18-cv-01658-BJR, 2019 U.S. Dist. LEXIS 83720 (W.D. Wash. May 17, 2019).

Cancelled Debt Not Part of Partner’s Basis Calculation. The IRS has determined that deferred cancellation-of-debt (COD) income under I.R.C. §108(i) is not included in calculating a transferee partner's share of adjusted basis to the partnership of partnership property for purposes of Treas. Reg. §1.743-1(d)(1) because that amount is not "tax gain" within the meaning of Treas. Reg. Sec. 1.743-1(d)(1)(iii). The IRS reasoned that this income is not taxable gain that would arise upon the disposition of partnership assets within the meaning of Treas. Reg. §1.743-1(d)(1)(iii) because it does not arise as a result of a disposition of partnership assets or property at fair market value (FMV) for cash. The hypothetical transaction described in Treas. Reg. §1.743-1(d)(2) is only concerned with determining the amount of partnership tax gain or loss that would result from the disposition of partnership assets at FMV for cash, for purposes of determining an inside basis adjustment to partnership property. Deferred COD income is not and does not relate to partnership assets or property for purposes of the hypothetical transaction described in Treas. Reg. §1.743-1(d)(2) but is simply an item of deferred income that does not have or attract basis, is not transferrable or marketable, and has no FMV. Tech. Adv. Memo. 201929019 (Apr. 30, 2019).

Tax Court Petition Not Timely Mailed. The petitioners, a married couple, attempted to file their Tax Court petitioner on the last possible day for it to be timely, March 5, 2018. The petitioner’s wife stamped an envelope with private postage on March 5, gave it to the petitioner later the same day who took it to a USPS office and dropped it there into a mailbox. The last pickup that day at that office was 5:00 p.m. The petitioner arrived at the Tax Court several days later bearing two postmarks – a private post mark dated March 5 and a USPS postmark dated March 6. While a private postmark is acceptable if it is legible and the package is received in the same amount of time had it been postmarked by USPS from the same origin point, the IRS pointed out that when a package bears both a private and USPS postmark, the USPS postmark takes precedence. Treas. Reg. §301.7502-1(c)(1)(iii)(B)(3). The taxpayer bears the risk that the USPS will postmark the document in a timely manner. Treas. Reg. §301-7502-1(c)(1)(iii)(A). The Tax Court agreed with the IRS that the petition had not been timely mailed and lack jurisdiction to hear the case. Thomas v. Comr., T.C. Memo. 2020-33.

Taxpayer “At Risk” On Loans. The taxpayer guaranteed the debt of an LLC and the IRS took the position that the taxpayer was not “at-risk” on the debt and, thus, could not deduct associated losses. The IRS claimed that, under state law, an LLC member is not personally liable for LLC debts. The Tax Court disagreed with the IRS position, finding that the taxpayer had become liable for the debt because he had executed a personal guarantee for the debt; was personally liable for the loan; and there was no right of contribution or reimbursement from any other LLC member. In addition, the Tax Court noted, there wasn’t any loss protection on the amount guaranteed. Thus, the petitioner was liable on the loans and was at risk to the extent of money and basis of other property he contributed to the LLC plus the loan amount. Bordelon v. Comr., T.C. Memo. 2020-26.

Posted March 16, 2020

Farmer Market Tax Exemption Approved. Legislation in Virginia has been signed into law that provides a state-level exemption from county food and beverage tax and city and town meals tax for sales by sellers at local farmers markets or roadside stands when the sellers’ annual income for the sales does not exceed $2,500. The sellers’ annual income includes income from sales at all local farmers markets and roadside stands, not just those sales occurring in the locality imposing the tax. H342, effective Jul. 1, 2020.

Club Not Tax Exempt. The IRS denied tax exempt status under I.R.C. §501(c)(7) for a game and fishing organization because it received more than incidental income from nonmembers. Nonmember-sourced income amounted to approximately three-fourths of total income for the organization. The IRS determined that the organization also operated the club as a business which rendered it ineligible for tax exemption. Priv. Ltr. Rul. 202011007 (Oct. 2, 2019).

Posted March 12, 2020

Early Withdrawal Penalty Constitutional. The petitioner had not yet reached age 59-1/2 at the time the petitioner received a distribution from a qualified retirement plan. Consequently, the IRS assessed the 10 percent early withdrawal penalty of I.R.C. §72(t). The petitioner sought review of the asserted tax deficiency and challenged the additional tax on the basis that the application of the tax to her early distribution violated the Constitution’s Fifth Amendment Due Process Clause because exceptions exist to the penalty that are applicable to taxpayers that haven’t reached age 59-1/2, such as for disability, etc. The Tax Court disagreed based on an application of the rational basis test (low-level scrutiny). The Tax Court determined that test applied because the provision did not invade a substantive constitutional right or freedom, or involve a suspect classification. As a result, the constitutionality of the provision could only be overcome by an explicit demonstration that the statute established hostile and oppressive discrimination against particular persons and classes. The Tax Court, noted that the petitioner did not claim that the penalty provision concerned a substantive constitutional right or freedom or involved a suspect classification. Age is not a suspect classification for purposes of equal protection. Thus, the provision was presumed constitutional if it had a legitimate governmental purpose. The Tax Court noted that Committee Reports concerning the provision provided that the statute aimed “to provide means for financing retirement” and that penalties for early withdrawals were “designed to insure that retirement plans will not be used for other purposes.” An exemption from the penalty for disability, for example, satisfied a legitimate objective of encouraging taxpayers to provide for times of inability to work. Conard v. Comr., 154 T.C. No. 6 (2020).

Posted March 7, 2020

Distributions From Inherited IRA Taxable; AUR Program Matching Not Examination of Records. The petitioner inherited an IRA from his father and didn’t report as income and pay tax on the distributions he received from the IRA. The Tax Court determined that the taxpayer couldn’t substantiate that any part of the IRA represented the decedent’s original investment. Thus, the distributions to the petitioner were fully taxable. The petitioner also claimed that the IRS was barred from assessing a proposed deficiency for one year because the IRS allegedly violated I.R.C. §7605(b) by conducting a second inspection of the petitioner’s books and records. Section 7605(b) provides: "No taxpayer shall be subjected to unnecessary examination or investigations, and only one inspection of a taxpayer's books of account shall be made for each taxable year unless the taxpayer requests otherwise or unless the Secretary, after investigation, notifies the taxpayer in writing that an additional inspection is necessary." The petitioner claimed that because both the AUR program (which automatically matches 1099s with returns and sends notices where income such as dividends, interest, etc. aren't reported) and an IRS Officer examined his 2014 return, the IRS violated I.R.C. §7605(b). The Court noted that under I.R.C. §7605(b) the AUR program's matching of third-party-reported payment information against the taxpayers already-filed 2014 return was not an examination of his records, and rejected the petitioner’s assertion. Essner v. Comr., T.C. Memo. 2020-23.

Failure To Disclose Foreign Bank Account On Return Triggers $1 Million Penalty. The taxpayer had a foreign bank account with aggregate highest balance of $1.9 million, $770,000 and $1.76 million for the three tax years at issue. Form 1040, Schedule B contains a question with a box to be checked asking whether the taxpayer had a financial interest in or signature authority over a financial account located in a foreign country. The box on Schedule B was checked “No” which was the default in the software that the return preparer used. The taxpayer also did not file an FBAR Form for any of the three years. The FBAR Form is required to be filed when the aggregate account balance exceeds $10,000. The IRS claimed that the taxpayer had constructive knowledge of his reporting requirements by signing his tax returns which included a reference to the FBAR on Schedule B, and that the naming his sister's Canadian address on the accounts was an act of concealment. The taxpayer argued that he was simply negligent and there was no will failure to file the FBARs. The Court examined the definition of willfulness for purposes of FBAR filing and concluded that the taxpayer could have easily determined the need to file the FBAR. Accordingly, the court held that the taxpayer willfully failed to file the FBAR Form and assessed penalties for the years at issue in the amount of $988,245. United States v. Ott, No. 18-cv-12174, 2020 U.S. Dist. LEXIS 32514 (E.D. Mich. Feb. 26, 2020).

Gain on Home Sale Underreported. The petitioner bought a rundown house in 1990. He and his wholly-owned company (CO) signed a contract under which the petitioner agreed to fund renovations. CO agreed to provide development services in exchange for 50 percent of any increase in property value, payable on sale of the house to a third party. When the house sold for $9.6 million, the petitioner reported $6.6 million on Form 2119 while CO reported over $3 million in ordinary income. The petitioner bought a replacement house within two years and deferred his gain under I.R.C. §1034 which was in effective at that time. The IRS claimed that the deal with CO was a scheme to avoid capital gains, but that the Tax Court disagreed. The Tax Court held that CO had a bona fide interest in the property but that the petitioner had realized $3 million in gain by reason of the transaction in which CO obtained its interest. The Tax Court calculated that, by reason of both transactions, the petitioner had realized a $5.110 million gain. After applying I.R.C. §1034, the Tax Court determined that the petitioner was required to recognize a $2.9 million gain. However, the petitioner was not liable for the I.R.C. §6662 penalty because he had shown that he had reasonably relied on his CPA in structuring the deal and reporting the transactions. The U.S. Court of Appeals for the Ninth Circuit affirmed the Tax Court in an unpublished opinion. Gaggero v. Comr., No. 18-72663 (9th Cir. Mar. 5, 2020), aff’g., T.C. Memo. 2012-331.

Posted March 1, 2020

“Small Producers” Can Revoke I.R.C. §263A Election. I.R.C. §263A requires the capitalization of pre-productive expenses associated with plants having a pre-productive period exceeding two years as listed by IRS. For tax years beginning before 2018, a taxpayer not required to use accrual accounting could elect out of I.R.C. §263A and deduct pre-productive costs in the year incurred, but at the cost of using alternative depreciation to depreciate other farm assets and not being able to utilize bonus depreciation. For tax years beginning after 2017, a taxpayer with average annual gross receipts of $25 million or less (adjusted for inflation) over the prior three years (through 2025) are excluded from I.R.C. §263A. The IRS has provided the mechanism for such taxpayers that elected out of I.R.C. §263A under prior law to revoke the election. For tax years beginning after 2018, the revocation election is to be made on the taxpayer’s original return, including extensions, for the tax year for which the taxpayer wants to revoke the election. The election is accomplished by not capitalizing the cost of plants; changing depreciation to GDS unless the property at issue is otherwise required to use ADS (bonus depreciation is not allowed); and continuing to treat plants that are or have been treated as I.R.C. §1245 property for prior tax years as I.R.C. §1245 property. A late revocation election can be made for a timely filed 2018 return by filing an amended return or filing Form 3115 with a timely filed return for the first through third tax years beginning after the 2018 tax year. Taxpayers that have already filed Form 3115 seeking permission to elect out of I.R.C. §263A has until the later of March 22, 2020 or the issuance of a private letter ruling notifying IRS that it chooses to apply the revocation procedures allowed under Rev. Proc. 2020-13. Rev. Proc. 2020-13, 2020-11 IRB; modifying Rev. Proc. 2019-43, 2019-48 IRB 1107.

Posted February 29, 2020

No Deduction For Farm Not Operated Form Profit. The Alabama Department of Revenue denied the petitioners’ deductions associated with their farm. The court upheld the denial for the expenses associated with the petitioner’s cattle farming operation. The petitioners worked full-time during the tax year at issue outside of their cattle farming activity which generated significant off-farm income. Simultaneously, they sustained net losses annually from 2005-2017 from the cattle farming activity. They also failed to maintain any general accounting ledgers or records concerning their livestock. The petitioners also didn’t present any evidence that their cattle business was for-profit and that the expenses should be allowed. Willis v. Alabama Department of Revenue, Alabama Tax Tribunal, No. 19-1003-JP (Feb. 27, 2020).

Posted February 27, 2020

SCOTUS Refuses To Hear Case Mailbox Rule Case. In 2011, the Treasury issued Treas. Reg. §301.7502-1(e)(2) concerning the timely mailing of documents to the IRS to specify that a postmark of registered or certified mail establishes prima facie evidence that the document was delivered to the IRS. In 1992, the U.S. Court of Appeals for the Ninth Circuit held that other evidence in addition to a postmark could be used to show that a document had been timely mailed. The appellate courts had split on the issue and the Treasury issued the 2011 regulations to clarify that a postmark is the sole method of establishing that documents (other than tax payments) have been timely mailed to the IRS. In this case, decided after the issuance of the regulation, the Ninth Circuit held that Treas. Reg. §301.7502-1(e)(2) rendered irrelevant the 1992 decision. The U.S. Supreme Court declined to hear the case. Baldwin v. United States, 921 F.3d 836, cert. den., No. 19-402, 2020 U.S. LEXIS 1359 (U.S. Sup. Ct. Feb. 24, 2020).

Employer “Roberts Tax” Not Subject to Statute of Limitations. I.R.C. §6501says that a tax must be assessed within three years after the tax return was filed. The tax (the rate of which is zero for tax years beginning after 2018) is imposed upon a taxpayer’s failure to obtain government-approved health insurance. I.R.C. §4980H(a) imposes the “Roberts tax” on an applicable large employer that fails to offer minimum essential health insurance coverage to full-time employees when at least one full-time employee enrolls in a health plan for which a premium tax credit or any cost sharing reduction is allowed or paid that full-time employee. I.R.C. §4980H(b) imposes a separate “Roberts tax” on an applicable large employer that offers full-time equivalent employees health insurance that is unaffordable. I.R.C. §4980H does not contain a separate limitations period. Thus, the IRS concluded that no statute of limitations applies because an applicable large employer does not file a document that qualifies as a “tax return” for statute of limitations purposes. Rather an applicable large employer files information returns Form 1094-C and 1095-C which do not contain enough data to calculate the tax that might be owed. F.A.A. 20200801F (Dec. 26, 2019).

Posted February 26, 2020

IRS Guidance on SALT Deduction Safe Harbor For Estates and Trusts. The IRS has provided guidance on how trusts and estates can report the use of the state and local tax (SALT) deduction safe harbor on Form 1041. Under I.R.C. §164(b)(6), the SALT deduction is limited to $10,000 (MFJ) per tax year through 2025. As a workaround the limitation, some states offer a SALT tax credit program offering taxpayers a choice of paying tax to the state or local government or making a payment to an entity for which the taxpayer can claim a federal charitable deduction and receive a state tax credit that offsets the taxpayer’s SALT liability. The IRS issued final regulations on such programs stating that the tax credit constitutes a return benefit to the taxpayer and reduces the taxpayer’s charitable contribution deduction under I.R.C. §170(a). The final regulations also provide similar rules under I.R.C. §642(c) for payments that a trust or decedent’s estate makes. Consequently, there could be taxpayers who itemize that are under the SALT limit but because of the requirement of Treas. Reg. §1.170A-1(h)(3), are unable to claim a charitable deduction for the payments made to a charitable organization for which a state tax credit is received. Accordingly, the IRS has issued a proposed regulation providing a safe harbor. Under Prop. Treas. Reg. §1.164-3(j), a taxpayer that itemizes deductions and makes a payment to a governmental entity or charity in exchange for a SALT credit can treat as a SALT payment the portion of such payment that would be disallowed as a charitable contribution under Treas. Reg. §1.170A-1(h)(3). The treatment is allowed in the tax year in which the payment is made to the extent that the resulting credit is applied pursuant to applicable state/local law to offset the taxpayer’s SALT liability for the tax year. Any unused credit that can be carried forward may be treated as a SALT payment in the tax year or years for which the carryover credit is applied under state or local law. The safe harbor applies only to payments of cash and cash equivalents. For trusts and estates, the safe harbor applies to the extent the trust or estate applies the SALT credit to this or a prior year’s state or local tax liability, then the trust or estate may include the amount on line 11 of Form 1041. To the extent the trust or estate applies a portion of the credit to offset its SALT liability in a subsequent year, it may treat this amount as SALT paid in the year the credit is applied. Preamble to Prop. Reg. REG-107431-19; Statements on IRS Website (Week of Feb. 23, 2020).

Another Failed Conservation Easement. The petitioners were members of a partnership that granted an easement restricting the use of the property and, in general, barred construction or occupancy of any dwellings on the restricted property to a qualified charity – the North American Land Trust. But, the partnership retained the right to build single-family dwellings in specified “building areas.” The locations of those building areas, however, were to be determined subject to the charity’s approval. The IRS denied the associated charitable deduction and the Tax Court agreed. The Tax Court held that because the restrictions that applied within the building areas allowed uses that were in opposition to the easement’s conservation purposes, the restrictions would be disregarded in determining whether the easement was included in the definition of “qualified real property interest” by virtue of I.R.C. §170(h)(2)(C) which requires that the property be granted in perpetuity. Carter, et al. v. Comr., T.C. Memo. 2020-21.

Deed Doesn’t Protect Conservation Purpose. In 2013, the petitioner executed a deed declaring a conservation easement in favor of a qualified charity. The petitioner claimed a $7,875,000 charity deduction for the donation. The IRS disallowed the deduction and imposed an accuracy-related penalty. The Tax Court upheld the IRS position because the easement failed to constitute a “qualified conservation contribution” because the charity did not have the right to participate in any future appreciation of the property and, thus, did not protect the conservation purpose of the easement in perpetuity. Instead, the easement only established a floor for the proceeds that the charity was entitled to which did not increase with the future appreciation in the property. As such, the deed did not provide the charity with a proportionate share of potential appreciation to which the charity was entitled under Treas. Reg. §1.170A-14(g)(6)(ii). Rock Creek Property Holdings, LLC v. Comr., No. 5599-17 (U.S. Tax Court Order Feb. 10, 2020).

Posted February 22, 2020

I.R.C. §501(c)(3) Organizations Must E-File Applications. The IRS requires applications for tax-exempt status under I.R.C. §501(c)(3) to be submitted electronically effective January 31, 2020 by submitting Form 1023 via Pay.gov. Under a transition rule, the IRS will accept a completed paper Form 1023 accompanied by the correct user fee if it is postmarked on or before 90 days after January 31, 2020. Submission requires the taxpayer to register for an account on Pay.gov; enter “1023” in the search box and select Form 1023; and complete the Form. A streamlined application process has been available since 2014 for U.S. organizations with assets of $250,000 or less and annual gross receipts of $50,000 or less. Rev. Proc. 2020-8.

Posted February 20, 2020

Personal Guarantee of Bank Loans Makes Them Deductible. The petitioner was the CEO of a health care company that he was the 100 percent owner of and also owned a 90 percent partnership interest in a partnership that owned and operated a Texas hospital. He also owned an LLC that he used to buy a hospital in Louisiana, financing it with a bank loan. The bank required that the petitioner personally guarantee the loan so that he would be directly liable on the loan. The Louisiana hospital generated net losses in 2008 and 2009 and the Texas hospital had substantial losses in 2008 which the petitioner carried forward and deducted in 2011. The partnership borrowed $550,000 from another bank and the petitioner personally guaranteed the loan. The petitioner deducted the losses and the IRS denied the loss deductions claiming that the loan amounts were not “at risk” as I.R.C. §465 required and asserted over $5.4 million in tax deficiencies and an additional penalty exceeding $1 million. However, the Tax Court disagreed noting that the petitioner demonstrated that he was personally liable for the loans and ultimately at risk to the extent of the disallowed deductions. He was not protected against losses related to the loans. As for the loan associated with the Texas hospital, the Tax Court determined that the loan guarantee became a recourse obligation and increased his basis in the partnership, which allowed him to deduct the $550,000 in 2011. Bordelon v. Comr., T.C. Memo. 2020-26.

Posted February 17, 2020

Not Establishing a Lawyer Trust Account Properly Results in Taxable Income. The petitioner, a lawyer, received a contingency fee upon settling a case. He deposited the funds in his lawyer trust account but did not report the deposited amount in his income for the tax year of the deposit claiming that his fee was in dispute and, thus, subject to a substantial limitation on his rights to the funds. The IRS disagreed and claimed that the account was not properly established as a lawyer trust account under state (CA) law. The IRS also pointed out that the petitioner commingled his funds with his clients’ funds which gave him access to the funds. The IRS also asserted that the petitioner should have reported the amount in income even if he later had to repay some of the amount. The Tax Court agreed with the IRS on the basis that the petitioner failed to properly establish and use the trust account and because the petitioner had taken the opposite position with respect to the fee dispute in another court action. The income was taxable in the year the IRS claimed. Isaacson v. Comr., T.C. Memo. 2020-17.

Posted February 15, 2020

Lack of Basis Information in Appraisal Summary Dooms Charitable Deduction for Conservation Easement Donation. In 2010, the petitioner executed a deed of conservation easement to a qualify land trust on 379 acres. The deed recited the conservation purpose of the easement. The petitioner claimed a $7,949,000 charitable deduction for the donation. Included with the petitioner’s return was an appraisal and Form 8283 which requires, among other things, basis information concerning the gifted property or an attached reasonable cause explanation of why the information was not included with the return. Basis information was not included on Form 8283, and the petitioner attached a statement taking the position that such information was not necessary. The IRS denied the deduction for noncompliance with Treas. Reg. §1.170A-13(c)(2). The Tax Court agreed with the IRS, noting that the lack of cost basis information was fatal to the deduction as being more than a minor and unimportant departure from the requirements of the regulation. The Tax Court cited its prior opinion in Belair Woods, LLC v. Comr., T.C. Memo. 2018-159. The Tax Court also rejected the petitioner’s argument that Treas. Reg. §1.170A-13(c)(4)(i)(D) and (E) was invalid. The petitioner claimed that the basis information was required with the return and not the appraisal summary, but the Tax Court rejected this argument because a “return” includes all IRS forms and schedules that are required to be a part of the return. As such, Form 8283 was an essential part of the return. In addition, the Tax Court noted that the underlying statute absolutely required basis information to be included with the appraisal summary and, in any event, the IRS’ interpretation of the statute via the regulation was reasonable. Oakhill Woods, LLC v. Comr., T.C. Memo. 2020-24.

Farm and Garden Association Not Tax-Exempt. A farm and garden association provided business benefits to fee-paying members. The IRS denied the association tax-exempt status under I.R.C. §501(c)(5) after advising the association of its position and the association failed to respond to the proposed adverse determination. The IRS noted that the association didn’t provide benefits to the farming industry at large. Priv. Ltr. Rul. 202005022 (Aug. 27, 2019).

Posted February 9, 2020

Farm Machinery and Equipment Subject to Sales Tax. The taxpayer purchased farm machinery and equipment and used it in land development activities in preparation of the taxpayer’s personal residence and build a fence around the home. The taxpayer did not pay sales tax on the purchase on the basis that the transaction qualified for sales tax exemption involving the purchase of farm machinery and equipment. The State Department of Revenue disagreed on the basis that the exemption only applied when the purchased machinery and equipment was used exclusively and directly in farming activities to produce food and fiber as a commercial business. As such, the items were personal property subject to state sales tax. The Department’s position was upheld at an administrative hearing. Arkansas Administrative Hearing Decision, Docket No. 19-45 (Jan. 31, 2019).

No Deduction For Donated Conservation Easement. The petitioner donated a permanent conservation easement to a qualified entity and claimed a $16 million charitable deduction. The deed granting the easement contained a clause specifying the result if the easement were extinguished as the result of a court order. Under I.R.C. §170(h)(5)(A), an easement (among other things) must be protected in perpetuity for the donor to receive a charitable deduction for the donation. However, in the event of a forced judicial sale, Treas. Reg. §1,70A-14(g)(6)(ii) requires the charity to receive an equal proportionate value of the sale proceeds that extinguishes the interest to the value of the easement as compared to the value of the property at the date of the donation. The language of the deed at issue held the charity’s payment constant, equal to the value as of the date of the contribution. It did not tie the charity’s payment to a percentage of the value of the property at the time of the forced sale equal to the percentage of value the easement was to the property at the time of the donation. The IRS denied the entire $16 million donation and the Tax Court agreed. The Tax Court noted that the deed language did not create a proportion or fraction representing the donee’s share of the property right and a corresponding fraction of the proceeds to which the donee was entitled in perpetuity. Rather, the Tax Court noted, the language gave the charity a “proportionate value…at the time of the gift” which guaranteed only that a fixed dollar amount would go to the charity. The Tax Court also held as irrelevant a declaration of intent executed by an officer of the charity that the deed language reflected the charity’s intent to be in full compliance with the Code. What mattered was the donor’s intent, not the charity’s intent. Even so, the deed language failed to conform to the Code. The Tax Court also determined that the deed language was not ambiguous. Thus, the easement was not protected in perpetuity and the full deduction was disallowed. Railroad Holdings, LLC, et al. v. Comr., T.C. Memo. 2020-22.

Posted February 2, 2020

IRS Did Not Abuse Discretion in Employment Tax Case. The petitioner was the sole member of two limited liability companies (LLCs). Each LLC failed to pay employment taxes with respect to employee wages. IRS revenue officers determined that the petitioner was a “responsible person” for each LLC for the payment of employment taxes. Each revenue officer completed IRS Form 4183 recommending that trust fund recovery penalties be assessed against the petitioner. IRS supervisors gave written approval to the recommendation, and the IRS issued Letters 1153 to the petitioner notifying him of the determination and of his right to appeal. He did not appeal, and the IRS assessed the penalties. The IRS gave notice of intent to levy to collect the unpaid tax and the petitioner requested a collection due process hearing. At the hearing, the petitioner requested that his account be placed into “currently not collectible” status. The hearing officer informed the petitioner that to do so, the petitioner would need to file delinquent returns and submit financial information. The petitioner did not do so, and the IRS sustained the levy. The petitioner filed suit in Tax Court. The Tax Court determined that a trust fund recovery penalty is a “penalty” under I.R.C. §6751(b)(1) and is subject to the written supervisory approval requirement for the initial determination. Letter 1153 satisfied that requirement by formally notifying the petitioner of the IRS decision to assert penalties. The Tax Court also determined that the IRS satisfied the I.R.C. §6751(b)(1) requirement by getting written supervisory approval of the trust fund recovery penalties on each Form 4183 on the same day that the Letter 1153 was mailed to the petitioner. Thus, there was no abuse of discretion of refusing to put the petitioner’s account in currently not collectible status. Chadwick v. Comr., 154 T.C. No. 5 (2020).

Posted January 29, 2020

No Flow-Through Deductions For Losses on Golf Course Transaction. The petitioners were developers of a golf course and the surrounding residential housing area via several entities that they owned. In 2009 and 2010, the entities engaged in real estate and financial transactions involving the golf course that purported to generate losses on the transfer of the golf course property and as a result of the abandonment of the golf course’s improvements and the sale of promissory notes. In 2009 and 2010, the petitioners also transferred tracts of real estate from an LLC that they owned (treated tax-wise as a non-TEFRA partnership) to another LLC that the husband owned (also treated tax-wise as a non-TEFRA partnership). They caused the selling LLC to use the installment method of accounting to defer recognition of gain on the transfers. The losses exceeding $7.3 million flowed through to the petitioners for which they claimed deductions for 2009 and 2010. For 2009, they also filed Form 1045 to carryback some of the losses to the 2004-2008 tax years. The IRS determined that the petitioners were not entitled to some of the deductions and had incorrectly accounted for the income from the real estate transfers by causing the LLC to improperly use the installment method. The Tax Court agreed, disallowing deductions for the losses from the golf course transfer, property abandonment and financial transactions. The Tax Court also determined that the selling LLC had adopted an impermissible method of accounting for the real estate transfers between the LLCs. As such, the petitioners could not defer the gain from the transferred property. The Tax Court also upheld an accuracy-related penalty levied under I.R.C. §6662. Cutherbertson v. Comr., T.C. Memo. 2020-9.

No Tax Remedy for Trustee’s Stock Sale. The plaintiffs, a married couple, created a revocable living trust in 2004 and amended it in 2012. The trust was created under Wisconsin law and named a bank as trustee with a different bank as successor trustee. The trust language gave the trustee broad discretion to invest, reinvest, or retain trust assets. However, the trust barred the trustee from doing anything with the stock of two companies that the trust held. The trustee apparently did not know of the prohibition and sold all of the stock of both companies in late 2015, triggering a taxable gain of $5,643,067.50. The sale proceeds remained in the trust. Approximately three months later, in early 2016, the trustee learned of the trust provision barring the stock sale and repurchased the stock with the trust’s assets. The grantors then revoked the trust later in 2016. On their 2015 return, the plaintiffs reported the gain on the stock sale and paid the resulting tax. On their 2016 return, the plaintiffs claimed a deduction under I.R.C. 1341 for the tax paid on the stock sale gain the prior year. The IRS denied the deduction and the plaintiffs challenged the denial and the IRS motioned to dismiss the case. The plaintiffs relied on the “claim of right” doctrine of I.R.C. §1341– they reported the income and paid the tax, but could be entitled to a deduction if and when their claim to the income is defeated. Under I.R.C. §1341, the plaintiffs had to: (1) establish that they included the income from the stock sale in a prior tax year; (2) show that they were entitled to a deduction because they did not have an unrestricted right to the income as of the close of the earlier tax year; and (3) show that the amount of the deduction exceeds $3,000. If the requirements are satisfied, a taxpayer can claim the deduction in the current tax year or claim a credit for the taxes paid in the prior year. The IRS claimed that the plaintiffs could not satisfy the second element because the plaintiffs were not actually required to relinquish the proceeds of the stock sale. The court agreed, noting that once the stocks were sold the plaintiffs had the unrestricted right to the proceeds as part of the revocable trust, as further evidenced by them revoking the trust in 2016. The court noted that neither the trustee nor the plaintiffs had any obligation to repurchase the stock. The court also noted that under Wisconsin trust law, the plaintiffs could have instructed the trustee to do anything with the proceeds of the stock sale, and that they had the power to consent to the trustee’s action of selling the stock. In other words, they were not duty-bound to require the trustee to buy the stock back. Accordingly, the court determined that I.R.C. §1341 did not provide a remedy to the plaintiffs, and that any remedy, if there was one, would be against the trustee. Heiting v. United States, No. 19-cv-224-jdp, 2020 U.S. Dist. LEXIS 10967 (W.D. Wisc. Jan. 23, 2020).

Posted January 23, 2020

Expenses For Thinning Maple Forest For Blueberry Production Are Start-Up Expenses. The petitioner lived in New York and bought a property in Quebec containing 200 maple trees with a significant number of them being mature, maple syrup-producing trees. The tract contained other types of trees and pasture ground and hay fields and a small amount of ground suitable for growing crops. There were also various improvements on the tract. Before collecting sap and producing syrup, the petitioner thinned underbrush and later install a pipeline to collect sap. Sap production began in 2017. When the petitioner bought the property in 2012, the cleared the areas of the tract where he planned to plant blueberry bushes. He ordered 2,000 blueberry bushes in 2014 and planted them in 2015. He reported a substantial amount of farming-related expenses in 2012 and 2013, with most of the expenses attributable to costs of repairs to improvements on the property. The petitioner deducted expenses attributable to preparatory costs for the production of selling maple syrup and blueberries as trade or business expenses under I.R.C. §162 (or as I.R.C. §212 expenses for income-producing property). The IRS denied the deductions, asserting that they were nondeductible start-up expenses under I.R.C. §195 on the basis that the petitioner had not yet begun the business of producing maple syrup and blueberries. The Tax Court upheld the IRS position. The Tax Court noted expenses are not deductible as trade or business expenses until the business is actually functioning and performing the activities for which it was organized. Here, the court noted, the petitioner had not actually started selling blueberries or sap in either 2012 or 2013. Accordingly, the expenses incurred in 2012 and 2013 were incurred to prepare the farm to produce sap and plant blueberries and were nondeductible startup expenses. The thinning activities, while a generally acceptable industry practice, did not establish that the business had progressed beyond the startup phase. In addition, during the years at issue, the petitioner had not collected sap, installed any infrastructure needed to convert sap into syrup, or bought any blueberry bushes. Primus v. Comr., T.C. Sum. Op. 2020-2.

Posted January 22, 2020

No Charitable Deduction For Property Gifts. The petitioners (a married couple) bought a house on .38 acres with the purpose of demolishing the house and building a new residence on the tract. To further that purpose, the petitioners entered into an agreement with a charity to perform the deconstruction of the existing house and donate personal property in the home to the charity. An appraisal calculated the cost to reproduce the house at $674,000. After labor costs and other fees and profit for a construction company was subtracted, and a reduction for new material cost was factored in along with depreciation, the resulting fair market value for the deconstructed house was determined to be $297,000. On their 2013 return, the petitioners claimed a $297,000 non-cash charitable contribution deduction for the donation of the improvements to the charity. On the appraiser summary attached to the return, the petitioners identified the donated property at “other” and “house improvements” that were in “excellent” condition. However, the appraisal form did not indicate the date of the donation or the petitioners’ cost basis in the improvements. In addition, the appraiser did not sign the appraisal form. The IRS denied the deduction on the basis that the appraisal did not appraise each donated item separately. The Tax Court upheld the IRS position and also noted that the petitioners did not strictly comply with Treas. Reg. §1.170A-13 which specifically required the petitioners to provide sufficient information to evaluate their reported contributions. The Tax Court held that basis was an important factor that needed evidentiary support. The Tax Court also noted that the petitioners failed to denote the contribution date or provide a reasonable cause explanation for their inability to provide basis information. Loube v. Comr., T.C. Memo. 2020-3.

Posted January 17, 2020

NOL Deduction Not Substantiated. The petitioners (a married couple) claimed a large net operating loss (NOL), but failed to file with the return a concise statement detailing the amount of the NOL claimed and all material facts relating to the NOL including a schedule showing how the NOL deduction was computed. The IRS rejected the NOL deduction and the Tax Court agreed. The Tax Court noted that the petitioners bore the burden to substantiate the claimed deduction and that the petitioners had provided no detailed information supporting the NOL. The Tax Court also noted that the petitioners bore the burden of proof to establish both the existence of the NOLs for prior years and the NOL amounts that can be carried forward to the years at issue. The petitioners did not satisfy these requirements either. The only “proof” the petitioners had was submitted copies of tax returns on which they reported the losses. The Tax Court declined to hold that submitted copies of returns was sufficient substantiation. Gebman v. Comr., T.C. Memo. 2020-1.

Posted January 14, 2020

Guidance on North Dakota Farm Residence Property Tax Exemption. The North Dakota Tax Commissioner has issued a reminder to taxpayers of the new eligibility requirements for the farm residence property tax exemption. Two laws enacted in 2019 (S2360 and S2278 impose new eligibility and filing requirements for claiming the exemption. Those qualifying for the exemption must complete a Farm Residence Exemption Application Form with the county, and submit a total gross income statement. The Form must be completed by February 1, 2020. The exemption must be renewed annually by submitting a new application and income statement. North Dakota Office of Tax Commissioner, Farm Residence Exemption, Jan. 8, 2020).

Cutting Horse Activity Not a Hobby. The petitioner operated a seed business and engaged in “cutting” horse activity. Based on an analysis of the nine factors in the regulations under I.R.C. §183, the petitioner was able to establish that the horse activity involving breeding, raising, boarding, training, and selling registered cutting horses, qualified as for-profit activity. Notably, although taxpayer failed to support his claim that the seed business and the horse activity should be treated as single activity, even standing alone, the evidence established that the horse activity was undertaken with the requisite profit objective. The petitioner had a business plan for the activity; kept activity records consistent with his profit objective; changed and scaled down operations in attempt to accommodate economic realities; and actively marketed the activity. This conduct indicated that the petitioner conducted the horse activity in a businesslike manner. In addition, the petitioner had expertise in and hired network of trainers to assist in horse operations; spent considerable time on the activity; had success in other businesses; and didn't engage in the activity solely for pleasure. Instead, the petitioner rode horses to train them and otherwise worked to prepare them for competition. Even although the petitioner had income from his seed business that was offset by the horse activity losses, the Tax Court found that he wasn't in the financial position to continue suffering horse activity losses without a bona fide profit motive and concluded that his claim of bona fide profit objective outweighed the countervailing factors regarding his loss history and lack of occasional profit during the years at issue. However, the Tax Court did deny some deductions for expenses that had both personal and business characteristics or weren't shown to have cleared his bank account. Besten v. Comr., T.C. Memo. 2019-154.

Posted January 13, 2020

Insufficient Stock Basis To Deduct S Corporation Loss. The controlling shareholders of an S corporation formed another S corporation that loaned funds to a qualified S corporation subsidiary (QSUB) of the first S corporation. The shareholders then attempted to claim losses from the first S corporation by using the loan as additional basis in the corporation. The loan was to be used to refinance third party debt to the QSUB. However, by terms of the agreement with other creditors (who had sold the business to the S corporation originally), any amounts borrowed from the shareholders of the S corporation had to be subordinated to the original owner’s debts to avoid the issuance of new debt. The shareholders claimed that the debt should count as basis because the new S corporation represented their “incorporated pocketbook.” The shareholders also claimed that the new S corporation should be treated as merely acting as an agent for the taxpayers for acquiring the loan. The IRS rejected the shareholders’ arguments and the Tax Court agreed. On appeal, the appellate court affirmed. The appellate court concluded that the loan ran to a related entity rather than the shareholders personally (even though the entity was wholly owned) and did not, therefore, increase debt basis that the shareholders could claim in the initial S corporation. Messina v. Comr., No. 18-70186, 2019 U.S. App. LEXIS 38704 (9th Cir. Dec. 27, 2019).

“Constructive Denial” Clause in Conservation Easement Not Violation of Perpetuity Requirement. A conservation easement deed may contain a clause specifying that if the easement holder fails to respond within a certain time to a request by the property owner regarding a proposed use that the request is considered to be denied. The IRS noted that because a constructive denial is not a decision by the easement holder based on the merits of the property owner’s request, it is not final or binding on the easement holder, and the property owner can resubmit the same or a similar request for approval. The IRS determined that such clause language does not violate the perpetuity requirements of I.R.C. §170(h). C.C.A. 202002011 (Nov. 26, 2019).

Posted January 12, 2020

Married Couple Can Exclude Gain on Sale of Home and Use Like-Kind Exchange Treatment. A married couple lived in a home on a property that one of the spouses had purchased before the marriage. After the marriage, they continued to use the home as their principal residence. They later moved into a new home and offered the prior residence for rent. The prior home was rented for both short-term rentals and was also rented to full-time tenants. The rental use stopped when a fire destroyed the property. The couple received insurance proceeds for the destroyed residence and sold the land without rebuilding the residence. In the same transaction, they used the insurance and sale proceeds to acquire two other rental properties, and sought to defer the gain on the sale under I.R.C. §1031 in addition to the use of I.R.C. §121 to exclude the gain associated with the residence. The gain on the sale exceeded the amount the couple could exclude under I.R.C. §121. They satisfied the ownership and use tests of I.R.C. §121. Thus, the question was whether they could use I.R.C. §1031 to defer the remaining gain to eliminate current tax on the transaction. The IRS determined that they could because excluding gain under I.R.C. §121 does not preclude the use of I.R.C. §1031 for property that involves an exchange of investment property. The IRS applied the same reasoning as it had in Rev. Proc. 2005-14, 2005-1 C.B. 528 which also provided the mechanics of recording the transaction. Under Section 4.02 of Rev. Proc. 2005-14, I.R.C. §121 is applied to the realized gain before I.R.C. §1031 is applied, and the basis of the property received in the exchange is increased by any gain attributable to the relinquished property that is excluded under I.R.C. §121.  Priv. Ltr. Rul. 201944006 (Jul. 31, 2019). 

Posted January 10, 2020

Special Valuation of Ag Land – Nebraska. The Nebraska Department of Revenue has updated its information guide regarding the special valuation of ag or horticultural land under which owners of ag or horticultural land may apply for special valuation for a taxable value based on 75% of the actual value of land used exclusively for agricultural or horticultural purposes. The property owner must file Form 456 (Special Value Application) with the county assessor on or before June 30 of the first year in which the valuation is requested. Form 456 is available on the Property Assessment Division's website, and at the county assessor's office. Any special valuation applications filed with the county assessor after June 30 will be considered an application for the next year. Nebraska Information Guide No. 96-276-2016 (Dec. 1, 2019).

Deduction For Worthlessness Upheld. The petitioner advanced money to a related partnership engaged in real estate development. The partnership fell of compliance with various financial covenants related to its debt and an auditor doubted that the partnership could continue as a going concern. Indeed, the partnership began having trouble with lenders and projections showed that it would not be able to make particular principal payments on its debt. Th petitioner claimed a deduction for the worthless debt under I.R.C. §165(a). The IRS denied the deduction on the basis that the debt was not worthless in the year the deduction was claimed. The Tax Court allowed the deduction because the loss was evidences by closed and completed transactions that were fixed by identifiable events and had actually been sustained during the tax year. The Tax Court examined several factors to determine whether the debt was essentially valueless for the tax year in question. Those factors included whether the petitioner claimed the debt was worthless on the return; whether the petitioner testified credibly concerning the losses, debt burden, and deteriorating cash flow projections. The Tax Court also examined other factors including liquidating value, lack of potential future value, hopeless insolvency, foreclosure, bona fide loss, and expert valuation. Based on all of the relevant factors, the Tax Court determined that the debt was worthless and was claimed in the year the debt became worthless. In re MCM Investment Management, LLC, et al., T.C. Memo. 2019-158.

Posted January 7, 2020

No Charitable Deduction for Donated Conservation Easement. The petitioner engaged in a syndicated easement transaction whereby it made a $6.9 million charitable contribution for an easement on 637 acres of a 652-acre parcel donated to a land conservancy. The IRS denied a charitable deduction due to the easement deed not satisfying the perpetuity requirement and imposed a 40 percent gross valuation misstatement and negligence penalties. The Tax Court agreed, determined that the actual value of the easement donation was less than 10 percent of what was originally reported on the petitioner’s return. In the process, the Tax Court gave more credibility to the approach of the appraiser for the IRS. TOT Property Holdings, LLC v. Comr., Docket No. 005600-17 (U.S. Tax Ct. Dec. 13, 2019).

Land and Mobile Homes Qualified for Installment Sale Treatment. The petitioner sold land and mobile homes on the installment method and the IRS asserted that the sales were not eligible for installment treatment because the petitioner was a dealer of real property. The Tax Court disagreed with the IRS and allowed the sales to occur on the installment method because the petitioner had not improved the property. While the IRS had claimed that the petitioner had improved the land by adding driveways, septic tanks, water wells and electrical hookups that benefitted the individual lots. The petitioner claimed it had only added roads, that the electric company installed electrical poles without charge and the property buyers installed the driveways. The Tax Court determined that the petitioner had not improved the lots in the land-only sales and was not a dealer with respect to the land-only sales. As such, the sales could occur on the installment method. Joyner Family Limited Partnership, et al., T.C. Memo. 2019-159.

Posted November 5, 2019

Travel Expenses to Care for Timber Property Allowed. In the 1980s, the petitioner inherited timber property from his mother. He traveled weekly to care for and monitor the timber of the property. Each roundtrip was about 300 miles. He also began planting additional trees. The trees appreciated in value, reaching an approximate harvest value exceeding $1 million. During a period when he was physical unable to travel to the property and monitor the trees, some of the trees were illegally harvested. He maintained a daily log of his trips and activities associated with the property. After preparing a summary for 2013 for IRS from the logs, the original records were lost due to vandalism of the building in which they were stored. According to the summary, the petitioner was present at the property during 161 days of 2013, via 47 roundtrips from his residence. For 2013, the petitioner did not have any timber income from the property, but did claim $7,011 of travel expenses. The IRS denied the travel expenses and $55,925 of per diem expenses that were claimed on the return on the basis that the expenses were not necessary business expenses and/or weren’t sufficiently substantiated. The Tax Court disagreed with the IRS with respect to the travel expenses, concluding that the petitioner had a repetitive, routine and predictable travel pattern that was sufficiently substantiated and were incurred to protect the property, a legitimate business purpose. However, the Tax Court allowed only $7,406 of per diem expenses because the petitioner used the incorrect per diem rate. Maki v. Comr., T.C. Sum. Op. 2019-34.

No Deduction For Donated Conservation Easement. The petitioner donated to a qualified charity an open space conservation easement over property which was previously subjected to surface coal mining and which was also subject to oil and gas leases and certain improvements. The IRS denied the deduction because the easement wasn’t protected in perpetuity, and the Tax Court agreed. The Tax Court determined that the donation didn't qualify for deduction because the conservation purpose of allowing the land subject to the easement to continue to recover from and provide scientific insight into the long-term effects of mining, didn’t entitle the charity to a proportionate part of the proceeds if the subject property were sold upon a judicial extinguishment of the easement. As such, the easement wasn’t perpetual in nature as required by I.R.C. §170(h)(5)(A) and I.R.C. §1.170A-14(g)(6). While the petitioner claimed that the deed language contained a “regulation override” mandating that the deed be interpreted to satisfy the perpetuity requirements of the Code and Regulations, the Tax Court rejected that argument because it was a condition subsequent constituting a savings clause that the court would not enforce. Coal Property Holdings, LLC v. Comr., 153 T.C. No. 7 (2019).

Posted November 2, 2019

Iowa Sales Tax Applicable to Fitness Facility Fee. The petitioner operated a stationary cycling fitness facility. Iowa imposes a sales tax on all commercial recreation including activities pursued for pleasure, including sports, games and activities which promote physical fitness. However, instruction in recreational activities is not taxed. The Iowa Department of Revenue (IDOR) determined that the petitioner’s classes were not exempt as instructions in recreational activities because there was no level of knowledge imparted to a learner as to knowledge or skill in the recreational activity that would not have been known to the ordinary person engaging in the recreational activity without instructions. The IDOR determined that ordinary people know, without instruction, how to ride a stationary exercise bike, when a bike seat or handles need adjusting, how to clip and unclip from the pedals, when they are exceeding their physical limits, and understand warming up and cooling down. Further, any amount of instruction was only incidental to the commercial recreation activity. In re CJ Health, Inc., No. 2019-300-2-0291 (Iowa Dept. of Rev. Declaratory Order, Sept. 26, 2019).

Posted October 26, 2019

No Charitable Deduction For Lack of Substantiation. The petitioner claimed a charitable deduction in 2010 for over $107,000 attributable to land improvements to property that a charity owned. The improvements occurred over several years and were made by the petitioner’s LLC. The petitioner did not claim any charitable deductions in the years that the improvements were made. The IRS denied the deduction and the Tax Court agreed. The petitioner conceded that the did not own the improvements, and the Tax Court noted that the petitioner could not claim the deduction in 2010 because the improvements were paid for in years preceding 2010. In addition, the Tax Court noted that even if the improvements had been paid for in 2010, the amounts that the LLC paid for were not directly connected with or solely attributable to the rendering of services by the LLC to the charity as Treas. Reg. §1.170A-1(g) requires. In addition, the Tax Court determined that the petitioner did not satisfy the substantiation requirements and did not include Form 8283 and did not have an appraisal of the improvements made as required when a charitable deduction exceeding $5,000 is claimed. Presley v. Comr., No. 18-90008, 2019 U.S. App. LEXIS 32018 (10th Cir. Oct. 25, 2019, aff’g., T.C. Memo. 2018-171.

Posted September 26, 2019

Golf Course Activity Conducted For Profit. The petitioner, a limited partnership, owned and operated a golf course. The limited partner and sole shareholder of the general partner was a real estate developer and developer of golf courses who created a nonprofit corporation to which he planned to donate the golf course at issue. The IRS approval of nonprofit status was conditioned on the corporation focusing only on charitable activities and distributing funds to a medical center. As a result, the golf course gave access to the corporation and members the corporation paid rent and members paid fees for golf rounds. The golf course was managed by an experienced manager. The manager kept complete books and records and maintained budgets for the course and facilities. Between 2001 and 2015, the golf course sustained losses which flowed through the petitioner to the limited partner. The golf course reported a net profit in 2016. The IRS denied the loss deductions on the basis that the golf course was not engaged in its activity for profit. The Tax Court disagreed based on the nine factors of Treas. Reg. §1.183-2(b), a predominance of which favored the petitioner. The golf course was operated in a businesslike manner with complete and accurate books and records, and the records were used to determine when capital improvements should be made. Steps were also taken to make the golf course more profitable. In addition, the managers had extensive experience in the golf industry and in managing golf clubs. The Tax Court also noted that the limited partner had successfully developed two other golf clubs and did not derive substantial tax benefits from the passed-through losses. While a long history of losses was present, that factor was not enough to negate the petitioner’s actual and honest intent to make a profit. WP Realty, LLP v. Comr., T.C. Memo. 2019-120.

Posted September 25, 2019

Debt Was a Fully Deductible Business Bad Debt. The petitioner claimed a business bad debt deduction for a loan made to an unrelated business when only part of the loaned amount was recovered. The IRS claimed that the debt was a nonbusiness bad debt which was not fully deductible against income but was a short-term capital loss. The IRS also challenged the petitioner’s year in which the debt was deducted. The Tax Court noted that the petitioner was in the business of lending money for real estate development via a corporation and had made personal loans to various borrowers for his own account and on a regular basis. The Tax Court noted that the petitioner’s lending activity totaled approximately $25 million and was engaged in on a substantial basis and with a profit intent. As for the loan in issue, the Tax Court noted that the petitioner conducted due diligence and that the loan was not with a related party. The Tax Court also refused the attempt of the IRS to distinguish the petitioner’s real estate and personal property loans, concluding that the taxpayer’s trade or business was lending in general. The Tax Court also found it relevant that the petitioner waited for the sale of the property involved before determining whether the loan was worthless. However, the Tax Court refused to discount the note for the lower interest on the note upon it’s transfer to a different creditor. Bercy v. Comr., T.C. Memo. 2019-118.

Posted September 24, 2019

Transfers Between Entities Are Constructive Dividends. The petitioner transferred receipts from his professional services corporation to other entities that he operated. The IRS claimed that the distributed amounts were taxable as dividends. The petitioner claimed that he could have withdrawn the amounts as salary. The Tax Court agreed with the IRS, concluding that the amounts were constructive dividends that were taxable to the petitioner and not corporate deductions. The Tax Court also upheld the IRS use of bank deposits to reconstruct income to support a finding that the petitioner had unreported income. Benavides & Co., P.C. v. Comr., T.C. Memo. 2019-115.

Posted September 22, 2019

Vacation Properties Could Not Be Grouped For Passive Loss Purposes. The plaintiff was a real estate professional within the meaning of I.R.C. §469(c)(7) that owned three properties (vacation properties) in different states that he offered for rent via management companies at various times during the year in issue. The plaintiff reserved the right for days of personal use of each rental property. The plaintiff sought to group the vacation rental properties with his other rental activities as a single activity for purposes of the material participation rules of I.R.C. §469. The IRS denied the grouping on the basis that the vacation rental properties were not rental properties on the basis that the average period of customer use for the vacation rentals was seven days or less as set forth in Treas. Reg. §1.469-1T(e)(3)(ii)(A), and that the petitioner was the “customer” rather than the management companies. The court agreed with the IRS position on the basis that the plaintiff’s retained right to use each vacation property eliminated the management companies from having a continuous or recurring right to use the property when applying the test of Treas. Reg. §1.469-1(e)(3)(iii)(D) providing for measuring the period of customer use. As such, the facts of the case differed substantially from the contracts at issue in White v. Comr., T.C. Sum. Op. 2004-139 and Hairston v. Comr., T.C. Memo. 2000-386. As such, the management companies were not customers with a continuous right to use the properties, but merely provided marketing and rental services for the petitioner to rent out the properties. Eger v. United States, No. 18-cv-00199-DMR, 2019 U.S. Dist. LEXIS 149060 (N.D. Cal. Aug. 30, 2019).

Posted September 7, 2019

Prior Bankruptcy Filings Extends Non-Dischargeability Period. The debtor filed Chapter 7 in late 2018 after not filing his 2013 and 2014 returns. The 2013 return was due on October 15, 2014, and the 2014 return was due April 15, 2015. The debtor had previously filed bankruptcy in late 2014 (Chapter 13). That prior case was dismissed in early 2015. The debtor filed another bankruptcy petition in late 2015 (Chapter 11). Based on the facts, the debtor had been in bankruptcy proceedings during the relevant time period, (October 15, 2014, through October 25, 2018) for a total of 311 days. 11 U.S.C. § 523(a)(1)(A) provides, in general, that a discharge of debt in bankruptcy does not discharge an individual debtor from any debt for an income tax for the periods specified in 11 U.S.C. § 507(a)(8). One of the periods provided under 11 U.S.C. § 507(a)(8), contained in 11 U.S.C. § 507(a)(8)(A)(i), is, the three years before filing a bankruptcy petition. Also, 11 U.S.C. § 507(a)(8) specifies that an otherwise applicable time period specified in 11 U.S.C. § 507(a)(8) is suspended for any time during which the stay of proceedings was in effect in a prior bankruptcy case or during which collection was precluded by the existence of one or more confirmed bankruptcy plans, plus 90 days. When a debtor files multiple, successive bankruptcy cases, the ordinary operation of the automatic stay 11 U.S.C. § 507(a)(8) is altered by 11 U.S.C. § 362(c)(3)(A) which specifies that if a debtor had a case pending within the preceding one-year period that was dismissed, then the automatic stay with respect to any action taken with respect to a debt or property securing that debt terminates with respect to the debtor on the 30th day after the filing of the later case. The debtor sought to have his 2013 and 2014 tax liabilities discharged in the present bankruptcy case under 11 U.S.C. §523(a)(1)(A) on the basis that the filing dates for those returns were outside the three-year look-back period. The IRS took the position that the three-year “look-back” period was extended due to the debtor's bankruptcy filings. The court agreed with the IRS, noting that the three-year look-back period began on October 25, 2015. However, the court concluded that an issue remained as to whether the look-back period extended back 401 days, or only for the first 30 days following each bankruptcy filing as provided by 11 U.S.C. § 362(c)(3)(A). Based on a review of applicable bankruptcy case law, the court concluded that the tolling provision of 11 U.S.C. § 507(a)(8) was not impacted by the automatic nature of 11 U.S.C. § 362(c)(3)(A). Instead, for purposes of the tolling provision, the stay of proceedings was in effect in each of debtor's three previous cases until each was dismissed. Therefore, the court found that the look-back period extended back three years plus 401 days. Since the debtor filed the bankruptcy petition in the present case on October 25, 2018, the three-year plus 401-day look-back period reached back to September 19, 2014. Because the debtor's 2013 and 2014 tax liabilities were due after that date (including the extension for the 2013 liability), neither was dischargeable in the current bankruptcy case. Nachimson v. United States, No. 18-14479-SAH, 2019 Bankr. LEXIS 2696 (Bankr. W.D. Okla. Aug. 23, 2019).

Posted September 4, 2019

No Casualty Loss Deduction Allowed. The petitioner claimed a casualty loss on the 2008 return for damage from a hurricane. An insurance company paid over $2.3 million in claims, and the claimed deduction was $888,345. The petitioner reported a basis in the property of $6.5 million, insurance reimbursement of $2.3 million and a pre-casualty fair market value of $15,442,059 and a post-casualty fair market value of $12,250,000. The pre-casualty FMV was based on the 2009 listing price of the property reduced for time spent on the market. No testimony was provided as to post-casualty FMV. The Tax Court (Judge Paris) noted that to compute a casualty loss deduction, the pre and post-FMV values of the impacted property must be computed and the property basis must be established. The Tax Court noted that decline in value can alternatively be established via the regulations under I.R.C. §165 if the taxpayer has repaired the property damage resulting from the casualty, the taxpayer may use the cost of repairs to prove the loss of value to the property from the casualty. In that instance, the taxpayer must show that (a) the repairs are necessary to restore the property to its condition immediately before the casualty, (b) the amount spent for such repairs is not excessive, (c) the repairs do not care for more than the damage suffered, and (d) the value of the property after the repairs does not as a result of the repairs exceed the value of the property immediately before the casualty. The Tax Court noted that the record did not establish that the valuations were based on competent appraisals, and didn’t indicate how the petitioner’s CPAs determined the pre or post-casualty FMV of the property, even though the pre-casualty FMV was consistent with the value reported to the insurance company. The Tax Court concluded that the appraisals were not reliable measures of the taxpayer's casualty loss and didn’t rely on them. In addition, the taxpayer received insurance payments that exceed the cost of repairs. That meant that a casualty loss deduction couldn’t be claimed based on the regulations. The Tax Court disallowed any casualty loss deduction. Taylor II v. Comr., T.C. Memo. 2019-102.

Posted August 31, 2019

Interest Payment By Partnership Not Investment Interest To Partner. The petitioner’s father owned interests in partnerships that made debt-financed distributions to the partners. The father used the proceeds of the distributions to buy investment assets. The father treated the interest that the partnerships paid on the debts that passed through to him as “investment interest” that was subject to the limit on deducting interest contained in I.R.C. §163(d). The father was not personally liable on any of the loans. The father transferred partnership interests to the petitioner by gift and then by bequest. As interest on the loans incurred, it passed through to the petitioner. The petitioner treated the debt as allocable to the partnerships’ real estate assets and reported the interest expense as fully deductible business interest that offset the income passed through from the partnership. The IRS denied the full deduction, asserting that the interest was investment interest. The Tax Court upheld the petitioner’s position. Contrary to his father, the petitioner did not receive any debt-financed distributions from the partnership and made to investment expenditures with those distributions. Instead, the petitioner made a debt-financed acquisition of the partnership interests he acquired from his father. Thus, under I.R.C. §163(d) the debt proceeds were fully allocable to the partnerships’ real estate assets (which were actively maaged operating assets) using a reasonable method, and the interest on the debt is allocated the same way. The Tax Court concluded that the petitioner acquired his interests in the partnerships subject to the partnership debts, even though he did not personally assume those debts, which remained nonrecourse with respect to the partners individually. That didn’t mean, however, the his partnership interest was not “subject to a debt” for purposes of Subchapter K. Thus, Treas. Reg. §1.163-8T(c)(3)(ii) in conjunction with Notice 89-35, resulted in the petitioner’s interest expense passed through to him being fully deductible business interest. Lipnick v. Comr, 153 T.C. No. 1 (2019).

Posted August 27, 2019

Horse Activity Not Trade or Business Without a Horse. During 2010, the year in issue, the petitioner worked 5-6 hours daily at her job and was heavily involved in litigation against her homeowner’s association. She claimed deductions associated with her horse breeding and showing business and the IRS denied the deductions. The Tax Court upheld the IRS position largely because the petitioner did not establish that the activity had begun in 2010. She did not own any horses during 2010, and did not breed or show any horses during 2010. The petitioner also did not participate in any horse competitions during the year. The Tax Court concluded that the activity, if there were one, would be deemed to not be conducted with a profit motive. Thus, deductions associated with the activity were disallowed. The Tax Court noted that the petitioner could have deductible start-up expenses in accordance with I.R.C. §195 when upon the activity starting. McMillan v. Comr., T.C. Memo. 2019-108.

Posted August 26, 2019

Inventory Property Not Eligible For Installment Reporting. The petitioner was a solar equipment manufacturing and sales corporation that sought to use the installment method of reporting the non-cash portion of a multimillion equipment sale as reflected in an unpaid balance of a promissory note. The Tax Court disallowed such treatment, noting that I.R.C. §453(b)(2)(B) clearly provides that installment sales don’t include any “disposition of personal property of a kind which is required to be included in the inventory of the taxpayer if on hand at the close of the taxable year.” The Tax Court held that even if the petitioner didn’t actually include the property in inventory, it was of a kind required to be included in inventory if on hand at the close of the tax year. The Tax Court reasoned that so holding would avoid an anomalous mismatching of income and associated deductions and credits that the transaction generated. King Solarman v. Comr., T.C. Memo. 2019-103.

Posted August 25, 2019

Real Estate Professional Status Not Attained – Losses Were Passive. The petitioners, a married couple, operated two rental properties. They maintained a calendar for each property that purported to show the number of hours that they worked each day on the properties. The calendars showed 360 entries and indicated the work that the petitioners performed, and the time committed. However, the calendars did not indicate which spouse undertook particular activities. The handwriting appeared to be identical on each calendar and most entries were recorded on a weekly basis rather than a daily basis. For the year in issue, the calendars showed a total of 932 hours of work that the petitioners performed. The IRS determined that the husband put in 669 hours and his wife worked 170 hours. 93 hours were not allocated to either spouse. The Tax Court agreed with the IRS and determined that the petitioners could not satisfy the 750-hour test of I.R.C. §469(c)(7)(B)(2). The Tax Court determined that the petitioners inflated their hours on the calendars and that rental property leases did not specify whether the petitioners were responsible for snow removal – a task that made up a substantial amount of the hours reported. The Tax Court also noted that the petitioner’s calendars were not fully contemporaneous in that the time spent on the rentals was not recorded on a daily basis. Hairston v. Comr., T.C. Memo. 2019-104.

No Casualty Loss Deduction Allowed. The petitioner’s property sustained storm damage before 2018 (when the rules on casualty losses changed). The petitioner’s appraiser established a 95 percent difference between the property’s value before the storm and after the storm. However, the post-casualty appraisal relied heavily on the stigmatization of the petitioner’s house due to the flooded basement. In addition, the appraiser failed to include any post-storm sales of comparable properties in the appraisal. The appraiser acknowledged a general market decline in the year at issue and also didn’t account for a drop in the property value due to the discovery of asbestos. The IRS disallowed a casualty loss deduction and the Tax Court agreed. The Tax Court agreed with the IRS that the cost of repairs could not be used to establish loss of value for various assets where the petitioner failed to establish the income tax basis of those assets. In addition, the petitioner received insurance that exceeded the cost of repairs that the petitioner would have been otherwise able to deduct as a casualty loss. Taylor v. Comr., T.C. Memo. 2019-102.

“Farming Activity” Was Not A “Trade or Business.” The petitioner had a non-farm job paying him over $200,000 annually during 2011-2012 – the years in issue. In 2007, he started to correspond with farmers from Ghana about cocoa farming in Ghana. He came to a belief that better management would make the cocoa farms profitable and sought to fund such farms to that end. In 2009 and 2010, the petitioner entered into various written partnership agreements with farmers from Ghana governed by Ghana law. Under the agreements the farmers transferred their land, improvements, unharvested crops and salable inventory of farm products to the partnerships. The petitioner contributed cash and received 50 percent ownership of the farms and the right to 50 percent of the profits from the farms. Any loans had to be repaid before profits were calculated and distributed to any of the partners. The petitioner did not manage the farms or keep their books or records. Instead, the farmers continued to manage the daily operations of the farms or hired local managers that the petitioner recommended. On his 2011 and 2012 returns the petitioner claimed business expense deductions for the farming activities on Schedule C. The IRS disallowed the deductions on the basis that the “farming activity” was not a trade or business. The Tax Court agreed. The Tax Court concluded that the petitioner was not sufficiently engaged in the farming activity to give rise to deductible expenses under I.R.C. §162. Rather, the petitioner’s involvement in the farms was limited primarily to wiring funds to the farmers. That conduct was insufficient to rise to the level of a trade or business. Wegener v. Comr., T.C. Memo. 2019-98.

Lack of Substantiation Dings Taxpayer; Other Expenses To Be Capitalized. The petitioner operated a property development business through his C corporation, but failed to properly document the business purpose of some of the claimed expenses. The Tax Court, agreeing with the IRS, denied business expense deductions for numerous meals, entertainment and travel expenses. The Tax Court allowed current deductions for marketing and promotional expenses , but noted that some expenses involved the cost of bidding on a contract which were not currently deductible. In addition, the Tax Court determined that assets sold did not qualify for capital gain treatment, and that deductions claimed in one year that were recovered in another year (such as a refund of state income tax) had to be included in income in the received. Draper v. Comr., T.C. Memo. 2019-95.

Non-Cashed Retirement Plan Distribution Taxable. An employer made a distribution to the taxpayer under a qualified retirement plan. Although the taxpayer received the check and could cash it in 2019, the taxpayer chose not to do so and did not make a rollover contribution of any portion of the distribution. The IRS determined that merely holding onto the check when it could have been cashed did not cause the distribution to be exempt from tax in 2019. The IRS noted that I.R.C. §402(a) provided for taxability of an actual distribution in the year of distribution. Rev. Rul. 2019-19.

Posted August 20, 2019

Lack of Documentation Leads to Receipt of Constructive Dividends. The petitioner was the sole shareholder of a C corporation. He paid many personal expenses from the corporate account. The IRS claimed that the distributions from the corporation to the petitioner constituted dividends that the petitioner should have included in gross income. The Tax Court noted that if the corporation has sufficient earnings and profits that the distribution is a dividend to the shareholder receiving the distribution, but that if the distribution exceeds the corporation’s earnings and profits, the excess is generally a nontaxable return of capital to the extent of the shareholder’s basis in the corporation with any remaining amount taxed to the shareholder as gain from the sale or exchange of property. The Tax Court noted that the petitioner’s records did not distinguish personal living expenses from legitimate business expenses, and did not provide any way for the court to estimate or determine if any of the expenses at issue were ordinary and necessary business expenses. Thus, the court upheld the IRS determination that the petitioner received and failed to report constructive dividends. Combs v. Comr., T.C. Memo. 2019-96.

Posted August 19, 2019

Some Costs of Ancestry Kit Deductible As Medical Care. The taxpayer sought to use funds in the taxpayer’s flexible spending account to buy genetic testing services that included a DNA collection kit and health services and resulting reports. In order to use the FSA, the taxpayer sought a private ruling on whether the services and ancestry reports are “medical care” as defined in I.R.C. §213(d). The IRS noted that I.R.C. § 213(d)(1)(A) provides that “medical care” is for the diagnosis, cure, mitigation, treatment, or prevention of disease, or for the purpose of affecting any structure or function of the body. The IRS concluded that some of the taxpayer’s funds would be spent to buy health services that would be “medical care” under I.R.C. § 213(d), such as the genotyping, but that some funds would be spent on non-medical care, such as the reports that provide general information to an individual. As a result, the IRS determined that the taxpayer must allocate the price paid for the DNA collection kit and health services between the medical and non-medical items and services (i.e., between the ancestry services and the health services) using a reasonable method to determine what is medical care under I.R.C. §213(d). Priv. Ltr. Rul. 201933005 (May 16, 2019).

Posted July 14, 2019

Restrictions On Using Ride Services Apply to IRS Agents. The Chief Counsel’s Office of the IRS has taken the positions that when an IRS agent uses third-party transportation for taxpayer’s appointments, an unauthorized disclosure of confidential return information under I.R.C. §6103 could be involved. The Chief Counsel noted that “return information” includes a taxpayer’s identity and whether the return was, is being, or will be, examined or subject to other investigation or processing in accordance with I.R.C. §6103(b)(2). The Chief Counsel’s Office noted that providing a taxpayer’s name and/or address to a third party transportation provider, coupled with the agent’s job description and employing agency, could disclose that the taxpayer is under examination, criminal investigation or collection procedures, which constitutes confidential return information. The Chief Counsel’s Office concluded that third-party transportation is acceptable is the taxpayer’s identity is preserved perhaps by terminating the ride well before the taxpayer’s residence or if the driver does not know or cannot infer the reason for the ride. Prog. Mgr. Tech. Adv.2019-007.

Expenses Denied For Lack of Substantiation. The petitioner’s job required him to move and operate oil fracking equipment away from his home residence. He deducted the associated travel costs and the IRS disallowed the deductions. The Tax Court agreed with the IRS because the petitioner’s tax home had shifted due to the indefinite work position. The petitioner also owned multiple businesses for which deductions were claimed. The Tax Court also upheld the denial of the business-related deductions due to lack of documentation. Auto-related expenses were also denied due to a lack of a log or diary and the necessary detail for vehicle expense substantiation. Also disallowed was the petitioner’s expense method depreciation deduction for tools on the petitioner’s 2012 return because they were purchased and placed in service in 2011. The Tax Court also denied other expenses due to a lack of documentation or failure to show a business relationship to the expense including a deduction for contract labor because the petitioners could not show how much the worker was paid. Baca v. Comr., T.C. Memo. 2019-78.

Posted June 29, 2019

Expert Witness Report Properly Excluded in Hobby Loss Case. At issue is whether the petitioners conduct a horse-related activity with a profit intent. Presently before the court is an IRS motion to exclude from evidence the taxpayer’s expert witness report concerning the value of the horses on the basis that the report failed to satisfy Federal Rule of Evidence 702 or Tax Court Rule 143(g)(1) by not detailing facts or data on which the expert relied. The report also didn’t identify principles and methods the expert employed, or show that the expert employed the methods in a reliable way. A thumb-drive allegedly containing the data had been given to the IRS, but it was not contained in the expert’s report. The thumb-drive was given to the IRS only days before trial and contained massive amounts of data on many horses, not just the ones at issue in the litigation. The Tax Court granted the motion of the IRS to exclude the petitioner’s expert witness report. Skolnick, et al. v. Comr., T.C. Memo. 2019-64.

Horse Activity Triggers Hobby Loss Rule. The petitioners bought a horse in 2011 and participated in horse shows in 2014 and 2015. The horse was top-ten in its class nationally, and the petitioners hoped to be able to sell the horse for more than they purchased it for. However, the lost more than $100,000 and sold the horse for what they paid for it. The petitioner’s deducted the $100,000 loss and the IRS rejected the deduction and assessed a penalty exceeding $6,000. The Tax Court agreed with the IRS that the hobby loss rules under I.R.C. §183 were not satisfied in that the petitioners had not engaged in the activity with a profit intent. The Tax Court noted that the petitioners had not conducted the activity in a businesslike manner. They had no written business plan and didn’t keep accurate books and records. They also made no changes in how they conducted the activity to reduce expenses or generate additional income, and did not attempt to educate themselves on how to conduct the activity. They also did not rely on the activity as a major source of their income, and never came close to making a profit. Sapoznik v. Comr., T.C. Memo. 2019-77.

Decades of Losses Result in Application of Hobby Loss Rules. The petitioners, a married couple, sustained losses in their horse breeding/racing activity for almost 30 years without ever showing a profit. The husband was a computer programmer and his wife a retired paralegal and business executive. The wife had been a life-long horse enthusiast. They operated the activity via a partnership as a “virtual farm.” The IRS denied the loss deductions from the activity for particular years. The Tax Court agreed with the IRS on the basis that the petitioners couldn’t satisfy the requirements of the regulations under I.R.C. §183. The Tax Court noted that the evidence that it was clear that the petitioners didn’t operate the activity in a businesslike manner. The petitioners didn’t breed, race or sell any of their horses during the years at issue. While they had separate bank accounts and some records, the records were incomplete or inaccurate. While the petitioners had written business plans, the plans projected net losses and remained essentially unchanged from the original plans 30 years earlier. The petitioner long string of unbroken losses were used to offset non-farm income, and the petitioners derived substantial personal pleasure from the activity. They left the “grueling aspects” of the activity to others that they paid, and there was no evidence that they sought expert advice concerning how to make a profit at the activity. Instead, they sought only general advice. Donoghue, et ux. v. Comr., T.C. Memo. 2019-71.

Grouping Not Allowed – Passive Loss Rules Apply. The petitioner, an aviation buff, purchased an airplane that he made available for rent, used for personal purposes, and used in his other business. The petitioner used the losses from operating the airplane against income from the petitioner’s other businesses including a law practice focusing on business and aviation law. The petitioner also operated a telephone skills training business for which he conducted training seminars. The petitioner spent more than 2,000 hours in the telephone training business for the tax year in issue. He also actively participated in the rental of five properties that he owned during the tax year. The petitioner did not spend sufficient hours in the airplane business to avoid the application of the passive loss rules. Consequently, the petitioner sought to group the airplane and telephone training businesses together such that the losses from the airplane business could offset the income from the petitioner’s other activities. The Tax Court determined that the airplane activity and the telephone activity could not be grouped because they did not constitute and appropriate economic unit. The appellate court affirmed. Williams v. Comr., No.15-71505, 2019 U.S. App. LEXIS 15930 (9th Cir. May 29, 2019), aff’g., T.C. Memo. 2014-158.

Posted June 28, 2019

Wind Energy Company Engaged in Sham Transaction. In early 2012, the plaintiff placed a qualified wind facility into service at a cost of $433,077,031. The plaintiff applied for a federal taxpayer grant (in lieu of tax credits) of $129,923,109. As part of the grant application, the plaintiff submitted a development agreement that claimed to show a “proof of payment” in support of a $60 million development fee. The plaintiff, a “project company,” paid the development fee to its parent company, Invenergy, LLC. The U.S. Treasury awarded the plaintiff a grant of $117,216,098. The Treasury explained that the reason for the $12.7 million shortfall was based on the plaintiff’s excessive cost basis in the facility based on the inclusion of the development fee in the cost basis calculation. The Treasury asserted that the development fee transaction was a sham lacking economic substance shaped solely by tax avoidance motives. The court agreed. Bank records showed that money passed through the bank accounts of several entities related to the plaintiff by wire transfer and then back into the original account. The court determined that the plaintiff could not establish any business purpose or economic substance to the banking transactions. A CPA from a national firm, as the result of an audit, testified that the development agreement contained no quantifiable services. Invenergy, LLC, was not able to produce any accounting journal entries showing a business purpose for the banking transactions. Thus, the court determined that the evidence showed a development fee with no quantifiable services, circular wire transfers that started and ended in the same bank account on the same day, none of which were corroborated by independent testimony. The court denied the plaintiff reimbursement of the $12,707,011 cash grant, and the U.S. Treasury was entitled to recover an overpayment of $4,380,039. Bishop Hill Energy, LLC, et al. v. United States, No. 14-251 C, 2019 U.S. Claims LEXIS 687 (Fed. Cl. Apr. 24, 2019).

Posted June 26, 2019

Failure to Maintain Records Dooms Taxpayer. The petitioners, millionaires, had two rental properties. They ultimately abandoned both properties, but before abandoning the properties the wife spent a great deal of time cleaning and refurbishing one of the properties. The wife stayed at the property while working on it. On audit the IRS claimed that the wife used the property for personal purposes for more than 14 days. Accordingly, the IRS denied the associated rental losses in accordance with I.R.C. §280A. While the petitioners convinced the Tax Court that the time spent at the property was for work on the property rather than for personal purposes, the petitioners failed to establish real estate professional status under I.R.C. §469(c)(7) due to a lack of contemporaneous logs. In addition, the Tax Court sustained the IRS in holding that the petitioners had unreported income based on the bank deposits method. In some instances, it was clear that bank account funds came directly from one account and were promptly deposited in another account, but lack of records prevented the petitioners from establishing the source of other funds in bank accounts. Rose v. Comr., T.C. Memo. 2019-73.

Posted June 6, 2019

Book-Related Payments Are S.E. Taxable. The petitioner is a well-known writer specializing in the macabre and violent crime genre, who has a personal fascination with the inner workings of the Manson family and states that her favorite book is Helter Skelter. She received two types of payments annually from her publisher – a nonrefundable advance and a royalty. No royalty was paid until the total computed amount for the royalty exceeded the nonrefundable advance that had been paid. The petitioner claimed that only the portion of her income related to writing should be subject to self-employment tax as reported on Schedule C, and that the other royalty portion and the portion related to her name brand benefitting a publishing house was properly reported on Schedule E where it was not self-employment taxable. The Tax Court disagreed, noting that none of the petitioner’s contracts allocated advances or royalties between writing and promotion. There were also no noncompete or exclusive option clauses. The Tax Court also noted that the payments were not designated separately for writing and for the petitioner’s brand. The tax preparer also did not have copies of the petitioner’s contracts, simply breaking out the total amount the petitioner received in accordance with the time petitioner spent actually writing. The Tax Court determined that all of the petitioner’s income was associated with the petitioner’s conduct of the petitioner’s trade or business, including the brand activities. Accordingly, all of the petitioner’s income was subject to self-employment tax. The Tax Court also rejected the petitioner’s argument that Rev. Rul. 68-499, 1968-2 C.B. 421 supported her position. That ruling involved two employees that were among five persons owning patents that the employer paid royalties to for licenses to manufacture items. The IRS determined that the royalty paid to the employees was not subject to payroll tax and were not included in their W-2 income. The Tax Court, however, viewed the Rev. Rul. as irrelevant because the issue before the court was self-employment tax where the issue in the Rev. Rul. was payroll tax. The Tax Court noted that self-employment tax was tied to the taxpayer’s conduct of a trade or business whereas payroll tax focused on the definition of wages as payment to an employee for services provided to the employer. As such, all of the petitioner’s brand activities were related to the conduct of the petitioner’s trade or business of writing books. Slaughter v. Comr., T.C. Memo. 2019-65.

Posted June 4, 2019

Some Forgiven Debt Excluded From Income. The petitioner had approximately $355,000 of debt forgiven. The loans on her principal residence could not be excluded under the principal residence debt forgiveness exception (effective through 2017) because the debt was not used to acquire or substantially improve the residence. But, amount she used to pay for a driveway project on a former principal residence did qualify. The IRS also concede that the petitioner was insolvent by $42,852. Consequently, the petitioner qualified under the insolvency provision to exclude the canceled debt from income to the extent of the insolvency. She could also exclude approximately $5,000 attributable to a home equity line of credit. The remaining approximately $307,000 of canceled debt was not excludible from income. The petitioner could not show that any of it had been used to pay for home improvements. Bui v. Comr., T.C. Memo. 2019-54.

Taxpayer Can’t Establish Exchange Basis; Selling Price In Foreclosure Sale Established FMV. The petitioners sold a tract of real estate in a foreclosure sale six years after acquiring it in a like-kind exchange. At that time, the petitioner submitted Form 8824 with the return that showed the basis of the three tracts received in the exchange. At the time of the exchange, the petitioner reported that the basis had been allocated among the properties based on their relative fair market values. The tract in issue was assigned a basis of $618,767. After adjustment for assumed liabilities and those that were satisfied in the exchange, the basis of the tract was represented to be $988,938. The tract was then sold as part of another like-kind exchange and another Form 8824 was filed, coupled with information on debt and the allocation of basis to the replacement properties. A new basis was established for the replacement tract – still the tract in issue. As a result of the foreclosure sale, the IRS challenged the basis of the tract to the extent its basis was tied to the basis of the tract that was sold as part of the initial like-kind exchange (e.g., the carryover portion). The only evidence the petitioner produced to establish basis were the depreciation schedules from the tax return for the year of the first like-kind exchange. The petitioner did not produce a settlement statement or deed. The Tax Court determined that the carryforward basis had not been properly documented and limited the petitioner’s basis in the tract to the cash paid and the debt assumed at the time the tract was acquired. As for the amount of canceled debt, the Tax Court noted that the petitioner owed $10,764 at the time of foreclosure, but that the only bidder for the property bid $7,204. The IRS claimed that there was no willing seller, no appraisal, and, as such, the price paid was not the true fair market value of the property. However, the Tax Court noted that, under Treas. Reg. §1.166-6(b)(2), the bid price is presumed to be the fair market value absent clear and convincing evidence to the contrary. The Tax Court pointed out that the lack of an appraisal meant that there was no clear and convincing evidence of a true fair value to overcome the presumption that the price was the fair value. The IRS then claimed that if the bid price were the fair market value, the remaining note balance was discharge of indebtedness income taxable as ordinary income. However, the Tax Court noted that because the bank filed a proof of claim in the petitioner’s later bankruptcy proceeding the taxpayers later filed, the preponderance of evidence suggested that the balance of the loan survived the foreclosure sale. Consequently, there was not a simultaneous cancellation of indebtedness, triggering ordinary income, at that time. Thus, the petitioner had a net capital loss on the foreclosure sales which was less than the petitioner originally reported, but more than the IRS claimed. Breland v. Commissioner, TC Memo 2019-59.

Posted May 31, 2019

Multi-Million Charitable Deduction Denied For Failure to Substantiate Basis. The petitioner donated an LLC interest that was subject to a prior estate-for-years to a university. The petitioner included an Appraisal Summary (Form 8283) with the return, but the Appraisal Summary failed to disclose the basis in the donated LLC interest which had been purchased for $2,950,000. The petitioner made the donation 17 months after the interest had been purchased and claimed a charitable deduction associated with the donated interest of $33,019,000. Two years after receiving the LLC interest, the done sold it for $1,940,000 to another LLC that the donor indirectly owned. On appeal, the appellate court affirmed because the petitioner failed to comply with the requirements of Treas. Reg. §1.170A-13 for the lack of disclose of the income tax basis of the LLC interest in a manner to allow IRS to determine the allowable deduction. The appellate court also upheld a 40 percent accuracy-related penalty under I.R.C. §6662 for gross valuation misstatement because the state value of the donated property was more than 400 percent of the property’s actual value. The appellate court also held that the petitioner did not show a good faith investigation under I.R.C. §6664(c)(3) to qualify for the reasonable cause exception to the penalty. The petitioner did not show any attempt had been made to investigate the value of the interest in addition to the appraisal. RERI Holdings I, LLC v. Commissioner, 149 T.C. No. 1 (July 3, 2017), aff’d., sub. nom., Blau v. Comr., No. 17-1266, 2019 U.S. App. LEXIS 15510 (D.C. Cir. May 24, 2019).

Posted May 26, 2019

IRS Can’t Change Code Via Administrative Notice. The petitioner received a Form W-2 reporting a difficulty of care payment under I.R.C. §131(c). However, such payments are excluded from income as a type of qualified foster care payment if made under a state’s foster care program. In Tech. Adv. Memo. 2010-007, the IRS took the position that the payment of a difficulty care payment to the parent of a disabled child to the parent was not excludible because the “ordinary meaning” of foster care excluded care by a biological payment. But, in Notice 2014-7, the IRS treated the payment as nontaxable to the recipient. The petitioner did not include the payment in income, but did include the amount as earned income in computing the earned income credit under I.R.C. §32 and in computing the refundable child tax credit under I.R.C. §24. The IRS position was that since the amount was not taxable under Notice 2014-7, the amount did not count as earned income for computing the credits. I.R.C. §32(c)(2)(A)(i) states that earned income includes wages, salaries, tips and other employee compensation that has been included in gross income for the tax year. The petitioner claimed that nothing in I.R.C. §131 allowed the IRS to treat the payment as not includible in gross income. The court agreed, with the result that the petitioner could exclude the difficulty of care payment and obtain credits on that (untaxed) earned income. Feigh v. Comr., 152 T.C. No. 15 (2019).

S Corporation is Related Party to ESOP Beneficiaries – No Accrued Wage Deduction. The taxpayer was the founder and owner of an S corporation. During the tax years at issue, 2009-2010, the corporation maintained an employee stock ownership plan (ESOP) for its employees that owned stock in the corporation. During those same two years, the corporation, accrued expenses for wages, vacation pay and other payroll items on behalf of its employees. Some of the accrued expenses were not paid until the following year. The IRS claimed that the ESOP was a “trust” within the definition of I.R.C. §267(c)(1) with the result that the beneficiaries (the ESOP-participating employees) were related persons and the corporation could not accrue wages to be paid to participants in the ESOP. I.R.C. §267(a) bars taxpayers from receiving a tax benefit for a related accrual basis taxpayer for an item that won’t be treated as income for the related party until a later year. I.R.C. §267(e) says that, with respect to an S corporation, an S corporation is a related party to a holder of any interest in the corporation whether that interest is held directly or indirectly. The Tax Court held that the ESOP was a trust for purposes of the related party rules and the Tenth Circuit affirmed. Petersen v. Comr., No. 17-9003, 2019 U.S. App. LEXIS 14360 (10 th Cir. May 15, 2019), aff’g., 148 T.C. 463 (2017).

Posted May 19, 2019

Taxpayer Materially Participated in Money Lending Business. The petitioner sold his trucking business and started a money lending business with an office in Chicago that capitalized on the network of contacts in the Chicago construction industry he had made while running his trucking business. The money lending business office was staffed with an accountant and a secretary. The petitioner made the determinations regarding making loans and the handling of loans that were in default. While the petitioner didn’t have another job that occupied his time, he only spent about 40 percent of the year in Chicago. He lived in Florida the balance of the time. He only worked about 200 days annually, from the Chicago office and from his Florida home. While in Chicago, he lived either in his home or his apartment. He did maintain a regular office schedule when in Chicago, working in the office at least 460 hours per year. When in Florida, he called the office daily and communicated via phone, fax and email. He averaged about two hours per day on lending business while in Florida. The money lending business lost money and the petitioner deducted the losses and also claimed a carryover net operating loss (NOL) to 2011 and 2012. The IRS denied the losses on the basis that the petitioner was not materially participating in the business and that the losses were passive losses that could only offset passive income. The IRS asserted deficiencies and penalties for 2009-2012 totaling over $600,000. The court noted that the petitioner cleared the 100-hour hurdle of Treas. Reg. §1.469-5T(a), and that the facts revealed that the participated in the business on a basis that was regular, continuous and substantial. Thus, the losses were fully deductible. He also participated more than 500 hours, but the court did not mention the application the 500-hour test in the Treasury Regulations. The court, however, ruled that the petitioner was potentially liable for penalties attributable to an underpayment of tax from other adjustments unrelated to the issue of material participation. Barbara v. Comr., T.C. Memo. 2019-50.

No Basis Increase in S Corporate Stock. The taxpayer was a shareholder in an S corporation that bought a condominium complex in a bankruptcy sale. To fund its operations, the S corporation accepted funds from numerous related entities. Ultimately, lenders foreclosed on the complex, triggering a large loss which flowed through to the taxpayer. The taxpayer deducted the loss, claiming that the amounts that the related entities advanced created stock basis (debt basis) allowing the deduction. The IRS disallowed the deduction and he Tax Court agreed. The appellate court affirmed on the grounds that the advances were not back-to-back loans, either in form or in substance. In addition, the related entities were not “incorporated pocketbooks” of the taxpayer. There was no economic outlay by the taxpayer that would constitute basis. There was no contemporaneous documentation supporting the notion that the loans between the taxpayer and the related entities were back-to-back loans (e.g., amounts loaned to a shareholder who then loans the funds to the taxpayer), and an accountant’s year-end reclassification of the transfers was not persuasive. While the taxpayer owned many of the related entities, they acted as business entities that both disbursed and distributed funds for the S corporation’s business expenses. The appellate court noted the lack of caselaw supporting the notion that a group of non-wholly owned entities that both receive and disburse funds can be an incorporated pocketbook. To generate basis, the appellate court noted, a loan must run directly between an S corporation and the shareholder. Meruelo v. Comr., No. 18-11909, 2019 U.S. App. LEXIS 13305 (11th Cir. May 6, 2019).

Posted April 29, 2019

Tribal Casino Income Distributions Included in Taxable Income. The taxpayers were members of an Indian Tribe. They operated a casino on tribal land that all of the tribe members owned communally. The tribe made distributions of casino revenue to members, but the taxpayers at issue did not report the distributions in income on the basis that they exempt from federal tax as being derived directly from tribal land. The Tax Court disagreed because the tribe had not made any allotment of tracts of land to tribe members. The Tax Court, however, did not uphold an accuracy-related penalty or substantial understatement penalty for lack of supervisor approval for the penalties. Osceola v. Comr., 152 T.C. No. 13 (2019).

Nebraska Law Providing Tax Relief For Destroyed Real Estate Constitutional. During its 2019 session, the Nebraska Unicameral has proposed LB 512. The proposed law would provide property tax relief to taxpayers with destroyed real property. The Nebraska Attorney General was asked to opine as to whether the proposal would violate the uniformity clause of the Nebraska Constitution. The legislation directs county boards of equalization to adjust the value of certain destroyed real property after local assessors identify and report the destroyed property. The Nebraska Attorney General concluded that while the law could be construed as providing for a non-uniform standard, there is justification for the separate classification. The Nebraska Attorney General determined that there is a '"substantial difference of situation or circumstances"' to warrant the separate classification due to the classification being based on real property destroyed by a natural disaster. However, the Attorney General suggested that the law be amended to remove destroyed property from the January 1 assessment date and clarify what is meant by the terms "natural disaster" and "destroyed." The Attorney General further recommended a change to the time frame for action by the local entities. Neb. Atty. Gen. Op. No. 19-006 (Apr. 24, 2019).

Iowa Guidance on Non-Conformity To Limitation on Interest Expense. The Iowa Department of Revenue (IDOR) has issued guidance on Iowa’s nonconformity to I.R.C. §163(i) for 2018. That provision limits the business interest expense deduction. The IDOR notes that taxpayers whose business interest expense deduction was limited for federal purposes will need to make adjustments to claim the larger Iowa deduction for 2018. For individuals, IDOR notes, the adjustments are reported on the IA 1040, Line 14, code U. For all other taxpayers, the adjustments are to be reported on the 2018 Nonconformity Adjustments Worksheet, Line 3. In the case of partnerships, the entity is not allowed to carry the deduction forward to future tax years for federal purposes. Instead, partnerships report the excess amount to their partners on the 2018 federal Schedule K-1 (Form 1065), Line 13, Code K, and the partners use the amount to make adjustments to the partner’s own interest expense limitation, if any, in future years, following the instructions on the federal forms. The IDOR also provided guidance on partners or S corporation shareholders who receive Iowa K-1s, and partners and shareholders who receive federal K-1s, but not Iowa K-1s. The IDOR notes that Iowa conforms to I.R.C. §163(i) for 2019. Thus, the Iowa interest expense deduction will generally be the same as the federal deduction, except that taxpayers who were allowed to deduct the full amount of interest expense in 2018 may have to make adjustments to any federal 2018 carryforward amounts claimed in future years. The IDOR notes that certain special adjustments may be needed in the case of partnerships, S corporations, and their partners or shareholders. IDOR, Guidance, Partnership Interest Nonconformity Adjustment, (Apr. 23, 2019).

IRS Explains Farm Income Averaging/QBID Relationship. Under a farm income averaging election (I.R.C. §1301), a farm taxpayer income tax liability is the sum of the I.R.C. §1 tax computed on taxable income reduced by “elected farm income” (EFI) plus the increase in tax imposed by I.R.C. §1 that would result if taxable income for the three prior years were increased by an amount equal to one-third of the EFI. The IRS has stated that "[i]n figuring the amount [of the]... Qualified Business Income Deduction, income, gains, losses, and deductions from farming or fishing should be taken into account, but only to the extent that deduction is attributable to your farming or fishing business and included in elected farm income on line 2a of Schedule J (Form 1040)." This appears to be saying that if an income averaging election is made, the taxpayer must use EFI to calculate the QBID. In other words, once the farm income averaging election is made, the taxpayer must use EFI to calculate the QBID. This appears to be consistent with I.R.C. §199A(c)(3)(A)(ii). Elected Farm Income May Be Used To Figure Qualified Business Income Deduction, IRS Website, Apr.19, 2019.

Court Construes Illinois Bankruptcy Law Application to IRA. Under Illinois bankruptcy law, "A debtor's interest in or right, whether vested or not, to the assets held in or to receive pensions, annuities, benefits, distributions, refunds of contributions, or other payments under a retirement plan is exempt from judgment, attachment, execution, distress for rent, and seizure for the satisfaction of debts if the plan is intended in good faith to qualify as a retirement plan under applicable provisions of the Internal Revenue Code... or..." (735 ILCS § 5/12-1006(a)) A "retirement plan" includes an individual retirement annuity or individual retirement account. (735 ILCS § 5/12-1006(b)(3)). State law also bars buying property with the intent of converting nonexempt property into exempt property. Under I.R.C. §408(d)(1), amounts distributed from an IRA are included in the payee’s gross income. But, under I.R.C. §408(d)(3), the amount is excluded if the entire amount is later paid into an eligible retirement plan no later than 60 days after the date on which the payee receives the distribution. In this case, the debtor withdrew $50,000 from his IRA on April 16, 2018. He then used $30,000 to buy lottery tickets. He put the remaining $20,000 into another IRA on June 15, 2018. He then filed bankruptcy on October 22, 2018. The bankruptcy trustee claimed that the $20,000 was not exempt because they had been commingled with other funds in the debtor’s checking account and could no longer be determined to be the exact $20,000 withdrawn from the original IRA. The court flatly rejected the trustee’s argument, noting that there is no tracing requirement that requires the originally withdrawn funds to be the same funds rolled over into another qualified account within the 60-day timeframe. The court also noted that the trustee did not allege any fraud with respect to the transfer from the personal account to the new retirement account, nor claim that the debtor bought property with the intent of converting nonexempt property into exempt property. As a result, the $20,000 was exempt. In re Jones, No. 18-31532, 2019 Bankr. LEXIS 1198 (Bankr. S.D. Ill. Apr. 15, 2019).

Obamacare’s Individual Mandate is a Tax For Bankruptcy Purposes. I.R.C. §5000A establishes the “individual mandate penalty” (repealed effective for months beginning after 12/31/18) that specifies that if a taxpayer or an individual for whom the taxpayer is liable isn't covered under minimum essential coverage for health insurance for one or more months, then, unless an exemption applies, the taxpayer is liable for the individual shared responsibility payment on his return. The Bankruptcy Code, in accordance with 11 U.S.C. §1328(a), allows a debt to be discharged unless it is listed as a priority claim in 11 U.S.C. §507(a). Priority taxes cannot be discharged, but a penalty amount is dischargeable. In this case, the debtors (a married couple) filed a proof of claim that included a $2,085 mandate assessment which the debtors claimed was dischargeable as a penalty. The IRS disagreed, citing National Federation of Independent Business v. Sebelius, 567 U.S. 519 (2012) in which the U.S. Supreme Court concluded that the assessment was a tax for constitutional purposes and cited the Bankruptcy Code in making its determination. The court also found that refusing to purchase health insurance and instead paying an assessment didn't constitute an "unlawful act," which was a strong indication that the individual mandate was not a penalty. In addition, the legislative history implied that the individual mandate was a tax since Congress referred multiple times to how it would raise revenue, the court said. Thus, the assessment was a nondischargeable tax and was entitled to priority under 11 U.S.C. §507(a)(8) and the court denied the debtors’ objection to the IRS claim. In re Cousins, No. 18-10739, 2019 Bankr. LEXIS 1156 (Bankr. E.D. La. Apr. 10, 2019).

Posted April 25, 2019

Tinkering Isn’t Research. I.R.C. §174 provides a 20 percent credit for qualified research and experimental expenditures over a base period amount, But, the expenditures must be for research and development costs.  That means they must be research and development expenses as those terms are construed in a laboratory sense that are incurred to discover processes and related information that would reduce/eliminate product uncertainty or development.  Routine product testing expenses don't qualify. In addition, costs must be allocated with respect to a research activity between qualified expenses and those that are not qualified expenses, such as between salary (not eligible) and quality control testing (eligible). Four tests must be satisfied to claim the credit:  the I.R.C. §174 test; a technological information test; a business component test; and a process of experimentation test. The taxpayer, upon the advice of a CPA firm, claimed the credit with respect to seven projects for the years at issue. However, the IRS claimed that the taxpayer had not proven that substantially all of the activities for which it claimed credits were a part of a process of experimentation.  The Tax Court agreed.  Thus, none of the projects constituted qualified research eligible for the 20 percent credit. Siemer Milling Co. v. Comr., T.C. Memo. 2019-37.

Posted April 16, 2019

IRS Says 2 Percent S Corporation Shareholder Can Claim Self-Employed Health Insurance Deduction. I.R.C. §1372 says that, for purposes of applying the provisions of the I.R.C. that relate to employee fringe benefits, an S corporation is treated as a partnership. Likewise, any 2 percent (as defined in I.R.C. §318 as owning more than two percent of the corporate stock) S corporation shareholder is treated as a partner in the partnership in accordance with I.R.C. §1372. An S corporation can deduct the cost of accident and health insurance premiums that the S corporation pays for or furnishes on behalf (i.e., reimburses) of its 2 percent shareholders. The two percent shareholders must include the amounts in gross income in accordance with Notice 2008-1, 2008-2 IRB 251 (i.e., the S corporation reports the amounts as wages on the shareholder’s W-2) provided that the shareholder meets the requirements of I.R.C. §162(l) and the S corporation establishes the plan providing medical care coverage. Under the facts of the CCA, a taxpayer owned 100 percent of an S corporation which employed the taxpayer’s family member. The family member is a two-percent shareholder under the attribution rules of I.R.C. §318. The S corporation provides a group health plan for all employees, and the amounts paid by the S corporation under the plan are included in the family members gross income. Provided the requirements of I.R.C. §162(l) are satisfied, the IRS determined that the family member could claim a deduction for the amounts the S corporation paid. Thus, the family member could convert what might be a nondeductible expense (because of either the 10 percent floor for medical expenses or because the family member takes the standard deduction) into an above-the-line deduction. C.C.A. 2019012001 (Dec. 21, 2018).

Posted April 14, 2019

No More “Black Hole” For Refund Claims. The taxpayer’s 2012 federal income tax return was due on April 15, 2013. By April 15, 2013, the taxpayer had already made income tax payments for 2012 totaling $112,000. On April 15, 2013, the taxpayer was granted a six-month extension for filing the return. The taxpayer failed to file her return by the extended due date and on June 19, 2015, the IRS issued a notice of deficiency asserting that she owed $1,666,463 in 2012 income tax and $572,756.90 in penalties. The taxpayer filed her 2012 return on August 29, 2015 reporting an income tax liability of $79,559. The parties stipulated that amount was correct. The return also reported an overpayment of $32,441. The taxpayer then filed a Tax Court petition seeking a redetermination of the 2012 tax deficiency and a refund for the overpayment. The issue before the court was whether the Tax Court had jurisdiction to order a refund of the overpayment, and the Tax Court determined that it did not based on I.R.C. §6512(b)(3). That Code section, the Tax Court reasoned, only entitled the taxpayer to a two-year lookback period for any refund based on its language which reads, “…where the date of the mailing of the notice of deficiency is during the third year after the due date (with extension) for filing the return of tax and no return was filed before such date, the applicable period under subsections (a) and (b)(2) or section 6511 shall be three years.” Thus, because no return had originally been filed and the IRS had issued a notice of deficiency before the return was filed, the taxpayer couldn’t claim a refund by filing a return after the issuance of the notice. The notice was issued in June of 2015 for the 2012 return that had an original due date of April 15, 2013 and an extended due date of October 15, 2013. Thus, according to the Tax Court, the notice was after the standard two-year statute for refund claims. On appeal, the appellate court reversed. The appellate court noted that I.R.C. §6511(b)(2)(A) provides for a look-back period of three years plus the period for any extensions. Thus, the taxpayer had retained the right to pursue the refund even though the IRS issued the notice of deficiency more than 2 years after the original due date, but before the date two years after the extended due date. Borenstein v. Comr., No. 17-3900, 2019 U.S. App. LEXIS 9650 (2d Cir. Apr. 2, 2019), rev’g., 149 T.C. 263 (2017).

IRS Provides Guidance on Home Office Deduction. The IRS has provided guidance on how the $10,000 limitation on the deduction of state and local taxes (SALT) under the Tax Cuts and Jobs Act (TCJA) and I.R.C. §280A work in conjunction with each other. For a taxpayer with SALT deductions at or exceeding $10,000, or who chooses to take the standard deduction, none of the SALT relating to the taxpayer’s business use of the home are treated as expenses under I.R.C. §280A(b). However, expenses relating to the taxpayer’s exclusive use of a portion of the taxpayer’s personal residence for business purposes remain deductible under I.R.C. §280A(b) or (c) or under another exception to the general rule of disallowance in I.R.C. §280A. The same rationale applies to other deductions that are subject to various limitations or disallowances, including home mortgage interest and casualty losses. For instance, interest on a mortgage balance exceeding the acquisition debt limitations becomes an I.R.C. §280A(c) limited expense when claiming a home office deduction. IRS Program Manager Technical Advice 2019-001 (Dec. 7, 2018).

Posted March 23, 2019

No Deduction For Personal Deduction of Estate Expenses. The plaintiff was the death beneficiary of her father’s defined benefit plan. During life, her father had made “basic employee contributions” to the plan from salary via payroll deductions from pre-tax income. Additional employee contributions were made from post-tax earnings. Upon her father’s death in 1994, the plan administrator notified the plaintiff that the total benefit payable was slightly over $400,000 with about 97 percent of that amount derived from the employer’s share. There was no indication given of how much of the other 3 percent was derived from post-tax additional employee contributions. The plaintiff was payed an annual annuity as the beneficiary of about $30,000. She also paid various expenses associated with the estate, including administration costs such as funeral expenses and professional fees with these amounts deducted on the state estate tax return. For 2009 and 2010, the plaintiff reported the full amount of annuity distributions for those years, but claimed that a portion of them was excludible from gross income. She also claimed that the expenses incurred associated with the estate were an estate tax Schedule A itemized deduction as a net operating loss carryforward to the 2009 tax year. The Tax Court determined that the father’s investment in the defined benefit plan was his entire contribution of $11,245. However, the plaintiff’s investment was limited to $5,000 under former I.R.C. §101 applicable as of the father’s death (pre-’96) which allowed that amount as an exclusion for amounts paid to an employee’s beneficiaries by or on behalf of an employer account of an employer’s death. The Tax Court also noted that the evidence “strongly-suggested” that the father’s contribution was the required pre-tax basic employee contribution. There was no evidence of any after-tax employee contribution or that any of the employer’s share of $392,584 was previously included in the father’s gross income. Thus, the Tax Court held, that none of the death benefit other than the $5,000 exclusion was an investment in the plan. Based on that, the Tax Court calculated an exclusion ratio amount of less than $100 of the annual pension payment which it allowed for 2009 and 2010. The Tax Court also disallowed the plaintiff’s itemized deductions for funeral expenses and estate administration fees. Funeral expenses are personal or family expenses only allowable to the estate via I.R.C. §2053, and estate administration expenses as personal. The Tax Court also disallowed the NOL carryforward on the same grounds. The appellate court affirmed. Harrell v. Comr., No. 17-4133, 2019 U.S. App. LEXIS 7670 (2nd Cir. Mar. 13, 2019).

REIT Revenue From Oil/Gas Investment Is Rent From Real Property. The taxpayer is a real estate investment trust (REIT) that primarily invests in U.S. energy infrastructure assets and intended to acquire an offshore oil and gas platform, storage tank facilities and pipelines (all of which are real property under I.R.C. §856). The platform includes equipment to manage the extraction and conditioning of oil and gas. The REIT will enter into a multi-year lease that provides the platform lessee with the exclusive right to use the platform and the equipment. The fair market value (FMV) of any personal property, including the equipment, leased to the platform lessee will be less than 15 percent of the total FMV of the real and personal property leased to the platform lessee. The platform lessee will be solely responsible for operating, maintaining and repairing the platform, equipment and any other property associated with the platform. The taxpayer will not perform any activities, and no services will be furnished, in connection with the lease of the platform or equipment. The IRS concluded that the platform rent, storage fees, and pipeline fees to be received will qualify as rents from real property under I.R.C. §856(d) for purposes of the I.R.C. §856(c)(2) 95 percent test and the I.R.C. §856(c)(3) 75 percent test. Priv. Ltr. Rul. 201907001 (Feb. 15, 2019).

Posted March 16, 2019

Ministerial Housing Allowance Income Exclusion Constitutional – Trial Court Reversed. 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 trial 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. The trial court stayed its opinion pending appeal. On further review, the appellate court reversed. The appellate court noted that while the exclusion of housing provided for the convenience of the employer provision was not made available to ministers of the gospel, the Congress soon provided an exclusion for church-provided ministerial housing as well as the cash allowance provision of I.R.C. §107(2) at issue in this case. The appellate court determined that the provision was simply an additional provision providing tax exemption to employees that having a work-related housing requirement. The appellate court viewed a categorial exemption for ministers as requiring much less government “entanglement” in religion than lumping ministers under the general employer-provided housing exclusion of I.R.C. §119. The appellate court also noted the long history of tax exemption for religious organizations, and deemed this long history of significance and that I.R.C. §§107(1)-(2) continued that history. Gaylor, et al., v. Mnuchin, No. 18-1277 (7th Cir. Mar. 15, 2019), rev’g., Gaylor v. Mnuchin, 16-cv-215-bbc, 2017 U.S. Dist. LEXIS 165957 (W.D. Wisc. Oct. 6, 2017).

Posted March 13, 2019

Advance PATC Must Be Included In Income If Ineligibility Later Determined. The petitioners obtained government-mandated health insurance by participating in an Obamacare exchange. They paid monthly premiums for the insurance and elected to receive an advance premium assistance tax credit (PATC) based on their projected household income and their expected eligibility for the PATC under I.R.C. §36B. The advance PATC totaled $8,420 for the year in issue, reducing the monthly premium by over $700. They filed a joint return for 2014, the year in issue, reporting adjusted gross income of $97,061, but did not attach Form 8962 (for the PATC) to the return or reconcile their advance PATC with their eligibility for the PATC. The IRS disallowed the $8,420 PATC. The petitioners filed a petition with the Tax Court and filed a motion for summary judgment asserting that the insurance companies in the exchange committed malfeasance that negated the benefit of the premiums that they paid and that other taxpayers paid on their behalf. The Tax Court noted that the PATC is available to taxpayers with household income that doesn’t exceed 400 percent of the federal poverty line (FPL) based on household size. In addition, the taxpayer is to reconcile the receipt of advance PATC with their eligibility for the PATC when the return for the year is filed and if the advance PATC exceeds PATC eligibility, the taxpayer must report the difference as additional income tax. The Tax Court noted that the petitioners had income exceeding 400 percent of the FPL for a two-person household and, thus, were ineligible for the advance PATC. Thus, the petitioners’ tax liability was properly increased by the advance PATC. The statute, the Tax Court noted, makes no provision for equitable exceptions under state law. The Tax Court noted that if the petitioners wanted to pursue their malfeasance claim, they were free to do so elsewhere. Kerns v. Comr., T.C. Memo. 2019-14.

Posted March 12, 2019

Excluded Social Security Must Be Included For Premium Assistance Tax Credit Computation. The petitioner elected to exclude a lump sum Social Security payment (which related to prior years) from gross income in 2014 under I.R.C. §86(e) and also excluded the amount from modified adjusted gross income (MAGI) for purposes of determining the premium assistance tax credit (PATC) under I.R.C. §36B. The IRS included the amount in MAGI for purposes of computing the PATC. The Tax Court agreed with the IRS. The court noted that the PATC can be taken in advance and then must be reconciled via Form 8962 at year-end to determine the actual PATC claimed on the return. The court noted that I.R.C. §36B(d)(2)(B) defines MAGI for purposes of the PATC and includes social security benefits that are not included in gross income via I.R.C. §86. The petitioner claimed that the amounts related to prior years should not be include in income for purposes of the PATC claimed on the 2014 return. The court held that because the taxpayer reported income on the cash basis, the year of receipt (2014) controlled the issue of inclusion in income of the social security benefits in accordance with Treas. Reg. §1.451-1(a). While the PATC code language of I.R.C. §36B is silent with respect to the effect on MAGI if an election is made under I.R.C. §86(e), the court held that I.R.C. §36B and the underlying regulations required that social security benefits received in a tax year that were not included in gross income under I.R.C. §86 for the tax year must be added to the taxpayer’s MAGI. As a result, the petitioner’s MAGI exceeded the threshold for PTC eligibility for 2014. Johnson v. Comr., 152 T.C. No. 6 (2019).

Posted March 9, 2019

“Roberts Tax” Is a Non-Dischargeable Priority Claim in Bankruptcy. The debtor filed Chapter 13 bankruptcy. The IRS filed a proof of priority claim for $5,100.10, later amending the claim to $5,795.10 with $695 of that amount being an excise tax under I.R.C. §5000A as a result of the debtor’s failure to maintain government mandated health insurance under Obamacare. The debtor object to the $695 amount being a priority claim that could not be discharged, and the bankruptcy court agreed, finding that the “Roberts Tax” under Obamacare was not a priority claim, but rather a dischargeable penalty in a Chapter 13 case. On appeal, the appellate court reversed. The appellate court noted that the creditor bore the burden to establish that the Roberts Tax was a priority claim and noted that it was the purpose and substance of the statute creating the tax that controlled whether the tax was a tax or a penalty. The appellate court noted that a tax is a pecuniary burden levied for the purpose of supporting government while a monetary penalty is a punishment for an unlawful act or omission. On this point, the appellate court noted that Chief Justice Roberts, in National Federation of Independent Business v. Sebelius, 567 U.S. 519 (2012), upheld the constitutionality of Obamacare on the basis that the “shared responsibility payment” was a tax paid via a federal income tax return and had no application to persons who did not pay federal income tax. The appellate court noted that the amount was collected by the IRS and produced revenue for the government. It also did not punish an individual for any unlawful activity and, the appellate court noted, the IRS has no criminal enforcement authority if a taxpayer failed to pay the amount. United States v. Chesteen, No. 18-2077, 2019 U.S. Dist. LEXIS 29346 (E.D. La. Feb. 25, 2019).

Posted March 4, 2019

IRS Can Charge For PTINs Because They Are A Service That Aids Tax Compliance and Administration. 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 “registered tax return preparer.” 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 preparer’s 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 “thing of value” 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 “service or thing of value.” The trial 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 trial court held that the IRS cannot impose user fees for PTINs. The trial court determined that PTINs are not a “service or thing of value” 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. The trial court determined that 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. On appeal, the appellate court vacated the trial court’s decision and remanded the case. The appellate court determined that the IRS does provide a service in exchange for the PTIN fee which the court defined as the service of providing preparers a PTIN and enabling preparers to place the PTIN on a return rather than their Social Security number and generating and maintaining a PTIN database. Thus, according to the appellate court, the PTIN fee was associated with an “identifiable group” rather than the public at large and the fee was justified on that ground under the Independent Offices Appropriations Act. The appellate court also believed the IRS claim that the PTIN fee improves tax compliance and administration. The appellate court remanded the casefor further proceeding, including an assessment of whether the amount of the PTIN fee unreasonable exceeds the costs to the IRS to issue and maintain PTINs. Montrois, et al. v. United States, No. 17-5204, 2019 U.S. App. LEXIS 6260 (D.C. Cir. Mar. 1, 2019), vac’g,. and rem’g., Steele v. United States, 260 F. Supp. 3d 52 (D. D.C. 2017).

No Charitable Deduction For Lack of Substantiation. The petitioner claimed a charitable deduction in 2010 for over $107,000 attributable to land improvements to property that a charity owned. The improvements occurred over several years and were made by the petitioner’s LLC. The petitioner did not claim any charitable deductions in the years that the improvements were made. The IRS denied the deduction and the Tax Court agreed. The petitioner conceded that the did not own the improvements, and the Tax Court noted that the petitioner could not claim the deduction in 2010 because the improvements were paid for in years preceding 2010. In addition, the Tax Court noted that even if the improvements had been paid for in 2010, the amounts that the LLC paid for were not directly connected with or solely attributable to the rendering of services by the LLC to the charity as Treas. Reg. §1.170A-1(g) requires. In addition, the Tax Court determined that the petitioner did not satisfy the substantiation requirements and did not include Form 8283 and did not have an appraisal of the improvements made as required when a charitable deduction exceeding $5,000 is claimed. Presley v. Comr., T.C. Memo. 2018-171.

No Charitable Deduction for Donated Conservation Easement. The petitioner claimed a $10.4 million charitable deduction related to the donation of a permanent conservation easement on a golf course. The IRS denied the deduction on the basis that the easement was not exclusively for conservation purposes because it didn’t protect a relatively natural habitat of fish, wildlife, or plants, or a similar ecosystem as required by I.R.C. §170(h)(4)(A)(ii). The IRS also asserted that the donation did not preserve open space for the scenic enjoyment of the general public or in accordance with a governmental conservation policy for the public’s benefit under I.R.C. §170(h)(4)(A)(iii). The Tax Court agreed with the IRS and denied the deduction. The Tax Court determined that the “natural habitat” requirement was not met – there was only one rare, endangered or threatened species with a habitat of only 7.5 percent of the easement area. In addition, the Tax Court noted that part of the golf course was designed to drain into this habitat area which would introduce chemicals into it. Thus, the easement’s preservation of open space was not for public enjoyment nor in accordance with a governmental policy of conservation. Champions Retreat Golf Founders, LLC v. Comr., T.C. Memo. 2018-146.

Posted March 2, 2019

Subordination Requirement Strictly Applied - Conservation Easement Perpetuity Requirement Not Satisfied; Penalties Tacked-On. The petitioner acquired a building in 2001 for $58.5 million. In 2004, the petitioner transferred a façade easement on the building via deed to a qualified charity (a preservation council) to preserve the exterior building perimeter. The easement deed placed restrictions on the petitioner and its successors with respect to the façade easement and the building – the petitioner and any subsequent owner couldn’t demolish or alter the protected elements without the charity’s permission. The building was subject to two mortgages, but before executing the easement deed, the petitioner obtained mortgage subordination agreements from its mortgagee banks. However, 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. By the time of the easement donation, the value of the building had increased to $257 million, of which $33.4 million was attributable to the easement. The petitioner claimed a $33.4 million 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. The IRS assessed a gross valuation misstatement penalty in 2008 and additional accuracy-related and negligence penalties in 2014. The petitioner contested the penalties, but the Tax Court, in a later proceeding, determined that there is no requirement that IRS determine the penalties at the same time or by the same IRS agent. The only requirement, the Tax Court held, was that each penalty, at the time of initial determination, was approved in writing by a supervisor before being communicated to the petitioner. That requirement was satisfied. Palmolive Building Investors, LLC v. Comr., 149 T.C. No. 18 (2017). Later proceeding on the penalty issue at 152 T.C. No. 4 (2019).

Posted February 27, 2019

No Supreme Court Review of Hobby Loss Case. The petitioner operated a real estate group that her father had founded. In 1998, the petitioner started a quarter horse breeding, training, showing and selling business. In operating the horse business, the petitioner bought the best mares; acquired stallions to breed; bred the mares; produced foals; and culled some foals and trained the balance. The petitioner did not have a formal business plan other than a five-page handwritten “business plan” that included a single-page income and expense projection that her CPA prepared in response to an IRS audit. Sometime after 2005, the petitioner moved some of the horses from Virginia to Texas and contracted with businesses there. The petitioner traveled to Texas once annually for approximately a week each time. The petitioner maintained a separate mailing address for the horse activity and also a separate checking account that she used to pay most of the horse-related expenses. She also maintained a separate brokerage account for the horse activity that she used to pay show fees, camping fees and other horse-related expenses. The petitioner reviewed the horse activity invoices and receipts once monthly. For tax years 2004-2010, the horse activity lost money, with approximately $2 million of losses incurred in just two of those years. The IRS, on audit, denied the loss deductions from the horse activity on the basis that the activity was not conducted with a profit intent. The petitioner was not entitled to the presumption of profit intent because the activity did not produce income in excess of deductions for any two of seven consecutive years. The Tax Court examined the nine factors for determining a profit intent under Treas. Reg. §1.183-2(b) and concluded that the petitioner did not have a profit intent. The appellate court affirmed and the U.S. Supreme Court declined to hear the case. Hylton v. Comr., T.C. Memo. 2016-234, aff’d., No. 17-1776, 2018 U.S. App. LEXIS 35001 (4th Cir. 2018), cert. den., No. 18-789, 2019 U.S. LEXIS 966 (U.S. Sup. Ct. Feb. 19, 2019).

Posted February 23, 2019

State Law Violates Intergovernmental Tax Immunity Doctrine. The plaintiff resided in West Virginia and retired from the U.S. Marshals Service. West Virginia taxed his federal pension benefits. However, West Virginia does not subject the pension benefits of certain former state and local law enforcement employees via an exemption contained in W. Va. Code Ann. §11-21-12(c)(6). The plaintiff claimed that the state law violated the Intergovernmental Tax Immunity Doctrine (ITID). Under the ITID, the U.S. consents to the way a state taxes the pay or compensation of federal employees, but only if the state tax does not discriminate on the basis of the source of the pay or compensation. The trial court agreed with the plaintiff on the basis that there was no significant difference between the plaintiff’s job duties before retirement and those of state and local law enforcement employees. On appeal, the state Supreme Court reversed. The state Supreme Court noted that the exemption applied only to a narrow class of state retirees and was not intended to discriminate against former federal marshals. On further review, the U.S. Supreme Court unanimously reversed for the same reasons that the trial court found for determining the law violated the ITID. Dawson v. Steager, No. 17-419, 2019 U.S. LEXIS 1349 (U.S. Sup. Ct. Feb. 20, 2019).

Posted February 21, 2019

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), acq. in result only, A.O.D. 2019-01.

Posted February 19, 2019

Value of Employer-Provided Meals Largely Included in Income. An employer provided meals to employees and an IRS examining agent sought guidance on whether the employer provided meals were excludible from the employees’ income. The National Office of IRS determined that the value of the meals was not excludible because of the employer’s goals of providing a secure business environment for confidential business discussions; innovation and collaboration; for employee protection due to unsafe conditions surrounding the business premises; and for improvement of employee health; and because of the shortened meal period policy. The National Office determined that the employer’s reasons weren't substantial non-compensatory business reasons as I.R.C. §119 requires. However, the IRS National Office determined that to the extent the taxpayer provided meals so that employees were available to handle emergency outages, the value of those meals were excludable from income under I.R.C. §119. Likewise, snacks provided to employees were excludible as a de minimis fringe.  Tech. Adv. Memo. 201903017 (Jan. 18, 2019).

Posted February 18, 2019

Settlement Proceeds Excludible if Paid on Account of Physical Injury or Sickness. The petitioner sued his former employer for emotional distress damages he allegedly sustained as a result of being fired. The suit settled, and the employer issued the petitioner Form 1099-MIsc. to report the amount paid. The petitioner did not report the amount, claiming that they were excludible from income under I.R.C. §104(a)(2). The IRS rejected that argument and the Tax Court agreed. The Tax Court noted that the petitioner had to prove that there was a direct causal link between the damages and personal injuries sustained. The Tax Court held that while the petitioner had physical symptoms such as nausea, vomiting and headaches, those symptoms were within the definition of nonexcludable emotional distress damages. The Tax Court, however, did not impose an accuracy-related penalty by virtue of the petitioner relying of professional tax advice and because the IRS examining agents did not seek supervisory approval for imposing penalties. Doyle v. Comr., T.C. Memo. 2019-8.

Posted February 17, 2019

No Sales Tax Exemption on Farm Machinery and Equipment Purchases. The taxpayer purchased farm machinery and equipment and sought to exclude the purchase from Arkansas sales tax via an exemption for machinery and equipment used in farming. The state denied the exemption on the basis that the taxpayer failed to demonstrate that he was engaged in farming as a commercial business or that the equipment was used directly and exclusively in farming. At an administrative hearing, the judge determined that the taxpayer’s activity and use of the equipment and machinery was more like land development rather than the production of food or fiber as a commercial business. The taxpayer use the machinery and equipment to initially prepare a section of the property for construction his family residence and build a fence around the property and home. These were merely indirect uses and, as a result, the taxpayer was not entitled to the exemption. Ark. Admin. Hearing Decision, Docket. No. 19-45, (Jan. 31, 2019.)

NOLs Can’t Be Carried Back. The plaintiff sought a refund attributable to his 2004 return based on a net operating loss (NOL) carryback. The IRS denied the carryback and the plaintiff paid the deficiency and sought a refund in court. The trial court disallowed the refund and the plaintiff appealed. The appellate court affirmed, determining that the application for refund based on an NOL carryback was not a claim refund in accordance with I.R.C. §6411(a). In addition, the appellate court noted that the plaintiff did not timely file a 2004 refund claim under I.R.C. §7422(a). In addition, the appellate court held that the plaintiff’s claim fell outside of I.R.C. §1346(a)(1) which meant that the trial court did not have jurisdiction over the claim. The plaintiff also sought a refund for 2005 based on an NOL carryback. However, the appellate court held that the plaintiff failed to meet his burden of proof of entitlement to a refund for 2005. The appellate court also held that the government was not equitably estopped from denying his refund requests. Silipigno v. United States, No. 17-2452, 2019 U.S. App. LEXIS 3191 (2nd Cir. Jan. 30, 2019), affn’g., 2017 U.S. Dist. LEXIS 107608 (N.D.N.Y. Jul. 12, 2017).

No Reversal of NOL Carryback to Wipe Out Tax Obligation. The plaintiffs, a married couple, signed and filed their 2013 federal income tax returns in which their paid preparer had overstated a net operating loss (NOL) of almost $4.7 million from the plaintiffs’ business, an investment firm. The loss was carried back and offset income in 2011 and 2012, generating refunds for those years. The plaintiffs also signed their 2014 return for which the preparer had elected to waive an NOL of approximately $12 million in accordance with I.R.C. §172(b)(3).  The preparer believed that no tax liabilities remained in the years to which the loss would be carried under the default rules (2015 and later years) and attached the election to the return which meant that the loss could only be carried forward. The preparer did not notify the plaintiffs of the waiver because she believed that the 2013 NOL would cover any past tax liability. Upon audit of the 2011-2014 returns, the IRS disallowed the overstated NOL and assessed a deficiency of $685,000 for 2012. The plaintiffs attempted to change the 2014 election waiver so as to carryback the 2014 loss to offset the tax liability, but the IRS rejected the ability to do so claiming that the plaintiffs had waived the right. The Tax Court agreed, and the plaintiffs appealed. The appellate court affirmed on the basis that I.R.C.§172(b)(3) states the election, one made, is irrevocable. In addition, the appellate court noted that when the plaintiffs signed the return at issue they affirmed that they had examined it, further confirming that the election was irrevocable. The appellate court noted that there is nothing in the statute that required either the court or the IRS to judge the plaintiffs’ subjective intent in making the election. Bea v. Commissioner, No. 18-10511, 2019 U.S. App. LEXIS 3153 (11th Cir. Jan. 31, 2019).

Posted January 25, 2019

Fertilizer Is Not “Propagative Material” Exempt From State Privilege Tax. The plaintiff sells fertilizer and pesticides to farmers. In 2014, the plaintiff filed a refund claim with the defendant claiming that the plaintiff paid $8,312,145.51 in state privilege tax between 2010 and 2013 on fertilizer, pesticide and seed sales that it should have been exempt from paying under Ariz. Rev. Stat. §42-5061(A)(33). That statutory provision permits a taxpayer to deduct “[s]ales of seeds, seedlings, roots, bulbs, cuttings and other propagative material” from its tax base. Alternatively, the plaintiff claimed that sales of fertilizer were exempt from state privilege tax as “sales for resale” under Ariz. Admin. Code §R15-5-101(A). The defendant denied the refund claim. After exhausting administrative appeals, the plaintiff sought judicial review. The trial court ruled for the defendant and the plaintiff appealed. The appellate court looked at both the common and technical meanings of “propagative material,” finding that “propagation” is a term used in horticulture to mean "the artificial multiplication of plants by vegetative means, including the taking of cuttings, layering, budding, and grafting[.]" Because fertilizers and pesticides do not reproduce or multiply plants, the court concluded that the taxpayer's sales of fertilizer and pesticides were not eligible for the exemption. In addition, the taxpayer's sales to farmers were not deemed sales for resale because the farmers purchased the products for their own use and not for resale. Wilbur-Ellis Co., et al. v. Arizona Department of Revenue, No. CA-TX 17-003, 2019 Ariz. App. Unpub. LEXIS 78 (Ariz. Ct. App. Jan. 22, 2019).

CFO of Medical Practice Is Perfect – Scores 100 Percent Tax Penalty. The plaintiff, a medical doctor, founded a professional medical association, in 1979. Another person was named the chief financial officer CFO of the business. The CFO ran the day-to-day operations, managed the business finances, controlled the company's bank accounts, and was responsible for preparing and filing payroll-tax returns The CFO also maintained the company’s books and records, paid creditors and determined the order of payment. The CFO was also authorized to hire and fire employees. The business started to accumulate tax debt in 2003, and by 2009 the business owed more than $11 million in employee payroll taxes. The CFO knew of the failure to file corporate tax returns or to make federal-tax deposits. From 2003 to 2009, the CFO paid the business’s creditors, other than IRS, after learning of the unpaid tax debt. In 2011, the IRS assessed $4,323,343.70 in trust-fund-recovery penalties against the CFO under I.R.C. §6672, alleging that he was liable for the failure to pay federal payroll taxes from July 2003 to December 2008. The IRS also assessed penalties against the plaintiff. The plaintiff paid a nominal portion of the assessment and sued the government for a refund of the amount paid and an abatement of the penalties. The government counterclaimed against the plaintiff and the CFO to recover the assessments. Ultimately, the government moved for summary judgment on the counterclaim against the CFO claiming that the CFO was liable to pay the to pay the trust-fund-recovery penalties because he was a "responsible person" who "willfully" failed to deposit payroll taxes. The CFO failed to respond to the motion. The court determined that the CFO satisfied the requirements to be a responsible person as set forth in Barnett v. Internal Revenue Service, 988 F.2d 1449 (5th Cir. 1993). Willfulness, the court noted requires only a voluntary, conscious, and intentional act, rather than a bad motive or evil intent. Simply being a responsible person that knew of the entity’s unpaid liabilities and failed to apply certain amounts toward them was sufficient to constitute willfulness. McClendon v. United States, No. H-15-2664, 2019 U.S. Dist. LEXIS 9600 (S.D. Tex. Jan. 22, 2019).

Posted January 21, 2019

Louisiana Guidance on Commercial Farmer Certification Process. In Louisiana, effective Jan. 1, 2018, a ”commercial farmer“ is a person who is (1) occupationally engaged in producing food or agricultural commodities for sale or for further use in producing food or such commodities for consumption or sale; (2) is regularly engaged in the commercial production for sale of vegetables, fruits, crops, livestock and other food or agricultural products; and (3) reports farm income and expenses on a federal Schedule F or similar federal tax form. Effective , January 15, 2019, the state has begun implementing a new certification process requiring certification as a commercial farmer to claim exemption from sales and use tax. Certification requires the completion and submission of Form R-1085 and attachment of federal Schedule F. Old farmer exemption certificates remain valid through June 30, 2019. Starting July 1, 2019, a copy of the certification must be attached to the completed exemption certificate for the farmer to receive an exemption from sales and use tax on the purchase of farm-related items. Dealers are advised to request and retain from each commercial farmer a copy of the current commercial farmer certification and applicable exemption certification and exemption certificate. Failure to do so result in the dealer being liable for payment of sale and use tax. Louisiana Revenue Information Bulletin, No. 18-025 (Jan. 15, 2019).

Posted January 20, 2019

Horse Activity Was Hobby – Losses Disallowed. The taxpayers operated a horse activity in Arkansas. Arkansas has adopted I.R.C. §183 for purposes of determining the deductibility of business losses claimed on Schedule F. Thus, if an activity is not engaged in for profit, the deductions from the activity are disallowed. Horse activities are presumed to operate for a profit if the activity shows a profit for at least two of the previous seven years. In the present case, the presumption was inapplicable because the activity never showed a profit from 2008-2017. The state revenue department determined that none of the nine factors contained in Treas. Reg. §1.183-2(b), were in the taxpayers’ favor even though three of them were neutral. No negligence penalty was imposed. Ark. Admin. Hearing Dec., No. 19-096-098 (Jan. 15, 2019).

Posted January 17, 2019

Without Sufficient Contact, State Can’t Tax Trust. The trust at issue, a revocable living trust, was created in 1992 with a situs of New York. The primary beneficiaries were the settlor’s descendants. None of the descendants lived in North Carolina at the time of the trust’s creation. The trust was divided into three separate trusts in 2002, one for each of the settlor’s children. The beneficiary of one of the sub-trusts was a North Carolina resident at that time. The trustee was replaced in 2005 with a successor trustee who resided in Connecticut. North Carolina tax returns were filed for tax years 2005-2008 for the accumulated trust income, that was distributed to the beneficiaries, including the non-North Carolina beneficiaries. In 2009, the trust filed a claim for a refund of North Carolina taxes in an amount slightly exceeding $1.3 million. The trust claimed that N.C. Gen. Stat. §105-160.2, which assesses tax on the amount of taxable income of the estate or trust that is for the benefit of a North Carolina resident, was unconstitutional on due process and Commerce Clause grounds. The defendant denied the claim, and the hearing officer later dismissed the case for lack of jurisdiction. The trial court dismissed the request for injunctive relief with respect to the refund claim, but denied the defendant’s motion to dismiss the constitutional claims. The trial court then granted summary judgment for the trust on the constitutional claim and ordered the defendant to refund the taxes paid on its accumulated income. On appeal, the appellate court affirmed. The court determined that the trust failed to have sufficient minimum contacts (as required by the Due Process Clause) with North Carolina to subject the trust to North Carolina income tax. The court cited both International Shoe Co. v. Washington, 326 U.S. 310 (1945) and Quill Corp. v. North Dakota, 504 U.S. 298 (1992) to support its position on this point. The trust did not have any physical presence in the state during the tax years at issue, contained no North Carolina property or investments, had no trust records that were created or kept in North Carolina, and the place of trust administration was not in North Carolina. Basing the imposition of state tax on a beneficiary’s domicile, by itself, did not establish sufficient minimum contacts with the state to satisfy the Due Process Clause and allow North Carolina to tax a non-North Carolina trust. The appellate court held that Brooke v. Norfolk, 277 U.S. 27 (1928) was controlling. In that case, a Maryland resident created a testamentary trust with a Maryland situs for a Virginia beneficiary. Virginia assessed tax on the trust corpus, but the Court held the assessment to be unconstitutional. On further review, the state Supreme Court affirmed, also noting that a key to the case was that the trust beneficiary did not receive trust distributions during the years at issue. As such, the North Carolina statute violated the Due Process Clause of the U.S. Constitution. On January 11, 2019, the U.S. Supreme Court agreed to hear the case. Kimberley Rice Kaestner Trust 1992 Family Trust v. North Carolina Department of Revenue, 789 S.E.2d 645 (N.C. Ct. App. 2016), aff'd., 814 S.E.2d 43 (N.C. 2018), pet. for cert. granted, No. 18-457, 2019 U.S. LEXIS 574 (U.S. Sup. Ct. Jan. 11, 2019).

Posted January 16, 2019

Disallowance of State Conservation Easement Tax Credit Timely. A corporation donated a conservation easement and transferred part of the resulting state tax credit to the defendants, a married couple. The defendants claimed the credit on their 2006 state income tax return. In 2007, the transferor corporation also claimed the credit and the state disallowed the credit in its entirety. The defendant claimed that the state’s notice of disallowance in March of 2011 was untimely because their 2006 filing triggered a four-year statute of limitations for the state to disallow a claimed credit. The state claimed that the corporation’s filing of a 2007 return tolled the statute and that the disallowance was timely. The trial court determined that the disallowance was timely, but the appellate court reversed, finding that the first filed return claiming the credit (2006) tolled the statute and, as a result, the state’s disallowance was not timely. On appeal, the State Supreme Court reversed. The Supreme Court determined that Col. Rev. Stat. §39-22-522(7)(i) and CO Dept. of Rev. Reg. §201-2:39-22-522(3)(g)(i) tolled the statute of limitations when the donor filed a return in October of 2007 claiming the credit. Because that occurred with the filing of the corporation’s 2011 return, the state’s disallowance within four years of the filing date of the 2007 return was timely. The Supreme Court reversed the decision of the court of appeals and remanded the case. Colorado v. Medved, No. 17SC33, 2019 Colo. LEXIS 25 (Colo. Sup. Ct. Jan. 14, 2019).

Minnesota Beginning Farmer Credit Guidance. The Minnesota Department of Revenue has issued a release explaining the beginning farmer management credit (BFMC). The BFMC is a nonrefundable credit, effective for tax years beginning after 2017, that a “beginning farmer” can claim after participating in a financial management program approved by the Rural Finance Authority (RFA) and becoming “certified.” The BFMC is potentially available to a taxpayer that owns agricultural assets and either sells or rents them to a “beginning farmer” in Minnesota. Unused portions of the BFMC can be carried over for up to 15 years. The BFMC is tied to the type of sale or lease of agricultural assets and the price or fair market value of the asset that are sold or leased. For an asset sale, the BFMC is five percent of the lesser of the selling price or hte fair market value of the assets, capped at $32,000. For rental agreements, the credit can be 10 percent of gross rental income capped at $7,000 annually for the first three years of the lease. If the rental is a share lease, the credit can be 15 percent of the cash equivalent of the gross rental income, capped at $10,000 annually for the first three years. The final amount of the BFMC is subject to approval by the RFA. is the amount a taxpayer paid, capped at $1,500, for participating in an RFA-approved financial management program. The BFMC is claimed on Schedule M1C, and the certificate number must be entered on the Schedule which is filed with the taxpayer’s MN return. Beginning Farmer Management Credit, Minnesota Dept. of Revenue (Jan. 4, 2019); Tax Credit for Owners of Agricultural Assets, Minnesota Dept. of Revenue (Jan. 8, 2019).

Posted January 15, 2019

Wisconsin Explains Tax Reporting of Capital Gains and Losses. The Wisconsin Department of Revenue (WDOR) has updated a publication to be used in preparing 2018 returns to explain the differences between Wisconsin and federal law in reporting capital gains and losses on Wisconsin and federal income tax returns. The WDOR noted that the amount of capital gain and loss to include in Wisconsin taxable income is computed on Schedule WD, Capital Gains and Losses, or Schedule 2WD for estates and trusts. The WDOR also noted that there are no substantive changes from the 2017 version of the publication. Importantly, the WDOR publication reflects the WDOR’s position concerning state law laws effective December 1, 2018. Wisconsin Department of Revenue, “Reporting Capital Gains and Losses for Wisconsin by Individuals, Estates and Trusts,” Pub. No. 103 (Jan. 2019).

Guidance on Withholding for Minnesota Ag Workers. The Minnesota Department of Revenue has revised a release that explains the state's income tax withholding responsibilities as they relate to agricultural workers. According to the release, if a person employs ag workers who work or reside in Minnesota and the employer is required to withhold federal income tax from the employees' wages, the employer must also withhold Minnesota income tax. However, before the employer begins withholding Minnesota income tax from employee wages, the employer must have a Minnesota tax ID number and be registered for withholding tax. If not, a $100 penalty applies. Minnesota Withholding Tax Fact Sheet No. 3, (Jan. 1, 2019).

Cancelled Debt Is Taxable Income. The petitioner, a financial advisor, joined a new brokerage firm that loaned him $3.6 million as a signing bonus. The loan was evidenced by a promissory note with $40,000 due and payable monthly and would be deducted from the taxpayer's compensation, a common industry practice. However, the petitioner was forced to resign and, according to the terms of the employment agreement, the loan became due and payable. The taxpayer disputed the forced resignation and brought an action against the brokerage firm. FINRA (Financial Industry Regulatory Authority) was asked to resolve the dispute through arbitration. FINRA determined that the loan should be forgiven but did not explain the rationale for their decision. The petitioner claimed that the unpaid portion of the loan proceeds was merely compensation for his book of business and the settlement should be taxed as a capital gain. The Tax Court noted that amounts received for injury or damage to capital assets in excess of basis would be taxable as capital gain, but that amounts received for lost profits are taxable as ordinary income. The Tax Court determined that the petitioner did not meet his burden to establish that the book of business was the reason for the settlement. The Tax Court held that the extinguishment of the taxpayer's debt constituted cancellation of debt income and the full amount was taxable as ordinary income. Connell v. Comr., T.C. Memo. 2018-213.

Posted December 31, 2018

No Sales Tax Exemption For Farm Repair Parts. The Arkansas Department of Finance and Administration has issue a legal opinion taking the position that, under Arkansas law, repair parts, component parts of farm machinery and chicken wire fencing are not entitled to a sales tax exemption as farm machinery and equipment. In addition, the Department took the position that the sales of electric motors purchased to repair a wench, feedline or fan, and cool cell pumps that are component parts of an evaporative cooling system are taxable on the basis of existing regulations providing that repair parts and labor are likewise not exempt as farm machinery. Ark. Reg. §GR-51(C)(3)(e). The Department also concluded that the sale of chicken wire fencing is taxable because fencing is not farm machinery and equipment, and also because fencing is not used directly in the production of food or fiber. The Department, however, did not reach any conclusion of the applicability of the exemption for services rendered in the removal of poultry equipment and systems and remodel facilities and install new systems without information specific to a particular situation. Arkansas Department of Finance and Administration, Legal Opinion No. 20181013 (Dec. 10, 2018).

Posted December 28

No Charitable Deduction for Conservation Easement. The petitioner acquired a tract and later conveyed conservation easements on small portions of the property to a qualified land trust, intending to claim a tax deduction for the value of the contribution pursuant to I.R.C. §170. Each easement set forth a defined area that was to be perpetually restricted from being developed and also specified where “building areas” could occur, all with the state purpose of protecting natural habitats of fish and wildlife and preserve open space to provide scenic enjoyment to the public. However, the easement conveyed in 2006 did not delineate the location of the building areas, and the 2005 easement conveyed allowed the petitioner (with the consent of the qualified land trust), to shift the building areas to another location within the conservation area. The 2005 easement also allowed the petitioner to construct in the conservation area such things as barns, riding stables, scenic overlooks, boat storage buildings, etc. The petitioner claimed charitable deductions for the easements which the IRS denied on the basis that the easements weren’t qualified real property interests under I.R.C. §170(h)(1)(A) and were not used exclusively for conservation purposes under I.R.C. §170(h)(1)(C), and that the fair market value of the easements were overstated. A majority of the full Tax Court agreed with the IRS because the easements did not restrict development on a specific, identifiable piece of property and it appeared that the petitioner could take back the conserved areas and use it for residential development that were not subject to the conservation easements. As such, the Tax Court determined that the easements did not constitute “a restriction (granted in perpetuity) on the use which may be made of the real property…”. The Tax Court, however, pointed out that the easement conveyed in 2007 did cover a specific, identifiable tract and was granted in perpetuity and was made exclusively for conservation purposes and did not reserve in the petitioner any right to construct structures appurtenant to residential development. In addition, the Tax Court noted that the language in the 2007 easement providing for amendments did not disturb the qualified nature of the easement because any amendment had to be “not inconsistent with the conservation purposes of the donation.” The Tax Court, in denying the charitable deduction for the 2005 and 2006 easements followed its decision in Belk v. Comr., 140 T.C. 1 (2013) which the Fourth Circuit affirmed. Belk v. Comr., 774 F.3d 221 (4th Cir. 2014). The Tax Court also determined that the acceptable boundary modification provisions present in the easements involved in Bosque Canyon Ranch II, L.P. v. Comr., 867 F.3d 547 (5th Cir. 2017) were distinguishable from those in Belk because they didn’t allow any the exterior boundaries of the easements or the acreages to change. Pine Mountain Preserve, LLLP v. Comr., 151 T.C. No. 14 (2018).

Posted December 27, 2018

Court Rules on Willful FBAR Reporting Failure Standard. 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 trial 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 trial court determined that the failure to file an FBAR for 2007 was not willful based on the facts. Rather, the trial court determined that the plaintiff simply committed an unintentional oversight or a negligent act. The trial court determined that did not do anything to conceal or mislead and inadvertently failed to report the second account on the FBAR. The trial 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 trial 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 trial 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. On further review, the appellate court held that it did not have exclusive jurisdiction under 28 U.S.C. §1295(a)(2) to review appeals from the trial court’s final judgment on a claim against the government for recovery of a civil FBAR penalty. The appellate court also concluded that the standard of willfulness for FBAR purposes referred to the civil willfulness standard, which included both knowing and reckless conduct. Accordingly, the appellate court remanded the case because it was not clear whether the trial court judged the taxpayer’s conduct under this standard. Bedrosian v. United States, 17-3525, 2018 U.S. App. LEXIS 36146 (3d Cir. Dec. 21, 2018), remanding No. 15-5853, 2017 U.S. Dist. LEXIS 154625 (E.D. Pa. Sept. 20, 2017).

No Deductions for Medical Marijuana Dispensary. The petitioner, a corporation, operated a medical marijuana dispensary in a state where medical marijuana is legal. As a result of doing business, the corporation incurred business expenses and attempted to deduct expenses that were allegedly not associated with medical marijuana. To do so, the corporation allocated expenses between its trafficking and non-trafficking activities. An S corporation was organized to handle the daily operations for the petitioner, including the payment of employee wages and salaries. The petitioner deducted business expenses that it claimed were not associated with trafficking activities, and also adjusted its cost of goods sold (COGS) to include indirect expenses in accordance with I.R.C. §263A. The IRS determined that both the petitioner’s and the S corporation’s sole trade or business was trafficking in a controlled substance. Thus, I.R.C. §280E barred any business expense deductions. The IRS also determined that the shareholders of the S corporation had underreported their flowthrough income from the S corporation, and that the petitioner could not claim COGS in an amount greater than what the IRS had previously allowed. The IRS applied an accuracy-related penalty to the petitioner. The Tax Court agreed, holding that both the petitioner and the S corporation were barred by I.R.C. §280E from deducting business expenses; that the petitioner could not claim COGS greater than what IRS had allowed; and that the S corporation shareholders underreported their flowthrough income. The Tax Court also upheld the accuracy-related penalty. Alternative Health Care Advocates, et al. v. Comr., 151 T.C. No. 13 (2018).

Posted December 25, 2018

IRS Provides More Ways To Avoid “Roberts” Tax. The IRS has identified additional “hardship” exemptions from the penalty (“Roberts”) tax of I.R.C. §5000A for a taxpayer failing to have the mandated government-approved health insurance under Obamacare for 2018. The additional exemptions apply when the taxpayer establishes that he has experienced financial or domestic circumstances causing a significant, unexpected increase in essential expenses barring the taxpayer from obtaining health insurance coverage. An exemption also applies if the taxpayer can establish that acquiring health insurance would have cause the taxpayer to experience serious deprivation of food, shelter, clothing or other necessities. In addition, the IRS specified that an exemption applies if the taxpayer establishes that any other circumstance prevented the taxpayer from obtaining health insurance coverage. Notice 2019-5, 2019-2 IRB.

IRS Issues Guidance on TCJA Depreciation Rules. In a Revenue Procedure, the IRS noted that for property placed in service after 2017 qualified improvement property as defined by I.R.C. §168(e)(6) as defined in I.R.C. §168(k)(3) in effect as of December 21, 2017. Also eligible is an improvement to nonresidential real property as defined in I.R.C. §168(e)(2)(B) if the improvement is placed in service after the date the nonresidential real property was first placed in service by any person, is I.R.C. §1250 property and is either a roof, HVAC system, fire protection and alarm system or security system. Also provided is an optional depreciation table for 30-years ADS property, and guidance on how to handle the change to ADS depreciation for certain farming assets of electing farm and real property businesses. Rev. Proc. 2019-8, 2019-3 I.R.B.

IRS and Treasury Reach Different Conclusions on Brokerage Services As SSBs. Prop. Treas. Reg. §1.199A-5(b)(2)(x) states that “the performance of services in the field of brokerage services includes services in which a person arranges transactions between a buyer and a seller with respect to securities (as defined in section 475(c)(2)) for a commission or fee. This includes services provided by stock brokers and other similar professionals, but does not include services provided by real estate agents and brokers, or insurance agents and brokers.” Thus services provided by real estate agents and brokers or insurance agents and brokers do not constitute an SSB. However, in the draft of Publication 535, the IRS states that a specified service business for purposes of I.R.C. §199A include, “Brokerage services, including arranging transactions between a buyer and a seller for a commission or fee such as stock brokers, real estate agents and brokers, insurance agents and brokers, and intellectual property brokers. Thus, Pub. 535 includes categories that the proposed treasury regulation excludes. Publication 535 also includes intellectual property brokers as an SSB, but the proposed regulations don’t make any mention of whether intellectual property brokers are included. IRS Draft Publication 535.

IRS Provides Guidance on Market Facilitation Payments. The IRS National Office has issued guidance to IRS national program executives and managers concerning certain tax issues involving the issuance by the USDA of Market Facilitation Payments (MFPs). The IRS noted that MFPs are direct payments to farmers of certain crops that have been adversely affected by tariffs. The IRS noted that the purpose of the MFPs is to make up for depressed crop prices caused by tariffs and that the payments are tied to what a farmer actually produced in 2018. The IRS noted that MFPs are intended to compensate a farmer for lost profits and, as such, are included in gross income in accordance with I.R.C. §61(a). See also Rev. Rul. 73-408, 1973-2 C.B. 15; Rev. Rul. 68-44, 1968-1 C.B. 191. The IRS also determined that MFPs are similar to counter-cyclical and price-loss payments authorized under prior Farm Bills which a farmer/recipient had to include in gross income. In addition, the IRS determined that MFPs are included in net earnings from self-employment and, thus, subject to self-employment tax because the MFPs are tied to earnings derived by a farmer from the farming business. See, e.g., Ray v. Comr., T.C. Memo. 1996-436. While the IRS did not comment on the issue, MFPs are also not deferrable as are crop insurance payments paid for actual physical destruction to the taxpayer’s crops. As noted, MFPs are payments for lost profit rather than to compensate a producer for physical damage or destruction to crop, or the inability to plant (the requirement for deferability under I.R.C. §451(f)). IRS Legal Advice to Program Managers, PMTA-2018-21 (Dec. 10, 2018).

Posted December 23, 2018

Personal Property Tax Changes in Nebraska. The Nebraska Dept. of Rev. has issued a bulletin summarizing the changes to the definition of “adjusted basis” for certain types of property in relation to I.R.C. §179. For property purchased after 2017 and before 2020, for which I.R.C. §179 has been elected, and the asset is traded-in as part of the payment for newly acquired property, the adjusted basis for Nebraska tax purposes is the remaining net book value of the asset in the year of the trade-in plus any additional cash paid (boot). The Guidance Bulletin also says that all farm machinery and equipment placed in service after 2017 is 5-yr. MACRS property, but this appears to be a misconstruction of the TCJA. Neb. Dept. of Rev. Guidance Bulletin, Dec. 2018.

Posted December 22, 2018

Elimination of Tax Associated With Individual Mandate Renders Health Care Law Invalid. The Tax Cuts and Jobs Act of 2017 reduces to zero, effective for tax years beginning after 2018, the tax rate of the payment for an individual failing to have governmentally-acceptable health insurance in accordance with the 2010 Patient Protection and Affordable Care Act (i.e., “Obamacare). In National Federation of Independent Business v. Sebelius, 567 U.S. 519 (2012), the Supreme Court upheld Obamacare as constitutional on the sole basis that the individual mandate, as the linchpin to the entire law, was constitutional under the taxing power of the Congress because the payment required for not having government-acceptable health insurance was a tax rather than a penalty. In the present case, the court noted that the payment was distinct from the individual mandate and determined that the individual mandate was no longer constitutional as of 1/1/2019 because it would no longer trigger any tax. In addition, because the individual mandate was the linchpin of the entire law, the provision could not be severed from the balance of the law. As a result, as of January 1, 2019, Obamacare no longer has any constitutional basis and is invalidated as being unconstitutional. Texas v. United States, No. 4:18-cv-00167-O, 2018 U.S. Dist. LEXIS 211547 (N.D. Tex. Dec. 14, 2018).

Posted December 15, 2018

No Deductions Due to Poor Records. The petitioners, a married couple claimed various business expenses on Schedule C. They self-prepared their return for 2014, the year in issue. Their Schedule C reported no gross receipts and total expenses of $28,173. They also claimed unreimbursed employee expenses of $23,931 on Schedule A. The IRS denied the Schedule C and Schedule A deductions and also took the position that the petitioners failed to report $25,622 of IRA distributions (and the associated penalty for early withdrawal). The IRS also determined that the petitioners failed to report $123,168 of cancelled debt income. The IRS also imposed a penalty for underpayment of tax associated with the substantial understatement of tax. The Tax Court determined that the wife failed to provide sufficient evidence that she was engaged in a business with a profit motive. The Tax Court also concluded that the wife failed to substantiate any of the business expenses associated with the wife’s business and provided no means for the court to estimate those expenses under the Cohan rule. In addition, the court noted that the Cohan rule has no application to I.R.C. §274(d) expenses (e.g., travel and entertainment expenses, gifts and listed property which are subject to strict substantiation requirements). While the petitioners claimed that they should not be subject to the 10 percent penalty for early withdrawal from their IRA because the withdrawn funds were used to pay for their daughter’s college tuition, The Tax Court, however, upheld the penalty because the petitioners failed to establish that the withdrawn funds were actually used to pay the daughter’s tuition. The Tax Court also upheld the imposition of a 20 percent penalty for substantial understatement of tax. On that issue, the Tax Court noted that the petitioners were college-educated and used a tax software (TurboTax), that software was not the same as relying on professional tax advice. Dasent v. Commissioner, T.C. Memo. 2018-202.

Property Tax Exemption for Farm Buildings Extended. The NY governor has announced the extension of the state property tax exemption for farm buildings for an additional 10 years. The exemption applies to eligible applicants with “structures and buildings” that are essential to the operation of lands that are actively used for agricultural purposes. Press Release, Office of Governor Cuomo (Dec. 4, 2018).

No Property Tax Exemption For Nonprofit Ag “Marketplace.” The taxpayer operated a “marketplace” that sold locally produced foods and was used for local farming-related activities. The taxpayer claimed that those activities were exclusively used in its charitable work. The taxpayer also provided educational programming in coordination with local schools, including field trips to local farms and volunteer labor program assistance to farmers and ranchers. The state denied a real property tax exemption for the taxpayer, and the state tax court agreed. The tax court determined that the evidence demonstrated that the taxpayer’s primary activity did not include any element of gifting or giving. Central Oregon Locavore v. Deschutes County Assessor, No. TC-MD 170319G (Oregon Tax Ct. Nov. 27, 2018).

ATV Used on Farm Not Exempt From Sales Tax. The taxpayer was an 18-year old that lived on his parent’s 500-acre farm. He bought an all-terrain vehicle (ATV) and did not pay sales tax on the purchase. The taxpayer claimed that the sale was tax-exempt because the ATV was to be used in farming to haul seed, grain, fertilizer, livestock feed and hay. The taxpayer also asserted that he would use the ATV to help in removing rocks from fields and to haul trash and garbage. When asked, the taxpayer did not submit the requested federal tax return documents. The state Department of Revenue denied the exemption because it couldn’t verify the taxpayer’s eligibility for the exemption and determine that the taxpayer was actually engaged in the business of farming. On further review, it was held that the taxpayer failed to show that the ATV was primarily used in a farming business. As a result, the ATV was not exempt from sales tax. Wells v. Testa, No. 2017-1342 (Ohio Bd. Tax App. Dec. 5, 2018).

Illinois Enacts Property Tax Abatement for Urban Areas Growing Ag Products. The Illinois General Assembly, via a veto override, has enacted legislation that provides for a property tax abatement for property located within an urban ag area that is used by a qualifying farmer for processing, growing raising or otherwise producing agricultural products. The abatement is possible after a majority vote of the governing body of a taxing authority and after a determination of the assessed value of the property. Parcels that are already assessed as farmland are ineligible, unless the property is reassessed and becomes eligible as a result. H3418 (P.A. 100-1133, effective Jun. 1, 2019).

Posted December 14, 2018

Land-Clearing Equipment Not Exempt From Sales Tax. The taxpayer purchased several pieces of land-clearing equipment for the purpose of “re-claiming” the land, maintaining crop land and maintaining roads. The taxpayer took the position that the purchase was not subject to sales tax under the exemption for farm machinery and equipment (Ark. Code Ann. §26-52-403). The exemption applies the such items that are used exclusively and directly for the agricultural production of food or fiber as a commercial business or the agricultural production of grass sod or nursery product as a commercial business. The Arkansas Department of Finance and Administration denied the exemption on the basis that the equipment was not used directly production of agricultural commodities. Ark. Admin. Hearing Decision, No. 19-013 (Ark. Dept. of Finance and Admin. Decision, Dec. 3, 2018).

ATV Used on Farm Not Exempt From Sales Tax. The taxpayer was an 18-year old that lived on his parent’s 500-acre farm. He bought an all-terrain vehicle (ATV) and did not pay sales tax on the purchase. The taxpayer claimed that the sale was tax-exempt because the ATV was to be used in farming to haul seed, grain, fertilizer, livestock feed and hay. The taxpayer also asserted that he would use the ATV to help in removing rocks from fields and to haul trash and garbage. When asked, the taxpayer did not submit the requested federal tax return documents. The state Department of Revenue denied the exemption because it couldn’t verify the taxpayer’s eligibility for the exemption and determine that the taxpayer was actually engaged in the business of farming. On further review, it was held that the taxpayer failed to show that the ATV was primarily used in a farming business. As a result, the ATV was not exempt from sales tax. Wells v. Testa, No. 2017-1342 (Ohio Bd. Tax App. Dec. 5, 2018).

Posted December 13, 2018

Capitalization Required For Interest and Real Property Taxes Associated with Crops Having More Than Two-Year Pre-productive 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 “production of real property” (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 pre-productive period of the crop or plant exceeds two years. I.R.C. §263A(f)(1) states that “interest 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.” 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 “real property produced by the taxpayer for the taxpayer’s use in a trade or business or in an activity conducted for profit” included “land” and “unsevered natural products of the land” and that “unsevered natural products of the land” generally includes growing crops and plants where the pre-productive period of the crop or plant exceeds two years. Because almond trees have a pre-productive period exceeding two years in accordance with IRS Notice 2000-45, and because the land was “necessarily intertwined” 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., No-17-71810, 2018 U.S. App. LEXIS 34267 (9th Cir. Dec. 5, 2018), aff’g., T.C. Memo. 2016-224.

Posted December 8, 2018

Minnesota Trust Taxation Law Unconstitutional. The grantor created four trusts in 2009. At the time of creation of the trusts, the grantor resided in Minnesota. Each trust was funded with shares of nonvoting common stock in a family S corporation. The trustee of each trust was domiciled in California. The grantor retained control over the trust assets, thus making them “grantor type trusts” for the first 30 months for Minnesota income tax purposes. This meant that the grantor was taxed on the income/loss of the trusts, and the trusts did not need to file a Minnesota state tax return. At the end of 2011, the grantor relinquished power to substitute assets in the trusts and the trusts ceased to be grantor trusts and became irrevocable trusts and classified as “resident trusts” under Minn. Stat. §290.1, subd. 7b(a)(2) because the grantor remained domiciled in Minnesota at the time the trusts became irrevocable. At that time, a Colorado resident became the sole trustee of each trust. For 2012 and 2013, the trusts filed Minnesota income tax returns as resident trusts. In mid-2014, a resident of Texas became trustee of the trusts. Later in 2014, all shareholders of the family S corporation and the trusts sold their stock. The trusts paid Minnesota tax on the trust income under protest claiming that the classification of the trusts as resident trusts was unconstitutional. The trusts filed amended returns claiming refunds for the difference between the taxes owed as resident trusts and the taxes owed as nonresident trusts (more than $250,000 per trust). The Minnesota Department of Revenue denied the refund claims and the trusts appealed to the Minnesota Tax Court claiming that the Minnesota taxing scheme violated the state and federal Constitutional Due Process Clauses and the U.S. Constitution’s Commerce Clause. The Minnesota Tax Court determined that the domicile of the grantor at the time the trusts became irrevocable, by itself, is insufficient for Due Process Purposes (both state and federal) to justify taxing trusts as residents. The grantor’s domicile was not a sufficient connection with Minnesota to support the exercise of taxing jurisdiction. The state of Minnesota, the Tax Court held, did not have subject matter jurisdiction over gain and income from items of tangible personal property not located within Minnesota. The Minnesota Department of Revenue appealed, and the state Supreme Court affirmed. Rather than only considering the residence of the grantor at the time the trusts became irrevocable, the Supreme Court held that all relevant contacts between a trust and the state should be considered. Those contacts include, for example, the relationship between the income that the trusts earned and the benefits conferred on that income by Minnesota. The Supreme Court pointed out that it was the trustee’s contacts that were relevant, the grantor no longer controlled the assets and the trusts didn’t have any physical property in Minnesota. In addition, the trusts’ intangible assets in a Minnesota corporation were held outside Minnesota. There simply was not basis, the Supreme Court determined, for attributing all of the trusts’ income, regardless of source, to Minnesota. Fielding v. Commissioner of Revenue, 916 N.W.2d 323 (Minn. Sup. Ct. 2018).

Real Estate Professional Test Not Satisfied. A decedent’s estate attempted to reclassify the decedent’s rental activities as active under the real estate professional test of I.R.C. §469(c)(7). However, the Tax Court determined that the estate could not satisfy the 750-hour test. The decedent was involved in other non-rental activities and did not maintain a contemporaneous diary of the time spent of real estate activities. The testimony of the decedent’s daughter was deemed not credible. In addition, the decedent had not elected to group the various rental activities as a single activity which meant that the decedent needed to meet the real estate professional test with respect to each rental activity. The Tax Court did not impose an accuracy-related penalty because the IRS did not prove that the penalty had been approved by an IRS supervisor. Estate of Ramirez v. Comr., T.C. Memo. 2018-196.

Posted December 1, 2018

No State Sales Tax Exemption for Lawnmower. The taxpayer purchased a riding lawnmower to cut grass around his chicken houses in order to control rodents. He claimed that the purchase was exempt from exempt from sales tax under Ark. Code Ann. §26-52-403(b) as farm equipment and machinery. The taxpayer testified that the integrated companies that he grows poultry for require rodent control as part of the production contract requirements and that the mower was used to fulfill that contract requirement. The state Department of Finance and Administration denied the exemption on the basis that Ark Reg. §GR-51 defines farm machinery and equipment as agricultural implements that are used exclusively and directly for the agricultural production of food or fiber as a commercial business or the agricultural production of grass sod or nursery products as a commercial business. Thus, the lawnmower was not exempt from sales tax unless it was used "directly" in the agricultural production of food or fiber as a business. The mowing of grass around the chicken houses did not involve the use of the mower in the direct production of an agricultural product. Merely having its use be beneficial to the farming operation was insufficient to make the mower be exempt from sales tax. Ark. Admin. Hearing Dec., No. 19-112 (Nov. 21, 2018).

No Business Deductions For Pot Shop. The petitioner is a dispensary of marijuana, a controlled substance under federal law. The petitioner claimed business-related expense deductions on the basis that its business was comprised of four separate enterprises: 1) marijuana and marijuana product sales; 2) sales of products without marijuana; 3) therapeutic services; and 4) brand development. The IRS denied the deductions and the Tax Court agreed with the IRS. The Tax Court determined that the dispensary had a single trade or business – trafficking in a controlled substance. Thus, deductions associated with the non-marijuana aspect of the business were not deductible. The petitioner was also required to adjust for cost of goods sold as a reseller rather than as a producer. Patients Mutual Assistance Collective Corporation v. Comr., 151 T.C. No. 11 (2018).

Posted November 25, 2018

No Deduction For Law School LL.M. Program Tuition. The petitioner attended law school in Spain and subsequently practiced international law in Spain for several years. The petitioner then moved to New York City and enrolled in an LL.M. program, incurring $27,435 in tuition expense. After graduation, the petitioner took a visiting attorney position in the U.S. practicing international law. The LL.M. qualified the petitioner to sit for the NY Bar exam, which he passed and became admitted to practice in NY. The petitioner continued working for the same law firm. The petitioner deduction the LL.M. tuition expense and the IRS denied the deduction. The Tax Court agreed with the IRS because the LL.M. degree allowed the petitioner to take the NY Bar exam and qualify for admission to practice in NY – a new trade or business. In addition, the petitioner did not need the LL.M. degree for his visiting attorney position. Thus, the deduction was properly denied in accordance with Treas. Reg. §1.162-5(b)(3)(i). Note – the deduction for unreimbursed education expenses of employees is presently suspended through 2025. Enrique Fernando Dancausa Valle v. Comr., T.C. Sum. Op. 2018-51.

Posted November 20, 2018

No Charitable Contribution For Donated Conservation Easement. The petitioner claimed a $1,798,000 charitable deduction for the contribution of a permanent conservation easement. The IRS disallowed the deduction in its entirety on the basis that the plaintiff stood to benefit from the contribution by virtue of owning land that adjoined the property subject to the easement and that the plaintiff had plans to create a master-planned community. The court agreed with the IRS, noting that “the plaintiff would benefit from the increased value to the lots from the park as an amenity.” Wendell Falls Development, L.L.C. v. Comr., T.C. Memo. 2018-45, motion for reconsideration denied, T.C. Memo. 2018-193.

Posted November 19, 2018

IRS Lien Not Eliminated by Bankruptcy Filing. The defendants had unpaid taxes and the IRS assessed a deficiency and penalties and filed Notices of Federal Tax Liens with the local county with respect to the defendants’ property in that county. The defendants then filed Chapter 7 bankruptcy and the bankruptcy court granted an Order of Discharge. The defendants chose the state (MA) bankruptcy exemptions and claimed a $500,000 homestead exemption which allowed them to exempt up to $500,000 of value from certain creditor liens and enforcement actions. The IRS sued to enforce the tax liens by selling the defendants’ property. The defendants claimed that the enforcement of the liens was barred because the property subject to the liens was exempt property in the bankruptcy estate. The trial court disagreed, holding that the state bankruptcy code exemption has no effect on the enforceability of federal tax liens citing as authority United States v. Rodgers, 461 U.S. 677 (1983) and United States v. Craft, 535 U.S. 274 (2002). The defendants also claimed that the court’s Order of Discharge barred the foreclosure sale. Again, the trial court disagreed. The trial court noted that the filing of Chapter 7 does not render the federal tax liens unenforceable but may relieve the debtor of personal liability. However, the trial court denied the motion of the IRS for partial final judgment because the trial court had not yet made findings concerning the order of priorities for distribution of sale proceeds. United States v. Seeley, No. 16-cv-10935-ADB, 2018 U.S. Dist. LEXIS 191082 (D. Mass. Nov. 8, 2018).

Posted November 3, 2018

Obamacare Payment Not a “Tax” – Federal District Court Lacked Jurisdiction. The plaintiff is a self-administered, self-insured employee health and welfare benefit plan created under a collective bargaining agreement. The plaintiff paid over $1 million into the "Transitional Reinsurance Program"—a feature of the ACA administered by the Department of Health and Human Services (HHS) to stabilize the insurance market for 2014 as a result of the destabilization of the market caused by Obamacare. The plaintiff sued in federal district court for a refund on the basis that the HHS regulations improperly required the plaintiff to pay into the program. The plaintiff claimed that the payment constituted a “tax” which gave the district court jurisdiction over the case via 28 U.S.C. §1346(a)(1). The trial court disagreed, citing the U.S. Supreme Court opinion of National Federation of Independent Business v. Sebelius, . Accordingly, the trial court determined that it lacked jurisdiction and granted the government’s motion to dismiss. The appellate court affirmed. The appellate court reasoned that 28 U.S.C. §1346(a)(1) had to be read in conjunction with I.R.C. §7421 and §7422 to mean that the federal district courts have jurisdiction over suits to recover “any internal revenue tax” collected by the IRS under the authority of the Internal Revenue Code. Here, the appellate court noted, the plaintiff made a “payment” to the HHS rather than the IRS. Thus, the “payment” was not an “internal revenue tax.” The appellate court also determined that the Congress had provided a remedy for the plaintiff to recover allegedly illegal fees and exactions by mean of jurisdiction over such cases in the Court of Federal Claims. Electrical Welfare Trust Fund v. United States, No. 17-1937, 2018 U.S. App. LEXIS 29856 (4th Cir. Oct. 23, 2018).

Posted October 26, 2018

Iowa Guidance on the Domestic Production Activities Deduction. While Iowa law conforms to much of the changes made by the Tax Cuts and Jobs Act (TCJA) pursuant to S. 2417, effective May 30, 2018, it does so primarily only for tax years beginning on or after January 1, 2019. As a result, while the TCJA eliminates the domestic production activities deduction (DPAD) effective for tax years beginning after 2017, Iowa coupling only becomes effective for tax years beginning on or after January 1, 2019. Thus, the DPAD remains available to be claimed on an Iowa return for tax year 2018. In guidance, the Iowa Department of Revenue (IDOR) noted that the DPAD will be calculated in accordance with the Internal Revenue Code in effect on January 1, 2015. Consequently, nonconformity adjustments may apply particularly with respect to the disallowance of federal bonus depreciation and the limitation of the I.R.C. §179 deduction. Iowa Tax Reform Guidance: Domestic Production Activities Deduction, Iowa Department of Revenue (Oct. 17, 2018).

Iowa Guidance on Like-Kind Exchanges of Personal Property. While Iowa law conforms to much of the changes made by the Tax Cuts and Jobs Act (TCJA) pursuant to S. 2417, effective May 30, 2018, it does so primarily only for tax years beginning on or after January 1, 2019. However, Iowa law does not couple on the TCJA provision that eliminates tax-deferral on like-kind exchanges of personal property for trades completed after 2018, by election for tax years beginning on or after January 1, 2019 and before January 1, 2020. The Iowa Department of Revenue (IDOR) has now provided guidance pointing out that the Iowa tax treatment of the like-kind exchange of personal property depends on the tax year of the transaction and the type of taxpayer involved. For fiscal year 2017 and 2018 filers, for personal property trades completed after 2017 but before 2019 and that would have qualified as a like-kind exchange under I.R.C. §1031 before amendment by the TCJ, the transaction is to be treated as a like-kind exchange of personal property for Iowa tax purposes. For personal property trades completed in tax year 2019, for an individual, estate, trust or pass-through entity other than a corporation or financial institution, can be treated by election at a tax-deferred exchange. For tax years 2020 and later, personal property trades are not eligible for like-kind exchange treatment. IA Form 8824 and associated worksheet is to be used to document like-kind exchanges of personal property. Iowa Tax Reform Guidance: Like-Kind Exchanges of Personal Property, Iowa Department of Revenue, Oct. 22, 2018).

Beginning in 2019, A Religious Exemption From “Roberts Tax” Applies. Starting in 2019, a religious exemption from the individual mandate contained in Obamacare will apply. The mandate forces taxpayers to have a government-approved amount of “minimal acceptable health insurance coverage” or face an additional penalty tax (i.e., the “Roberts Tax”). The individual mandate, under the Tax Cuts and Jobs Act (TCJA), is eliminated for tax years beginning after 2018, but the employer mandate remains. The religious exemption applies to individuals who are members of a religious sect or division which is not described in Sec. 1402(g)(1) of Obamacare who rely solely on a religious method of healing, and for whom the acceptance of medical health services is not consistent with their religious beliefs. H.R. 6, amending I.R.C. §5000A(d)(2)(A), effective for tax years beginning after 2018, signed into law on Oct. 24, 2018.

TCJA Does Not Impact Concrete Foundation Repair Safe Harbor. 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 (“Casualties and Thefts”) 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. As additional guidance, IRS, in early 2018, stated that taxpayers cannot claim the safe harbor and treat amounts paid to fix a foundation as a casualty loss for the 2017 tax year as late as a timely filed Form 1040X for the 2017 tax year. Rev. Proc. 2018-14, 2018-9 I.R.B., modifying Rev. Proc. 2017-60, 2017-50 I.R.B. In late 2018, the IRS clarified that the Tax Cuts and Jobs Act (TCJA) has no impact on the safe harbor. Thus, casualty loss deductions that qualify for the safe harbor under Rev. Proc. 2017-60 and Rev. Proc. 2018-14 will be treated as trade or business deductions and can create or increase a taxpayer’s NOL (which can be carried back two years and forward 20, and offset 100 percent of the taxpayer’s taxable income in those years). Such NOLs are treated as arising in or before the 2017 tax year. IRS letter to Rep. Courtney (D-CT) from IRS Commissioner Rettig (Oct. 2018).

Posted October 22, 2018

Qualified Opportunity Zone Fund Investment Regulations Issued. The Treasury and the IRS on I.R.C. have issued guidance on I.R.C. §1400Z-2 that is intended to describe and clarify the requirements that a taxpayer must satisfy to defer gain recognition by investing in a qualified opportunity fund (QOF). The guidance specifies that a corporation or a partnership can self-certify as a QOF. The guidance also provides proposed regulations on other requirements that a corporation or partnership must satisfy to be a QOF. The IRS also provided guidance on the “original use” and “substantial improvement” requirements for property that a QOF purchases after 2017 in a qualified opportunity zone. In addition, the proposed regulations address self-certification and valuation of fund assets and include guidance on the type of qualifying opportunity zone business investment. The proposed regulations also provide guidance on the types of gains that may be deferred; the time by which investments must be made; and the manner in which investors make the election to defer gains. As for the purchase of an existing building in a qualified opportunity zone, the IRS provided guidance on whether the building would meet the “original use” requirement and how a substantial improvement could be made to an existing building. The preamble to the proposed regulations state that regulations will be forthcoming on the statutory meaning of “substantially all” and information reporting requirements. Rev. Rul. 2018-29, IR 2018-206 and Prop. Reg. 115420-18 (Oct. 19, 2018).

Charitable Deductions Denied For Failure To Satisfy Numerous Requirements. The petitioner was an optometrist that he operated via an S corporation. The petitioner was also the pastor and president of a non-profit religious corporation. The petitioner donated a tractor/mower to the religious corporation but failed to substantiate the donation by not getting an appraisal and include Form 8283 with the tax return. The petitioner also failed to substantiate the donation of his residence to the religious corporation. The petitioner also could not deduct land improvement costs (creation of ponds to provide irrigation source for the petitioner’s blueberry farm) that the petitioner’s single-member LLC farming operation would operate on land leased from the religious corporation. The improvements were made and costs paid before the donation. The petitioner also didn’t execute a contemporaneous acknowledgment that was dated. Presley, et ux. v. Comr., T.C. Memo. 2018-171.

Posted October 18, 2018

Real Estate Professional Test Not Met. The petitioners, a married couple, managed rental properties that they owned which lost money. The IRS denied the loss deduction on the basis that the petitioners were passive investors. The petitioners produced computerized logs that showed the hours the wife spent on the rental properties. However, the Tax Court, agreeing with the IRS position, noted that the wife’s activities were mere investment activities that didn’t count toward the 750-hour test of I.R.C. §469(c)(7)(B). In addition, the logs included entries for time spent attending seminars because the petitioners could not show how the seminars pertained to managing the rental properties. In addition, the logs were inconsistent and included excessive hours for time spent by management companies that were hired or services that repairmen or gardeners performed. There were no other supporting documents to substantiate the wife’s hours spent on the rental properties. Antonyshyn, et ux. V. Comr., T.C. Memo. 2018-169.

Cash Gifts To Pastor Constituted Taxable Income. The petitioner, the pastor of a church and the head of various church related ministries in the U.S. and abroad. The petitioner got behind on his tax filings and IRS audited years 2008 and 2009. While most issues were resolved, the IRS took the position that cash and checks that parishioners put in blue envelopes were taxable income to the petitioner rather than gifts. The amounts the petitioner received in blue envelopes were $258,001 in 2008 and $234,826 in 2009. There was no question that the church was run in a businesslike manner. While the church board served in a mere advisory role, the petitioner did follow church bylaws and never overrode the board on business matters. As for contributions to the church, donated funds were allocated based on an envelope system with white envelopes used for tithes and offerings for the church. The white envelopes also included a line marked “pastoral” which would be given directly to the petitioner. The amounts in white envelopes were tracked and annual giving statements provided for those amounts. The petitioner reported as income the amounts provided in white envelopes that were designated as “pastoral.” Amount in gold envelopes were used for special programs and retreats, and were included in a donor’s annual giving statement. Amounts in blue envelopes (which were given out when asked for) were treated as pastoral gifts and the amounts given in blue envelopes were not included in the donor’s annual giving statement and the donor did not receive any tax deduction for the gifted amounts. Likewise, the petitioner did not include the amounts given in blue envelopes in income. The IRS took the position that the amounts given by means of the blue envelopes were taxable income to the petitioner. The Tax Court agreed, noting that the petitioner was not retiring or disabled. The court also noted that the petitioner received a non-taxable parsonage allowance of $78,000 and received only $40,000 in white envelope donations. The court also upheld the imposition of a penalty because the petitioner, who self-prepared his returns, made no attempt to determine the proper tax reporting of the donations. Felton v. Comr., T.C. Memo. 2018-168.

Posted October 14, 2018

Exchange of Real Property For Financial Instruments Is Not A “Like-Kind” Exchange. The plaintiff exchanged its power plants for an interest in financial instruments, and claimed that the tax on the transaction was deferred under the like-kind exchange rules of I.R.C. §1031. The appellate court, in affirming the Tax Court, determined that the transaction did not involve true leases, but were loans because the benefits and burdens of ownership didn’t transfer between the parties to the exchange. Exelon Corporation v. Comr., No. 17-2964/2965, 2018 U.S. App. LEXIS 28023 (7th Cir. Oct. 3, 2018).

Uber Driver Failed to Substantiate Expenses. The petitioner claimed deductions for uniforms, shirts, shoes, mileage and other expenses associated with his job as a driver for a ride sharing company. While the IRS allowed some deductions, many were disallowed due to lack of substantiation and the lack of supporting records. Hagos v. Comr., T.C. Memo. 2018-166.

Farmer’s Market Sales Tax Exemption Inapplicable. The taxpayer owned a small cattle ranch and had a third party slaughter and process the beef. The taxpayer then made retail sales of the processed beef via Facebook Marketplace, and claimed that the sales were exempt from state (MO) sales tax pursuant ot the farmer’s market exemption of Mo. Rev. Stat. §144.527. The MO Dept. of Revenue took the position that the taxpayer must register its business with the Dept. of Revenue for the collection of sales tax on the sales. The Dept. of Revenue noted that the Facebook Marketplace forum is not a “farmer’s market” as defined under the statute because the taxpayer did not operate it “principally” as a "common marketplace” where farm products are sold. To qualify as a farmer’s market, the sales must be public and occur at a location that is held out and operated as public location. The Department of Revenue held that the applicable definition of “marketplace” does not include virtual platforms or e-commerce because those forums do not comprise a physical space where public sales are held. In addition, Mo. Rev. Stat. §144.527 requires that the farm products that are sold be “processed by the participating farmer.” However, in this instance, the taxpayer did not process the livestock farm products, but rather sent the cattle to a slaughterhouse for processing. However, the Mo. Dept. of Revenue noted that the beef qualified for the reduced food tax rate of one percent provided under Mo. Rev. Stat. § 144.014(1). Mo. Dept. of Rev. Priv. Ltr. Rul. 7975 (Sept. 4, 2018).

Posted October 6, 2018

Silage Bags Might Be Exempt From State Use Tax. The plaintiff purchased silage bags to use in growing corn and converting the corn to silage to feed cows. The defendant asserted that the purchase was subject to state use tax, but the plaintiff claimed it was not because the bags were essential to production agriculture. State (IL) law provides for a use tax exemption for farm machinery and equipment, both new and used that the buyer certifies will be used primarily for production agriculture. The plaintiff claimed that the bags were an integral part of the fermentation process and not just used simply to store corn. As such, the plaintiff claimed, the bags improve production agriculture by improving the quality of livestock feed and reduce cost and improve safety. The defendant denied the exemption. The trial court affirmed. On further review, the appellate court reversed and remanded the case to the defendant for a determination of whether silage bags were essential to production agriculture. The appellate court determined that whether the bags qualified for the farm machinery and equipment exemption involved a determination of whether the bags qualified as farm "machinery" or "equipment," and were "used primarily for production agriculture." The appellate court noted that Ill. Admin. Code Title 86 § 130.305(k) defines “equipment” as any independent device or apparatus separate from any machinery, but essential to production agriculture. The appellate court further noted that the plain dictionary meaning of "apparatus" is a set of material or equipment designed for a particular use. The appellate court determined that the silage bags worked together for a particular use by creating the desired environment for the creation, fermentation, and preservation of silage. The silage bags, the appellate court noted, were separate from any machinery and intended for a specific use. As an apparatus, the silage bags satisfied the regulatory definition of “equipment.” However, the appellate court noted that the exemption was also required that the silage bags be essential to production agriculture. The appellate court determined that the defendant had not yet addressed that question, Thus, the appellate court remanded the case to the defendant for a determination of that matter. Erdman Dairy, Inc. v. Illinois Department of Revenue, No. 4-17-0434, 2018 Ill. App. LEXIS 738 (Ill. Ct. App. Oct. 3, 2018).

IRS Lists Areas Eligible For Extended Replacement Period. The IRS has issued its annual Notice announcing those areas that are eligible for an extension of the replacement period for livestock that farmers and ranchers must sell because of severe weather conditions (Notice 2018-79, 2018-42 I.R.B). I.R.C. § 1033 allows non-recognition of gain for involuntarily converted livestock that is replaced with property similar or related in service or use. A farmer or rancher who sells an excess number (more than is typically sold in the normal course of business) of livestock (other than poultry) that have been held for draft, breeding, or dairy purposes can treat the excess sold as an involuntary conversion if the livestock are sold or exchanged solely on account of drought, flood, or other weather-related conditions. While the livestock must be replaced with "like-kind" livestock (normally within four years from the close of the first tax year in which any part of the gain from the conversion is realized), the Treasury has the discretion to extend the replacement period for taxpayers impacted by prolonged drought. In those areas, the replacement period is extended until the end of the taxpayer's first tax year ending after the first drought-free year. So, if an area is designated as not having a drought-free year, the extended replacement period applies. Livestock owners in the listed areas who were anticipating that their replacement period would expire at the end of 2018 now have until the end of 2019 to replace the involuntarily converted livestock. The relief applies to any farm located in a county in one of the 41 states (and the District of Columbia) as having suffered exceptional, extreme, or severe drought conditions by the National Drought Mitigation Center during any weekly period between September 1, 2017, and August 31, 2018. The Kansas counties included are Allen, Anderson, Atchison, Barber, Barton, Bourbon, Brown, Butler, Chase, Chautauqua, Cherokee, Clark, Clay, Coffey, Comanche, Cowley, Crawford, Dickinson, Doniphan, Douglas, Edwards, Elk, Ellis, Ellsworth, Finney, Ford, Franklin, Geary, Gove, Grant, Gray, Greeley, Greenwood, Hamilton, Harper, Harvey, Haskell, Hodgeman, Jackson, Jefferson, Johnson, Kearny, Kingman, Kiowa, Labette, Lane, Leavenworth, Lincoln, Linn, Lyon, McPherson, Marion, Marshall, Meade, Miami, Montgomery, Morris, Morton, Nemaha, Neosho, Ness, Osage, Osborne, Ottawa, Pawnee, Pottawatomie, Pratt, Reno, Rice, Riley, Rush, Russell, Saline, Scott, Sedgwick, Seward, Shawnee, Stafford, Stanton, Stevens, Sumner, Trego, Wabaunsee, Wallace, Wichita, Wilson, Woodson, and Wyandotte. IRS Notice 2018-79, 2018-42 I.R.B.

No IRS Priority on Obamacare Penalty Tax. The debtor filed Chapter 13 bankruptcy and the IRS claimed priority position with respect to the debtor’s tax liability, including the debtor’s liability for “shared responsibility payment” under I.R.C. §5000 created as part of Obamacare. Under Chapter 13, the debtor’s reorganization plan must provide for the full payment of al claims entitled to priority under 11 U.S.C. §507. Obamacare mandates that individuals obtain health care coverage during the tax year or pay a “shared responsibility payment,” also referred to as the “individual mandate penalty” or the “Roberts tax” (so-named after Chief Justice Roberts that construed the payment as a “tax” so as to uphold the constitutionality of Obamacare in National Federation of Independent. Business. v. Sebelius, 567 U.S. 519 (2012)). Based on the Supreme Court’s 2012 opinion, the IRS asserted priority over the debtor’s outstanding obligation to make the payment in accordance with 11 U.S.C. §507(a)(8) which affords the IRS priority status to “allowed unsecured claims of governmental units” (including an excise tax on a transaction) on the basis that the payment was an excise tax. The IRS noted that in Sebelius, the Supreme Court noted that the penalty, once imposed, had to be reported on the taxpayer’s return and the IRS had to assess and collect it in the same manner as taxes in general. The debtors objected on the grounds that the payment was not a “tax” that entitled the IRS to priority under 11 U.S.C. §507(a)(8), but was merely a penalty for failure to obtain the government-mandated health insurance. The court noted that characterizations in the Internal Revenue Code are not dispositive in the bankruptcy context, but that an exaction is a tax when it lays a pecuniary burden on an individual or property for the purpose of supporting the government. On that point, the court noted that the “Roberts tax” had been estimated to generate about $4 billion annually by 2017. However, the court noted that the burden of the penalty on any particular person was “light,” contained no “scienter” requirement and the IRS had no criminal enforcement authority to enforce payment. Thus, failure to pay the penalty was not “unlawful.” In addition, the court reasoned that the payment was not a tax on the production or use of goods, but was a penalty imposed for doing nothing in terms of health insurance (note: the court glossed over the point that a penalty imposed on persons that self-insure is a “tax” in every sense of the word to those persons). Thus, it was a penalty on a condition or status rather than an activity. Accordingly, the penalty could not be an excise tax because it wasn’t imposed on the enjoyment of a privilege (although being free to self-insure is a privilege that such persons enjoy). The court was not willing to take an expansive view of the definition of an excise tax. In addition, the court noted that 11 U.S.C. §507(a)(E)(8) requires that an excise tax be imposed on a transaction for the IRS to have priority. However, the court concluded, the penalty was triggered not on a transaction, but on the lack of a transaction. Thus, the court disallowed as a priority unsecured claim the IRS claim attributable to the debtor’s outstanding “shared responsibility payment” imposed under I.R.C. §5000A in the amount of $1,043, plus $9.18 in interest. The court allowed the claim as a nonpriority unsecured claim. In so holding, the court followed the precedent set forth in In re Parrish, 583 B.R. 873 (Bankr. E.D. N.C. 2018) and In re Chesteen, No. 17-11472, 2018 Bankr. LEXIS 360, 2018 WL 878847 (Bankr. E.D. La. Feb. 9, 2018). In re Huenerberg, No. 17-28645, 2018 Bankr. LEXIS 2992 (Bankr. E.D. Wisc. Sept. 28, 2018).

Posted October 1, 2018

“Kid” Wages Included in Parent’s Income. The petitioner co-founded a tax-exempt organization and was the sole financial officer. He did not receive a salary from the organization due to the organization’s lack of cash, however, he did hire and pay his adult children $260,000 over a six-year period for work they performed for the organization. However, the petitioner did not issue a Form W-2 or Form 1099, and some of the funds were deposited into an account that the petitioner controlled. The petitioner used the funds in the account to pay his household expenses. The IRS took the position that the funds should be included in the petitioner’s income. The Tax Court agreed on the basis that the petitioner was the party that actually earned the income. Ray v. Comr., T.C. Memo. 2018-160.

Posted September 30, 2018

No Deductions Because Business Had Yet To Start. The petitioner was starting a boat rental business and incurred repair costs associated with a boat that he intended to rent out. The IRS denied the deductions on the basis that the business had not yet begun. The Tax Court agreed with the IRS on the basis that the boat was not yet seaworthy and, as a result, the petitioner was not yet actively engaged in the boat rental business. The Tax Court also determined that the petitioner was not eligible for a net loss carryover due to the petitioner’s lack of documentation. The Tax Court held the petitioner liable for approximately $20,000 in deficiencies and over $7,000 in penalties for failure to file or make tax payments for two years. De Sylva v. Comr., T.C. Memo. 2018-165.

Posted September 29, 2018

Reasonable Cause May Exist For Faulty Form 8283. The petitioner, an LLC taxed as a partnership, donated a permanent conservation easement to a land trust. The easement was placed on a wooded tract. The filed Form 8283 did not include any cost or adjusted basis information, and the IRS denied the deduction due to the petitioner’s failure to substantially comply with Treas. Reg. §1.170A-14(c). The petitioner asserted that its omission was reasonable because it did not know what to report, and that the petitioner ultimately cured the defect in Form 8283 by later supplying cost basis information to the IRS during audit. The petitioner also claimed that it had effectively disclosed the required information elsewhere on its return. The Tax Court disagreed with the petitioner, noting that the Form 8283 information was necessary to alert the IRS as to whether further investigation was needed. The Tax Court determined that the petitioner had made the conscious decision to not supply the required information on Form 8283. However, the Tax Court held that the petitioner did have reasonable cause for relying on a consulting firm that, in turn, relied on an outside firm. Such qualified reasonable cause under I.R.C. §170(f)(11), the Tax Court held, raised material fact questions that the Tax Court could not presently resolve. Belair Woods, LLC, et al. v. Comr., T.C. Memo. 2018-159.

Posted September 23, 2018

Timber Farming is Not “Farming” For State Tax Purposes. The taxpayer purchased a tractor and attachments and claimed that the purchases were exempt from state (AR) sales and use tax as “farm equipment.” The taxpayer asserted that he was engaged in producing livestock when he executed an exemption form. The state denied the exemption and the taxpayer challenged the denial. At an administrative hearing, it was revealed that the taxpayer, according to his Schedule F, was engaged in timber farming rather than agricultural production of food and fiber as state law required. The taxpayer was also not engaged in the production of grass sod or nursery products as a commercial business. State law does not provide a sales tax exemption for purchases of implements that are used in producing and severing timber. Ark. Admin. Hearing Decision, Docket No. 19-063 (Sept. 18, 2018).

ATV Used in Timber Farming Not Sales and Use Tax Exempt. The taxpayer purchased an all-terrain vehicle (ATV) for use in timber farming and claimed that the purchase was not subject to state (AR) sales and use tax as “farm equipment.” The taxpayer asserted that the a “tree farm” is a “farm” and that wood is “fiber” such that Ark. Code Ann. §26-52-403 applied to exempt the ATV from sales and use tax. However, the administrative judge disagreed, noting that the statute excluded machinery and equipment used in the production and severance of timber. Ark. Admin. Hearing Decision, Docket No. 18-356 (Sept. 6, 2018).

Posted September 13, 2018

Real Estate Professional Test Satisfied - Passive Loss Deduction Allowed. The petitioners, a married couple, managed rental properties that generated a significant loss. The IRS denied the loss as a passive loss and assessed approximately $9,000 in penalties. The IRS determined that the petitioners had failed to satisfy the real estate professional test of I.R.C. §469(c)(7). The wife was involved in the daily management of the rental properties. She cleaned the common areas, collected coins from washing machines, performed repairs, communicated with tenants, deposited rent, maintained insurance policies, bought materials for the properties, paid bills, and kept the books and records for tax purposes. The wife also hired contractors to perform tasks that she couldn’t complete herself, and would spend considerable time researching and contacting contractors. She also inspected rental units, prepared them for rental, advertised vacant units, screened potential tenants, showed the units and processed rental applications. Her records showed that she logged 844.75 hours managing the rental properties in 2014 and, when investor hours and driving time were included, she logged 1, 136 .25 hours. The log was constructed from the wife’s calendar for the first half of 2014 and from her phone for the second half of 2014. She also supplied receipts and invoices to substantiate the hours logged. While the IRS conceded that the wife satisfied one of the tests of I.R.C. §469(c)(7) – she did not perform personal services in any other trade or business and, thus, spent more than half of her time on the rental activity, the IRS claimed that she failed to satisfy the 750-hour test on the basis that her logs were not contemporaneous and “contained inaccuracies.” The Tax Court disagreed with the IRS, noting the wife’s credible, honest and forthright testimony, and detailed spreadsheets of management activities. While the court cautioned that the records weren’t contemporaneous, her credible testimony and time logs were a “reasonable means” of proof that convinced the court that the real estate professional test was satisfied. Birdsong v. Comr., T.C. Memo. 2018-148.

Cost of Seismic Surveys Are G&G Expenditures. The taxpayer was engaged in offshore oil and gas drilling and development activities within the U.S. Via wholly-owned subsidiaries, the taxpayer owned a working interest in and operated two fields, which were discovered in Year 1 and Year 2. The joint owners of both fields sanctioned development in late Year 5, including drilling development wells. In Year 6, the taxpayer approved net funding for the acquisition of a seismic survey of the two fields. The taxpayer used the data generated by the seismic survey to optimize placement of development wells in the two fields. Stage 1 development drilling occurred in both fields, resulting in development wells that first produced oil in Year 8. Through the first quarter of Year 9, The taxpayer had drilled exploratory wells and development or production wells in the development areas of both fields. Stage 2 development drilling began later and included additional wells. The first oil produced from Stage 2 drilling was expected in Year 10. The taxpayer deducted the costs of the seismic survey related to one of the two fields as intangible drilling costs on its Year 7 return. The IRS, however, determined that these costs should be treated as geological and geophysical (G&G) expenditures. In support its claim that the survey was an intangible drilling cost, the taxpayer presented an authorization for expenditure for the seismic survey that stated, among other things, that the purpose of the survey was to provide better imaging than the seismic data previously obtained in Years 3 and Year 4. The IRS disagreed, noting that the legislative history of I.R.C. §167(h)(3) (which requires the amortization of G&G expenses) includes costs incurred for the purpose of obtaining and accumulating data that will serve as the basis for the acquisition and retention of mineral properties by taxpayers exploring for minerals. Survey costs, the IRS concluded, are capital in nature. They were not incurred to prepare for the drilling of a specific well, but were used to determine where to drill. C.C.A. 201835004 (May 10, 2018).

Posted September 7, 2018

No Income Exclusion For Cancelled Debt. The petitioner did not report income from cancelled mortgage debt on Form 1099-C. The IRS included the discharged debt in income and the Tax Court agreed. While there is an exception for reporting discharged debt if it relates to the taxpayer’s principal residence, the petitioner failed to prove that the home to which the cancelled mortgage debt related was his principal residence. The petitioner also could not establish that he was insolvent (another exception to the inclusion rule for discharged debt). Smethers v. Comr., T.C. Memo. 2018-140.

Posted September 4, 2018

Simply Concluding A Partnership Interest Is Worthless Is Not Enough For a Bad Debt Deduction. The petitioners deducted losses associated with their partnership interests on a 2008 amended return. The losses were associated with partnership losses from real estate development. However, the partnerships remained in business and the petitioners did not sell or abandon their interests during the years in issue (2008-2011). Instead, the petitioners subjectively concluded that their interests were worthless as of the end of 2008. The IRS denied the losses and the Tax Court agreed. The Tax Court noted that the petitioners could claim an ordinary loss deduction relating to their partnership investments if the investment is worthless (and sale or exchange treatment does not apply). However, the Tax Court determined that a loss relating to a worthless interest must be evidenced by a closed and completed transaction that is fixed by an identifiable event or events that occurred during the tax year in issue. Simply a decline in the assets’ value is insufficient to justify a loss deduction. The Tax Court noted that the filing of bankruptcy, liquidation, insolvency or market events and conditions can sufficiently establish a closed and completed transaction to justify a loss deduction associated with a worthless interest in a partnership. Due to the remaining value in the partnerships in 2008 as a result of its underlying properties, the petitioners’ investments were not worthless. Forlizzo v. Comr., T.C. Memo. 2018-137.

Posted August 29, 2018

No Deductible Losses Associated With Horse-Leasing Activity. The petitioners, a married couple had almost $500,000 of cancelled debt income in 2001. In early 2002, they got involved in a “mare lease and breeding activity” via the husband’s friend. The venture was designed to produce net operating losses that could be carried back to prior tax years to offset income in the carryback years, and also possibly generate gains that would be capital in nature and taxed at a favorable tax rate. Participants in this type of venture have been involved in prior Tax Court litigation. The petitioners were advised that they needed to put in at least 100 hours annually into the activity which they did via entities that they created. Ultimately, the activity generated $1.3 million in losses. The IRS denied the losses and the Tax Court agreed with the IRS. The Tax Court determined that the petitioners did not spend at least 500 hours annually in the leasing/breeding activity and did not handle any of the daily operations or management. Instead, the Tax Court determined that the petitioners’ involvement in the activity was passive. They also did not engage in the activity with a profit intent – their involvement was primarily recreational and they used the activity to offset their large income from other sources. Householder v. Comr., T.C. Memo. 2018-136.

Posted August 28, 2018

No Charitable Contribution Deduction For Donated Easement by Lessee. A nonprofit corporation owned two buildings that were listed on the National Register of Historic Places. The petitioner was the long-term lessee of the buildings. The parties jointly transferred a façade easement on the buildings in 2009 to a qualified organization and the petitioner claimed a charitable deduction of approximately $4.5 million for the donation. The IRS denied the deduction because the petitioner did not own a fee interest in the buildings, and assessed an accuracy-related penalty. Without fee ownership, the IRS claimed that the perpetuity requirement of I.R.C. §§170(h)(2)(C) and (h)(5)(A) could not be satisfied. The petitioner, however, claimed that fee ownership was not expressly required and that the contribution was similar to a façade easement granted by tenants in common. The petitioner also claimed, in the alternative, that it was the equitable owner of the buildings for tax purposes and equitable ownership was sufficient to claim the deduction. The Tax Court agreed with the IRS that the petitioner could not claim a deduction. The court determined that the only thing the petitioner gave up were the contractual rights it held under the lease rather than a qualified property interest. Thus, the petitioner could not grant a perpetual restriction on the use of the buildings as required for the deduction. A personal property right (e.g., contractual rights under the lease) is not a qualified property interest under I.R.C. §170(h)(2)(C). The court also rejected the petitioner’s argument that it was the equitable owner of the buildings for property tax purposes because, even if the petitioner were, it was only for a finite period rather than for an indefinite period. The building owner, however, could grant a perpetual easement that could give rise to a charitable deduction. Harbor Lofts Associates v. Comr., 151 T.C. No. 3 (2018).

Posted August 26, 2018

Conservation Easement Donation Not Perpetual – Charitable Deduction Denied. The petitioner owned a tract of land subject to a use restriction requiring it to only be used for recreational facilities open space for 30 years. At the time of the petitioner’s ownership, the property was a golf course with a clubhouse. The petitioner wanted to sell the property, but before doing so wanted to remove the use restriction. A local buyer expressed interest, but also wanted to block any removal of the use restriction. The sale went through after the buyer agree to allow the removal of the use restriction. However, before the sale closed, the petitioner conveyed a conservation easement of the property to a land trust. The terms of the easement stated that the property was to remain open for public use for outdoor recreation and that fees for such use could be charged. Upon extinguishment of the easement, the land trust would be entitled to a portion of the sale proceeds equal to the greater of the fair market value of the easement at the time of the donation or a share of the proceeds after expenses of sale and an amount attributable to improvements constructed on the property. The Tax Court denied any charitable deduction for the easement based on its findings that the easement did not protect the conservation purpose under I.R.C. §170(h)(4)(A) and didn’t satisfy the perpetuity requirement of I.R.C. §170(h)(5)(A) because the easement deed’s extinguishment provision did not comply with Treas. Reg. §1.170A-14(g)(6). As such, the easement donation was not “exclusively for conservation purposes as required by I.R.C. §170(h)(1)(C). The Tax Court held that the easement value was $100,000 rather than the $15.2 million that the petitioner claimed. The Tax Court also upheld the gross valuation misstatement penalty that the IRS had imposed. On appeal, the appellate court affirmed that the petitioner was not entitled to any charitable deduction and upheld the penalty. The appellate court held that when determining whether the public access requirement for a recreation easement is fulfilled, the focus is to be on the terms of the deed and not the actual use of the land post-donation. The appellate court determined that the terms of the easement satisfied the public-access requirement of Treas. Reg. §1.170A-14(d)(5)(iv)(C). However, the appellate court concluded that the contribution was not exclusively for conservation purposes because the requirements of Treas. Reg. §1.170A-14(g)(6)(ii) were not satisfied because the deed allowed the value of improvements to be subtracted from the proceeds before the donee took its share, and that Priv. Ltr. Rul. 200836014 no longer represented the current position of the IRS and could not be used to alter the plain meaning of the regulation which mandates that the done receive at least the proportionate value of the “proceeds.” The appellate court also agreed with the Tax Court that the gross valuation misstatement penalty applied to the difference between the amount the petitioner deducted on its return ($15 million) and the $100,000 deduction allowed by the Tax Court. PBBM-Rose Hill, Ltd., v. Comr., No. 17-60276, 2018 U.S. App. LEXIS 22523 (5th Cir. Aug. 14, 2018).

Taxpayer Can’t “Spin” Garbage” Into Tax Credits. The taxpayer was involved in the production and sales of landfill gas to a third party, which had entered into landfill license agreements with the owners and operators of 24 landfills primarily in Illinois, but also including ones in Ohio and Columbus, Kansas. The taxpayer claimed over $11 million in tax credits for producing fuel from a nonconventional source under I.R.C. §45K with respect to landfill gas asserted to have been produced from 23 landfills in 2005, 2006, and 2007. The taxpayer claimed the credits for one landfill for 2006 and 2007. The 24 landfills had varying degrees of equipment, monitoring, and production, from the nonexistent to the substantive, depending on the respective landfill and time-period in question. The levels of documentation of the gas rights, gas sales, and operation and maintenance agreements between the taxpayer and the third party varied, as did the documentation of actual landfill gas production and the documentation of expenses for which deductions were claimed. While the Tax Court determined that untreated landfill gas is a qualified fuel under I.R.C. §45K, and that the landfills at issue had the necessary equipment and were set-up properly to constitute a “qualified facility” under I.R.C. §45K(f)(1), the Tax Court disallowed the credits due to lack of substantiation of alleged production during the years at issue except as to one facility for the time period that the gas-to-electricity equipment was running at the facility. However, the Tax Court held that no tax credits were allowed for any period of time the landfills were engaged in “venting” or “flaring” because venting and flaring did not involve the production of a qualified fuel that was meant to produce energy that could be used by someone else. The Tax Court upheld the IRS imposition of an accuracy-related penalty. On further review, the appellate court affirmed. The appellate court noted that the “fuel” at issue was not qualified fuel used to produce energy but was simply released into the atmosphere. In addition, the appellate court noted the lack of credibility of the taxpayer’s records and that the taxpayer did not have rights to sell landfill gas at the landfills at issue. The taxpayer failed to produce any operation-and-maintenance agreements or documents that payments were actually made. The appellate court also held upheld the accuracy-related penalty. Green Gas Delaware Statutory Trust, Methane Bio, LLC, Tax Matters Partner, et al., v. Comr., No. 17-1025, 2018 U.S. App. LEXIS 22581 (D.C. Cir. Aug. 14, 2018), affn’g, 147 T.C. No. 1. (2016).

Posted August 18, 2018

IRS Can Continue Voluntary Annual Filing Season Program. Of the four categories of persons who prepare returns for a fee, “unenrolled” preparers have not historically been subject to licensing requirements. However, in 2011, the IRS developed a rule requiring an unenrolled preparer to become a “registered tax return preparer” by paying a fee, passing a one-time competency exam and completing a prescribed course of continuing education each year. 31 C.F.R. §§10.4(c); 10.5(b)-(c); 10.6(e)(3). However, the rule was invalidated on the basis that the IRS lacked the statutory authority to regulated unenrolled preparers. Loving v. IRS, 917 F. Supp. 2d 67 (D. D.C. 2013). The IRS was permitted, however, to continue its testing and continuing-education centers, but couldn’t require enrollment, test-taking or payment of a fee for those services. The trial court’s decision was affirmed on appeal. Loving v. IRS, 742 F.3d 1013 (D.C. Cir. 2013). The IRS continued, consistent with the court’s opinion, its testing and continuing education programs as part of a Voluntary Annual Filing Season Program (“Program”) in accordance with Rev. Proc. 2014-42, 2014-29 I.R.B. 192. When an unenrolled preparer completes the Program, the preparer receives a “Record of Completion” and is then listed in the IRS online directory of tax preparers along with all other preparers. Such unenrolled preparers then gain a limited right to represent in the initial stages of the audit of a return that such person has prepared, just like they could before the program was established. The plaintiff challenged the ability of the IRS to conduct the Program. The trial court dismissed the case for lack of standing. On appeal, the court reversed and remanded. On remand, the trial court again held that the plaintiff lacked standing on the basis that what the plaintiff was attempting to do was merely limit competition. The trial court dismissed the case. On appeal, the appellate court reversed on the standing issues and, rather than remanding the case, decided it on the merits. The court determined that the plaintiff had standing based on 31 U.S.C. §330(a) because that provision gives the Treasury the power to regulate character and reputation (among other things) of the parties that practice before it and consequently, the obligations of the plaintiff’s members to supervise unenrolled agents. On the merits, the appellate court held that the 31 U.S.C. §330(a) authorized the IRS to operate the Program. The appellate court also rejected the plaintiff’s claim that the revenue procedure establishing the program should have been subjected to notice and comment requirements of the Administrative Procedure Act (APA). The appellate court determined that the revenue procedure was merely interpretive and not legislative and, thus, not subject to the APA. The appellate court also determined that the Program was not arbitrary and capricious. American Institute of Certified Public Accountants v. Internal Revenue Service, No. 16-5256, 2018 U.S. App. LEXIS 22583 (D.C. Cir. Aug. 14, 2018), rev’g., 199 F. Supp. 3d 55 (D. D.C. Aug. 3, 2016).

Posted August 16, 2018

Bankruptcy Plan Payments Don’t Count For Purposes of PTC. The petitioners, a married couple, got their government mandated health insurance through an Obamacare state exchange. Their monthly premium was $716 monthly and an advanced premium assistance tax credit (PTC) of $609 per month for the 10 months of the 2014 tax year that they had health insurance coverage was paid directly to their insurer on their behalf. Also, during 2014 the petitioners made a monthly $25 payment in accordance with a Chapter 13 bankruptcy plan. On their 2014 return, the petitioners reported modified adjusted gross income of $86,312, but did not report any of the $6,090 of PTC that they received during the year. The IRS disallowed the $6,090 PTC. The agreed with the IRS, noting that I.R.C. §36B allows a PTC to a taxpayer with income between 100 percent and 400 percent of the federal poverty line. As applied to the petitioners’ household size, 400 percent of the federal poverty line was $78,120 for 2014. While their MAGI exceeded the 400 percent threshold, the petitioners claimed that their income should be reduced by their bankruptcy plan payments. The court noted that I.R.C. §36B does not provide for any reductions to AGI for any purpose. In any event, the reduction of their income by $300 would not reduce their income sufficiently to allow them to claim the PTC for 2014. Palafox v. Comr., T.C. Memo. 2018-124.

Posted August 11, 2018

Treasury Issues Final Regulations on Reporting Charitable Contributions. In 2008, the Treasury issued proposed regulations governing the tax reporting of charitable contributions. Now, the Treasury has issued final regulations on the topic that largely adopt the proposed regulations but do make some modifications. Under the final regulations, a donor must maintain records of charitable contributions. For cash contributions, the donor must retain a canceled check, or other reliable written record showing the donee’s name, date of contribution and amount. While some charitable organizations provide a blank form for donors to complete, the Preamble to the final regulations specific that the blank form is insufficient to satisfy record keeping requirements for tax purposes to substantiate the donation. For contributions over $250, the donee organization must provide a contemporaneous written acknowledgment of the gift. I.R.C. §170(f)(8). In addition, the final regulations state that a donor may be required to complete and submit a Form 8283, depending on the type of gift and the amount. The Preamble to the final regulations provides that the Form 8283 itself does not meet the contemporaneous written acknowledgment requirement. Rather, a separate written acknowledgment is required. The final regulations note that appraisals are required for non-money contributions over $5,000, and state that an appraiser can meet the requisite education and experience requirements by successfully completing professional or college-level coursework. But, mere attendance is not sufficient, and evidence of successful completion is required. For contributions exceeding $500,000 in value, the appraisal must be attached to the donor’s income tax return. Under the final regulations, the appraisal is not attached just to the return of the contribution year but must also be attached to any return involving a carryover year (due to the limitation on the charitable contribution deduction). TD 9836. Substantiation and Reporting Requirements for Cash and Noncash Charitable Contribution Deductions (Jul. 27, 2018).

Posted August 6, 2018

Court Invalidates FBAR Regulation. The plaintiff had money in a Swiss bank account in 2007, but failed to timely file Form TD F 90-22.1 (Report of Foreign Bank and Financial Accounts – or FBAR). The plaintiff claimed that she did not willfully fail to file the FBAR, but learned of her responsibility to file the Form via her mother in 2009 and that she relied on her accountant to make application to the IRS’ Offshore Voluntary Disclosure Program (OVDP). If the plaintiff qualified for the OVDP her FBAR penalties could be reduced to 20 percent of the account balance rather than 50 percent. The IRS noted that if the taxpayer filed an amended return along with an FBAR and paid the related tax and interest for the previously unreported foreign income, the plaintiff could be criminally prosecuted. The plaintiff did not apply to the OVDP, but did file an amended return. The IRS asserted the 50 percent penalty under 31 U.S.C. §5321(a)(5) which modified prior law on this point and increased the penalty for the greater of $100,000 or 50 percent of the balance in the account at the time of the violation. The IRS had not updated its regulation on the issue which it promulgated under the prior version of the statute that had the lower penalty. While prior court decisions had upheld the regulation as being consistent with the new statute resulting in the lower level of penalty being applied, the court in this case invalidated the regulation as inconsistent with the mandatory language of the modified statute requiring the higher penalty amount. In addition, the court determined that the taxpayer’s failure to file the FBAR was willful. Norman v. United States, No. 15-872T, 2018 U.S. Claims LEXIS 888 (Fed. Cl. Jul. 31, 2018).

Posted August 5, 2018

Determination of Wind “Farm” Basis Incorrect. At issue in this case was the appropriate method for determining the income tax basis in wind “farm” property for purposes of eligibility for grants under I.R.C. §1060. The U.S. Court of Federal Claims used a method that resulted in a value of nearly $207 million in cash grants in lieu of tax credits to the owners equal to 30 percent of the investment in development costs associated with “specified energy property.” On further review, the appellate court determined that the lower court erroneously excluded the residual method of assessing cost basis as required by I.R.C. §1060. The appellate court determined that the transactions involved were “applicable asset acquisitions” under I.R.C. §1060. Accordingly, the appellate court remanded to the trial court for a determination of the proper allocation of the purchase prices to determined appropriately fair market value. The appellate court pointed out that the cost basis of purchased property must be divided among asset categories, with some being eligible to be counted toward the cash grants and some that are not, such as goodwill. Because that was not done, the unallocated method resulted in a much higher basis and much higher grant amount. The appellate court also determined that the trial court had improperly disallowed testimony of one of the government’s witnesses, a socialist and head of MIT’s MBA Program Finance Track. Alta Wind I Owner Lessor C v. United States, No. 2017-1410, 2018 U.S. App. LEXIS 20931 (Fed. Cir. Jul. 27, 2018).

Posted July 29, 2018

Joint Returns Containing Forged Signature Were Valid and Cannot Be Revoked. The plaintiff and her husband were married until his death in 2011. He took care of all financial matters for the family. In late 2009, the husband filed married-filing-jointly returns for the 2001-through 2006 tax year. In 2010, the husband filed a joint return for the 2007 tax year. The husband signed the returns and forged his wife’s signature on the returns. The plaintiff had no knowledge of her husband signing her names to the returns and did not consent. The husband paid the taxes in connect with the late-filed returns. Upon his death in 2011, the plaintiff learned of the jointly filed returns and filed married filing separate returns for the 2001-2007 tax years and sought a refund of part of the taxes paid for tax years 2001-2007. The IRS disallowed the refund and the court agreed. The court held that it was undisputed that the plaintiff intended to file joint tax returns for the 2002 through 2007 tax years with her husband and that the joint tax returns for those years, filed in 2009 and 2010, were valid. As a result, the plaintiff could not revoke the joint returns in order to pay a lesser amount pursuant to a separate return filed years later. The plaintiff ultimately conceded that she was not entitled to a refund for the 2001 tax year, and the court granted summary judgment to the IRS on all other claims. the defendant is entitled to summary judgment on the claims arising out of those tax years. Coggin v. United States, 1:16-CV-106, 2018 U.S. Dist. LEXIS 119104 (D. N.C. Jul. 17, 2018).

Posted July 27, 2018

IRS Can’t Impose Revised Statutory FBAR Penalty. The IRS assessed civil penalties against the plaintiff for the plaintiff’s repeated and willful failures to timely file Form TD F 90-22.1 (Report of Foreign Bank and Financial Accounts – or FBAR). The IRS assessed penalties of $196,082 for another four FBAR violations, and smaller penalties in 2009 and 2010. The IRS referenced 31 U.S.C. §5321(a)(5) and 31 C.F.R. §1010.820(g)(2) when assessing the penalties. The IRS moved to reduce the penalties to judgment, and the plaintiff moved for summary judgment on the basis that the IRS didn’t properly apply the law when calculating the amount of the penalties. The plaintiff argued that the IRS was limited by a prior version of 31 U.S.C. §5321(a)(5) which allowed the Treasury Secretary to impose civil or monetary penalties amounting to the greater of $25,000 or the balance of the unreported account up to $100,000. A related Treasury regulation reiterated the statute. In 2002, the Treasury delegated penalty enforcement authority to the Financial Crimes Enforcement Network (FinCEN), but the related regulations were not affected. Shortly thereafter, the FinCEN delegated penalty assessment authority to the IRS. In 2004, the Congress amended 31 U.S.C. §5321(a)(5) to increase the maximum civil penalties that could be assessed for willful failure to file an FBAR form. Under the revision, applicable for the years in issue in the present case, the civil monetary penalties for willful failure to file the FBAR were increased to a minimum of $100,000 and a maximum of 50 percent of the balance in the unreported account at the time of the violation. However, the underlying regulations were not changed to comport with the new statute, and IRS relied on the new statute for assessing the penalties against the plaintiff. The court agreed with the plaintiff, noting that the revised statute only set a penalty ceiling but did not set a floor and that the regulation was consistent with both versions of the statute, and that the regulation had not been amended to reflect the higher penalties authorized by the modified statute. As such, the IRS acted arbitrarily and capriciously in not applying the regulation to cap the penalties assessed against the plaintiff at $100,000. The court specifically noted that the IRS had 14 years to revise the regulation and failed to do so, which indicated to the court that the IRS had made a conscious decision to limit the penalties to the $100,000 cap. United States v. Colliot, No. AU-16-CA-01281-SS, 2018 U.S. Dist. LEXIS 83159 (W.D. Tex. May 16, 2018). For another case that reached the same conclusion, see, United States v. Wadham, No. 17-CV-1287-MSK, 2018 U.S. Dist. LEXIS 119910 (D. Co. Jul. 18, 2018).

Wisconsin Sales and Use Tax On Hunting Preserve and Gun Club Sales. In a recent publication, the Wisconsin Department of Revenue (WDOR) has taken the position, based on state laws in effect as of July 1, 2018, that sales and use tax applies to sales by a hunting preserve of annual passes, dues, and membership fees, range fees, or other fees, regardless of whether the fees are based on the animals released or harvested. However, WDOR stated that the sale of admissions by a gun club, including the sale of a gun club membership, is not taxable if the gun club is a nonprofit organization and if the gun club provides safety classes to at least 25 individuals in the calendar year. Nontaxable sales also include processing animals for human consumption; dog training; guide service provided for a separate charge, if the customer has the option of hunting without the guide service; safety training; and shooting lessons. WDOR noted that, effective January 1, 2016, sales of "farm-raised deer" sold to a person operating a hunting preserve or game farm in Wisconsin are exempt from sales and use taxes. The information in the publication reflects the position of the Department of laws enacted by the Wisconsin Legislature and in effect as of July 1, 2018. Wisc. Dept. of Revenue, Pub. No. 244 (Jul. 1, 2018).

Posted July 23, 2018

Preparing Property For Cattle Farming Is Not “Farming.” The taxpayer bought a tractor that he used to cut grass in a field and perform other work on his property in converting the tract from a farm to a cattle operation. When he bought the tractor, he completed a Commercial Farming Machinery & Equipment Sales Tax Exemption Certification form that indicated he was engaged in the production of timber or grass as a commercial farming business. State (AR) law (Ark. Cod. Ann. §26-52-403(b)) exempts farm equipment and machinery from sales tax. However, the trees on his property were not produced for food or fiber, and he didn’t sell any of the cut hay. In addition, the tractor was not used “exclusively and directly in farming” as the statute required. Similarly, none of the underlying regulations which provided a detailed list of activities that constituted being engaged in the business of farming described any activity that the taxpayer was engaged in. Ark. Admin. Hearing Dec., No. 18-423 (Jul. 19, 2018).

Posted July 21, 2018

Disproportionate Withdrawals Didn’t Create Second Class of S-Corporate Stock. The petitioner and his brother formed an S corporation with the petitioner owning 49 percent of the stock and the brother owning 51 percent. Initially, the petitioner and his brother filed K-1s and returns with each of them reporting their share of S corporate tax items in proportion to their stock interests. But, as time went on, the petitioner’s brother started withdrawing corporate funds for personal use in excess of his proportional interest. The petitioner discovered the brother’s conduct and withdrew from the corporation. The petitioner claimed that he was not responsible for his share of corporate income for the years at issue because his brother’s disproportionate withdrawals created a second class of stock causing the corporation to lose its S status. The court disagreed, noting that there was no evidence that the brother took any steps to redefine shareholders’ rights or create a new class of stock. As a result, the petitioner remained subject to tax on his portion of the S corporate income. Mowry v. Comr., T.C. Memo. 2018-105.

S Corporation Election Inadvertently Terminated. A C corporation elected S corporate status and had retained earnings and profits from the prior C corporate years. The S corporation had three consecutive tax years in which its passive income exceeded 25 percent of gross receipts. As a result, the S election was terminated in accordance with I.R.C. §1362(d)(3)(A)(i). In addition, the S corporation was subject to the “sting” tax of I.R.C. §1375. However, the IRS determined that the S election was inadvertently terminated because the tax advisors involved in making the S election did not advise about the potential problem with passive income. Priv. Ltr. Rul. 201827010 (Apr. 3, 2018).

Posted July 8, 2018

No Deduction For Pre-Paid Property Taxes That Haven’t Yet Been Assessed. The IRS has informed the state of New Jersey (NJ) that its actions ordering municipalities to accept payments for 2018 personal property taxes in calendar year 2017 for the purpose of deducting those payments in 2017, will not provide a federal income tax deduction to the payor for property taxes that have not yet been assessed under state law as of the end of 2017. The IRS pointed out that a deduction for state and local real property taxes is allowed if the tax is both assessed and paid in the tax year. See, e.g., Estate of Hoffman v. Comr., 8 Fed. Appx. 262 (4th Cir. 2001); I.R.C. §164. IRS Info. Ltr. 2018-0009, following IR 2017-120.

Posted July 3, 2018

Farm Equipment Depreciation – North Carolina. Effective for taxes imposed for tax years beginning on or after July 1, 2019, the North Carolina Department of Revenue (DOR) must publish a depreciation schedule for farm equipment to assist counties that use the cost approach to appraise farm equipment. The DOR is to make the schedule available electronically via its website. In addition, if any particular county uses the cost approach method when appraising farm equipment, the county is to use the depreciation schedule that IDOR publishes. North Carolina S711.

Posted June 26, 2018

I.R.C. §280E Doesn’t Discriminate Against S Corporations. The petitioners were owners of an S corporation engaged in the illegal drug business of growing and selling an illegal drug, marijuana. The IRS treated the petitioner’s wage income as an S corporation expense subject to I.R.C. 280E which caused the income to be taxed twice – once as wages and again as S corporation income. The petitioners claimed that this double taxation resulted in the disallowed officer wages attributable to the illegal drug activity to be included in the S corporation earnings which then flowed through to the shareholders without an offsetting deduction. In essence, the petitioners were allocated wages and the balance of S corporate earnings, which they reported on their return. However, the IRS disallowed the wage expense which resulted in passthrough income of the entire amount of S corporate earnings, with the petitioners still having the wage income to report. The petitioners claimed that this tax treatment violated the purpose and intent of Subchapter S. The Tax Court disagreed, noting that the petitioners were free to operate as any business entity, chose the S corporate form, and were responsible for the tax consequences of their choice. Loughman v. Comr., T.C. Memo. 2018-85.

No Business-Related Deductions For Pot Shop. The petitioner claimed various business-related deductions associated with operating its business that dealt in marijuana and the IRS denied the deduction in accordance with I.R.C. §280E. I.R.C. §280E disallows deductions for expenses paid or incurred in the carrying on of any trade or business (including employee salaries) involving a federal controlled substance such as marijuana, a Schedule I controlled substance under federal law. The Tax Court agreed with the IRS position, and also upheld the imposition of a 20 percent penalty on the petitioner for underpayment of tax liability. Alterman v. Comr., T.C. Memo. 2018-83.

Posted June 25, 2018

Arkansas Ruling on Taxability of Services to Farmers. The Arkansas Department of Finance and Administration (ADFA) has determined that technology services that a company provides to farmers are not taxable to the extent that the services contribute to the farm’s increased efficiency and productivity. Nontaxable services include soil testing to determine the need for soil amendments, tissue sampling of plants to determine the presence of diseases or pests, issuance of prescriptions for fertilizers or pesticides, driving the borders of a farm property to assist in data collection, and record keeping. However, to the extent that the services result in the sale of tangible personal property or are provided with the sale of tangible personal property, they could be taxable. Also, the ADFA determined that the sale of a device that provides data for a farmer to use is also taxable because it is not farm machinery and is not used in the direct production of an agricultural product. ADFA reached the same conclusion with respect to the sale of a system that is used to monitor soil moisture. Accessories (cables and battery packs, e.g.) that are sold separately from farm machinery or equipment are tax-exempt. Fees charged for a moisture monitoring system are taxable, but a third-party connectivity fee is not taxable. ADFA Legal Op. No. 20170822 (May 29, 2018).

Posted June 24, 2018

Horse Activity Had Profit Motive, But Was Passive. The petitioners, a married couple, worked for a technology company in the San Francisco Bay. During the years in issue, 2010-2014, the husband’s salary ranged from $1.4 million to $10.5 million. He also was an Executive Vice President of Hewlett-Packard Co. In 1999, the petitioners bought a 410-acre tract in Utah for $2,000,000. They later acquired additional land, bringing their total land holdings to over 500 acres. After refurbishing the property, the hired a full-time manager to operate the ranch. However, the plaintiffs never showed a profit from their “ranching” activity. They showed losses ranging from slightly under $200,000 to nearly $750,000 every year. The petitioners deducted the losses, which the IRS disallowed. The Tax Court applied the nine-factor test of Treas. Reg. 1.183-2(b) and determined that the petitioners did have a profit motive. However, the employment of a ranch manager indicated to the Tax Court that the petitioners might be engaged in a passive activity subject to the passive loss rules of I.R.C. §469. Of the seven tests contained in Treas. Reg. §1.469-5T(a) to determine whether the petitioners were materially participating in the activity on a basis that was regular, continuous and substantial, the Tax Court determined that only two were relevant – the 500-hour test and the facts and circumstances test. The petitioners prepared logs showing that they devoted more than 500 hours to the activity during the years in issue, but the logs were prepared after-the-fact in preparation for trial. The Tax Court determined, that “a very significant portion” of the hours the petitioners spent on the activity were as investors rather than as material participants. In addition, the presence of the paid manager destroyed the hours the petitioners devoted to management activities. Accordingly, the Tax Court determined that the 500-hour test had not been satisfied. The presence of the manager also meant that the petitioners could not satisfy the facts and circumstances test. Thus, the petitioners were entitled to claim the deductions for the losses from the ranching activity, but the deductions were suspended until years in which they showed a profit from the activity. In those, years, the deductions would be limited to the profit from the activity. If they never showed a profit, the losses could be deducted upon sale of the activity. Robison v. Comr., T.C. Memo. 2018-88.

Posted June 16, 2018

Taxpayer Entitled To Bonus Depreciation and Energy Credits For Solar Activity. An individual entered into agreements with three property owners to provide electricity at a discount in exchange for permission to install solar panels and equipment and the retention of ownership of the panels and any associated tax credits and/or rebates. The agreements were entered into and the solar panels were installed in 2010 between March and December. The solar panel equipment was connected to the grid in 2011. The panels and equipment generated $57,750 in tax rebates for the individual. In early 2011, the petitioner bought the equipment on the three properties for $300,000, including a $90,000 down payment; a credit for the tax rebates of $57,750 that were assigned to him; and a promissory note of $152,250. The equipment secured the note and the petitioner guaranteed the note. The petitioner defaulted on the note in 2011, but it was not cancelled. The petitioner claimed $255,000 of depreciation on the equipment and an energy investment credit of $90,000. The IRS disallowed the depreciation deduction as well as the credit. In doing so, the IRS cited inaccurate and irrelevant sections of the I.R.C. which meant that the burden of proof shifted to the IRS to establish that the petitioner, 1) had failed to establish a basis in the property; 2) failed to qualify for bonus depreciation; 3) was not at risk under I.R.C. §465; 4) was subject to the passive loss rules of I.R.C. §469. The Tax Court determined that the petitioner’s basis in the property was $152, 250. The property was determined to have been placed in service by the petitioner in 2011 when it was connected to the grid and capable of producing electricity. Accordingly, the petitioner was entitled to first-year “bonus” depreciation on the property to the extent of basis in 2011. The Tax Court also held that the petitioner was entitled to the energy investment credit, and also determined that the petitioner was at-risk with respect to the promissory note for purposes of I.R.C. §465. The Tax Court also held that the petitioner had materially participated in the solar activity on a basis that was regular and continuous with at least 100 hours spent in the activity which was not less than any other person. The Tax Court did not uphold the imposition of any accuracy-related penalties. Golan v. Comr., T.C. Memo. 2018-76.

Posted June 11, 2018

60-Day Rollover Period Waived Due To Misinformation. On Jan. 14, 2017, the taxpayer retired and requested a lump sum distribution from her employer’s employee stock option plan, a qualified plan under I.R.C. §401 (a). On Feb. 10, 2017, she deposited an amount into a credit union account that she jointly owned with her husband with the intent to roll over a portion of that amount into an IRA that would be established at a financial institution. She did not follow through on that intent. Instead, she and her husband transferred a portion of the funds to a different account on Feb. 27, 2017. The taxpayer left the remaining portion of her initial deposit in her credit union account. In late August or early September of 2017, her husband contacted their tax adviser about rolling over the funds transferred to the account on February 17 to an IRA. The advisor informed them that they had missed the 60-day rollover period. The taxpayer claimed that she missed the 60-day rollover because she and her spouse were mistaken aobut the timeframe for rolling over the funds. The taxpayer sought a ruling on whether she could have the 60-day period waived. The IRS determined that a waiver was appropriate on the basis that she had been misinformed and reasonably thought she had until the end of 2017 to complete the rollover. Accordingly, the IRS said that it would waive the 60-day rule with respect to the second amount. If the other I.R.C. §402(c)(3) requirements were satisfied and the money was paid to an IRA, the contribution would constitute a rollover contribution. Priv. Ltr. Rul. 201822033 (Mar. 5, 2018).

Posted June 2, 2018

Sale Under Threat of Condemnation Is Involuntary Conversion. IRS determined that when the taxpayer, an entertainment corporation, gave up some of its television broadcast spectrum user rights to the Federal Communications Commission, the transaction would qualify as an involuntary conversion under I.R.C. §1033. The IRS noted that the taxpayer had reason to believe that it would have been forced to operate with different facilities or frequencies or at least less valuable frequencies if the rights had not been given up. As such, the relinquishment was deemed to be a disposition under the threat or imminence of condemnation for purposes of I.R.C. §1033. Priv. Ltr. Rul. 201821012 (Feb. 20, 2018).

No Deductions Associated with Sham Trust. The petitioners reorganized their business to include an irrevocable trust. The trust named the petitioners as the beneficiaries. A third-party corporate service provider was named trustee. The trustee was barred from managing the petitioners’ business and from participating in management. The petitioners’ business was in the form of a limited partnership which was funded by all of the assets of the S corporation that the petitioners previously operated their business in. As a result, most of the income from the limited partnership flowed to the trust and the trust took large distributions deductions even though the trust did not actually distribute all of its income to the petitioners’ non-exempt charitable trust. The IRS denied the deductions on the basis that the trust was a sham and the Tax Court agreed. The Tax Court noted that the petitioners’ relationship to the property did not change after it was transferred to the trust; the trustee was not truly independent; there wasn’t an economic interest that passed to the beneficiaries; and the petitioners did not operate as if they were bound by the trust restrictions or the law of trusts in general. Full Circle Staffing, et al. v. Comr., T.C. Memo. 2018-66.

Posted May 30, 2018

Business Engaged in With Profit Intent, But No NOL Deduction Allowed. The petitioner was involved in the music industry and was a 95 percent owner of an entertainment LLC/partnership. The IRS denied associated business deductions based on its claim that the business was a hobby that was not operated with a profit intent. The court rejected the IRS claim, noting that the petitioner had prior business successes in the music industry as well as outside of the music industry. The court noted that the petitioner relied on his past experience and contacts to start the LLC, that the LLC was operated in a business-like manner and that he had committed a significant amount of capital to the business. Even though the LLC had sustained losses for numerous years, those losses, the court determined, were as a result of problems within the music industry and the petitioner had positioned the LLC to ultimately make a profit by gathering a collection of songs that it could profit from. While the court determined that the petitioner derived elements of pleasure from working in the music industry and had substantial income from other sources, the court held that those factors in favor of the IRS did not outweigh the other factors in his favor. The court also found that simply because the petitioner’s son was one of the musicians that the LLC had signed did not mean, by itself, that the LLC was simply a vehicle for funding the son or a hobby as IRS had claimed. The court noted that the LLC has signed other musicians and did not devote a majority of its resources to the son. However, the court held that the petitioner did not provide enough evidence to substantiate or estimate the total amount of his business expenses for all of the prior years that the LLC was in operation or for the year in issue. Even if he could provide substantiation, the court determined that the petitioner failed to show that the losses had been absorbed by other income in prior years or the impact that those years had on the NOL in the year in issue. As such, the court denied any NOL deduction. Barker v. Comr., T.C. Memo. 2018-67.

Posted May 27, 2018

No Basis Increase for Unpaid Judgments. The petitioners, a married couple operated a real estate development company – an S corporation. The wife was a 50 percent shareholder and the husband was an employee. They made guaranteed loans to the corporation. The company defaulted on its loans and third party lenders sued. The petitioners were found jointly and severally liable along with the corporation for the debt. Before making any payment on the judgments, the petitioners filed returns taking the position that the mere entry of the judgments entitled the wife to a basis increase in her corporate stock of $1.5 million for 2008 and $30 million for 2009. Such basis increase allowed the petitioners to claim a Schedule E loss of $3.89 million on their 2008 return, and a $10.5 million Schedule E loss and an NOL of $10.35 million on their 2010 return. The petitioners then elected to carryback the NOL five years to apply against their 2004 tax liability. They sought (and received) a refund for each of 2004 and 2005 (because some of the carried-back loss was applied to the 2005 return). The petitioners, on their 2010 return, claimed a Schedule E deduction of $937,000 attributable to the flow-through loss from the S corporation and a carryforward NOL for 2010 as a result of the basis increase. The IRS later determined that that wife was not entitled to any basis increase and adjusted downward the flow-through deduction in 2008 and 2009. Thus, the 2009 NOL was smaller and was exhausted as applied against their 2004 tax liability. The Tax Court upheld the IRS adjustments, determining that an increase in basis required the wife to make an actual payment toward the judgments rendered against the S corporation. On appeal, the appellate court affirmed. The appellate court noted that a basis increase could only result from an actual economic outlay – an actual payment on the debt at issue. The S corporation, the court noted, was the primary obligor on the loans and the petitioners’ liability for the judgments rendered against the S corporation did not give rise to indebtedness from the S corporation to the petitioners until and unless the petitioners paid part of the obligation. Liability is not the same thing as debt. Phillips v. Comr., No. 2018 U.S. App. LEXIS 13037 (11th Cir. May 17, 2018), aff’g., T.C. Memo. 2017-61.

Deductions Disallowed Because Business Had Not Begun. In 2010, the petitioner began investing in homes with friends and family. The group would buy homes, renovated them, and then sell them – a “fix and flip” strategy. The petitioner became a licensed real estate agen in 2010 and continued that licensing in 2013 and 2014, but earned no commissions from selling real estate in 2013 or 2014. He researched potential investment properties for the group and had access to properties that were for sale. The group never got beyond merely looking at real estate for which auto mileage was claimed for driving to and from the same house, which was the home of the petitioner’s brother and where a “client” lived, and for miles driven to take the client to look at a potential investment property. The IRS disallowed any deductions, taking the position that the petitioner had not yet begun operating a trade or business. The Tax Court agreed. The Tax Court noted that merely having a real estate license is insufficient to create a trade or business of being a real estate agent. The petitioner did not continuously and regularly buy and sell real estate as a real estate agent to clients. The Tax Court also noted that the house flipping business had also not commenced in the years in question. The business was merely in the exploratory or formative stages. The Tax Court noted that carrying on a trade or business requires more than initial research into a potential business opportunity. Deductions are not allowed for startup or pre-opening expenses before business operations begin. The Tax Court noted that startup expenses are held until the time the business begins. At that time, the expenses are either deducted or amortized over 180 months in accordance with I.R.C. §195(b). If the business never starts, the expenses are not deductible. Samadi v. Comr., T.C. Sum. Op. 2018-27.

Posted May 19, 2018

No Charitable Deduction When Quid Pro Quo Involved. The petitioner was developing a master planned community on property that it owned. In a prior transaction with the city, the petitioner’s parent entities received additional development credits (rights to develop units) that doubled the number of units that they could develop. But, to develop the additional units, the entities had to follow the city’s development procedures and received development approvals from the city council. The entities did so and the development plan was approved by the city council. However, the city council’s approval was contingent on the parent entities’ dedicating real property to the city and reducing density. The petitioner thus transferred 746.789 acres and 1,958 development credits to the city. After the transfer, the entities received another development approval, which allowed the development of additional units. The petitioner claimed an $11,040,000 charitable contribution deduction for the transfer. The IRS disallowed the deduction and the Tax Court agreed on the basis that the petitioner transferred the real estate and development credits in exchange for a development plan approval and with the expectation of a future development plan approval. Those benefits, the court noted has substantial value that were not reported. As such, the petitioner was not entitled to a charitable contribution deduction. Triumph Mixed Use Investments, III, LLC, et al. v. Comr., T.C. Memo. 2018-65.

Failure to Substantiate Nixes Claimed Deductions. The petitioners, a married couple, claimed various deductions on behalf of their children as well as auto expenses and meal and entertainment expenses. However, the court held that they failed to meet the strict substantiation requirements of I.R.C. §274(d). They failed to show that the expenses for the children were bona fide or reasonable compensation relating to the value of the services provided. Expenses also failed to be separated between business-related and personal. Wax v. Comr., T.C. Memo. 2018-63.

Funds in Son’s Savings Account Count in Parents’ Insolvency Calculation. The petitioners, a married couple, obtained student loans to finance their son’s college education. The husband later injured his back and became permanently disabled as a result. Consequently, the husband sought to have the loans discharged because of his disability and $158,511 was discharged. The husband also received $308,105 in a nontaxable cash distribution relating to his 14.4 percent interest in an LLC. He also started engaging in erratic spending behavior and his wife took over his finances. The petitioners transferred $323,000 to the son’s savings account with the wife having the ability to transfer funds from the account. The wife regularly transferred funds from the savings account to the petitioners’ joint account to pay household bills. The petitioners claimed that the insolvency exclusion of I.R.C. §108(a)(1)(B) applied to exclude the discharged debt from income because their debts exceeded their liabilities at the time of the discharge. However, their tax preparer did not include the amount in the son’s account in the petitioners’ insolvency calculation. The IRS claimed that the amount in the account should be included in the petitioners’ insolvency calculation because the son was merely holding the account as a nominee for his parents. The Tax Court agreed, based on state (UT) law determining asset ownership. Hamilton v. Comr., T.C. Memo. 2018-62.

Termination Payments From Insurance Company Were Ordinary Income. The plaintiff had been an insurance agent and a district manager for an insurance company. Upon his promotion to district manager, the plaintiff could no longer sell insurance. As a result, he sold his insurance agency to his sister in 1998 for a note payable over 20 years. The plaintiff reported the interest on the note as ordinary income and the principal as capital gain from the sale of an intangible asset. After undergoing several audits over the years, this tax treatment was never questioned. In 2009, the plaintiff separated from the insurance company and, pursuant to his employment agreement, the insurance company had to pay the plaintiff the “contract value” which was an amount based on the number of years he worked as a district manager and the commissions he received during the six months immediately preceding the termination. The contract value payments were reported to the plaintiff on Form 1099-Misc. as non-employee compensation. The plaintiff’s return was prepared professionally who was not provided with the 1099’s or the termination agreement. The preparer believed that the “contract value” payments the plaintiff received were for work the plaintiff performed as an insurance agent and were, therefore capital gain. The payments were included as gross receipts on the plaintiff’s Schedule C with the same amount deducted as “other expenses.” In 2009, a portion of the payments was reported as capital gains. For 2010, none of the payments were reported as capital gains. The plaintiff claimed that capital gain treatment was appropriate because the insurance agency was the capital asset that had been sold – a sale of goodwill. However, the court determined that the plaintiff never owned the goodwill and that Baker v. Comr., 338 F.3d 789 (7th Cir. 2003). Thus, the plaintiff did not own any capital asset and had no income from the sale or exchange of a capital asset. Thus, the gains were ordinary income. The court also upheld the imposition of an accuracy-related penalty. Pexa v. United States, No. 2:16-cv-00994-TCN (E.D. Ca. May 7, 2018).

Partnership Advances Were Bona Fide Debt. The petitioner made advances to a partnership with the advances structured as demand notes with no maturity date. The petitioner claimed that the advances constituted debt and deducted the associated interest payments. The IRS objected, claiming that the advances were equity and the payments were not deductible. The Tax Court noted that a lack of a fixed maturity date was “highly significant” when determining whether an advance is debt or equity, and that the facts of the case revealed a long standing practice of advancing and repaying loans. The court also noted that related parties were involved and that a bona fide debtor-creditor relationship existed. The factors, the Tax Court concluded, indicated that the advances were bona fide debt resulting in deductible interest. However, the Tax Court also held that the transfers between the family members were made at less than fair market value and, as a result, were constructive distributions. Dynamo Holdings Limited Partnership, et al. v. Comr., T.C. Memo. 2018-61.

Lack of Substantiation Costs Taxpayer Numerous Deductions. The petitioners, a married couple, claimed various deductions on their return. The IRS denied most of their Schedule C deductions and all of their charitable contribution deductions. The Tax Court disallowed all deductions associated with the wife’s teaching activity because she admitted that she had no profit intent. Expenses associated with attendance at a seminar and a training event were also denied for lack of substantiation. Car and truck expenses were also denied due to an inadequately prepared log. Claimed legal and professional expenses were also denied because they were personal in nature. Supply expenses were also denied due to lack of substantiation as were office expenses, expenses for utilities and expenses for repairs and maintenance. All non-cash charitable contributions deductions were also denied due to lack of substantiation. The Tax Court also imposed an accuracy-related penalty. Moore v. Comr., T.C. Memo. 2018-58.

Posted May 3, 2018

No Summary Judgment For IRS On Liability For Payroll Taxes. The plaintiff served as a volunteer board member of a tax-exempt private school and was elected Treasurer of the Board of Directors. No Board member was responsible for the school’s daily operations, but the plaintiff did have the authority to sign or co-sign checks and he did so for those checks that were presented to him. However, the plaintiff was not responsible for determining who to pay or which bils required delayed payment. Those decisions belonged to the CEO who also handled payroll. The preparation and filing of all IRS form also was the responsibility of the CEO. The school fell behind in paying payroll taxes for the quarter ended December 31, 2011, and the Board of Directors notified on October 17, 2012 that the school had approximately $35,000 of unpaid payroll taxes. The plaintiff understood that the CEO was making installment payments as to the payroll tax liability. However, the IRS also assessed the plaintiff with liability for the unpaid payroll taxes. The plaintiff disputed liability under I.R.C. §6672. He paid the tax for one employee for each quarter of liability that he contested and then filed a refund claim via Form 843. He entered into an installment agreement with the IRS and made payments of $100 per month under protest in order to avoid collection. The school later closed in 2013. During this timeframe, the plaintiff continued to sign checks as Treasurer that made payments to other creditors. The plaintiff asserted that he was not a responsible party for the unpaid payroll taxes and the IRS moved for summary judgment. The court denied summary judgment for the IRS on the basis that the plaintiff had a reasonable belief that the taxes were being paid. Bibler v. United States, No. 2:17-cv-134, 2018 U.S. Dist. LEXIS 68044 (S.D. Ohio Apr. 23, 2018).

Posted May 2, 2018

Penalties and Interest Apply to E-Filed Return Even Though Paper-Filed Return Would Have Been Timely. On April 12, 2013, the plaintiff electronically filed a joint return for the 2012 tax year via TurboTax software. The return contained an erroneous Social Security number for a dependent. The same day, the IRS rejected the return because the Social Security number and last name did not match IRS records. Later that same day, TurboTax sent the plaintiff an email notifying him that the return had been rejected due to the mismatch of the name and Social Security number for the dependent. However, the plaintiff failed to check his email account and did not learn of the e-file status of the return until about 18 months later. The IRS assessed late payment and late filing penalties. The plaintiff filed the 2012 return on January 7, 2015 and paid the $395,619 tax liability in full. On February 16, 2015, the IRS assessed a late filing penalty of $89,014.27 and a late payment penalty of $41,539.99 plus interest of $26,216.81 on the late payment. The plaintiff paid the interest, but not the penalties. On April 27, 2015, the plaintiff submitted a statement to the IRS noting that had he realized that the return had not been accepted he could have paper filed the return on a timely basis. The plaintiff also conceded that he didn’t read the “fine print” of the tax software agreement that “may have” notified him that he needed to log back in to ensure that the return was accepted. The plaintiff, in August of 2016, filed a request via Form 843 for abatement of the penalties for late filing and late payment, and lied that the 2012 return had been electronically filed via TurboTax without issue. The plaintiff filed suit challenging the assessment of the penalties. At trial, the plaintiff conceded the late payment penalty (and associated interest) but challenged the other penalties and interest assessed. The plaintiff claimed that the document filed should have been accepted as a “return” and should not have been rejected. The plaintiff claimed that the return met all of the requirements of Beard v. Comr., 82 T.C. 766 (1984) because it was sufficient to calculate the tax liability; purported to be a return; was an honest and reasonable attempt to satisfy the requirements of the tax law; and was executed under the penalty of perjury. The plaintiff also pointed out that the IRS would have accepted the return had it been paper-filed, citing the Internal Revenue Manual (IRM). However, the court determined that the plaintiff had not properly established a foundation for the IRM, and did not create a triable issue of fact as to whether the same mistake on a paper-filed return would have been accepted by the IRS. Accordingly, the court held that the return, as filed, did not allow the IRS to compute the plaintiff’s tax liability (without providing any explanation of how a Social Security number mismatch had anything to do with computing tax liability) and granted the government’s motion for summary judgment. Spottiswood v. United States, No. 17-cv-00209-MEJ, 2018 U.S. Dist. LEXIS 69064 (N.D. Cal. Apr 24, 2018).

Posted April 30, 2018

Bad Debt Not Deductible. From 2004-2006, the plaintiff loaned money to a friend with the amount loaned growing over time to $430,500 not counting accrued interest. A promissory note was entered into after-the-fact. In 2010, the plaintiff contributed the loan to her LLC which soon thereafter made final demand for payment of the loan and then sued to collect. The LLC obtained a judgment for the amount, plus legal fees, but was not able to collect. Consequently, the LLC claimed a business bad debt deduction for the loss which flowed through to the plaintiff’s Schedule C. The IRS denied the deduction and the court agreed. The court determined that the debt was a nonbusiness debt that did not become worthless in 2010 as claimed. The court noted that the plaintiff was required to show that the debt was worthless to be able to claim the loss. The court determined that the plaintiff failed to show that there were reasonable grounds for abandoning any hope of repayment in the future. Hatcher v. Comr., No. 17-60315, 2018 U.S. App. LEXIS 9100 (5th Cir. Apr. 9, 2018).

Posted April 17, 2018

Fix and Flip House Is Capital Asset; Associated Expenses Must Be Capitalized. The petitioner resided on the East Coast and was a retiree. To keep himself busy, the petitioner purchased a run-down home 250-miles away with the intent to fix it up and sell it. The petitioner would travel to the house during the week and would work on it, traveling home on the weekends. The petitioner kept detailed records of his trips and deducted his travel expenses, which IRS allowed for 2012 but disallowed on the 2013 return after auditing the 2013 return. The IRS asserted that the travel expenses needed to be capitalized into the petitioner’s income tax basis in the home. The Tax Court noted that the home was purchased with the intent to make it habitable and increase its value for resale. However, the home remained a capital asset that was not held for sale in the ordinary course of the petitioner’s trade or business because the petitioner did not keep separate records for the activity regarding the home; made no other real estate purchases and sales; the activity did not otherwise produce any income; and the petitioner did not maintain a business office. The Tax Court determined that the expenses incurred were to increase the value of the property and extend its useful life which were both characteristics of capital expenses that would not generate any current deduction. Havener v. Comr., T.C. Sum. Op. 2018-17.

Cattle Ranching Activity Deemed to be a Hobby; Losses Disallowed. After growing up on the family ranch in the Texas panhandle, the petitioner had a career as a chiropractor and also operated a publishing and research business and a gun shop. He sold his chiropractic practice and bought an 1,100-acre ranch in south-central Texas. The petitioner ran a feeder-stocker cattle operation on the ranch, employing two ranch workers to tend to the cattle. The petitioner also hired a bookkeeper to manage his various business activities and a CPA to do the tax work for his businesses. He put approximately six to eight hours a week into the cattle ranching activity, and also spent time in his other business ventures. He modified his cattle operation after encountering problems that were detrimental to the viability of the business. The petitioner’s publishing business showed an average profit of approximately $300,000 each year; the gun shop was approximately a break-even business; and the cattle business averaged Schedule F losses of about $100,000 annually over a 15-year period, never showing a profit in any year (although losses declined on average over time). The IRS examined years 2011 and 2012 and disallowed the loss from the ranching activity on the basis that the petitioner did not engage in the activity with a profit intent. The Tax Court analyzed each of the nine factors under Treas. Reg. §1.183-2. Of the nine factors, the only one that favored the petitioner was that the Tax Court determined that he did not derive any personal pleasure from the cattle ranching activity. The Tax Court determined that the petitioner did not operate the ranch in a businesslike manner; had no formal education in animal husbandry; did not view the hours spent in the activity by the employees as attributable to the petitioner; did not have a reasonable expectation of appreciation of the value of the ranch’s assets (but the Tax Court ignored the building improvements and fences that were built); no history of running comparable businesses profitably; and had substantial income from other sources that the losses from the ranching activity offset. Williams v. Comr., T.C. Memo. 2018-48.

Posted April 14, 2018

Genetic Testing and Consulting Services Subject to State Sales Tax. The plaintiff offers lab testing and consulting services for food, feed and agricultural companies. The services include genetically modified organism (GMO) testing, plant and animal species identification, gluten testing, food microbiology testing and contract research services. The plaintiff’s customers are located in the U.S. and in other parts of Canada, Latin American and South America. The customer orders testing services by completing an Analysis Order Form and Agreement and a Genetic ID Analysis Customer Agreement Form. The forms contain the terms of sale and the rights and obligations of the parties. The customer sends samples to the plaintiff and the plaintiff sends test results to the customer with an invoice for the services ordered. The state department of revenue determined that when the taxpayer delivers test result via U.S. mail to an in-state address, the sales price for the testing service is subject to state sales tax. The same result occurs, when the test results are emailed to an in-state business. Sales tax also applies when a customer accesses test result via the plaintiff’s web portal. In addition, the location where a sample originates has no impact on the taxability of the testing service. But, customers may have an obligation to remit state use tax if the customer uses the testing service in-state, even if no state sales tax is due on the sale. In re Genetic ID, NA, Inc., No. 2017-300-2-0217 (Iowa Dept. of Rev. Mar. 1, 2018).

Grouping of Real Estate and Aviation Activities Not Allowed. The petitioner owned 60 percent of a C corporation that was engaged in developing real estate. The balance of the stock was owned by two others. The business had its headquarters in southern California and the plaintiff participated in the business for more than 500 hours in 2007, the year in issue. The business had a development project in 2007 in northern California several hundred miles away. The shareholders discussed buying an airplane for the trips to the project and back to southern California. Ultimately, instead of the corporation buying the plane, the plaintiff bought it personally through his LLC. In 2006, the plaintiff had formed and LLC (taxed as a partnership) in which he owned 51 percent and his wife owned 49 percent. The LLC entered into a management agreement with an aviation company that provided that the aviation company was responsible for all managerial duties related to the plane and had the exclusive right to charter the plane for commercial flights by third parties whenever the petitioner did not need to use the plane. The plaintiff was also given access to other planes when his was being chartered. In 2007, the plaintiff used the plane on only one occasion. On four other occasions he used a different plane because his was being chartered. On petitioner’s 2007 return, he reported a $683,000 loss. Upon audit, the IRS recharacterized the loss as a passive loss on the basis that the plaintiff had not materially participated in the LLC’s activities. The Tax Court agreed with the IRS and also concluded that the petitioner could not group the airplane activity with the real estate development activity because none of the Treas. Reg. §1.469-4(c)(2) factors favored grouping the two activities together. There was no functional similarity between the two activities and the plane was not integrated into the real estate activity in any way. While the factors for extent of common ownership and common control were neutral (the petitioner held controlling interests in both entities, but the interests were very different), there was no interdependence between the two businesses. In addition, the court noted that the petitioner did not materially participate in the aviation activity because there was no evidence to support the petitioner’s contention that he participated for at least 100 hours including no contemporaneous logs, appointment books, calendars or narrative summaries. In any event, the petitioner did not devote 500 or more hours in the aggregate to “significant participation activities.” The real estate development activity did not qualify as a significant participation activity. Brumbaugh v. Comr., T.C. Memo. 2018-40.

Posted April 9, 2018

No Charitable Contribution For Donated Conservation Easement. The petitioner claimed a $1,798,000 charitable deduction for the contribution of a permanent conservation easement. The IRS disallowed the deduction in its entirety on the basis that the plaintiff stood to benefit from the contribution by virtue of owning land that adjoined the property subject to the easement and that the plaintiff had plans to create a master-planned community. The court agreed with the IRS, noting that “the plaintiff would benefit from the increased value to the lots from the park as an amenity.” Wendell Falls Development, L.L.C. v. Comr., T.C. Memo. 2018-45.

Posted April 7, 2018

Developer’s Land Sales Generated Capital Gain. The petitioner was established in 1998 primarily to acquire contiguous tracts of land for development purposes as single family residential building lots and commercial tracts. For 10 years, the petitioner operated in that fashion, acquiring and preparing tracts for ultimate sale. Indeed, small portions of a tract that had been developed were sold. However, in 2008, the petitioner’s managers decided that the petitioner would no longer develop the balance of the property it owned due to the downturn in the economy. Thus, it was decided that the petitioner would hold the property as investment property until the real estate market recovered, and then sell it. This decision was formalized and included in a member resolution as the petitioner’s policy. For four years, the property sat with no development occurring, and without the petitioner listing it for sale or marketing it in any manner. However, in 2011, the petitioner was approached by a potential buyer who subsequently bought a portion of the property. The buyer bought the balance of the property in 2012. The petitioner then closed-out all of its holdings by disposing the balance of the property it owned. The petitioner reported the income from the sales as capital gain. The IRS, on audit, asserted that the gain was ordinary in nature. The court held that the sales generated capital gain because the parcels sold were held for investment and were not held as part of the petitioner’s ordinary course of business. The court noted that the petitioner had ceased holding its property primarily for sale and had begun to hold it for investment purposes as of 2008. In addition, no development occurred from 2008 forward, and no advertising occurred. The court noted that a taxpayer is entitled to show that its primary purpose changed to an investment purpose. Furthermore, the court noted that after 2008 the petitioner disposed of all of its property in only nine sales over eight years, and the tracts ultimately sold that were at issue in the case had not been developed and constituted over one-half of the petitioner’s holdings. Sugar Land Ranch Development, LLC v. Comr., T.C. Memo. 2018-21.

Posted April 5, 2018

Retirement Plan Payments Subject to S.E. Tax. The petitioners, a married couple, filed joint returns for the years in issue. The wife was the national sales director for Mary Kay, Inc. The wife participated in the company “Family Security Program” which offered her various benefits and monthly payments of one-twelfth of her final average commission for 15 years. The final average was the average of her highest three years of commissions during her last five years of service. The company informed the wife that the payments under the program were subject to self-employment tax. For 2013 and 2014, the wife received $173,707 each year and it was reported on the couple’s return as “other income” not subject to self-employment tax. The Tax Court held that the payments were subject to self-employment tax, citing its prior opinion in Peterson v. Comr., T.C. Memo. 2013-271 which the court determined was factually the same as the present case. The payments were tied to the quantity and quality of the wife’s prior labor as being based on average commissions she had received over the five years before she retired. They were not comparable to “termination payments” in the insurance industry. Sherman v. Comr., T.C. Sum. Op. 2018-15.

No QJV Election Means Partnership Return Should Have Been Filed. A married couple were the members of the petitioner, an LLC. The IRS held a collection due process (CDP) hearing regarding a levy with respect to the penalty for failure to file a partnership return. The couple argued that they weren’t liable for the failure-to-file penalty because the entity was a single member LLC on the basis that they constituted a single member. The petitioner’s returns for 2010 and 2011 stated that the I.R.C. §6231(A)(1)(B)(ii) election for the petitioner was in effect (under the TEFRA audit procedures that apply to partnerships). But, the 2010 and 2011 returns were not timely filed, causing the IRS to assess late filing penalties for failure to file the partnership returns. For tax years 2010 and 2011, the couple filed Form 1065 and Schedules B-1 as owning 100 percent of the petitioner. The Tax Court agreed with the IRS, noting that the petitioner had represented itself as a partnership on its returns and could not argue it was a different type of entity. The Tax Court also noted that the couple had not made a qualified joint venture election pursuant to I.R.C. §761(f). The IRS, the Tax Court noted, did not abuse its discretion via its determination. Argosy Technologies, LLC v. Comr., T.C. Memo. 2018-35.

Posted April 2, 2018

S Corporation Land Rents Not Passive; Trust Shareholder Was ESBT. The taxpayer, an S corporation engaged in farming and managing real property had a grantor trust as a shareholder. The taxpayer engaged in four leases involving the farming operation that generated rental income to the taxpayer. The taxpayer sought a ruling on whether the taxpayer’s rental income was passive investment income under I.R.C. §1362(d)(3)(C), and whether the trust would qualify as an electing small business trust (ESBT) under I.R.C. §1361(e). The trust grantor died and the trust beneficiaries were two distributing trusts that are U.S. individuals and two tax-exempt organizations. Each beneficiary received a stepped-up basis under I.R.C. §1014. Three of the leases provide that the taxpayer is a full participant in the farm’s management, and that the tenant could not deviate from the managerial plan without the taxpayer’s approval. The leases were crop-share leases that also split expenses between the taxpayer and the tenant. The fourth lease provided for the tenant’s plowing, land clearing and crop cultivation for a share of the crops. The IRS determined that the taxpayer’s rental income from the leases was not passive investment income under I.R.C. §1362(d)(3)(C), and that the trust qualified as an ESBT because the beneficiaries were qualified beneficiaries and no interest of the trust was acquired by purchase. Priv. Ltr. Rul. 201812003 (Dec. 15, 2017).

Posted March 31, 2018

Horse Breeding Activity Not Engaged in With Profit Intent. The petitioner was engaged in a horse breeding activity, but never earned a profit. She had occasional sales from the activity, but those sales were insufficient to cover the petitioner’s losses from the activity. The plaintiff deducted expenses associated with the activity, but the Oregon Department of Revenue (ODOR) determined that she wasn’t engaged in the activity with a profit intent. As such, the ODOR limited the petitioner’s deductions to the extent of her gross income from the activity. The court agreed with the ODOR. The court noted that the plaintiff testified that her ledger was reconciled monthly, but the court did not believe her testimony given that she underreported horse sale proceeds and didn’t record horse dispositions from inventory. However, the court did allow deductions for expenses associated with insurance, repairs, maintenance and supplies. Feola v. Oregon Department of Revenue, No. TC-MD 160081N, 2018 Ore. Tax. LEXIS 48 (Ore. Tax. Ct. Mar. 27, 2018).

Posted March 30, 2018

Company Not Entitled To Alternative Fuel Mixture Credit. The plaintiff, a Pella, Iowa firm, produced alternative fuel mixtures consisting of liquid fuel derived from biomass and diesel fuel. The plaintiff registered with the IRS via Form 637 and was designated as an alternative fueler that produces an alternative fuel mixture that is sold in the plaintiff’s trade or business. To produce alternative fuel mixtures, the plaintiff bought feedstock from a supplier, with a trucking company picking up the feedstock and adding the required amount of diesel fuel to create the alternative fuel mixture. The mixture would then be delivered to a contracting party and use the fuel in its business. The plaintiff entered into contracts with various parties that could use the alternative fuel mixture in their anaerobic digester systems to make biogas. One contract in particular, with the Des Moines Wastewater Reclamation Authority (WRA) provided that the plaintiff would pay WRA to take the alternative fuel mixtures from the plaintiff. The plaintiff’s consulting attorney (a supposed expert on energy tax credits from Atlanta, Georgia) advised the plaintiff that it would “look better” if the plaintiff charged “anything” for the fuel mixtures. Accordingly, the plaintiff charged the WRA $950 for the year for all deliveries and the plaintiff was charged a $950 administrative fee for the year. The WRA also charged the plaintiff a disposal fee for accepting the alternative fuel mixtures in the amount of $.02634/gal. for up to 50,000 gallons per day. The plaintiff treated the transfers of its alternative fuel mixtures as sales for “use as a fuel.” That was in spite of the fact that the plaintiff paid the fee for the transaction. However, the Atlanta “expert” energy tax credit attorney advised the plaintiff that the transaction qualified as a sale, based upon an IRS private letter ruling to a different taxpayer involving a different set of facts and construing a different section of the Internal Revenue Code. As such, the plaintiff claimed the alternative fuel mixture credit (I.R.C. §6426) of $.50/gal. for blending an alternative fuel with at least .1 percent of a taxable fuel to produce a mixture that is used or sold for use as a fuel in a vehicle, motor boat, or used to produce an alternative fuel in the taxpayer’s trade or business. The plaintiff claimed a refundable alternative fuel mixture credit in accordance with I.R.C. §6426(e) of $19,773,393 via Form 8849. The IRS initially allowed the credit, but upon audit the following year disallowed the credit and assessed a tax of $19,773,393. In addition, the IRS imposed a 200 percent penalty of $39,546,786 for claiming excessive fuel credits without reasonable cause. The court agreed with the IRS. While the court noted that the plaintiff was registered with the IRS and produced a qualified fuel mixture, the court determined that the plaintiff did not sell any alternative fuel mixture for use as a fuel. While the court noted that the term “use as a fuel” is undefined by the Code, the court rejected the IRS claim that the alternative fuel mixtures were not used as a fuel because the mixtures did not directly produce energy. Instead, they produced biogas that then produced energy, and the court noted that the IRS had previously issued Notice 2006-92 stating that an alternative fuel mixture is “used as a fuel” when it is consumed in the energy production process. However, the “production of energy” requirement contained in the “use of a fuel” definition meant, the court reasoned, that the alternative fuel mixture that is sold must result in a net production of energy. As applied to the facts of the case WRA could not provide any data that showed which of the feedstock sources from its numerous suppliers was producing energy, and which was simply burned off and disposed of. As such, the plaintiff could not prove that its fuel mixtures resulted in any net energy production, and the “use as a fuel” requirement was not satisfied. In addition, even if the “use as a fuel” requirement was deemed satisfied, the court held that the plaintiff did not “sell” the alternative fuel mixture to customers. The nominal flat fee lacked economic substance. The fee, the court noted was “charged” only for the purpose of receiving the associated tax credit. In addition, no sales taxes were charged on the “sales.” Thus, the plaintiff was not entitled to any alternative mixture fuel credits. The court upheld the 200 percent penalty insomuch as the professional advice the plaintiff received was not reasonable (the IRS private letter ruling upon which the “expert” based his opinion on involved a different statute, a distinguishable set of facts, and did not support the plaintiff’s position) and was ultimately not relied upon. The end result was that that plaintiff had to repay the $19,773,393 of the claimed credit and pay an additional penalty of $39,546,786. Alternative Carbon Resources, LLC v. United States, No. 1:15-cv-00155-MMS, 2018 U.S. Claims LEXIS 189 (Fed. Cl. Mar. 22, 2018).

Posted March 29, 2018

No Business or Research Expense Deduction for Pro Bono Work. The petitioner provided litigation consultant services via his sole proprietorship, billing clients at $250/hour. During 2014, the petitioner also performed 100 hours of pro bono legal research and related services, including expert witness testimony in legal cases. The petitioner did not conduct experiments or conduct any work in a laboratory. On his 2014 return, the petitioner claimed a Schedule C deduction in the amount of $25,000 for “Research on cases.” The IRS disallowed the deduction and the Tax Court agreed, noting that I.R.C. §162 does not allow a deduction based on the value of the taxpayer’s own labor. The Tax Court also noted that the expenditure of labor “does not constitute the payment of an expense within the meaning” of I.R.C. §162. The petitioner also asserted that the expense was deductible as a research and development expense under I.R.C. §174. However, the petitioner conceded that he did not conduct research in the experimental or laboratory sense as I.R.C. §174 required. In addition, the Tax Court noted that I.R.C. §174 did not apply to the petitioner’s value of his time because his time was not “paid or incurred,” the same language as contained in I.R.C. §162. Bradley v. Comr., T.C. Sum. Op. 2018-13.

Short Sale of Real Estate Generated Capital Loss. The petitioner owned a historic waterfront mansion and was in the process of restoring it with plans to rent it. The restoration turned out to be more costly and take longer than originally anticipated. The petitioner never actually rented the property even though a listing agent did talk to prospective renters that expressed interest in renting it. Ultimately the petitioner abandoned attempts to rent the property due to economic issues, and entered into a short-sale of the property for $6.5 million. On the petitioner’s 2009 return, the seven-figure loss on sale was reported as a capital loss, limited the ability to offset income other than capital gains to $3,000 per year. Later, the petitioner met with an estate planner that questioned the tax treatment of the loss on the 2009 return. As a result, the petitioner hired another tax preparer to file an amended 2009 return to treat the sale as the sale of an I.R.C. §1231 asset. The result was that the loss was ordinary in nature, which also triggered a large net operating loss that the petitioner carried back to 2004 and forward to 2010. The IRS issued a refund, but later examined the 2009 return and determined that the loss was not an I.R.C. §1231 loss, but involved the sale of a capital asset generating a capital loss. The Tax Court agreed with the IRS, noting that for property to be treated as property that is used in a taxpayer’s trade or business, the taxpayer must be engaged in the activity on a basis that is, “continuous, regular, and substantial” in relation to the management of the property as part of the rental activity. The Tax Court noted that there was never any rental activity that was engaged in in any meaningful or substantial way. Thus, the IRS was correct to disallow the NOL carryover and carryback. The Tax Court also sustained the imposition of an accuracy-related penalty for the petitioner’s failure to rely on the advice of a professional. The Tax Court noted that the petitioner knew that a rental activity had never been engaged in. Keefe v. Comr., T.C. Memo. 2018-28.

Posted March 28, 2018

No Charitable Donation of House For Failure To Comply With Substantian Requirements.  The petitioner was a 50 percent partner in a real estate development partnership that sold lots for residential development. The partnership owned a house that it used an office, and the partnership donated the house to the petitioner’s church with the understanding that church volunteers would disassemble the house and move the building materials to the church’s property. The house was disassembled and moved to the church’s property. The petitioner, on his 2011 return, reported that he had donated a house with a value of $176,255 to the church. That amount was the appraised value of the intact house obtained three years after the transfer to the church. The plaintiff represented to his CPA that he had donated the intact house to the church in a prior year and wanted to deduct one-half of its value on his return. The return was filed with the claimed deduction and the IRS objected. The court agreed with the IRS, finding that no charitable deduction was allowed and no partial charitable deduction was allowed. The court determined that the petitioner failed to substantially comply with the various requirements for substantiating a charitable deduction. The court also noted that the petitioner tried to deduct 100 percent of the value of an intact house rather than 50 percent of a non-intact house as a 50 percent partner in the partnership. The petitioner also did not provide an appraisal of the various parts of the home as donated. In addition, the court noted that a charitable deduction can only be claimed for the year in which it was made. Here, the court found, the donation was made in 2000, but the deduction was claimed in 2001. Thus, the appraisal attached to Form 8283 of the 2001 return was invalid as not received by the donor before the due date (including extensions) of the return on which a deduction is first claimed. The due date for the petitioner’s return was Oct. 15, 2002, but the appraiser’s transmittal letter was prepared on Nov. 8, 2002. In addition, the appraisal was prepared more than 60 days before the date of the contribution. The appraisal was also improper for valuing an intact house. The court determined that the petitioner’s compliance was so far from substantial that he was not entitled to a charitable deduction for the contribution of building parts in 2001. Platts v. Comr., T.C. Memo. 2018-31.

Posted March 23, 2018

Farm Not Engaged in For Profit – Deductions Limited to Net Farm Income. The plaintiff succeeded to his father’s farming business in 2008. Later that year he started fishing as a crew-hand and eventually became captain of a boat. In 2008, approximately a dozen of the plaintiff’s cows died from blackleg disease. In addition, the plaintiff testified that in 2009 his father took the plaintiffs’ cattle to market without his permission and kept the proceeds, leaving the plaintiff with only five animals. The plaintiff testified that although he felt what his father did was wrong he did not report his loss to the authorities. During the tax years at issue the plaintiff did not show any cattle as an asset, did not depreciate the animals, identified his farm business as “hay” on his tax returns and did not declare a loss on the 2009 incident. During the tax years at issue the plaintiff engaged a CPA firm to prepare and file his returns. Those returns did not list cattle ranching as a business. The plaintiff did not create a written business plan for the farm until after he was audited for the tax years at issue. The defendant, Oregon Department of Revenue (defendant), sent the plaintiff a Notice of Deficiency for the tax years at issue (2012, 2013 and 2014). The plaintiff appealing the notice of deficiency. The court determined that the issue was whether the plaintiff’s farm was a business for which deductions would be allowed under I.R.C. §162, or an activity not engaged in for profit under I.R.C. §183. To make this determination the court considered several different factors. The court determined that the plaintiff did not have complete and accurate books and records for farm income and expense for the tax years at issue. This factor weighed against the plaintiff. The plaintiff presented evidence that he spent 525 hours a year to feed cattle. Additionally, he presented evidence of at least 650 hours per year of equipment time for hay production and 120 hours per year for hay storage. The court determined that his was a significant amount of time, with this factor weighing in the plaintiff’s favor. In addition, the only asset the plaintiff could assert might increase in value was his cattle. However, no evidence was presented of actual ownership of the cattle and scant evidence was presented to show how the cattle value would appreciate. This factor weighed against the plaintiff. No evidence was presented that the plaintiff had been successful in similar farm activities. On the contrary, the plaintiff was a successful fisherman/boat captain and his wife was a banker and county employee. Success in these occupations, the court noted, was not similar to farming. This factor weighed against the plaintiff. In addition, the court determined that the plaintiff’s losses in excess of $260,000 over a seven-year period painted a very clear picture which did not weigh in the plaintiff’s favor. The plaintiff’s testimony also indicated that he was not in a hurry to make a profit to offset expenses despite a long history of losses. This factor weighed against the plaintiff. Thus, if it weren’t for the plaintiff’s and his wife’s other significant income he would have been unable to sustain his farm activity. This factor also weighed against the plaintiff. Finally, the plaintiff’s testimony of family heritage and sense of accomplishment appear to be significant motivation for the continuation of the farm activity, rather than a more contemporaneous profit motive. This factor weighed against the plaintiff. Consequently, after consideration of all the factors as a whole the court concluded that the plaintiff did not operate his farm with the requisite intent to make a profit during the 2012, 2013 and 2014 tax years. As such, the plaintiff’s farm deductions for those years were limited to net farm income. Howard v. Department of Revenue, No. TC-MD 160377R, 2018 Ore. Tax LEXIS 35 (Ore. Tax Ct. Mar. 16, 2018).

Posted March 22, 2018

Losses From Horse-Related Activities Not Subject to Passive Loss Rules and IRS Position Not Substantially Justified. The petitioner was a Minnesota lawyer with a client that introduced him to horse racing. The petitioner got heavily involved in horse breeding activities in Louisiana. The petitioner sustained losses associated with his horse activities and IRS limited deductibility under the passive loss rules of I.R.C. §469, conceding that the petitioner was engaged in the horse activities with a profit intent. In an earlier action, the Tax Court determined that the petitioner satisfied the material participation test of I.R.C. Sec. 469 based on telephone logs, credit card invoices, and other contemporaneous materials including trips to Louisiana, buying insurance, recordkeeping and continuing education. The Tax Court did not require the petitioner to call customers as witnesses. In a subsequent action, the petitioner sought reasonable litigation costs associated with a qualified offer associated with the passive activity loss adjustment. The Tax Court determined that the IRS could have interviewed the customers that didn’t testify but provided affidavits. The IRS claimed that it was substantially justified in not conceding that the petitioner satisfied the 500-hour rule under I.R.C. §469 because most of the hours represented the petitioner’s work as an investor. However, the Tax Court noted that an investor’s activities count as materially participating when the investor’s is directly involved in the daily management and operations of the activity. As a result, the reliance of the IRS on Treas. Reg. §1.469-5T(f)(2)(ii) was not reasonable because the evidence showed that the petitioner was directly involved in the activity. As the prevailing party, and because the position of the IRS was not substantially justified, the Tax Court held that the petitioner could recover reasonable litigation costs. The Tax Court established the award at approximately 60 percent of the total attorney hours that the petitioner claimed at the statutory rate of $180 per hour rather than the $400 per hour that were requested. There were no special factors warranting a departure from the statutory rate. Tolin v. Comr., T.C. Memo. 2014-65; T.C. Memo. 2018-29.

Loan Repayments Not Deductible As Bad Debt. In 2008, the plaintiffs (a married couple) opened a small marine supply store. In 2010, the company secured a Small Business Administration (SBA) loan in the principal amount of $85,000. The business was not successful and was unable to make payments on the loan. To repay the company's debts, the plaintiffs obtained a reverse mortgage on their residence to pay off the SBA loan, a bank loan and associated fees. However, the reverse mortgage did not yield sufficient funds to save the company, which closed in early 2012. The corporation did not reimburse the plaintiffs or offer any collateral to the plaintiffs for the amount they personally paid toward the SBA loan. As a result, the plaintiffs claimed a bad debt deduction in accordance with I.R.C. §166 and a tax refund of approximately $140,000. The IRS moved for summary judgment. The court granted the IRS motion, noting that there was no written agreement between the taxpayer and the corporation to reimburse the plaintiffs for amounts personally paid on the SBA loan. Thus, the court reasoned, there was no bona fide debt issued by the corporation. Consequently, the amount of the loan repayments and associated expenses were a nondeductible contribution of capital to the business. Norgaard v. United States, No. 16-12107-FDS, 2018 U.S. Dist. LEXIS 28293 (D. Mass. Feb. 22, 2018).

Receipt of Payment Without Restrictions Results in Income. The petitioner received a check from a client in the amount of $150,000 for the provision of tax services in the future. The check placed no restrictions on the petitioner and the petitioner used some of the proceeds for business purposes. The petitioner claimed the $150,000 need not be included in income until the services were provided, but the IRS disagreed. The court sided with the IRS, holding that the $150,000 was included in income in the year received. The court also determined that certain expenses the petitioner paid on behalf of the client was not deductible because the petitioner failed to prove that the amounts paid were for carrying on the petitioner’s trade or business. RJ Channels, Inc. v. Comr., T.C. Memo. 2018-27.

Posted March 19, 2018

No Gain or Loss on Short Sale of Rental Property. The petitioners, a married couple, bought their home with nonrecourse debt. They moved out five years later and converted their home to a rental property. Shortly thereafter, they completed a “short sale” of the property in which they sold the property to a third party for an amount that was insufficient to cover the outstanding loan balance. The lender agreed to release its lien on the property to facilitate the sale. The petitioners gave all of the sale proceeds to the lender. The petitioners reported a deductible loss on the sale of the rental property, and did not report the cancelled debt as income, believing that the debt forgiveness and the short sale were two separate transactions. The IRS determined that the transaction was a single sale resulting in no cancelled debt income, but also no deductible loss. The IRS also imposed an accuracy-related penalty. The Tax Court agreed with the IRS position, with the amount realized including the discharged nonrecourse debt. The court determined that the amount realized exceeded the petitioners’ loss basis in the property in accordance with Treas. Reg. §1.165-9(b)(2). However, the amount realized was less than the petitioners’ gain basis in the property. Consequently, there was no gain nor loss on the sale. The court did not uphold the accuracy-related penalty. Simonson v. Comr., 150 T.C. No. 8 (2018).

Posted March 11, 2018

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., 691 Fed. Appx. 320 (9th Cir. 2017), aff’g., T.C. Memo. 2015-109, cert. den., No. 17-899, 2018 U.S. LEXIS 1351 (U.S. Sup. Ct. Feb. 20, 2018).

Posted March 4, 2018

Simply Correcting Wrongful Recognition of Income Is Not A Method Change. The IRS has concluded that the erroneous treatment as income of the assets of a real estate investment trust (REIT) upon purchase of all of the REIT’s common stock that had been owned by a failed bank did not constitute a change in accounting method when the income reporting was corrected. Thus, no negative I.R.C. §481(a) adjustment was necessary. The IRS noted that an accounting method change involves a change in the overall plan of accounting for gross income or deductions or a change in the treatment of any material item used an overall plan of accounting. A “material item” is any item involving the proper time for the inclusion of the item in income or the taking of a deduction (Treas. Reg. §1.446-1(e)(2)(ii)(a)). In determining whether timing is involved, the key inquiry is whether the accounting practice permanently affects the taxpayer’s lifetime income or merely changes the tax year in which taxable income is reported. If the practice simply changes the tax year in which the income is reported and does not permanently affect lifetime income, the practice is a change in accounting method. LAFA 20180601F (Oct. 25, 2017).

No Current Deduction for “Repairs” to Rental Properties. The petitioners, a married couple, claimed deductions for repairs to rental properties that they owned on their 2013 return. The IRS disallowed a majority of the deducted amount, treating the disallowed amount as a capital expenditure that had to be added to basis of the rental properties. The IRS determination had the effect of increasing the petitioners’ depreciation deduction. The overall result, however, was a tax deficiency on the 2013 return. The “repairs” included the installation of new carpet, vinyl tile, staining ceiling tiles, removing walls, installing new ceiling tiles, and updating electrical wiring. The petitioners claimed that the expenditures were all made to keep the properties in operating condition and didn’t prolong life or increase value. In other words, the petitioners claimed that the expense were incurred in the course of routine property maintenance. The IRS asserted that the expenditures were capital improvements and that the petitioners provided no evidence concerning when original components were placed in use or what their condition was at the time of replacement. The IRS also claimed that the petitioners did not show that the useful life of any of the disputed repairs was less than one year or that the expenditures should not be deemed a general plan of improvement. The IRS also claimed that the petitioners did not provide evidence of compliance with the terms of any lease agreements concerning the expenditures or that the work was done on a recurring basis. The Tax Court agreed with the IRS. Brown v. Comr., T.C. Sum. Op. 2018-6.

Note: Final regulations issued on September 17, 2013, and effective for tax years beginning after 2013, allow the cost of certain capital improvements to be currently deductible. In addition, a “small taxpayer” (one with gross receipts of $10 million or less) that owns or leases a building with an unadjusted basis of $1 million or less can elect to use a safe harbor. Under the safe harbor, the total annual expenditures for repairs, maintenance, and improvements on a building can be immediately deductible as long as the expenses don’t exceed the lesser of 2% of the unadjusted basis of the building, or $10,000.

Mortgage Payments Not Deductible as “Rents.” The petitioner was a corporation having a medical doctor as its sole shareholder and employee. The shareholder is a physician that contracted with an emergency medicine medical group to provide emergency medical services to a hospital. The corporate business address was that of the shareholder’s personal residence in Los Angeles. The shareholder used the second story of the residence to access patient records remotely, complete notes on patients, and do continuing education training as well as certification activities for medical boards. No patients were treated at the residence, and the only other persons that have used the residence for business purposes were the shareholder’s paid “assistant” and his medical malpractice defense attorneys. Upon advice of a tax return preparer, the petitioner deducted 100 percent of the shareholder’s mortgage payments as “rents.” In addition, the shareholder, on his personal return, claimed an itemized deduction for the mortgage interest. The IRS disallowing the rent deduction on the corporate Form 1120 because it was, in reality, a mortgage payment made by the corporation for the shareholder’s personal residence. The Tax Court agreed with the IRS. The Tax Court noted that, under I.R.C. §162(a), a C corporation may deduct payments made to lease home office space from an employee (or from its owner) as rent if they are ordinary and necessary business expenses that are directly connected with or pertaining to the corporation’s trade or business if the lessor-employee reports the rent payments received as income on Schedule E with no offsetting home office deduction. However, for the deduction to be claimed, the Tax Court noted that there must be a valid rental arrangement and that the burden to establish the existence of the arrangement was on the corporation/lessee shareholder. The Tax Court determined that the valid lease arrangement was not established. There was no written rental agreement, and the shareholder didn’t report the rental income on his personal return. The court noted that the entity at issue was a C corporation, which did not invoke the rules of I.R.C. §280A as would have been the case with a sole proprietorship or S corporation. Christopher C.L. NG MD, APC v. Comr., T.C. Memo. 2018-14.

Posted March 2, 2018

Gravel Severed From Tribal Lands Subject To Income Tax. The petitioners, a married couple, were members of the Seneca Nation, and lived on tribal property. They received permission from the Nation Council to mine and sell gravel from their property during 2008 and 2009, generating $1.5 million in gross receipts in 2008 and $1.7 million in 2009. They also had sufficient gravel to sell in 2010, even after their permit to mine expired at the end of 2009. When they filed their 2008 and 2009 tax returns (which were filed late) they attached a “detail sheet” to each return that said the income from the gravel was from Native American land and was not subject to federal income tax under the Indian General Allotment Act of 1887. The IRS disagreed, and sent the plaintiffs a notice of deficiency for years 2008-2010. The IRS also imposed penalties in accordance with I.R.C. §§ 6651(a) (failure to timely file) and 6662(a) (accuracy-related). The petitioners paid the asserted deficiency for 2010 and filed a refund suit in federal district court. They also filed a petition with the Tax Court for the 2008 and 2009 tax years. The IRS moved for summary judgment in both cases. During discovery, the petitioners modified their argument to claim that the gravel sale income was not taxable under either the Canandaigua Treaty of 1794 and/or the Seneca Treaty of 1842. The IRS moved for summary judgment in both cases. The district court rejected the IRS motion to dismiss on the belief that the Seneca Treaty of 1842 might apply. In the Tax Court case, for tax years 2008-2009, the Tax Court noted that the General Allotment Act of 1887 specifically exempted the reservations of the Seneca Nation. Thus, the General Allotment Act of 1887 had no application to the petitioners and, as a result, did not exempt them from income tax. The Tax Court also cited a prior caselaw holding that the Canandaigua Treaty did not create a tax exemption for the individual members of the constituent nations of the Iroquois Confederacy, of which the Seneca Nation was a member. Likewise, the Tax Court also held that the Seneca Treaty of 1842 did not exempt the petitioners' gravel income from federal taxation. That Treaty, the court noted, exempts land (real property) from taxation rather than gravel that’s been severed from the land before it was sold. The Tax Court upheld the late-filing penalty, but not the accuracy-related penalty because the IRS examining agent did not obtain written approval of the initial accuracy-related penalty before issuing the notice of deficiency as required by Chai v. Comr., 851 F.3d 190 (2d Cir. 2017). Perkins v. Comr., 150 T.C. No. 6 (2018).

Posted March 1, 2018

Court Says IRS Wrong On Which Form To File When Seeking Penalty Refund. The plaintiffs, a married couple, jointly filed their 2014 income tax return. They didn't maintain the government mandated health care coverage throughout 2014 and self-assessed a $575 “shared responsibility payment” (AKA, the “Roberts Tax”). They received a refund of $2,525 on or around May 15, 2015, which they claimed was $575 less than they would have been entitled to but for assessment of the Roberts Tax. The plaintiffs them submitted Form 843 to IRS requesting an additional $575 refund, raising various constitutional objections to its assessment against their tax refund. The IRS rejected the refund claim, noting that, “[t]o change any information on your original tax return, you should file an amended return on Form 1040X.” The plaintiffs did not file Form 1040X, instead filing suit in federal district court. The district court dismissed the suit for lack of subject matter jurisdiction, on the basis that the plaintiffs failed to exhaust their administrative remedies because they had filed their refund claim using an improper form. The plaintiffs claimed that their use of Form 843 was appropriate because the Roberts Tax was a penalty and not a tax. However, the district court concluded that point was immaterial because the IRS had the power to assess it via the filing of a Form 1040X. On appeal, the appellate court vacated and remanded the district court’s decision, determining that the Roberts Tax was a penalty under I.R.C. §5000A(b). As such, there was no applicable regulations providing for Roberts Tax refund claims, and Form 843 was, therefore, appropriate. Form 1040X, the appellate court noted, is used to amend a previous income tax return, but the plaintiffs weren’t seeking to amend a prior return, they were merely challenging the authority of the IRS to assess the Roberts Tax by withholding it from their tax refund. In addition, the court noted that Form 1040X clearly states that a taxpayer is to not file Form 1040X when requesting a refund of a penalty. Cash v. United States, No. 17-1441, 2018 U.S. App. LEXIS 3111 (3d Cir. Feb. 9, 2018).

Nontaxable State Credits Exceeding State Tax Liability Subject To Federal Income Tax. The plaintiffs, a married couple, acquired and restored an abandoned shoe factory. From 2004-2011 they converted it into a 134-unit residential rental building in Brooklyn, NY. The state designated the site as a “brownfield site” and approved the plaintiffs’ application to participate in the “Brownfield Redevelopment Tax Credit” (BRTC) program. The plaintiff husband received a payment from the state that passed through to him from a partnership that he was a 90 percent owner of. The payment represented 10 percent of the site preparation and tangible property expense cost. The state first applied the credit against the plaintiffs’ state income tax liability, with the plaintiffs then having the option to deferring the balance of the credit to another year of receiving it as a cash payment. The plaintiffs chose the latter option and received a cash payment in 2013 of $1,864,618 – the amount exceeding their 2011 state income tax liability. They did not report the amount in income for 2013, and IRS asserted a tax deficiency of $602,530. The plaintiffs paid the deficiency and sued for a refund. The plaintiffs claimed that the income was a recovery of capital and, if not, was excludible as a nontaxable contribution to capital under either the tax benefit rule or the general welfare exclusion. The IRS asserted that the excess amount was income under I.R.C. §61. The court noted that the plaintiffs’ characterization of the excess credit as a “refund” was improper because the excess amount was an “overpayment” as properly characterized by the state of New York. It was simply a cash transfer from the other taxpayers to the plaintiffs by the state of New York, with no strings attached. It was an accession to wealth over which the plaintiffs had complete dominion and control. It could not be excluded from income as a recovery of capital because there was no sale of goods or transfer of a capital asset. The plaintiffs’ capital investment remained ongoing. It was also not a nontaxable contribution of capital because it was not paid in exchange for a partnership interest. It was also not excludible as a “general welfare” payment because the plaintiffs did not show a need for the payment and its payment was not conditioned on a showing of need. The court denied the plaintiffs’ refund claim. Ginsburg v. United States of America, No. 17-75 T, 2018 U.S. Claims LEXIS 55 (Ct. Cl. Jan. 31, 2018).

Posted February 28, 2018

Retained Nonrefundable Advance Deposits Not Taxed As Capital Gain. The plaintiff, an LLC taxed as a partnership, owned bought a hotel in 2005. In 2006, the plaintiff entered into a contract to sell the property to a buyer for $39 million. The buyer made deposits of $9.7 million, but the contract failed to close in 2008 and the plaintiff retained the deposits pursuant to the purchase contract. The plaintiff treated the retained deposits as capital gain. The IRS disagreed with that treatment, claiming that the retained deposits were ordinary income. I.R.C. §1234A provides that gain or loss attributable to the cancellation, lapse, expiration or other termination of a right or obligation which is or would be a capital asset in the taxpayer’s hands is to be treated as gain or loss from the sale of a capital asset. The plaintiff was not holding the hotel as investment property, but was operating the hotel and taking depreciation deductions, which means that the hotel was not a capital asset as defined by I.R.C. §1221(a)(2) because it was property used in the taxpayer’s trade or business, of a character subject to a depreciation allowance. While I.R.C. §1231 causes net gains from property used in a trade or business to be taxed as long-term capital gains, that fact does not make the assets capital assets. Indeed, if such an asset is sold at a loss, the loss is ordinary. If such asset is sold at a gain and there have been I.R.C. §1231 losses in the last five years, the gain is ordinary to that extent. The Tax Court agreed with the IRS that the retained deposit was ordinary income, rejecting the plaintiff’s argument that I.R.C. §1234A applied to I.R.C. §1231 assets. The Tax Court held that the statute was unambiguous. On appeal, the appellate court agreed. I.R.C. §1234A provides for capital gains treatment of income resulting from canceled sales only where the underlying property constitutes a “capital asset,” and I.R.C. §1221 defines “capital asset” in a way that excluded the hotel. The appellate court noted that while there was some support for the notion that I.R.C. §1234A was meant to extend beyond capital assets as defined in I.R.C. §1221 so as to include I.R.C. §1231 property, it was up to the Congress to make amendments to reflect that. Thus, the appellate court reasoned, the plaintiff could not treat the deposit as capital gain. CRI-Leslie, LLC v. Comr., No. 16-17424, 2018 U.S. App. LEXIS 3504 (11th Cir. Feb. 15, 2018).

Posted February 15, 2018

Minnesota DOR Explains Tax on Farm Fuel. The Minnesota Department of Revenue (MDOR) has issued a revised fact sheet explaining the taxability of gasoline sales to farmers. Gasoline (does not include alternative fuels or undyed diesel fuel) sold and delivered to on-farm bulk storage for farm use may be sold tax-free. In order for gasoline sales to be claimed tax-free it must be delivered to a farm for farm use; sales tickets must clearly reflect the purchaser's name and complete address (tickets prepared with “CASH” as the purchaser will not be accepted); and invoices must clearly indicate that the gasoline was sold tax free. Licensed distributors may claim the credit based on the current tax filing requirements. Unlicensed distributors are to report tax-free gas sales on Form PDR-1. The claims are to be filed within one year and two months from the date of purchase (postmark date is the filing date). The claimant is to obtain a sales ticket/invoice for each purchase made during the claim period, regardless of amount. Receipts are not to be sent with the claim. Records are to be kept of all sales tickets/invoices for at least 3.5 years. MDOR advised that it is not always the case that gasoline that is used for off-highway use or in a non-licensed piece of equipment is tax-free. For instance, gasoline that is used in a tractor that is not used on a farm is not a tax-free sale. MDOR also provided a list of businesses that do not qualify for tax-free sales from distributors. MN Petroleum Tax Fact Sheet No. 100 (Feb. 2, 2018).

Posted February 4, 2018

Music Club Activity Not Engaged in With Profit Intent. The petitioner’s predeceased husband was a country music producer and record company owner. While he was living, they bought a small music club near Nashville, TN. The club’s purpose was to provide a place for songwriters to perform their songs for talent scouts, agents and record producers. The petitioner continued to operate the club after her husband’s death, operating it on Friday and Saturday nights and charging a nominal admission fee and nominal amount for snacks. For 2012-2014, the club averaged about $15,000 in gross receipts and approximately $69,000 in operating expenses. The petitioner reported a net operating loss for 2012 and 2013. The IRS took the position that the petitioner did not operate the club with a profit intent as required by I.R.C. §183(b), limiting the expenses to offset income from the club’s activity and disallowing the expenses from offsetting the petitioner’s other income. The IRS also imposed an accuracy-related penalty under I.R.C. §6662(a). The Tax Court agreed with the IRS on the application of the “hobby loss” rules to the club. The court noted that the petitioner had no business expertise in owning a music club, maintained horrible business records that didn’t match tax filings, didn’t heed expert business advice or take advantage of opportunities to make the club profitable, willingly accepted the club’s losses year after year, didn’t try to minimize expenses or increase revenue or improves the club’s performance. The court also agreed with the IRS that the petitioner was “primarily motivated by personal pleasure, not profit, and simply used the club’s losses to offset her trust and capital gain income.” While the court upheld the disallowance of the petitioner’s NOL deductions, the court did not uphold the accuracy-related penalty because the IRS failed to get the penalty approved in writing by the supervisor that made the determination that a penalty should be imposed. Ford v. Comr., T.C. Memo. 2018-8.

Posted February 1, 2018

Purpose of Holding Property As Framed By Facts Determines Tax Characterization. The petitioner was engaged in the business of building and custom-built homes and then selling them to buyers via the petitioner’s S corporation. The S corporation owned large tracts of undeveloped land that it bought for speculative purposes and did not use in its business operations or hold as inventory. The petitioner was also the sole owner of several LLCs through which he acquired additional tracts of undeveloped land. The petitioner’s wife also held property for rental purposes via an LLC that she transferred ownership of to the petitioner. The petitioner elected to treat all rental activities as a single activity via I.R.C. §469(c)(7)(A). In 2013, the petitioner sold one property at an approximate $2 million loss. The petitioner had planned to develop the property, but due to changed circumstances didn’t proceed past the planning stages. The petitioner reported the income and expense associated with the property on Schedule C, and fully deducted the resulting loss. The IRS recharacterized the transaction such that the gross receipts were investment income on Schedule A and disallowed the associated cost-of-goods-sold deduction. The court agreed with the IRS, noting that the facts indicated capital loss treatment particularly because the petitioner had placed the land in a conservation program that barred development. The petitioner also incurred expenses associated with another property which he had planned to develop but never got beyond the planning stages. The petitioner deducted the expenses associated with this property on Schedule C, but the IRS moved them to Schedule A where they were subject to the 2 percent of AGI limitation. Again, the court agreed with the IRS that the expenses were deductible as investment expenses limited by I.R.C. §163(d)(1). On two other tracts, the IRS recharacterized the petitioner’s reporting of rental income as investment income and allowed expenses as investment expenses. The IRS denied losses associated with another tract under the passive loss rules of I.R.C. §469. The petitioner also reported an I.R.C. §1231 loss of $747,000 on the sale of depreciable business property from his S corporation that he reported on Form 4797 which the IRS disallowed. The IRS also disallowed a net operating loss carryforward under I.R.C. §469. As for all of the various LLCs, the court determined that the properties were held for investment and the grouping election did not result in a trade or business for the combined properties. The petitioner also did not satisfy the material participation requirement of I.R.C. §469 with respect to the LLCs so as to avoid the passive loss limitations of I.R.C. §469. The court also sustained the determination of the IRS with respect to the computation of the taxpayer’s NOL carryforward. Because the court determined that the petitioner held land for investment purposes that he then donated to charity, the charitable deduction was the difference between the selling price of the land to the charity and the fair market value, and I.R.C. §170(e) did not apply. The court did allow the $747,000 loss on depreciable business property. The court did not impose an accuracy-related penalty as he justifiably relied on the advice of his tax preparer who was well-versed in preparing such complex returns. Conner v. Comr., T.C. Memo. 2018-6.

Posted January 30, 2018

IRS Denied Summary Judgment on Hobby Loss Claim Against Cattle Operation. The plaintiff owned and operated a company that provided mechanical inspection services for major oil refineries and gas plants. Since 2006, the plaintiff had reported approximately $1 million of adjusted gross income on his tax return annually, and had an approximate net worth of $7 million. In addition to his business, the plaintiff, in the late 1990’s, built a cattle ranch that he has maintained ever since as the sole owner and operator, performing all of the labor and spending three to four days weekly working on the ranching activity. However, the cattle ranching activity never showed a year of profitability, with total gross receipts from 1997 through 2015 totaling $32,602 and net losses totaling $807,380. The plaintiff did not establish a written business plan or have any written financial projections, and did not use any accounting software or form a business entity for the cattle operation, although he did use a spreadsheet to track his expenses. He also did not market or promote the cattle operation, insure the herd against catastrophic loss or consult a financial advisor. Before 1997, the plaintiff’s only experience with cattle was feeding and working them as a child. However, the plaintiff did buy 80 acres of land containing a dilapidated barn and unusable fence which he repaired. He purchased two longhorn heifers, built a new barn, bought and adjacent 180-acre tract to increase the herd to make the venture ultimately profitable, and improved the entire property by replacing fence, enlarging an existing pond, installing rural water and constructing a cattle working facility and loafing shed. The plaintiff also consulted with a successful local rancher regarding profitable methods of cattle ranching. He also purchased 20 cows to crossbreed so as to produce quality milk and beef, knowing that obtaining a crossbreed would take at least four years. The plaintiff also purchased new hay baling equipment and feed bins. The plaintiff sold cattle in 2013, after the cattle market had rebounded from prior lows. The plaintiff also attended seminars on cattle breeding and pasture management and read as much as he could about raising cattle. He also joined two different state cattlemen’s associations. For 2010 and 2011, the IRS denied the loss deductions for the plaintiff’s cattle ranching (and horse racing) activity, and assessed penalties with the total amount of tax and penalties (including interest) due being $89,838.09. The plaintiff paid the deficiency (plus interest) and sued for a refund, claiming that he engaged in the cattle ranching activity with profit intent as defined by Treas. Reg. §1.183-2(b). Later, at the plaintiff’s request, the court dismissed the refund claim related to the horse racing activity. The IRS moved for summary judgment on the plaintiff’s remaining claim related to the cattle ranching activity, arguing that the activity was not engaged in for profit and the resulting losses were non-deductible under the hobby loss rules of I.R.C. §183. On an evidentiary question, the court allowed tax return information from post-2011 years into evidence because it was relevant in showing whether the plaintiff had a profit intent for the tax years in issue. The court also denied the plaintiff’s motion to include in evidence an affidavit containing factual statements the plaintiff made concerning the ranching activity that had not been made in previous filings or testimony. The court also allowed into evidence testimony of an ag economist for the plaintiff to the extent the testimony bore on economic conditions and their impact on the plaintiff’s cattle ranching activity. The court examined each of the nine factors in Treas. Reg. §1.183-2(b) in its analysis of the issue. The court determined that the plaintiff’s lack of the uses of sophisticated businesses practices weighed in the favor of the IRS. On the issue of the plaintiff’s expertise, either personally or via advisors, the court determined that the factor was neutral. He neither zealously pursued nor neglected chances to gain opportunities to gain expertise in cattle ranching. The court, however, did note that the plaintiff put in a substantial amount of time on the ranching activity without any substantial recreational benefit, which weighed in the plaintiff’s favor. The court reasoned that the plaintiff also had a reasonable expectation of the appreciation in value of the capital improvements that he made to the land. On the issue of whether the plaintiff had experienced success in carrying on similar (or dissimilar activities), the court noted that the factor was neutral. The court pointed out that the evidence showed that the plaintiff expended a substantial amount of time in the ranching activity, even though he didn’t operate it with great sophistication, and was successful in running a highly profitable mechanical inspection service business which could provide an inference that he engaged in the cattle ranching activity with profit intent. The many years of consecutive losses from the ranching activity weighed in the favor of the IRS although, as the court noted, the factor was mitigated to a degree by the fact that small farming operations are not generally lucrative. While the court noted that the taxpayer was wealthy, which would allow him to participate in the cattle ranching activity without a profit intent, the court noted that the IRS had not provided any evidence that the plaintiff received any personal or recreational benefit from the ranching activity – which made it less likely that the plaintiff engaged in the activity without a profit intent. Thus, the factor involving elements of personal pleasure or recreation weighed in the plaintiff’s favor. The court concluded that, based on the totality of the circumstances, and viewing the evidence in the light most favorable to the plaintiff, that a reasonable jury could conclude that, for 2010 and 2011, the plaintiff engaged in the cattle ranching activity with a profit intent. The court denied the IRS motion for summary judgment. The court also denied summary judgment to the IRS on the penalty issue. Wicks v. United States, No. 16-CV-0638-CVE-FHM, 2018 U.S. Dist. LEXIS 9352 (N.D. Okla. Jan. 22, 2018).

No Traveling Abroad For Those With Tax Debt. By virtue of legislation enacted in 2015 which created I.R.C. §7345, the Secretary of State has the power to deny, revoke or limit the passport of persons with delinquent taxes. Under the provision, the IRS is to provide notice of such delinquency to the Treasury Secretary who will then transmit that notice to the Secretary of State. Generally, the provision applies to delinquent tax debt over $50,000 (adjusted for inflation), for which a notice of lien has been filed or a levy has been made. Upon receipt of an I.R.C. §7345 certification, the State Department is directed to deny an application for issuance or renewal of a passport from such individual, and may revoke or limit a passport previously issued to such individual. Now, the Treasury Department has announced that the IRS and the State Department will begin implementing these provisions as of January, 2018. The Notice provides information about the implementation of the rules. IRS Notice 2018-01.

Posted January 21, 2018

IRS DPAD Ruling on Cooperative’s Payments Made to Members. An agricultural cooperative proposed to assume the grain origination function from a limited liability company that it was a member of. Payments for grain made to the cooperative members, the IRS ruled would constitute “per-unit retain allocations paid in money” as defined by I.R.C. §1382(b). The IRS also ruled that the cooperative would be treated as having manufactured, produced, grown or extracted, in whole or significant part, the grain that it bought from its members that raised the grain, and that the cooperative’s qualified production activities income and taxable income would be computed without regard to any deduction for the grain payments that the cooperative made to its members. Priv. Ltr. Rul. 201750003 (Aug. 30, 2017).

Posted January 20, 2018

Discharge of Debt Income Counts Toward Premium Tax Credit Eligibility Computation. During 2015, the petitioner estimated here “household income” to be low enough that she was eligible for a premium assistance tax credit of $335 per month to help offset the higher cost of health insurance caused by Obamacare that Obamacare mandated she buy or pay an additional penalty tax. The petitioner started receiving the payments in March of 2015. During 2015, the petitioner earned $39,210 and had $16,163 of debt discharge income. Consequently, the petitioner’s income exceeded 400 percent of the federal poverty level for a one-person family in Alabama, her state of residence. In late 2016, the IRS issued the petitioner a notice of deficiency disallowing the $3,350 advance premium assistance tax credit and increasing her tax liability by the amount of the disallowed credit. The petitioner claimed that the cancelled debt income should be disregarded in determining her eligibility for the credit, but the Tax Court disagreed. The court noted that gross income included cancelled debt income. The court reasoned that while modified adjusted gross income for premium assistance tax credit purposes reflects certain adjustments to gross income, no adjustment is made for cancelled debt income. Keel v. Comr., T.C. Memo. 2018-5.

Trust’s Charitable Deduction 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 IRS claimed that the trust could not take a charitable deduction equal to the full fair market value, but rather that the deduction 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. §642(c)(1) allowed the charitable deduction to be computed based on the donated property's fair market value. The trial court agreed, noting that I.R.C. §642(c)(1) allowed a deduction without limitation contrary to the basis limitation contained in I.R.C. §170, and that charitable deduction provisions are to be construed liberally in the taxpayer's favor. The trial 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 trial court noted that the IRS admitted that there was no caselaw or other substantial authority that supported the government's position. The trial court granted summary judgment for the trust. On appeal, the appellate court reversed. The appellate court noted that the parties agreed that the trust had acquired the donated properties with gross income and that the charitable donation was made out of gross income. However, the IRS claimed that only the basis of the properties was traceable to an amount paid out of gross income. It was that amount of gross income, according to the IRS, that was utilized to acquire each property. The appellate court agreed. There was no realization of gross income on the appreciation of the properties because the underlying properties had not been sold. So, because the trust had not sold or exchanged the properties, the gains tied to the increases in market value were not subject to tax. The appellate court reasoned that if the deduction of I.R.C. §642(c)(1) extended to unrealized gains, that would not be consistent with how the tax Code treats gross income. The appellate court tossed the “ball” back to the Congress to make it clear that the deduction under I.R.C. §642(c)(1) extends to unrealized gains associated with real property originally purchased with gross income. Green v. United States, No. 16-6371, 2018 U.S. App. LEXIS 885 (10th Cir. Jan. 12, 2018), rev’g., 144 F. Supp. 3d 1254 (W.D. Okla. 2015).

Posted January 13, 2018

Basis Can Be Established When After-Tax Contributions Rolled to Traditional IRA. In 2006, the taxpayer rolled funds contained in his employer’s I.R.C. §401(k) plan to a traditional IRA. That plan contained I.R.C. §401(k) after-tax contributions and the taxpayer inadvertently rolled those funds into a traditional IRA rather than a Roth IRA. The taxpayer sought guidance from the IRS concerning how he could obtain credit for the taxes paid on those funds. In 2006, a rollover from an employer-sponsored retirement plan to a Roth IRA was impermissible, only become permissible for such rollovers made after 2007. However, the IRS pointed out that the taxpayer could complete Form 8606 upon taking a plan distribution. Form 8606 will provide the taxpayer with credit for the basis in the account due to the rollover of pre-tax contributions from the IRA. IRS noted that “any after-tax monies would be excluded as they came out of the receiving plan or IRA.” The IRS further noted that when traditional IRAs contain both pre-tax and post-tax funds, any distribution consists of a proportionate share of each, and the distribution must be reported on Form 8606. Line 2 of Form 8606 reports the nontaxable portion of a rollover which is where the taxpayer is credited for after-tax funds that were rolled into the account, even if the rollover was made in an earlier tax year. The IRS also noted that Form 8606 is not filed for a year just to report a rollover of after-tax funds to a traditional IRA. IRS Info. 2017-0028 (Nov. 16, 2017).

South Dakota Sales Tax on Remote Sellers Unconstitutional; U.S. Supreme Court to Review. 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 “separate transactions” 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), rev’g., 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 court’s 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 petitioned the U.S. Supreme Court for review and the U.S. Supreme Court granted it. State v. Wayfair, Inc., et al., 901 N.W.2d 754 (S.D. 2017), pet. for cert. granted, South Dakota v. Wayfair, Inc., No. 17-494 (U.S. Sup. Ct. Jan. 12, 2018).

Posted January 1, 2018

Experience In Appraising Land With Minerals Sufficient For Qualified Tax Appraisal. The plaintiff’s family has owned a 450-acre farm in Virginia for more than 160 years. In anticipation of applying for a land preservation tax credit provided for under state law, the plaintiff hired a professional, licensed appraiser to appraise the property. On November 25, 2011, the appraiser provided a detailed appraisal which valued the property at $13.5 million without a land preservation easement, and at $1,070,000 as burdened by a conservation easement which had been donated to the Virginia Outdoors Foundation two weeks earlier. According to the appraiser, the value of the land overwhelmingly relied upon unmined sand and gravel deposits. At the time of the appraisal, the plaintiff had obtained a special use permit from the county and an active state permit through the Virginia Department of Mines Mineral and Energy for the mining of sand and gravel. However, the permits limited mining to five acres, and the site was not being actively mined. The easement encumbered the entire property and barred the plaintiff from mining the sand and gravel on the property. The plaintiff then applied for land preservation tax credits. The Department of Taxation (the defendant in the case) awarded the plaintiff a tax credit in the amount of $4,972,000 based on the appraiser’s assessment. The plaintiff later transferred the tax credits to 168 transferees and paid the Department $248,600 in fees for administering the transfers. On December 3, 2013, the defendant notified the plaintiff that there were “material deficiencies and/or issues that cause the appraisal to be unreliable”. After the parties had a meeting, the plaintiff submitted a second appraisal that lowered the appraised value of the conservation easement from $12,430,000 to $10,180,000. However, the parties could not resolve their differences and the defendant rejected the plaintiff’s appraisals and disallowed all tax credits. The plaintiff appealed and the defendant motioned for summary judgment. The trial court judge, noting that the appraiser acknowledged he was not formally educated in appraising minerals, granted the defendant’s motion. On further review, the state Supreme Court determined that in this instance the property was an active farm with open land and significant sand and gravel deposits. Therefore, a qualified appraiser needed “verifiable education and experience in valuing” this kind of property. However, the court also held that it was sufficient if the appraiser could, from education and/or experience, make an informed and accurate appraisal of the property. Thus, the court held that the appraiser was qualified by virtue of his experience in evaluating properties that contained sand and gravel deposits. Therefore, the Supreme Court held that the trial court erred in holding that the appraiser was not a qualified appraiser. However, the Supreme Court also held that the defendant was not constrained from auditing the value of the tax credits claimed by the plaintiff after initially awarding the credits. Woolford v. Virginia Department of Taxation, 806 S.E.2d 398 (Va. 2017).

Posted December 30, 2017

Court Upholds IRS 40 Percent Penalty for Undervalued Conservation Easement Donation. The petitioners, in 2007, granted a conservation easement on 40 acres in Colorado to a qualified charity. They claimed a charitable deduction for the grant in 2007 and a carryover deduction for 2008. In total, the deduction totaled $970,000. In the notice of deficiency, the IRS disallowed the deductions, valuing the easement at zero, and assessed a 20 percent accuracy-related penalty for each of 2007 and 2008. The examining agent had determined that the penalty should be 40 percent, however. That penalty was approved in writing by the examining agent’s immediate supervisor. However, the IRS appeals office imposed the 20 percent penalty. The petitioners sought a redetermination of the deficiencies and penalties, and entitlement to a deduction for 2007 for the repayment during 2013 and 2014 of proceeds they had received from the sale of Colorado state income tax credits. In its answer to the petition, the IRS asserted a 40 percent penalty under I.R.C. §6662(h) for gross misstatement penalties in 2007 and 2008. Via settlement, the IRS agreed that a $30,000 charitable deduction was proper for 2007 and that the petitioners had reasonable cause for the easement value but that the 40 percent penalty should apply because of the disparity in value. The petitioners attacked the application of the 40 percent penalty due to procedural violations of I.R.C. §6751(b)(1). Also, due to another easement donation in 2006 the petitioners received CO state income tax credits. In 2007, the petitioners sold some of the credits for $195,000 and reported that amount in income. In 2013 and 2014, the petitioners repaid over $100,000, and claimed that they were entitled to a deduction for the repayment in 2007 under I.R.C. §1341. The Tax Court determined that the 40 percent penalty was appropriate because an immediate supervisor had approved it in writing. The court also denied a 2007 deduction for repayment of the state income tax credits. Roth v. Comr., T.C. Memo. 2017-248.

Posted December 26, 2017

No Deductions For Rental Property Expenses Because Daughter Lived In It Without Paying Fair Rental. The petitioner was a cardiologist and his wife also worked in his practice. They constructed a second house in Woodland Hills, CA, in addition to their residence in Bel Air in 1997 and tried to sell it for four years, after which they rented the house for four years to an unrelated tenant, and then to their daughter at one-third of the rate charged the unrelated tenant. They resumed sales efforts in 2010. On their 2008 return, the petitioners indicated the house was rental property with a net loss of $134,360 which they characterized as a passive loss on Form 8582. On the 2009 and 2010 returns the petitioners again showed net losses on the property, but indicated they were in the construction business. They filed a 2008 amended return claiming a refund relating to expenses claimed on the house, which IRS disallowed and also assessed an accuracy-related penalty. The IRS determined that the house was held for the production of income and that the losses were passive losses under I.R.C. §469. The IRS also asserted that the deductions attributable to the house were limited by I.R.C. §280A. The court agreed with the IRS because a related party lived in the house and used it for personal purposes for more than the greater of 14 days a year or 10 percent of the number of days the house was rented at fair rental. The court rejected the petitioners’ claim that they were real estate developers that needed to have their daughter live in the house to keep it occupied as required by their homeowner’s policy which would then make I.R.C. §280A inapplicable. Thus, the deductions attributable to the house were limited to the extent of rental income. The court upheld the application of the accuracy-related penalty, and did not need to determine whether the losses were passive. On appeal, the court affirmed determining that the daughter provided only minimal services while she resided in the home which did not make up for the difference between the fair market rent and the amount she paid. Okonkwo v. Comr., No. 16-71020, 2017 U.S. App. LEXIS 24960 (9th Cir. Dec. 11, 2017), aff’g., T.C. Memo. 2015-181.

Posted December 25, 2017

Employers Have Until March 2 to Furnish Forms 1095-B and 1095-C. The IRS has extended the due date for furnishing Forms 1095-B and 1095-C (e.g. health coverage for employees) to March 2, 2018. The normal due date would be January 31, 2018. However, the date for filing copies of the forms with the IRS remains due on February 28, 2018 (for those not filing electronically; April 2, 2018 for those filing electronically). Thus, some taxpayers will not have the necessary forms concerning health insurance coverage when filing 2017 returns. Thus, taxpayers may rely on other information either the employer or insurance company provides for return filing purposes and for purposes of eligibility for the I.R.C. §36B credit, and confirming the taxpayer had the government-mandated insurance coverage for 2017. The IRS indicated that such relief would not be provided for 2018 returns filed in 2019. 2018 is the last year the government mandate to buy health insurance will apply because the tax penalty for failing to have such insurance is repealed effective for months beginning after 2018. IRS Notice 2018-6, 2018-3 I.R.B.___.

Posted December 24, 2017

Ranching Corporation Not Treated Separately From Owners With Result That Losses Not Deductible. The petitioners, two brothers, owed cattle, land and oil operations in Texas. Their father had established a C corporation in the 1950s to pursue the various ranching and oil and gas operations. The corporation handled all of the sales, expenses and payroll of the ranching/oil and gas activities. The petitioners inherited the business interests from their father upon his death. The petitioners also owned two ranches individually that they leased to the corporation and also had numerous other oil and gas interests and real estate holdings that they owned together in partnerships, LLC and other corporations. The C corporation developed a “joint interest accounting system” and had 17 employees and held the employees’ workers’ compensation and employers’ liability policies for the cattle operation and bought farm and ranch insurance in the corporate name. The corporation was the record owner of various farming/ranching assets. Under the “joint interest accounting system”, which the petitioners’ counsel testified at trial was common in the oil and gas industry, the corporation would account for all of the income and expense and then on a monthly basis write a check to each brother for each brother’s one-half share of the net income of the corporation. If there was a loss for a month, the brothers would write a check to the corporation. The corporation experienced losses for 2010-2012 and reported not gross receipts or taxable income for 2012-2013, but the petitioners reported six-figure losses on their personal returns (via Schedule C) derived from the cattle operation. Upon audit in 2014 for the 2010-2012 tax years, the IRS determined that the cattle losses should have been reported by the corporation (where the losses were not deductible) rather than on the petitioners’ personal returns. The IRS also determined that penalties under I.R.C. §6662(a) applied. The total tax deficiency and penalties that the IRS asserted exceeded $1 million. The Tax Court ruled for the IRS and the appellate court affirmed. The appellate court rejected the petitioners’ agency argument under which they claimed that the C corporation acted as their agent by merely holding title to assets for the petitioners who owned the assets and ran the operation. They claimed that the corporation was merely an accounting entity that acted on behalf of the petitioners rather than on its own behalf. On appeal, the petitioners claimed that the corporation was simply the “manager” of the operation. However, the appellate court disagreed. The appellate court noted that the petitioners failed to provide the Tax Court with their “controlling law” cases for the proposition that cattle ownership is not relinquished when another entity manages the daily cattle operations. In addition, the appellate court noted that the petitioners had not argued their “manager” theory (based on Jones Livestock Feeding Co. v. Comr., T.C. Memo. 1967-57) at the Tax Court, and had waived the argument. The appellate court noted that the petitioners’ “agency” argument and “manager” argument were fundamentally different. The appellate court, agreeing with the Tax Court, noted that all ranching operations were conducted by the corporation and the corporation publicly appeared to be conducting the all business activity, not the petitioners individually. Thus, all of the income and loss of the ranching and oil/gas activity should have been reported at the corporate level where the losses weren’t deductible. The appellate court also upheld the IRS-imposed accuracy-related penalties which exceeded $200,000. The appellate court noted that the petitioners’ “substantial authority” for reporting the ranching transactions in the manner that they did was based on their theory that the corporation was the “manager” of the operations. However, that argument was not raised at the Tax Court and was deemed waived. The petitioners did not present the Tax Court with any authority for their tax reporting position. Thus, the appellate court held that the Tax Court’s determination of negligence was proper. The appellate court also held that the Tax Court did not err in determining that the petitioners lacked reasonable cause for the manner in which they reported their income. The petitioners had represented themselves as “savvy” businessmen that were experienced in complex business entities, but didn’t try to determine the correctness of their income tax reporting. Thus, the Tax Court’s ruled properly in rejecting the petitioners’ good-faith and reasonable-cause defenses even though they been consistent in their accounting and tax reporting for numerous years. Consistently wrong is still wrong. Barnhart Ranch Co. v. Comr., No. 16-60834, 2017 U.S. App. LEXIS 25789 (10th Cir. Dec. 20, 2017), aff’g., T.C. Memo. 2016-170.

Posted December 23, 2017

Amount Paid As A Result of Violating Federal Securities Law is a Nondeductible Fine. I.R.C. §162(f) bars a deduction for any fine or similar penalty paid to a government for the violation of any law. The IRS determined that the provision applied to a monetary sanction imposed for the violation of a federal securities laws, following the guidance of the Supreme Court in Kokesh v. Securities and Exchange Commission, 137 S. Ct. 1635 (2017). The IRS noted that the statute does restrict itself to payments that are punitive. Thus, disgorgement payments constitute “penalties.” C.C.A. 201748008 (Nov. 17, 2017).

No Deductible Loss Because Sale to Ex-Spouse Part of Property Division of Divorce. The petitioner divorced in 2007 and received the couple’s “Horse Ranch Property” subject to an agreement that made the petitioner and his ex-wife responsible for payment of particular expenses associated with the property. Under the agreement, the petitioner was to try to sell the property and accept any offer that was at least 93 percent of the listed price. The property did not sell due to the poor real estate market during the years in question. In late 2012, the petitioner’s ex-wife bought the property from the petitioner for $175,000 and assumed the debts on the property that exceeded $2,000,000. On the 2012 return the petitioner and ex-wife claimed a loss, with $598,341 carried over to 2013. The carryover loss offset capital gains in both 2013 and 2014. The IRS disallowed the losses on the grounds that the transaction was the last step in the property division between the ex-spouses and was, therefore, incident to the divorce. As such, the petitioner was not entitled to a loss deduction. The Tax Court agreed with the IRS, rejecting the petitioner’s claim that a transfer only relates to a divorce if it discharges a marital obligation which the transaction did not do. The Tax Court noted that I.R.C. §1041(c) did not contain such a restriction. The Tax Court determined that the martial property division was not complete until the property was sold – both the petitioner and the ex-wife had retained significant rights and obligations in the property. Thus, the deduction because of the capital loss carryforward was properly disallowed on both the 2013 and 2014 returns. Stapleton v. Comr., T.C. Sum. Op. 2017-87.

Relief For Partnerships Impacted by Law Change For Return Due Date. The IRS granted relief from late-filing penalties for partnerships (and other entities that may properly file Form 1065) that failed to file their return or extension by the original due date. In the IRS relief, relief was extended to other items (such as funding a contribution to an employee benefit plan by the due date of the return for which a deduction is claimed on the prior year return), except interest on tax due, that were impacted by the change in the law as a result of legislation enacted during the summer of 2015 that changed the due date for partnership returns. Under the legislation, calendar year partnership returns for 2016 became due on March 15, 2017, rather than April 15 as under prior law. In the relief, the IRS noted that a filed Form 1065 will be treated as timely for the first taxable year that began after December 31, 2015, and ended before January 1, 2017, if the entity would have been deemed to timely file under prior law. The IRS also provided instructions for getting reconsideration from IRS of a penalty that had already been assessed. The IRS later revised its guidance such that any act performed by a partnership of other entity that may properly file Form 1065 is deemed to have properly filed if such filing would have been timely under prior law whether the tax year ends in 2016 or 2017. IRS Notice 2017-47, 2017-38 I.R.B. 2017-141, as revised by IRS Notice 2017-71, 2017-51 I.R.B.

Posted December 16, 2017

Bad Drafting Dooms Deduction for Perpetual Easement Grant. The petitioner, a timber company, granted a perpetual conservation easement on a 1,032-acre property for which the petitioner claimed a $2.13 million deduction on its 2009 return. The easement preserved the view of natural, environmentally significant habitat on the Cooper River by barring development. The petitioner received $400,000 for the donated easement, and the done satisfied the definition of a “qualified organization” under I.R.C. §170(h)(1)(B). The appraised value of the easement was $2,530,000. The IRS disallowed the deduction on the basis that the easement grant allowed the original easement to be replaced by an easement held by a disqualified entity. In addition, the IRS claimed that the grant allowed the property to be released from the original easement without the applicable regulation concerning extinguishment being satisfied. The petitioner claimed that there was a negligible possibility that the easement could be held by a non-qualified party. The court agreed with the IRS, noting that the grant did not define the term “comparable conservation easement” or what type of organization could hold it, just that an “eligible donee” could hold it. The court noted that an assignment of the easement is different from a replacement of the easement. As such, the grant did not restrict that the holder of the easement had to be a “qualified organization.” The court also determined that the chance that the easement could be replaced was not non-negligible under Treas. Reg. §1.170A-14(g)(3). Salt Point Timber, LLC, et al. v. Comr., T.C. Memo. 2017-245.

To Be Fully Deductible, Expenses for Meals, Entertainment and Lodging Must Be Strictly Substantiated. The petitioner incurred substantial travel-related expenses related to the production of a film. However, he failed to substantiate any of the lodging. IRS allowed the deduction of 50 percent of the amount the petitioner claimed for meals and lodging based on the Federal per diem rate for meals and incidental expenses (M&IE). The petitioner stayed with his ex-wife for 167 nights and his aunt for 21 nights, and bought housekeeping supplies and groceries for his host that he claimed as a deduction in lieu of lodging. However, he couldn’t substantiate the claimed amount and the IRS allowed 50 percent of the claimed amount. The Tax Court agreed with the IRS on all issues. Cristo v. Comr., T.C. Memo. 2017-329.

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.

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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).

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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).

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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.

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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).

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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).

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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.

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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.

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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.

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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.

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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).

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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).

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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).

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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.

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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).

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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.

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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.

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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).

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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.

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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).

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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).

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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).

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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.

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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.

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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.

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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).

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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.

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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).

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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).

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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.

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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).

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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).

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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)

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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.

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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).

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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.

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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.

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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.

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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).

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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.

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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).

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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.

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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.

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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).

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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.

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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.

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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).

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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).

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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

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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.

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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).

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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.

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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.

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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).

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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

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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.

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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.

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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).

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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.

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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).