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Tax Alerts

Tax Alerts

Not all penalties/interest may be suspended for disaster victims

IRS Chief Counsel has clarified that taxpayers affected by disasters, who had taxes due prior to the start of the postponement period granted for disaster relief, and who did not pay before that due date, do not get the benefit of the Tax Code’s suspension of penalties and interest for failure to pay penalties and interest. Chief Counsel, however, advised that as a fallback position, taxpayers should consider a reasonable-cause argument.

Comment. This Chief Counsel’s advice underscores that just being an otherwise "affected taxpayer" within a disaster area does not automatically halt the running of all interest and penalties that the taxpayer may temporarily not be able to pay because of the disaster. If interest/penalties began to run before the disaster strikes, the taxpayer’s alternatives are reduced to being able to gather enough direct evidence for abatement under the general "reasonable cause" exception to penalties/interest.

In the situation under consideration, the disaster-postponement period began August 11, 2016, and ended on January 17, 2017. Payment of the tax under consideration, however, was due on April 15, 2016.

Chief Counsel’s holding. Chief Counsel, citing regulations under Code Sec. 7508A, found that since the payment of the tax had been due April 15, 2016, penalties and interest began to accrue before the postponement period began. As a result, the taxpayers would not get a suspension of penalties and interest between August 11, 2016 and January, 17, 2017. Chief Counsel added that if the taxpayers had received a valid extension to pay, then the tax would have been due during the postponement period and abatement for the disaster period would be available. But the most common six-month extension for Form 1040s from April 15th to October 15th allows for an extension to file but not to pay.

CCA 201723023



Supreme Court upholds ERISA exemption for church-affiliated pension plans

The U.S. Supreme Court, in Advocate Health Care Network v. Stapleton, SCt., June 5, 2017, has held that a defined benefit (DB) plan maintained by a principal-purpose organization, one controlled by or associated with a church for the administration or funding of a plan for the church's employees, qualifies as a "church plan," regardless of who established it under ERISA. The IRS and other federal agencies have long-exempted plans like the plans in this case from ERISA, the Court observed. Justice Kagan delivered the Court’s unanimous opinion.

In the case before the Supreme Court, several church-affiliated nonprofits operated hospitals and other healthcare facilities and offered defined benefit (DB) pension plans to their employees. The DB plans were established by the hospitals and managed by internal employee benefits committees. Some current and former employees of the hospitals argued that the DB plans were outside of ERISA’s church-plan exemption. According to the employees, the DB plans were not established by a church as required by ERISA.

Supreme Court approves. "From the beginning, ERISA provided that the term ‘church plan’ means a plan established and maintained for its employees by a church or by a convention or association of churches. In 1980, Congress amended the statute to expand that definition by deeming additional plans to fall within it. The amendment specified that, for purposes of the church-plan definition, an ‘employee of a church’ would include an employee of a church-affiliated organization," reasoned Justice Kagan, writing for the Court.

"Further, a plan established and maintained for its employees by a church or by a convention or association of churches includes a plan maintained by an organization…the principal purpose or function of which is the administration or funding of a plan or program for the provision of retirement benefits or welfare benefits, or both, for the employees of a church or a convention or association of churches, if such organization is controlled by or associated with a church or a convention or association of churches."

"Congress added language whose most natural reading is to enable a plan ‘maintained’ by a principal-purpose organization to substitute for a plan both ‘established’ and ‘maintained’ by a church. That drafting decision indicates that Congress did not in fact want what the employees claim," Kagan wrote. "Under the best reading of the statute, a plan maintained by a principal-purpose organization therefore qualifies as a ‘church plan,’ regardless of who established it," Kagan concluded.

Advocate Health Care Network v. Stapleton, SCt., June 5, 2017


Chief Counsel limits reach of Mescalero in employment tax discovery

In what is likely not to be the end of the matter, IRS Chief Counsel has advised that the Tax Court decision on Mescalero, 148 TC —, No. 11, Dec. 60,867, earlier this year does not stand for the proposition that taxpayers and/or their representatives are entitled to workers’ return information during the ordinary conduct of an employment tax audit or at the Appeals level. Special situations that may exist for discovery require Tax Court consideration, according to Chief Counsel.

Comment. Not only is Chief Counsel saying that a taxpayer would need to go to court before discovery involving other taxpayers’ returns is permitted, but in court the IRS would argue only the very limited and rare special circumstances as found in Mescalero would permit disclosure. At press time, the IRS has not indicated whether it would appeal Mescalero, issue a nonacquiescence or acquiescence in result only to it, or just let the case stand as a unique situation.

Mescalero. Mescalero involved an employment tax audit in which the IRS had determined that some of the contractors who received Forms 1099 from the taxpayer should have been classified as employees. Under Code Sec. 3402(d), the taxpayer could escape liability if it could prove that the workers paid the taxes themselves.

IRS’s position. Chief Counsel stressed how limited the use of Mescalero should be by taxpayers to facilitate discovery in employment tax situations. Chief Counsel concluded that the case does not stand for the proposition that taxpayers are entitled to workers' return information during the conduct of an employment tax audit or at the Appeals level. Instead, Chief Counsel viewed the decision as limited to discovery requests made during the pendency of a Tax Court proceeding, "where the Tax Court has the ability to determine whether the requested information is disclosable …and has balanced the relevancy of the requested information against the burden placed on the Service pursuant to Tax Court Rules.”

CCA 201723020


Over- and underpayment interest rates remain same for third quarter 2017

Although the Federal Reserves’ gradual interest rate increases may eventually impact the interest rates that the IRS uses to bill underpayments and pay on overpayments, they have not yet reached the baseline established with the Tax Code, when lower interest rates were not considered. As a result, the IRS has once again announced that the interest rates on overpayments and underpayments of tax for the calendar quarter beginning July 1, 2017, will remain unchanged. The rates will be:

  • 4 percent for overpayments, other than corporations;
  • 3 percent for overpayments by corporations (except 1.5 percent of the portion of a corporate overpayment exceeding $10,000);
  • 4 percent for underpayments (except large corporations); and
  • 6 percent for large corporate underpayments.



Tax Court finds lack of profit motive in auto racing business

An automobile racing enthusiast lacked an actual profit motive in running his business, the Tax Court has recently held. The taxpayer genuinely enjoyed racing but his pattern of losses as well as “books and records” reflected the lack of a profit or “business purpose.”

Background. In 2011, the taxpayer organized an automobile racing business using funds from his retirement plan. The taxpayer participated in 18 to 22 races each year. At the time he organized the business, the taxpayer was unemployed and generally spent more than 40 hours every week on racing. In time, he obtained employment and spent some 20 hours every week on the activity. The IRS ultimately determined that the racing activity was not engaged in for profit.

Comment. The business in this case was the taxpayer’s second attempt at racing. Some years earlier, the taxpayer had established a racing business but closed it after several years of losing money.

Court’s analysis. The court first found that taxpayers may not deduct expenses incurred in connection with activities not engaged in for profit, such as activities primarily carried on as sport, as a hobby, or for recreation, to offset taxable income from other sources. An activity is engaged in for profit if the taxpayer has an actual, honest profit objective, even if it is unreasonable or unrealistic. Determining profit motive is based on all the facts and circumstances, the court added.

The court also found that a business-like operation would have a business plan. Here, the taxpayer did not have a written business plan for the racing business, only a mental one, the court found. "Failure to keep adequate books and records and the lack of a written business plan indicate that petitioners did not conduct the business in a business-like manner nor in a manner similar to those of other profitable racing activities," the court held.

The court acknowledged that the taxpayer had more than 20 years of engagement in racing. This experience, the court noted, is a way to gain expertise in an activity. The court also acknowledged that the taxpayer devoted substantial time to racing, especially during the period when he was unemployed. However, the court found that the taxpayer had never won a race during the tax years in dispute. The profits the taxpayer earned were from the sale of used parts and cars, an annual sponsorship payment, and minimal race prize money. The court concluded that the taxpayer did not have an actual and genuine profit objective in operating his business.

Comment. Code Section 183(d) provides that an activity is presumed to be engaged in for profit if the activity produces income in excess of deductions for any three of the five consecutive years which end with the tax year. The taxpayer appeared to assert that the business had shown profits for 2013-2015 but the court found that the business had losses for 2014 and 2015.

Stettner, TC Memo. 2017-113


Software engineer denied deductions for Executive MBA degree

Expenses for an MBA degree may or may not be deductible depending upon a taxpayer’s current employment situation. Take two close cases with opposite results:

  • In Creigh, TC Summary Opinion 2017-26, a software engineer, who worked as a project manager, was not entitled to deduct expenses related to her executive masters of business administration (EMBA). The Tax Court found that the education qualified her for a new trade or business. One determining factor was that the taxpayer’s employment was largely unrelated to her EMBA coursework.
  • In contrast, in Long, TC Summary Opinion 2016-88, the cost of an MBA degree was deductible since the court reasoned that the degree did not qualify that taxpayer for a new trade or business but further developed skills he was already using in his current trade or business. 

Background. The general rule is that education expenses, to be deductible, must be incurred to maintain or improve skills required of an employee. They are not deductible if they are incurred to meet minimum job requirements, to meet minimum requirements for a promotion, or to train for a new trade or business. Thus, the costs of obtaining a master’s degree in business administration have been deductible only as long as the reason for obtaining the MBA satisfies those rules.

Tax Court’s analysis. In the recent case that went against winning an EMBA deduction (Creigh v. Commissioner), the Tax Court found that taxpayer’s employment was largely unrelated to her EMBA coursework. While the taxpayer continued to be qualified to manage people as a project manager, she also became qualified to perform additional business, management, finance and marketing tasks not performed before enrolling in the EMBA program. Further, the court pointed to particular coursework within the EMBA program the entitled her to a "new trade or business," namely work on a project for the quality systems division of a laboratory, which involved tasks unrelated to her prior work in designing and developing computer software systems and integrating and implementing them to improve business processes.

Comment.  Since the expenses related to the EMBA program were not deductible under Code Sec. 162, the taxpayer was also not entitled to deduct car and truck expenses for her travel to the EMBA classes and events.


President directs IRS to exercise discretion in enforcement of “Johnson amendment”

An Executive Order, issued on May 4, directs the IRS to exercise maximum discretion in its enforcement of the "Johnson amendment" concerning Code Sec. 501(c)(3) charitable/religious organizations.  The Johnson amendment (passed by Congress in the 1950s) and subsequent IRS regulations generally prohibit Code Sec. 501(c)(3) organizations from directly or indirectly participating in, or intervening in, a political campaign on behalf of (or in opposition to) any candidate. This prohibition is known as the Johnson amendment, named after the sponsor of the original legislation, President Lyndon Johnson, while he served in the House of Representatives. 

Under current rules, political intervention is defined to include any campaign and any activity that favors or opposes a candidate for office. Leaders of exempt organizations can generally voice their opinions on political matters as long as they are speaking for themselves and not on behalf of the organization. When a candidate is invited to speak at an exempt organization’s event, the IRS has set out factors to determine if the organization participated in, or intervened in, a political campaign.

Comment. Violation of this prohibition may result in denial or revocation of tax-exempt status and the imposition of certain excise taxes.

Executive Order. The White House explained that the Executive Order instructs the IRS "to exercise maximum enforcement discretion to alleviate the burden of the Johnson amendment, which prohibits religious leaders from speaking about politics and candidates from the pulpit." The White House added that the Executive Order is effective immediately. However, until either further guidance is provided either by the Executive Branch, Congress or the courts, most observers forecast that not much likely will change as a practical matter for impacted organizations.


IRS updates FAQs on passport certification

In 2015, Congress added Code Sec. 7345 as part of the Fixing America’s Surface Trans­portation Act of 2015 (FAST Act). Upon receiving certification of seriously delin­quent tax debt from the IRS, the FAST Act directs the State Department to deny an individual’s passport application and/or to revoke the individual’s current passport. Although authorized at the end of 2015, the IRS’s passport certification program has only lately gotten up and running. Recently, it has updated its website to expand on the applicable rules. 

“Seriously delinquent tax debt” for this purpose is an individ­ual's unpaid, legally enforceable federal tax debt totaling more than $50,000 (including interest and penalties) for which a notice of federal tax lien has been filed and all ad­ministrative remedies under Code Sec.6320 have lapsed or been exhausted; or levy has been issued. The $50,000 threshold is in­dexed for inflation after 2016.

Comment. Some tax debt is excluded from determining seriously delin­quent tax debt, such as tax liabilities being paid in a timely manner under an installment agreement or offer in compromise. Tax debt for which a collection due process hearing is timely requested in connection with a levy to collect the debt or for which collection has been suspended because a request for innocent spouse relief has been made also is excluded from determin­ing seriously delinquent tax debt.

Notification. The FAST Act requires the IRS to notify an affected taxpayer in writing at the time the agency certifies seriously delinquent tax debt. The IRS explained on its web­site that it is using Notice CP 508C for this purpose. Updated IRS guidance explains that taxpayers who need to resolve passport issues should call the phone number listed on their Notice CP 508C. If the taxpayer al­ready has a U.S. passport, the taxpayer may be allowed to travel until he or she is noti­fied by the State Department, the IRS ex­plained. In addition, once a taxpayer is cer­tified and his or her passport is cancelled or revoked, the certification will be reversed if the taxpayer resolves the tax debt, makes alternate payment arrangements or shows that he or she received the certification by mistake, the IRS explained.


No equitable relief from missing tax court deadline for innocent spouse review

The Third Circuit Court of Appeals has found that the Tax Court properly dismissed for lack of jurisdiction an individual’s petition for review of the IRS’s denial of innocent spouse relief, which was submitted outside of the 90-day deadline specified by Code Sec. 6015(e)(1)(A). Any equitable reasons for missing the 90-day deadline under Code Sec. 6015(e)(1)(A) were irrelevant. 

Generally, when spouses file a joint tax return, each spouse is jointly and severally liable for under Code Sec. 6015(c). However, a jointly filing spouse may seek relief from joint and several liability for a tax deficiency if the couple is legally separated, no longer married, and not living together. In addition, for taxpayers who do not satisfy §6015(c), the IRS has discretion to grant relief where it would be “inequitable to hold the individual liable for any … deficiency.” These avenues for relief are referred to as the innocent spouse relief provisions. If the IRS denies relief, then the taxpayer may file a petition with the Tax Court.

In this case, the taxpayer submitted additional information to the IRS before the 90-day deadline was to expire on April 12. The IRS, however, did not change its original determination and reminded the taxpayer that the original 90-day deadline still applied. However, in its correspondence, it noted April 19 rather than April 12 as the end of the 90-day deadline. The taxpayer filed her petition on April 19. Too late, said the Tax Court, the 90-days were up.

Comment. "Rigid deadlines, such as those embodied in the tax law's jurisdictional requirements, promote predictability of the revenue stream, which is vital to the government …If a deadline is jurisdictional, it is not subject to equitable tolling," the appellate court stated.

Rubel, CA-3, 2007-1 ustc ¶50,224


Stock broker proves real estate professional status for rental losses

Winning real estate professional status –and the benefits gained from taking business deductions and losses from an “active” rather than “passive” business-- often depends upon good recordkeeping. As shown in a recent Tax Court decision, the ability of a taxpayer to provide precise hours devoted to a number of real estate properties as well as what time the taxpayer spends on other business pursuits is critical in meeting the 750-hours test for real property trades or businesses; and the related more-than-half personal services test. 

Latest example. In the most recent case before the Tax Court, the taxpayer worked part-time as an investment manager, for reported wage income of $285,437. She claimed that she worked sufficiently in her real estate business, however, to be characterized as a real estate professional for purposes of not being subject to the passive activity loss rules under Code Sec. 469. She therefore claimed net losses from her real estate business ($103K sales less $307K losses) against her wage income. The IRS denied her status as a real estate professional, as well as related meals, entertainment, vehicle and cell phone expenses.

Tax status as a real estate professional. Although, the taxpayer did not make an election to group her separate rental properties together as one activity under Sec. §1.469-9(g)(3) and Rev. Proc. 2010-13, the taxpayer’s testimony and logs nevertheless showed that she spent more than 100 hours on each of them; or, on the others, her participation constituted substantially all of the participation in those properties. Further, the 889 total hours during the tax year on her real estate activities, which was more time than one-half of the total time (although just barely) she spent on all of her business activities. Further, the taxpayer could show that she spent a considerable amount of time and money to keep her rental real estate activities viable. She handled all aspects of the business from collecting rent to overseeing the work of repairmen, meeting prospective buyers and addressing problems with utility and service companies.

Comment. Rev. Proc. 2010-13 requires that any grouping of real estate activities in testing for material participation must be made on the taxpayer’s original return for the tax year. Taxpayers, therefore, should test status before filing a return to determine the overall best option to have their activities evaluated – separately or as a group.

Windham, TC Memo 2017-68


CBO reports on top tax incentives/expenditures

The Congressional Budget Office (CBO) issued a report in mid-March about current tax incentives. Tax expenditures, CBPO explained, reduce the amount of revenue that is collected for any given set of statutory tax rates. Tax incentives also affect the distribution of the tax burden in ways that may not always be recognized, both among people at different income levels and among people who have similar income but differ in other ways, CBO reported.

CBO identified the top five largest tax expenditures in 2017 as:

  • The exclusion from workers’ taxable income of employers’ contributions for health care, health insurance premiums, and premiums for long-term care insurance;
  • The exclusion of contributions to and the earnings of pension funds (minus pension benefits that are included in taxable income);
  • Preferential tax rates on dividends and long-term capital gains;
  • The deferral for profits earned abroad, which certain corporations may exclude from their taxable income until those profits are returned to the U.S.; and
  • The deductions for state and local taxes (on nonbusiness income, sales, real estate, and personal property).

Other significant tax expenditures include the earned income tax credit (EITC), the deduction for mortgage interest, the immediate deduction for investments in certain business property, and the deduction for charitable contributions, according to CBO. Watch for all of these scores to play a role in the upcoming debate on tax reform.


IRS updates 401(k) hardship distributions exam materials

The IRS Tax Exempt and Government Entities Division (TE/GE) has updated guidance used to determine whether a Code Sec. 401(k) plan hardship meets the safe-harbor standards set forth in applicable regulations. Specifically, the memorandum, TE/GE-04-0217-008, sets out the substantiation guidelines that IRS auditors are to use in conducting related examinations.

Under Code Sec. 401(k), plans may provide hat an employee can receive a distribution of elective contributions from the plan on account of hardship. Generally, a hardship distribution form a retirement account can only be made for immediate and heavy financial need of the employee and is in an amount necessary to satisfy the financial need of the applicable.

Under Reg. §1.401(k)-1(d)(3)(iii)(B), the safe harbor provides that a distribution is deemed to be as a result of immediate and heavy financial need if made for the following reasons:

  • Expenses for medical care deductible under Code Sec. 213(d);
  • Costs directly related to the purchase of a principle residence;
  • Payment of tuition, related educational fees, and room and board expenses for up to the next 12 months of post-secondary education for the employee or employee’s spouse, children or dependents;
  • Payments necessary to prevent the eviction of the employee from the employee’s principal residence or foreclosure of the mortgage on that residence;
  • Payments for burial or funeral expenses for the employee’s deceased parent, spouse, children or other dependent; or
  • Expenses for the repair of damage to the employee’s principal residence that would qualify for the Code Sec. 165 casualty deduction.

The TE/GE guidance details the steps that an examiner is to take in substantiation that a distribution is made for one of the enumerated reasons. Firstly, the examiner is to determine whether the employer or a third-party administrator had the requisite source documents or summary of source documents prior to making a distribution to an affected employee. In addition, the examiner may need to ensure that the employee was given the relevant notifications prior to a hardship distribution, to include being told that the hardship is taxable, and that the amount of the distribution may not exceed the immediate and heavy financial need.

Next, the IRS examiner is to review the provided documentation to determine if they substantiate the requested hardship distribution. If they do not, the examiner is to ask the employer or the third-party administrator to substantiate that a hardship distribution is deemed to be on account of an immediate and heavy financial need. If an examiner determines that the requirements of the first and second steps are met, the plan is to be treated as satisfying the substantiation requirement for making hardship distributions deemed to be for an immediate and heavy financial need.


Employee consent requirements for employer refund claims released

The IRS recently issued the employee consent requirements that an employer need to adhere to in order to support a claim for refund of overpaid taxes under the Federal Insurance Contributions Act (FICA) and the Railroad Retirement Tax Act (RRTA). The guidance clarifies the basic requirements for both a request for employee consent and the content needed for the employee consent. It also permits employee consent to be requested, furnished and retained in electronic format. In addition, the procedure contains guidance concerning what constitutes “reasonable efforts” if employee consent is not secured in order to permit the employer to claim a refund of the employer share of overpaid FICA and RRTA taxes.

The new guidance applies to employee consents requested as of June 5, 2017. It does not require employers to solicit new employee consents and will not affect the validity of any employee consent received pursuant to a request made prior to June 5, 2017, that was provided in accordance with existing law. For employee consents requested before June 5, 2017, employers may rely on the proposed revenue procedures set forth in Notice 2015-15.


New Offers in Compromise policy starts April 27

The IRS informed taxpayers and tax professionals of its updated policy with regards to the Offer in Compromise (OIC) application process. OIC applications received on or after March 27, 2017, will now be returned without further consideration in instances where the taxpayer has not filed all required tax returns, the Service explained. In addition, the associated application fee will also be returned. Further any required initial payment submitted with the OIC will be applied to the outstanding tax debt. The agency also noted that taxpayers continue to be required to make nonrefundable partial payments with the submission of any OIC, the IRS noted. The new policy will not apply to current year tax returns so long as a valid extension is on file.

The new policy can be read on the Offer in Compromise page located on the IRS website and the newly updated Offer in Compromise Booklet, Form 656-B, available as of March 27.


Tax refund offsets may be used toward unpaid debts

A taxpayer who incurs an unpaid debt may notice a reduction in his or her federal tax refund. The Treasury Offset Program is allowed to use all or part of a taxpayer’s federal refund to settle unpaid federal or state debts, to include unpaid individual shared responsibility payments.

For example, the IRS is prohibited from using liens or levies to collect any individual shared responsibility payment, if a taxpayer owes a shared responsibility payment, the IRS may offset the taxpayer’s tax refund against the liability.

The Department of Treasury’s Bureau of the Fiscal Service, or BFS, runs the Treasury Offset Program. The BFS may use part or all of a taxpayer’s tax refund to pay certain debts such as federal tax debts, federal agency debts (e.g. a delinquent student loan), state income tax obligations, past-due child and spousal support, and certain unemployment compensation debts owed to a state.

The BFS mails a taxpayer a notice if it offsets any part of the taxpayer’s refund to pay the debt incurred. The notice lists the original refund and the offset amount. It also includes the agency that received the offset payment, as well as the agency's contact information.

A taxpayer may dispute the offset by contacting the agency that received the offset payment. Note that taxpayers should only contact the IRS if the offset was applied to a federal tax debt.

Taxpayers who filed a joint tax return with their spouse may be entitled to part or the entire offset. However, this rule only applies if the spouse is solely responsible for the debt. For the taxpayer to obtain his or her part of the refund, he or she should file Form 8370, Injured Spouse.

Further, although the IRS is prohibited from using liens or levies to collect any individual shared responsibility payment, if a taxpayer owes a shared responsibility payment, the IRS may offset the taxpayer’s tax refund against the liability.


Passport certifications will begin in early 2017, IRS posts on website

The IRS has informed taxpayers via its website that the agency will begin, in early 2017, to remit certifications to the U.S. State Department for individuals who are seriously delinquent in paying their tax debt. Such certification could impact an individual’s ability to obtain or keep a U.S. passport. At this time, the IRS has not started certifying tax debt to the State Department, the agency reported on its website.

On its website, the IRS explained that seriously delinquent tax debt is an individual's unpaid, legally enforceable federal tax debt totaling more than $50,000 (including interest and penalties) for which a notice of federal tax lien has been filed and all administrative remedies under Code Sec.6320 have lapsed or been exhausted, or a levy has been issued.

However, the IRS explained, some tax debt is not included in determining seriously delinquent tax debt. Such tax debt includes:

  • Being paid in a timely manner under an installment agreement entered into with the IRS.
  • Being paid in a timely manner under an offer in compromise accepted by the IRS or a settlement agreement entered into with the U.S. Justice Department.
  • For which a collection due process hearing is timely requested in connection with a levy to collect the debt.
  • For which collection has been suspended because a request for innocent spouse relief under Code Sec. 6015 has been made.

Before an applicant’s passport is denied, the State Department will hold the application for 90 days. During the 90 days, an individual can resolve any erroneous certification issues; make full payment of the tax debt; and/or enter into a payment alternative, such as an installment agreement. There is no grace period for resolving the debt before the State Department revokes a passport, the IRS added.

The IRS will notify taxpayers in writing if the agency makes a certification to the State Department. The agency will also notify taxpayers in writing if it reverses a certification. In addition, the IRS will provide notice within 30 days of the date the debt is fully satisfied, becomes legally unenforceable or ceases to be seriously delinquent tax debt.

Taxpayers may seek judicial review of certifications. If the Tax Court or a federal district court finds the certification was erroneous, the court may order the IRS to notify the State Department. There is no administrative process before filing suit in court, the IRS explained.


Tax returns lacking ACA coverage status will not be rejected

The IRS has announced that it will continue to process individual returns that do not report the taxpayer’s health coverage status under the Affordable Care Act (ACA). The IRS will accept returns that fail to indicate coverage, an exemption or a shared responsibility payment. The IRS had planned to reject these returns (known as "silent returns") this filing season after having accepted them in past years. Taxpayers may, however, be contacted later, the IRS cautioned.

The IRS left open the question of whether it would revise other aspects of ACA compliance during the balance of this filing season. The IRS announcement on processing silent returns began with the statement, without elaboration: "The IRS is currently reviewing the January 20, 2017, Executive Order on the ACA to determine the implications. Taxpayers should continue to file their tax returns as they normally would."

Executive order. Shortly after taking office, President Trump announced that it is the policy of his administration to seek "prompt repeal" of the ACA. In Executive Order 13765, the President instructed the heads of federal agencies "to waive, defer, grant exemptions from or delay the implementation of any provision or requirement of the ACA that would impose any cost, fee, tax, penalty, or regulatory burden on individuals."

Return processing. Processing silent returns means that returns are not systemically rejected by the IRS at the time of filing, allowing the returns to be processed and minimizing burden on taxpayers, including those expecting a refund,” the agency reported.

Follow-up. Taxpayers may receive follow-up questions and correspondence at a future date, about their coverage status, after the filing process is completed, the IRS reported. The IRS also emphasized that its revised treatment does not change the underlying legislative provisions of the ACA that remain in force at this time, including penalty payments, until changed by Congress.


Dentist persuades Tax Court of material participation in real estate business

The Tax Court determined, in Zarrinnegar v. Commissioner, TC Memo. 2017-34, that a dentist by profession, was a real estate professional, and therefore could deduct rental real estate losses. As such, the losses were not barred by the passive activity rules.

The taxpayer was a dentist married to another dentist with whom he shared a dental practice. The two worked in shifts, often with the wife working the morning shift and the husband working the afternoon shift. The couple also owned a real estate brokerage firm and four rental properties. The husband managed the properties, while the wife did not. The husband reported that he spent over 1,000 hours every year on the real estate business.

For several years, the couple reported income from the dental practice on their returns, and losses from their real estate business. The IRS disallowed the deductions for the losses after characterizing them as passive activity losses.

In general, losses from the rental activities of a real estate professional are not considered passive losses. One requirement to be classified as a real estate profession, among many, is that an individual perform more than 750 hours of services during the tax year in real property trades or businesses in which he or she materially participates.

The Tax Court held that a passive activity is trade or business in which the taxpayer does not materially participate. Material participation requires regular, continuous and substantial involvement in business operations. Rental activities are generally considered passive in nature, regardless of a taxpayer’s material participation. However, there is an exception for rental activities of taxpayers who are real estate professionals.

A taxpayer is a real estate professional if more than one-half of the personal services performed in trades or businesses by the taxpayer during the tax year are performed in real property trades or businesses in which the taxpayer materially participates, and the taxpayer performs more than 750 hours of services during the tax year in real property trades or businesses in which the taxpayer materially participates.

The court determined that the husband had worked more than 1,000 hours each year on the real estate business, as he substantiated this claim with credible time logs. Witness testimony also substantiated the amount of time the husband spent on the real estate business. In addition, the court found that the husband worked less than 1,000 hours every year at the dental practice. As such, the court concluded that the couple was not bared from claiming the losses from their real estate business.


IRS confirms automatic six-month extension for C corporations

The IRS has confirmed that a new revision of the Instructions for Form 7004 correctly reflects that calendar year C corporations are eligible for an automatic six-month extension. Code Sec. 6081(a) provides that the IRS may grant a reasonable extension of time for filing returns, so long as the extension is not more than six months, the IRS explained.

Domestic corporations are required to annually file Form 1120, U.S. Corporation Income Tax Return, to report the income, credits, gains, losses, deductions, and income tax liability of the corporation unless it elects, or is required to file, a special return. Corporate income tax returns are usually filed on Form 1120, but specified types of corporations are required to file on specialized forms.

The automatic extension provided by Reg. §1.6081-3(a) to C corporations filing Form 1120 was codified by the Surface Transportation Act and changed to six-months. This change applies to returns for tax years beginning after December 31, 2015. However, a special rule under Code Sec. 6081(b) provides that in the case of any calendar-year C corporation with a tax year beginning before January 1, 2026, the maximum extension allowed is five months. In the case of a C corporation with a fiscal year ending on June 30 and beginning before January 1, 2026, the maximum extension allowed is seven months.


Future pension payouts not counted as asset in determining insolvency exclusion

The Tax Court, in Schieber v. Commissioner, TC Memo. 2017-32, found that the right to a continuing monthly payment state pension plan was not an asset in determining insolvency for purposes of exclusion from cancellation of indebtedness income. The court rejected the IRS’s argument that the ability of the taxpayers to use their monthly pension payments to continue to pay off existing tax indebtedness was sufficient to disprove insolvency.

The taxpayer-husband’s public employees’ defined benefit pension provided monthly payments with cost of living increases. Other than the monthly amounts as they became payable, the husband and his wife could not access the value in the plan. They could not convert their interest into a lump-sum cash amount, sell their interest, assign their interest, borrow against their interest or borrow from the plan. The plan withheld federal income tax from the payments.

A mortgage lender cancelled $418,000 of the taxpayers’ debt. The taxpayers claimed that their liabilities exceeded their asset by $293,000, and that should be excluded from cancellation of indebtedness income under the insolvency exception provided in Code Sec. 108. The IRS, however, claimed that the taxpayers were not insolvent since the income stream from the pension should be counted as an asset.

The Tax Court observed that although the Tax Code does not define assets, case precedent did find that an asset exempt from creditors could still be an asset for purposes of Code Sec. 108 because such an asset can give the taxpayer the ability to pay an immediate tax on income from the canceled debt. The IRS argued that the taxpayers’ interest in the pension plan should be considered an asset because they could use their monthly payments to pay liabilities.

However, the Tax Court appeared to view the insolvency test to be one predicated on whether the asset gives the taxpayer the ability to pay an “immediate tax on income” from the canceled debt, not to pay the tax gradually over time. Here, the taxpayers’ interest in the pension plan could not be used to immediately pay the income tax on canceled-debt income. Therefore, the court found that it could not be considered an asset within the meaning of Code Sec. 108.


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