Specialized tax breaks for the farming industry

Tax provisions directly affecting farmers in the Heartland, Habitat, Harvest, and Horticulture Act of 2008

The recently enacted “Heartland, Habitat, Harvest, and Horticulture Act of 2008” (the 2008 Farm Act) contains a package of tax changes including specialized tax breaks for the farming industry (along with a crackdown on farm losses) and new and modified credits related to the production of certain fuels, among other things. Here's a summary of the key tax provisions in the 2008 Farm Act that directly affect farmers:

• Conservation reserve payments made after 2007 are not subject to self-employment tax if received by an individual who is getting Social Security retirement or disability payments.
• The favorable tax treatment of capital gain property donated for qualified conservation is extended for two years (through 2009).
• A new deduction is allowed for endangered species recovery expenses incurred after 2008.
• A new tax credit is created for the development of cellulosic biofuels, which are biofuels produced from agricultural waste, wood chips, switch grass and other non-food feedstocks. This credit, available for fuel produced after 2008 and through 2012, is a nonrefundable income tax credit for each gallon of qualified cellulosic fuel production of the producer for the tax year. The amount of the credit per gallon is $1.01, except for cellulosic biofuel that is alcohol. For cellulosic biofuel that is alcohol, the $1.01 credit amount is reduced by (1) the credit amount applicable for such alcohol under the alcohol mixture credit in effect at the time cellulosic biofuel is produced, and (2) in the case of cellulosic biofuel that is ethanol, the credit amount for small ethanol producers as in effect at the time the cellulosic biofuel fuel is produced.
• The 51¢ per-gallon incentive for ethanol is reduced to 45¢ per gallon for calendar year 2009 and thereafter. This reduction is subject to an exception geared to ethanol production.
• A new tax credit is created for agricultural chemicals security. The new law provides retailers of agricultural products and chemicals and manufacturers, formulators, or distributors of certain pesticides a business tax credit for 30% of costs for the protection of such chemicals or pesticides. Such protection costs include employee security training and background checks, installation of security equipment, and computer network safeguards. The credit has a $2 million annual limit and a per facility limitation of $100,000 (reduced by credits received for the five prior tax years). This credit is effective for expenses paid or incurred after May 22, 2008, and before Jan. 1, 2013.
• Qualifying mutual ditch, reservoir, or irrigation company stock may be eligible for Code Sec. 1031 treatment. This provision is effective for exchanges after May 22, 2008.
• Temporary assistance to victims of the 2007 Kansas tornado disaster is provided, including increased ability to deduct personal losses, increased business expense deductions, and help for affected businesses that continued to pay their employees after the disaster struck.
• The amount of farming losses (other than those losses arising because of fire, storm losses, etc.) that a taxpayer may use to reduce other non-farming business income is limited for certain taxpayers. For tax years beginning after 2009, the farming loss of a non-C corporation taxpayer for any tax year in which any applicable subsidies are received will be limited to the greater of (1) $300,000 ($150,000 in the case of a married person filing a separate return), or (2) the taxpayer's total net farm income for the prior five tax years. Applicable subsidies are (a) any direct or counter-cyclical payments under title I of the Heartland, Habitat, Harvest, and Horticulture Act of 2008 (or any payment elected in lieu of any such payment), or (b) any Commodity Credit Corporation (CCC) loan. Total net farm income is an aggregation of all income and loss from farming businesses for the prior five tax years.
• For tax years beginning after 2007, the farm optional method and nonfarm optional method for computing net earnings from self-employment are modified so that electing taxpayers may pay more in optional self-employment taxes and thus become eligible for Social Security benefits.
• The CCC is required to always provide IRS and the farmer with information returns showing the amount of market gain the farmer realizes when he or she repays a CCC market assistance loan.
  

Limitation on farming losses in the Heartland, Habitat, Harvest, and Horticulture Act of 2008

The recently enacted “Heartland, Habitat, Harvest, and Horticulture Act of 2008” (the 2008 Farm Act) contains a package of tax incentives to promote conservation investment in farm country. Those incentives are paid for, in part, by a new limitation on farming losses for certain taxpayers. In essence, the new law limits agricultural losses that can be claimed to the greater of $300,000 ($150,000 for a married person filing separately) or the net farm income for the previous five years if the taxpayer receives any 2008 Farm Act commodity payments or Commodity Credit Corporation loans. Here is a closer look at this new limitation.

Except for passive activity rules in Code Sec. 469, the amount of farming losses that a taxpayer may claim is not limited under pre-2008 Farm Act law. The new provision, which is effective for tax years beginning after December 31, 2009, alters that situation by limiting the amount of farming losses that a taxpayer, other than a C corporation, may use to offset non-farm business income. The limitation amount is the greater of $300,000 ($150,000 in the case of a married person filing a separate return) or the total net farm income the taxpayer has received over the last five years. For example, assume a taxpayer has $300,000 of net farm income and $700,000 of non-farm income in 2010, and $1 million of net farm income in each tax year 2011 to 2014. In 2015, he incurs a $7 million farming loss. Under the new provision, his farming loss in 2015 is limited to the greater of (1) $300,000 or (2) $4.3 million (total net farm income for the prior five tax years). The $4.3 million of the farming loss allowed in 2015 may be carried back to the prior five tax years.

Losses that are limited in a particular year may be carried forward to subsequent years.
For partnerships and S corporations, the limit is applied at the partner or shareholder level. Farming losses arising by reason of fire, storm, or other casualty, or by reason of disease or drought, are disregarded for purposes of calculating the new limitation.

This provision only applies to eligible taxpayers who receive any direct or counter-cyclical payments under title I of the 2008 Farm Act (or any payment elected in lieu of any such payment), or any Commodity Credit Corporation loan. For purposes of this provision, the definition of “farming business” is broadened to include the processing of commodities, without regard to whether such activity is incidental, by a taxpayer otherwise engaged in a farming business with respect to such commodities.

Agricultural chemicals security tax credit created by the Heartland, Habitat, Harvest, and Horticulture Act of 2008

The recently enacted “Heartland, Habitat, Harvest, and Horticulture Act of 2008” (the 2008 Farm Act) contains a package of tax incentives to promote conservation investment in farm country. One fairly specialized new incentive addresses the need to safely secure agricultural chemicals. Agricultural chemicals and pesticides purchased for legitimate uses are increasingly vulnerable to theft because of the drug trade and national security threats. Some agricultural businesses may pay tens of thousands of dollars on new measures to secure their storage sites. In recognition of this, the 2008 Farm Act creates a new credit to help agricultural businesses afford the increasing expenses of protecting agricultural chemicals and pesticides.

The new law provides retailers of agricultural products and chemicals and manufacturers, formulators, or distributors of certain pesticides a business tax credit for 30% of costs for the protection of such chemicals or pesticides. Such protection costs include employee security training and background checks, installation of security equipment, and computer network safeguards. The credit has a $2 million annual limit and a per facility limitation of $100,000 (reduced by credits received for the five prior tax years). This credit is effective for expenses paid or incurred after May 22, 2008, and before Jan. 1, 2013.

I hope this information is helpful. If you would like more details about this or any other aspect of the new law, please do not hesitate to contact us.

Tax Provisions in the Heartland, Habitat, Harvest, and Horticulture Act of 2008

Overview of the tax changes in the Heartland, Habitat, Harvest, and Horticulture Act of 2008

The recently enacted “Heartland, Habitat, Harvest, and Horticulture Act of 2008” (the 2008 Farm Act) contains a package of tax changes including specialized tax breaks for the farming industry (along with a crackdown on farm losses) and new and modified credits related to the production of certain fuels, among other things. Here's a summary of the key tax provisions in the 2008 Farm Act:

• Conservation reserve payments made after 2007 are not subject to self-employment tax if received by an individual who is getting Social Security retirement or disability payments.
• The favorable tax treatment of capital gain property donated for qualified conservation is extended for two years (through 2009).
• A new deduction is allowed for endangered species recovery expenses incurred after 2008.
• There is a one-year cut in the tax rate for a corporation's qualified timber gain. For tax years ending after May 22, 2008 and beginning on or before May 22, 2009, a 15% alternative tax applies on the portion of a corporation's taxable income that consists of qualified timber gain (or, if less, the net capital gain) for a tax year. In addition the rules for REITs (real estate investment trusts) holding timber property are liberalized temporarily.
• A new tax credit is created for the development of cellulosic biofuels, which are biofuels produced from agricultural waste, wood chips, switch grass and other non-food feedstocks. This credit, available for fuel produced after 2008 and through 2012, is a nonrefundable income tax credit for each gallon of qualified cellulosic fuel production of the producer for the tax year. The amount of the credit per gallon is $1.01, except for cellulosic biofuel that is alcohol. For cellulosic biofuel that is alcohol, the $1.01 credit amount is reduced by (1) the credit amount applicable for such alcohol under the alcohol mixture credit in effect at the time cellulosic biofuel is produced, and (2) in the case of cellulosic biofuel that is ethanol, the credit amount for small ethanol producers as in effect at the time the cellulosic biofuel fuel is produced.
• The 51¢ per-gallon incentive for ethanol is reduced to 45¢ per gallon for calendar year 2009 and thereafter. This reduction is subject to an exception geared to ethanol production.
• A new tax credit is created for agricultural chemicals security. The new law provides retailers of agricultural products and chemicals and manufacturers, formulators, or distributors of certain pesticides a business tax credit for 30% of costs for the protection of such chemicals or pesticides. Such protection costs include employee security training and background checks, installation of security equipment, and computer network safeguards. The credit has a $2 million annual limit and a per facility limitation of $100,000 (reduced by credits received for the five prior tax years). This credit is effective for expenses paid or incurred after May 22, 2008, and before Jan. 1, 2013.
• Qualifying mutual ditch, reservoir, or irrigation company stock may be eligible for Code Sec. 1031 treatment. This provision is effective for exchanges after May 22, 2008.
• For property placed in service after 2008 and before 2014, all racehorses are classified as three-year property for depreciation purposes, regardless of their age.
• Temporary assistance to victims of the 2007 Kansas tornado disaster is provided, including increased ability to deduct personal losses, increased business expense deductions, and help for affected businesses that continued to pay their employees after the disaster struck.
• The amount of farming losses (other than those arising because of fire, storm losses, etc.) that a taxpayer may use to reduce other non-farming business income is limited for certain taxpayers. For tax years beginning after 2009, the farming loss of a non-C corporation taxpayer for any tax year in which any applicable subsidies are received will be limited to the greater of (1) $300,000 ($150,000 in the case of a married person filing a separate return), or (2) the taxpayer's total net farm income for the prior five tax years. Applicable subsidies are (a) any direct or counter-cyclical payments under title I of the Heartland, Habitat, Harvest, and Horticulture Act of 2008 (or any payment elected in lieu of any such payment), or (b) any Commodity Credit Corporation (CCC) loan. Total net farm income is an aggregation of all income and loss from farming businesses for the prior five tax years.
• For tax years beginning after 2007, the farm optional method and nonfarm optional method for computing net earnings from self-employment are modified so that electing taxpayers may pay more in optional self-employment taxes and thus become eligible for Social Security benefits.
• The CCC is required to always provide IRS and the farmer with information returns showing the amount of market gain the farmer realizes when he or she repays a CCC market assistance loan.
• For large corporations (those with assets of at least $1 billion), estimated tax payments due in July, August, and September of 2012 are increased by 7.75% of the payment otherwise due, and the next required payment is reduced accordingly.

Please keep in mind that this is only a summary of the tax changes in the new law. If you would like to discuss any of these provisions in greater detail, please do not hesitate to contact us.

Heroes Earnings Assistance and Relief Tax Act of 2008

Overview of tax changes in the Heroes Earnings Assistance and Relief Tax Act of 2008

The recently enacted “Heroes Earnings Assistance and Relief Tax Act of 2008” (the 2008 Heroes Act) provides targeted tax relief for military members and their families, fully offset with tightened expatriation rules, a new rule requiring U.S. companies working under federal government contract to treat overseas employees as subject to employment taxes, and a higher failure to file penalty. Here's a summary of the tax provisions in the Act:

New relief provisions. The 2008 Heroes Act makes the following liberalizations for members of the military and their families:

• Clarifies that those in the active military who file a joint tax return are eligible for the stimulus rebate payment under the Economic Stimulus Act of 2008 even if one spouse does not have a Social Security number.
• Makes permanent the ability to include combat pay as earned income for purposes of the earned income tax credit (EITC) (under pre-2008 Heroes Act law, this benefit was only available for tax years ending before 2008).
• Makes permanent an exception that permits qualified mortgage bonds to be issued to finance mortgages for qualified veterans who served in the active military without regard to the first-time homebuyer requirement (under pre-2008 Heroes Act law, this exception only applied for bonds issued before 2008).
• Modifies the law which provides certain retirement plan protections for reservists who are called to active duty and who are able to return to their civilian employers after serving our country. The new law requires tax-qualified retirement plans to provide that if a participant dies while performing qualified military service, his or her survivors would be entitled to any additional benefits (other than benefit accruals relating to the period of qualified military service) that would have been provided had the participant resumed employment and then terminated employment on account of death. Similar rules apply to 403(b) annuities and 457(b) plans. Additionally, the new law provides that retirement plans can permit individuals who leave for qualified military service and cannot be reemployed on account of death or disability to be treated as if they had been rehired as of the day before death or disability and then had terminated employment on the date of death or disability. These changes apply to deaths or disabilities occurring after 2006.
• Includes differential wages paid by an employer to an employee who becomes active duty military in the calculation of wages for retirement plan and IRA purposes, effective for years beginning after 2008. Differential pay is also made subject to federal income tax withholding, effective for amounts paid after 2008.
• Extends the limitations period for filing tax refund credit claims arising from Department of Veterans Affairs disability determinations.
• Makes permanent the expiring Internal Revenue Code provision that permits active duty reservists to make penalty-free withdrawals from retirement plans.
• Permits a military death gratuity or amount received under the Servicemembers' Group Life Insurance (SGLI) program to be rolled over to a Roth IRA or Coverdell education savings account, notwithstanding the contribution limits that otherwise apply.
• Entitles Peace Corps volunteers and certain employees to a similar tolling of the homesale exclusion ownership and use period that already applies to members of the uniformed services, Foreign Service, and intelligence community. The Act also makes permanent the special homesale exclusion rules for certain employees of the intelligence community and repeals the requirement that those employees move overseas in order to qualify for special treatment.
• Provides small employers with a 20% tax credit for differential wage payments made to employees who are on active military duty.
• Provides an exclusion for state or local payments of bonuses to active or former military personnel or their dependents on account of such military personnel's service in a combat zone.
• Allows members of the reserves who are called to active duty to withdraw unused amounts held in a health flexible spending account (health FSA).
• Retroactively clarifies that certain property tax rebates and other benefits made with respect to volunteer firefighters, and excluded from gross income under the Mortgage Forgiveness Debt Relief Act of 2007, are not subject to Social Security tax or unemployment tax.

Revenue raising provisions. To offset the cost of the new tax breaks (and the cost of various SSI liberalizations for the military), the Act:

• Tightens the expatriation rules. U.S. citizens and long-term U.S. residents are subject to tax on their worldwide income. Taxpayers can avoid taxes by renouncing their U.S. citizenship or terminating their residence. The Act tightens the expatriation rules to ensure that certain high net-worth taxpayers can't renounce their U.S. citizenship or terminate their U.S. residency in order to avoid U.S. taxes. Under this provision, high net-worth individuals are treated as if they sold all of their property for its fair market value on the day before they expatriate or terminate their residency. Gain is recognized to the extent that the aggregate gain recognized exceeds $600,000 (which will be adjusted for cost of living in the future). The provision, which applies for those who relinquish U.S. citizenship or terminate their U.S. residency on or after the enactment date, is estimated to raise $411 million over 10 years.
• Treats foreign subsidiaries of U.S. companies performing services under a U.S. government contract as American employers for employment tax purposes. Under the new law, the domestic parent is jointly liable for employment taxes imposed on the foreign subsidiary. The new provision applies to services performed in calendar months beginning more than 30 days after the enactment date and is estimated to raise $846 million over ten years.
• Increases the minimum penalty for a failure to file an individual tax return within 60 days of the due date to the lesser of $135 (up from $100) or 100 percent of the amount of tax required to be shown on the return, effective for tax returns required to be filed after 2008. The provision is estimated to raise $296 million over ten years.

Please keep in mind that this is only a summary of the tax changes in the new law. If you would like to discuss any of these provisions in greater detail, please do not hesitate to contact us.

Intellectual property payment deferral tax problem resolution

The IRS OKs deferral of income from intellectual property payments

Mike Habib, EA

myIRSTaxRelief.com

The IRS has privately ruled that a taxpayer could defer reporting income from intellectual property payments until the tax year following the tax year of receipt of the payments under a revenue procedure governing advance payments.

Background. Under the accrual basis method of accounting, income is reported when: (1) all events have occurred which establish the right of the taxpayer to receive the income; and (2) the amount can be determined with reasonable accuracy. (Reg. § 1.451-1(a)) All the events that fix the right to receive income occur when the first of the following events happens:

• the required performance takes place;
• payment is due; or
• payment is made. (Rev Rul 84-31, 1984-1 CB 127)

Certain taxpayers may use the deferral method described in Rev Proc 2004-34, 2004-22 IRB 991, Sec. 5.02(1)(a). A taxpayer using the deferral method must include an advance payment in gross income in the tax year of receipt to the extent recognized in revenues in its applicable financial statement in that year, and include the remaining amount of the advance payment in gross income in the next succeeding tax year.

A payment received by a taxpayer for the use (including by license or lease) of intellectual property, such as patents and similar intangible property rights, is an advance payment if including the payment in gross income for the tax year of receipt is a permissible method of accounting for federal income tax purposes (without regard to Rev Proc 2004-34) and the payment is recognized by the taxpayer (in whole or in part) in revenues in its applicable financial statement for a subsequent tax year. (Rev Proc 2004-34, Sec. 4.01(3))

A taxpayer may adopt any permissible method of accounting for advance payments for the first tax year in which the taxpayer receives advance payments. (Rev Proc 2004-34, Sec. 8.01)

Facts. Taxpayer is engaged in Business. Before Date 1, Taxpayer owned or controlled certain intellectual property (the IP), including patents and know-how, related to Product. Taxpayer and Company entered into an agreement as of Date 1 (the Agreement), under which Taxpayer granted Company an exclusive license to develop, use, offer for sale, sell, sublicense and otherwise commercialize any products for human use containing Product that are made by a process covered by the IP (licensed products). The license granted to Company was co-exclusive with Taxpayer so that Taxpayer could exercise its rights and perform its obligations under the Agreement. Under the Agreement, Taxpayer and Company will collaborate in developing, marketing, and obtaining regulatory approval for, licensed products. They agreed how they would share the costs of development of the initial licensed product for Indication X and Indication Y.

In consideration for entering into the Agreement Company is obligated to: (1) pay Taxpayer a nonrefundable initial license fee (the Fee) in Year I; (2) make payments to Taxpayer if and when certain milestones in the development of the IP are met (the Milestone Payments); and (3) if licensed products are commercialized, make payments of royalties to Taxpayer based on the level of sales of the product (the royalty payments).

The Milestone Payments are solely for the use of the IP and compensate Taxpayer for the increased value of the IP as it progresses through each stage of development, testing, and regulation. No part of the Milestone Payments is compensation for services.

Taxpayer has a certified audited financial statement, accompanied by the report of an independent CPA, which is used for credit purposes, reporting to shareholders, and other substantial non-tax purposes, and is an applicable financial statement as defined in Rev Proc 2004-34, Sec. 4.06(2). Taxpayer anticipates that it will recognize the Fee in revenues in the applicable financial statement over Period 1, rather than in the year of receipt. Taxpayer received no advance payments, as defined in Rev Proc 2004-34, Sec. 4.01, before Year 1. Taxpayer anticipates that current financial reporting rules will require it to recognize the Milestone Payments in income in the tax year of receipt, but will include the Milestone Payments in income in its applicable financial statement in a subsequent tax year to the extent financial reporting rules permit.

Deferral OK'd. Based on the language of the Agreement and Taxpayer's representations, IRS concluded that the Fee and the Milestone Payments are payments for the use of intellectual property and are advance payments within the meaning of Rev Proc 2004-34, Sec. 4.01, to the extent the Taxpayer recognizes the payments in its applicable financial statement for a tax year following the tax year of receipt. Therefore, IRS concluded that, under Rev Proc 2004-34, Sec. 5.02, it is a proper method of accounting for Taxpayer to defer to the next succeeding tax year following the year of receipt the inclusion in gross income of the Fee and each Milestone Payment to the extent that they are recognized by Taxpayer (in whole or in part) in revenues in its applicable financial statement for a tax year subsequent to the tax year of receipt. Because Year 1 is the first tax year in which Taxpayer receives an advance payment, Taxpayer may adopt the deferral method of Rev Proc 2004-34, Sec. 5.02 in Year 1, under Rev Proc 2004-34, Sec. 8.01.

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Fiduciary Estate Trust Tax Resolution - Irrevocable Grantor Trust

Grantor's power to substitute trust property didn't trigger inclusion in estate - Rev Rul 2008-22, 2008-16 IRB 796

Mike Habib, EA
myIRSTaxRelief.com

A new revenue ruling concludes that the corpus of an irrevocable trust that a grantor created during life is not includible in his gross estate under Code Sec. 2036 or Code Sec. 2038 on account of the grantor having retained the power, exercisable in a nonfiduciary capacity, to acquire property held by the trust by substituting other property of equivalent value.

Observation: This ruling is good news for anyone who wants to set up a defective grantor trust - a trust intentionally structured so that the grantor, rather than the trust or its beneficiaries, will be taxed on the trust's income without the trust being included in the grantor's estate. Under Code Sec. 675(4), a grantor's power to substitute property causes trust income to be taxed to the grantor and is commonly used to create a defective grantor trust. The new ruling gives this technique a big boost by making it clear that such a power of substitution won't cause inclusion in the grantors' estate.

Background. Under Code Sec. 2036, a decedent's gross estate includes transfers under which he retained the possession or enjoyment of, or the right to the income from, the transferred property. The decedent need not have a legally enforceable right, but there must be an agreement, either expressed or implied, that the decedent will retain the benefit. Under Code Sec. 2038 , a decedent's gross estate includes a lifetime transfer if the enjoyment of the transferred property was subject at his death to any change through the exercise by him of a power to alter, amend, revoke or terminate. This includes any power affecting the time or manner of enjoyment of property or its income. Inclusion is not required under Code Sec. 2036 or Code Sec. 2038 if the transfer was a bona fide sale for full and adequate consideration.

Facts. In Year 1, Danny, a U.S. citizen, established and funded an irrevocable inter vivos trust (Trust) for the benefit of his descendants. Danny is barred from serving as Trustee. Danny has the power, exercisable at any time, to acquire any property held in Trust by substituting other property of equivalent value. The power is exercisable by Danny in a nonfiduciary capacity, without the approval or consent of any person acting in a fiduciary capacity. To exercise the power of substitution, he must certify in writing that the substituted property and the trust property for which it is substituted are of equivalent value.

Under local law, Trustee has a fiduciary obligation to ensure that the properties being exchanged are of equivalent value. If a trust has two or more beneficiaries, under local law, the trustee must act impartially in investing and managing the trust assets, taking into account any differing interests of the beneficiaries. Further, under local law and without restriction in the trust instrument, Trustee has the discretionary power to acquire, invest, reinvest, exchange, sell, convey, control, divide, partition, and manage the trust property in accordance with the standards provided by law.

Danny dies in Year 2.
Inclusion not required. IRS noted that, under the posited facts, the trust instrument expressly prohibits Danny from serving as trustee and states that his power to substitute assets of equivalent value is held in a nonfiduciary capacity. IRS thus noted that Danny is not subject to the rigorous standards attendant to a power held in a fiduciary capacity. However, the ruling went on to observe that the assets Danny transfers into the trust must be equivalent in value to the ones he receives in exchange. In addition, Trustee has a fiduciary obligation to ensure that the assets exchanged are of equivalent value. As a result, Danny cannot exercise the power to substitute assets in a manner that will reduce the value of the trust corpus or increase his net worth. Further, in view of Trustee's ability to reinvest the assets and his duty of impartiality regarding the trust beneficiaries, Trustee must prevent any shifting of benefits between or among the beneficiaries that could otherwise result from a substitution of property by Danny. Under these circumstances, the ruling concluded that Danny's retained power will not cause the value of the trust corpus to be included in his gross estate under Code Sec. 2036 or Code Sec. 2038.

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Protective refund claim - possible tax recovery

No refund suit is allowed in the absence of a timely claim filed with IRS

U.S. v. Clintwood Elkorn Mining Co., (S Ct 4/15/2008) 101 AFTR 2d ¶ 2008–696

Mike Habib, EA
myIRSTaxRelief.com

The Supreme Court, reversing the Court of Appeals for the Federal Circuit, has held that the plain language of Code Sec. 7422(a) and Code Sec. 6511 requires a taxpayer seeking a refund of a tax assessed in violation of the Export Clause of the U.S. Constitution, just as for any other unlawfully assessed tax, to file a timely administrative refund claim with IRS before bringing suit against the Government.

Background. A manufacturers excise tax is imposed on coal mined from underground or surface mines located in the U.S. and sold or used by the producer. (Code Sec. 4121) In '98, a district court (Ranger Fuel Corp v. U.S., (DC VA 1998) 83 AFTR 2d 99-375) held that the coal excise tax is unconstitutional to the extent it applies to exported coal based on the blanket prohibition imposed by the Export Clause of the U.S. Constitution and IRS acquiesced, in effect, in that decision by issuing guidance (Notice 2000-28, 2000-1 CB 1116) on how to claim a refund for coal excise tax imposed on exported coal.

A taxpayer must file a refund claim with IRS before starting a suit for refund (or credit). (Code Sec. 7422(a))
A taxpayer must file a claim for credit or refund of an overpayment within three years from the time the relevant return is filed, or two years from the time the tax is paid, whichever period expires later. (Code Sec. 6511(a)) No credit or refund is allowed if a claim is not filed within these time limits. (Code Sec. 6511(b))

Facts. The taxpayers, three coal companies, had all paid taxes on coal exports under Code Sec. 4121 since as early as '78. After Code Sec. 4121 was held unconstitutional as applied to coal exports, the companies timely filed administrative claims for refund of coal taxes they had paid in '97 through '99. IRS refunded those taxes, with interest.

The companies also filed suit in the Court of Federal Claims seeking a refund of $1,065,936 in taxes paid between '94 and '96. They did not file any claim for those taxes with IRS. The Supreme Court noted that any such claim would of course have been denied, given the limits set forth in Code Sec. 6511. Notwithstanding the failure of the companies to file timely administrative refund claims, the Court of Federal Claims allowed the companies to pursue their suit directly under the Export Clause. Jurisdiction rested on the Tucker Act, 28 USCS 1491(a)(1), and the companies limited their claim to taxes paid within that statute's 6-year limitations period. The Court of Federal Claims did not, however, allow the companies to recover interest on the taxes. (Andalex Resources, Inc. v. U.S., (2002 Ct Fed C) 90 AFTR 2d 2002-7393) The Court of Appeals for the Federal Circuit allowed the refund and also allowed interest. (Clintwood Elkhorn Mining Co v. U.S., (2007, CA Fed Cir) 99 AFTR 2d 2007-613)

Supreme Court reverses. The Supreme Court observed that the Code provides that taxpayers seeking a refund of taxes unlawfully assessed must comply with its tax refund procedures. Under those procedures, a taxpayer must file an administrative claim with IRS before filing suit against the Government. Such a claim must be filed within three years of the filing of a return or two years of payment of the tax, whichever is later.

The Supreme Court noted that the Tucker Act is more forgiving—it allows claims to be brought against the U.S. within six years of the challenged conduct.

The question before the Court was whether a taxpayer suing for a refund of taxes collected in violation of the Export Clause of the Constitution could proceed under the Tucker Act, when the suit does not meet the time limits for refund actions in the Code. In a unanimous opinion, the Court said the answer is no.

The Court based its decision on the plain language of the pertinent Code provisions. The Court stressed that Code Sec. 7422(a) provides that no suit shall be maintained in any court for the recovery of any internal revenue tax alleged to have been erroneously or illegally assessed or collected until a claim for refund or credit has been duly filed with IRS. The Court said that the companies did not file a refund claim with IRS for the '94 through '96 taxes. Thus, they may bring no suit in any court to recover the taxes.

The Supreme Court further noted that the time limits for administrative refund claims apply to any tax imposed by the Code (Code Sec. 6511(a)) and that the Code provides that no refund shall be allowed after the expiration of those time limits. (Code Sec. 6511(b)) This language clearly covered the companies' claim for refund of taxes imposed by Code Sec. 4121.

The companies nonetheless argued that their claims were exempt from the Code provisions' broad sweep because the claims derived from the Export Clause of the Constitution. The Supreme Court said that there is no basis for treating taxes collected in violation of that Clause differently from taxes challenged on other grounds. Because the companies acknowledged that their claims were subject to the Tucker Act's time bar, the question was not whether their refund claim could be limited, but rather which limitation applied. Their argument that, despite explicit and expansive statutory language, the Code's refund scheme did not apply to their case as a matter of statutory interpretation was without merit. Accordingly, the Supreme Court reversed the Federal Circuit and denied the claim.

Observation: If a taxpayer believes that a tax is unlawful, it should file a refund claim. If IRS denies the claim, the taxpayer can then challenge the tax in court. A taxpayer who does not intend to challenge a tax that it feels is unlawful should nonetheless file a protective refund claim if it is aware that another taxpayer is challenging the tax. The protective claim may serve to allow the taxpayer to recover the tax if the other taxpayer subsequently prevails in its suit against IRS.

Truck Drivers - Trucking Company Tax Problem Resolution

IRS acquiesces to TLC Leasing - explains meals deduction limit in employee leasing setting Rev Rul 2008-23, 2008-18 IRB

TRUCKER TAX RELIEF & TRUCKER TAX PROBLEM RESOLUTION

Mike Habib, EA

myIRSTaxRelief.com

IRS has acquiesced to the Eighth Circuit's holding in Transport Labor/Contract Leasing (TLC Leasing) that a company leasing truck drivers to client companies wasn't subject to the Code Sec. 274(n) deduction limit on meal reimbursements it made to drivers because it substantiated these expenses to the clients. Instead, the Eight Circuit said the client companies were subject to the limitation because they ultimately bore the expenses. The ruling clarifies IRS's stance on reimbursed meal expenses involving leasing companies by way of three examples.

Observation: The new ruling isn't limited to leased truckers. Its conclusions may be applied to any situation where leased employees are reimbursed for expenses subject to the Code Sec. 274(n) deduction limit.

Background. Business-related meals such as those incurred while away from home overnight on business generally are subject to the Code Sec. 274(n) 50% deduction limit for meal and entertainment expenses. Under Code Sec. 274(n)(3), for tax years beginning in 2008 or thereafter, an 80% deduction limit applies to certain transportation workers, such as interstate truck operators and interstate bus drivers under Department of Transportation regulations. Under Code Sec. 274(e)(3)(B) and Code Sec. 274(n)(2)(A), the Code Sec. 274(n) deduction limit doesn't apply to a taxpayer who incurs an expense on behalf of a person other than an employer under a reimbursement or other expense allowance arrangement with the other person, if the taxpayer accounts for the expense to the other person, and the payment is not treated as compensation. This requires the taxpayer to substantiate each element of the expense to the person for whom he incurs the expense (time, place, business purpose and amount). Here, the Code Sec. 274(n) limit applies to the person for whom the expense was incurred.

Reg. § 1.274-2(f)(2)(iv)(a) provides that for Code Sec. 274 purposes, a reimbursement or other expense allowance arrangement is defined as it is under Code Sec. 62(a)(2)(A), i.e., an arrangement that shows the business connection of the expense, substantiates it, and provides for a return of excess reimbursements.

M&IE (meals and incidental expenses) incurred while traveling away from home on business are treated as an expense for food and beverages and are subject to the Code Sec. 274(n) limit. An employee who is reimbursed for M&IE may follow simplified substantiation procedures (time, place and business purpose).

In 2004, the Tax Court held in TLC Leasing that a company that leased truck drivers to independent trucking companies was the common-law employer of each driver-employee and, as a result, per diems paid by the leasing company to cover amounts spent by the drivers for food and beverages while traveling away from home were subject to the Code Sec. 274(n) deduction limit on meals. In the decision, client trucking companies submitted reports to TLC for each payroll period showing the gross wages and per diem amounts for each driver-employee. TLC made the appropriate payments to each driver-employee and sent the client company an invoice showing total expenses for all the driver-employees leased to the client.

The Tax Court's holding reached the result IRS had urged (but did so for different reasons).
In 2006, the Eighth Circuit reversed the Tax Court and held on the facts that the Code Sec. 274(n) limit did not apply to TLC because it was not the party that ultimately bore the per diem expenses. [See Federal Taxes Weekly Alert 08/31/2006] Instead, the limit applied to the client companies, who actually bore the per diem expense under the reimbursement arrangement between the parties. The appellate court concluded that status as a common law employer is not dispositive in the Code Sec. 274(n) analysis, but did not explicitly reject that status as a relevant factor.

IRS acquiescence. In Rev Rul 2008-23, IRS acquiesces in the result in TLC and agrees with the Eighth Circuit's opinion that the Code Sec. 274(n) deduction limit should apply to the party that ultimately bears the per diem expenses. However, IRS says it does not agree with the opinion to the extent that it could be read to imply that status as a common law employer is relevant to the Code Sec. 274(n) analysis.

Observation: The new ruling is much more than an unconventional vehicle for an acquiescence. It also formulates IRS's approach to situations where a reimbursed expense is substantiated and submitted to one party who in turn passes on the cost to someone else. The ruling also clarifies when IRS will and will not treat an M&IE (or a meals expense only) as substantiated to a third party. In TLC, there was no formal substantiation of the truckers' meal expenses in the generally accepted sense.

Substantiating to third party. The ruling establishes IRS's position where (1) an employee (or independent contractor) adequately substantiates a M&IE expense to an initial payor (i.e., a company like TLC) that initially makes the reimbursement, and (2) the initial payor in connection with its performance of services for a third party, is reimbursed under a reimbursement or other expense allowance arrangement with a third party. In this instance, IRS rules that if the initial payor accounts to the third party in the same manner that the employee (or independent contractor) accounted for the expenses to the initial payor, then the initial payor satisfies Code Sec. 274(e)(3)(B) and the third party bears the expenses and is subject to the Code Sec. 274(n) deduction limit on the expenses.

IRS illustrates this principle, and what it will treat as adequate substantiation to the third party, with three examples, all dealing with these common facts:

• Leasing Company (LC) leases its employee truck drivers to Client under a contract that provides that LC will calculate Client's periodic payments to cover LC's expenses (driver wages, payments of M&IE to drivers under a reimbursement arrangement between LC and the drivers, and other expenses) plus a profit. The M&IE are incurred while drivers travel overnight away from home on business. All reimbursements paid to Driver are paid under a “reimbursement or other expense allowance arrangement,” within the meaning of Code Sec. 274(e)(3) between LC and each driver. Neither LC nor Client deducts the M&IE amounts as compensation on its originally filed income tax return, and neither of them treat the M&IE amounts as wages for withholding purposes.
• The employee leasing contract does not address which party reimburses the drivers' M&IE for purposes of applying the Code Sec. 274(n) deduction limit.
• Driver adequately accounts for his M&IE expenses to LC.
• Either LC or Client may be Driver's employer under the usual common law rules.

Illustration1: After Driver accounts to LC for M&IE, LC calculates his wages and any M&IE payments that may be due, and sends Client a billing invoice for a periodic payment due. The invoice does not itemize the M&IE reimbursement, but immediately after LC pays Driver, it sends Client a statement indicating the amount paid to Driver as a M&IE reimbursement. LC also accounts for the M&IE amount by delivering to Client a copy of the substantiation that Driver had originally submitted to LC. Client accepts the substantiation and acknowledges that the portion of its periodic payment equal to the amount that LC paid to reimburse Driver's M&IE is paid under a reimbursement arrangement with LC and is subject to the Code Sec. 274(n) deduction limit.

Illustration2: The facts are the same as in the first illustration except that Driver accounts for his M&IE to Client who in turn sends the paperwork to LC, which (a) calculates Driver's wages and any M&IE reimbursements that may be due, and (b) sends Client a lump-sum, non-itemized billing invoice for a periodic payment due. After Client makes the invoice payment, LC pays both Driver's wages and M&IE reimbursement, and sends Client a statement indicating the amount paid to Driver as an M&IE reimbursement, and referring to the substantiation Client had received from Driver and had submitted (via a copy) to LC.

Results. In both illustrations (1) and (2), IRS concludes that LC meets the requirements of Code Sec. 274(e)(3) because (1) LC can prove that it has established a reimbursement or other expense allowance arrangement with Client, and (2) LC accounts to Client by (in the first illustration) delivering a copy of the substantiation that Driver had provided to LC or (in the second illustration) referring to the substantiation Driver originally submitted to Client. LC is not subject to Code Sec. 274(n) deduction limit and, instead, Client bears the expense of the M&IE, and is subject to the Code Sec. 274(n) for the M&IE, regardless of whether LC or Client is Driver's employer under the usual common law rules.

If the initial payor does not properly substantiate the M&IE expenses to the third party payor, then the initial payor will be treated as bearing the expenses and will be subject to the Code Sec. 274(n) deduction limit.

Illustration3: After calculating Driver's wages and any M&IE payments that may be due, LC sends Client a lump-sum, non-itemized billing invoice for a periodic payment due. Client pays LC the lump-sum periodic payment, and then LC pays both Driver's wages and M&IE reimbursement.

Result. Because LC provides Client with only a lump-sum, non-itemized billing invoice, and does not account to Client or have a reimbursement or other expense allowance arrangement with Client, LC bears the expense of the M&IE and it is subject to the Code Sec. 274(n) deduction limit on Driver's M&IE, regardless of whether LC or Client is Driver's employer under the usual common law rules. Even if LC had provided an itemized invoice to Client designating part of the payment as an M&IE reimbursement. LC still does not satisfy Code Sec. 274(e)(3)(B) because it didn't adequately account to Client and didn't have a reimbursement or other expense allowance arrangement with Client.

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Non US Person Tax Problem Resolution

IRS Begins Focus on Foreign Athletes and Entertainers

The IRS recently launched an Issue Management Team focused on improving U.S. income reporting and tax payment compliance by foreign athletes and entertainers who work in the United States. The initial focus is on those engaged in tennis, golf and music. These individuals and those associated with arranging their appearances in the U.S. and managing their financial affairs are typically high income individuals. Because of this, it is important to ensure proper tax reporting and payment. IRS is using a three pronged approach for this initiative: improving the availability of information and guidance needed to help this group comply with income reporting and tax payment requirements providing IRS enforcement personnel with information they need to identify and work compliance issues frequently encountered with this population and conducting direct compliance and enforcement activity. Artists and Athletes (Income Code 20) Because many tax treaties contain a provision for pay to artists and athletes, a separate category is assigned these payments for withholding purposes. This category may include payments made for performances by public entertainers (such as theater, motion picture, radio, or television artists, or musicians), athletes, or other persons as defined by the applicable treaty article. Note: As a general rule the tax treaty article dealing with artists and athletes must be applied before the articles on independent personal services and dependent personal services are applied to the income of the artists and the athletes. As a general rule Form W-8ECI may not be used to exempt withholding on a payment for personal services provided by a foreign individual. In addition, special rules apply to artists and athletes who have formed partnerships or corporations as the beneficial owners of the income accruing to them. Refer to Withholding Exemption on Effectively Connected Income for more information. Withholding Rate You must withhold tax at a 30% rate on payments to artists and athletes for services performed as independent contractors. Refer to pay for independent Personal Services for more information. You must withhold tax at graduated rates on payments to artists and athletes for services performed as employees. Refer to pay for dependent Personal Services for more information. However, in any situation where the nature of the relationship between the payor of the income and the artist or athlete is not ascertainable, you should withhold at a rate of 30%. Payments to a U.S. Agent of a Foreign Person Caution should be taken when payments are made to a U.S. agent of a foreign person. Withholding agents who have knowledge that the payee is an agent of a foreign person must treat the payment as made to a foreign person. An exception is made for a payee who is a "financial institution". Treasury Regulation 1.1441-1(b)(2)(ii) effective for payments made after December 31, 2000 Follows: §1.1441-1. Requirement for the deduction and withholding of tax on payments to foreign persons. (b)(2)(ii) Payments to a U.S. agent of a foreign person. A withholding agent making a payment to a U.S. person (other than to a U.S. branch that is treated as a U.S. person pursuant to paragraph (b)(2)(iv) of this section) and who has actual knowledge that the U.S. person receives the payment as an agent of a foreign person must treat the payment as made to the foreign person. However, the withholding agent may treat the payment as made to the U.S. person if the U.S. person is a financial institution and the withholding agent has no reason to believe that the financial institution will not comply with its obligation to withhold . . . Central Withholding Agreements Nonresident alien entertainers or athletes performing or participating in athletic events in the United States may be able to enter into a withholding agreement with the IRS for reduced withholding provided certain requirements are met. Under no circumstances will a withholding agreement reduce taxes withheld to less than the alien's anticipated income tax liability. Nonresident alien entertainers or athletes requesting a central withholding agreement must provide the following information. A list of the names and addresses of the nonresident aliens to be covered by the agreement. Copies of all contracts that the aliens or their agents and representatives have entered into regarding the time period and performances or events to be covered by the agreement including, but not limited to, contracts with: Employers, agents, and promoters, Exhibition halls, Persons providing lodging, transportation, and advertising, and Accompanying personnel, such as band members or trainers. An itinerary of dates and locations of all events or performances scheduled during the period to be covered by the agreement. A proposed budget containing itemized estimates of all gross income and expenses for the period covered by the agreement, including any documents to support these estimates. The name, address, and telephone number of the person the IRS should contact if additional information or documentation is needed. The name, address, and employer identification number of the agent or agents who will be the central withholding agents for the aliens and who will enter into a contract with the IRS. A central withholding agent ordinarily receives contract payments, keeps books of account for the aliens covered by the agreement, and pays expenses (including tax liabilities) for the aliens during the period covered by the agreement. When the IRS approves the request, the Associate Chief Counsel (International) will prepare a withholding agreement. The agreement must be signed by each withholding agent, each nonresident alien covered by the agreement, and the Commissioner or his delegate. Generally, each withholding agent must agree to withhold income tax from payments made to the nonresident alien; to pay over the withheld tax to the U.S. Treasury on the dates and in the amounts specified in the agreement; and to have the IRS apply the payments of withheld tax to the withholding agent's Form 1042 account. Each withholding agent will have to file Form 1042 and Form 1042-S for each tax year in which income is paid to a nonresident alien covered by the withholding agreement. The IRS will credit the withheld tax payments, posted to the withholding agent's Form 1042 account, in accordance with the Form 1042-S. Each nonresident alien covered by the withholding agreement must agree to file Form 1040NR or, if he or she qualifies, Form 1040NR-EZ. A request for a central withholding agreement should be sent to the address shown in the discussion found at Central Withholding Agreements at least 90 days before the agreement is to take effect. Refer to Revenue Procedure 89-47, C.B. 1989-2, 598 for more information. Tax Treaties Under many tax treaties, compensation paid to artists, entertainers, or athletes for services performed in the United States is exempt from U.S. income tax only when the services are performed during a limited period of temporary presence in the United States and the pay is within limits provided in the tax treaty that applies (Refer to Table 2 of Publication 515, Withholding of Tax on Nonresident Aliens and Foreign Entities (PDF)). Employees and independent contractors may claim an exemption from withholding under a tax treaty by filing Form 8233 (PDF). Often, however, you will have to withhold at the statutory rates on the total payments to the artist, entertainer or athlete. This is because the exemption may be based upon factors that cannot be determined until after the end of the year. References/Related Topics Withholding on Specific Income Note: This page contains one or more references to the Internal Revenue Code (IRC), Treasury Regulations, court cases, or other official tax guidance. References to these legal authorities are included for the convenience of those who would like to read the technical reference material. To access the applicable IRC sections, Treasury Regulations, or other official tax guidance, visit the Tax Code, Regulations, and Official Guidance page. To access any Tax Court case opinions issued after September 24, 1995, visit the Opinions Search page of the United States Tax Court.

NOL Net Operating Loss Carryback Ruling

Failure to follow IRS procedure prevented use of longer NOL carryback

Tualatin Valley Builders Supply, Inc. v. U.S. 101 AFTR 2d ¶ 2008–688

Mike Habib, EA

myIRSTaxRelief.com

The Ninth Circuit, affirming a district court, has held that a taxpayer could not use the special 5-year carryback period that applied for net operating losses arising in tax year 2001 because the taxpayer did not follow IRS procedures for choosing that carryback period.

Dispute over 5-year carryback period. Tualatin Valley Builders Supply, Inc. (Tualatin), now dissolved, was seeking a refund of $366,043 of corporate income taxes assessed and collected from it for '96, plus interest. It filed a claim for refund of the '96 taxes with IRS in 2004. After IRS denied the claim and Tualatin lost administrative appeals, Tualatin went to district court.

Before the district court, Tualatin said it was entitled to claim an NOL carryback from its tax year ending Mar. 31, 2001, to its tax year ending Dec. 31, '96. IRS argued that Tualatin lost the opportunity to use the 5-year carryback period because it didn't timely elect to claim it.

Underlying facts. Tualatin timely filed its 2001 Form 1120 on Oct. 15, 2001 after getting an extension. At that time, it elected to utilize the 2-year carryback period for its NOL under Code Sec. 172(b)(1)(A). This election entitled Tualatin to choose between either amending its return for the year to which the NOL was being carried back in accordance with Code Sec. 6511, or filing for a tentative carryback adjustment for its NOL under Code Sec. 6411(a) . It chose to file for a tentative carryback adjustment. IRS granted the tentative carryback application and Tualatin received what is colloquially referred to as a “quickie refund” for the carryback of the 2001 NOL to '99.

Subsequent law change. Subsequently, in March 2002 [see Federal Taxes Weekly Alert 3/14/2002], Congress, in the Job Creation and Worker Assistance Act of 2002 (JCWAA), changed the law to provide an elective 5-year carryback period for NOLs arising in tax years ending in 2001 or 2002. (Code Sec. 172(b)(1)(H)) In mid-2002, IRS issued Rev Proc 2002-40, 2002-1 CB 1096, which addressed how a taxpayer who had already filed tax returns for 2001 or 2002 and had already elected a strategy for NOL carrybacks, could take advantage of the new March 2002 law (see Federal Taxes Weekly Alert 5/30/2002).

Specifically, Rev Proc 2002-40, Sec. 5.01 stated that a taxpayer (such as Tualatin) who had previously filed an application for a tentative carryback adjustment (whether or not IRS had acted upon it) or an amended return using a 2-year carryback period for an NOL incurred in a tax year ending in 2001 or 2002, and that did not elect to forgo the 5-year carryback period under Code Sec. 172(j), could use the 5-year carryback provided under Code Sec. 172(b)(1)(H) by following the procedures of Rev Proc 2002-40, Sec. 7 on or before Oct. 31, 2002.

Rev Proc 2002-40, Sec. 7 provided that corporations seeking to choose the 5-year carryback period had to file either a Form 1139, Corporation Application for Tentative Refund, or Form 1120X, Amended U.S. Corporation Income Tax Return. Rev Proc 2002-40, Sec. 5 explicitly required one of these two forms to be filed by Oct. 31, 2002 in order for a taxpayer to elect the 5-year carryback.

Action taken after deadline expired. IRS released Rev Proc 2002-40 on May 23, 2002 and published it in the Internal Revenue Bulletin on June 10, 2002. Tualatin attempted to amend its filing to take advantage of the new 5-year carryback by filing an amended return (Form 1120X) for the '96 tax year, on Jan. 7, 2003, over two months after the Oct. 31, 2002, deadline for such amendments established by Rev Proc 2002-40, Sec. 5. Because Tualatin acted after this deadline expired, IRS sought to have the case dismissed.

District court sided with IRS. The district court sided with IRS after pointing out that Code Sec. 172(j) provided that the election was to be made in such manner as IRS may prescribe and was to be made by the due date (including extensions of time) for filing the taxpayer's return for the tax year of the NOL. It also provided that the election, once made for any tax year, was irrevocable for that year. The court said that this language clearly gave IRS the explicit authority to determine how and when the election was to be made and that IRS exercised this authority by publishing Rev Proc 2002-40 . The instructions prescribed by IRS established the deadline of Oct. 31, 2002, for electing the five-year carryback. Rev Proc 2002-40 made it clear that unless the taxpayer followed the procedures of Rev Proc 2002-40, Sec. 7, the taxpayer would be considered to have made an election under Code Sec. 172(j) to forgo the 5-year carryback period in favor of the 2-year carryback period.

Ninth Circuit affirms. Before the Ninth Circuit, Tualatin argued that neither Code Sec. 172(j) nor a Congressional Letter to IRS on the intent concerning the carryback provision, directed IRS to issue rules specifically related to a taxpayer that filed an application for tentative adjustment under the 2-year carryback rule and then sought to apply the 5-year net operating loss carryback rule. The Ninth Circuit said that Congress authorized IRS, both generally and specifically, to promulgate rules implementing the new five-year carryback period. IRS did so in Rev Proc 2002-40 , which established an Oct. 31, 2002, deadline for taxpayers in Tualatin's position. The Ninth Circuit said that this deadline was consistent with the text of the statute and the authority Congress conferred on IRS. Moreover, Congress implicitly ratified Rev Proc 2002-40 when it made technical changes to the 5-year carryback provision in the Working Families Tax Relief Act of 2004 while leaving Rev Proc 2002-40 untouched.

The Court also held that because Rev Proc 2002-40 did not prohibit a taxpayer from filing a claim for refund in the absence of compliance, it neither shortened the period for filing a claim for refund or credit under Code Sec. 6511(d)(2)(A) nor conflicted with Code Sec. 6511(d)(2)(B)(i), which mandates that a refund from a carryback be allowed even if otherwise prevented by operation of law. Accordingly, it agreed with the district court that Tualatin's refund claim for '96 was untimely.

Tax Exempt Status Wrongfully Revoked By The IRS

IRS wrongfully revoked DLC's tax-exempt status

Democratic Leadership Council, Inc. v. U.S., 101 AFTR 2d ¶ 2008-661

Mike Habib, EA

myIRSTaxRelief.com

A district court has held that IRS violated its own regs when it retroactively revoked the tax exempt status of the Democratic Leadership Council (DLC) as a Code Sec. 501(c)(4) social welfare organization.

Facts. In '85, several prominent Democrats, including then-Governor Bill Clinton, formed the DLC. Specifically, on Nov. 8, '85, the DLC filed its Form 1024 application with IRS for tax-exempt status as a “social-welfare” organization under Code Sec. 501(c)(4). The application included the DLC's Articles of Incorporation. It further explained that the DLC was organized by certain elected officials and others who were concerned with the formulation of national policy and with the direction of policy debate within the Democratic Party.

The application stated that “the organization was conceived as an active forum for the development of fresh policy options and approaches which could spark and advance public debate.” To further this purpose, the application stated, the DLC intended to: create task forces; hold town meetings and issue forums with business, labor, civic, student, and other audiences; hold policy meetings; contract for studies; initiate public-affairs programs (including press conferences, meetings with editorial boards, and press releases); and host fund-raising receptions.

The application also represented that the DLC would “not intervene in campaigns on behalf of any public candidate,” nor “seek to influence voter perceptions indirectly, such as by establishing voting records or other ratings of candidates.”

On Feb. 7, '86, based on the DLC's application for exempt status, IRS recognized the DLC as a tax-exempt organization under Code Sec. 501(c)(4).

In 2002, IRS revoked the DLC's tax-exempt status for the years '97, '98, and '99, concluding that the DLC rendered an impermissible level of private benefit during those years—namely, support to Democratic officials.

The DLC paid approximately $20,000 in total taxes and interest for those years, but filed a suit for a refund.
IRS didn't revoke the DLC's tax-exempt status for any time period since tax year '99. Accordingly, since that time, the DLC has filed each year as a tax-exempt, Code Sec. 501(c)(4) organization.

Parties's arguments. Under Reg. § 601.201(n)(6), the revocation or modification of a determination letter or ruling recognizing exemption may be retroactive if the organization omitted or misstated a material fact, operated in a manner materially different from that originally represented, or engaged in a prohibited transaction of the type described in the regs. The DLC contended that it was entitled to summary judgment because (1) it qualified as a Code Sec. 501(c)(4) organization during the years at issue and (2), even if it did not so qualify, IRS improperly revoked the DLC's Code Sec. 501(c)(4) status retroactively in violation of Reg. § 601.201(n)(6) because the DLC did not omit or misstate a material fact, or operate in a manner materially different from that originally represented.

IRS countered that it was entitled to summary judgment because (1) the DLC did not qualify as a Code Sec. 501(c)(4) organization during the years in issue; and (2) the retroactive revocation of Code Sec. 501(c)(4) status was permissible because the cited reg does not apply in refund suits and, in any event, IRS complied with the reg.

Wrongful revocation. The district court acknowledged that there could be legitimate questions as to whether the DLC was entitled to Code Sec. 501(c)(4) status. However, it held that because the DLC did not omit or misstate a material fact in its '85 application for that status or operate in a manner materially different from that originally represented when the IRS granted it that status, IRS violated its regs when it retroactively revoked the DLC's tax-exempt status. Accordingly, the court granted summary judgment to the DLC and ordered a refund of the taxes the DLC paid for the years in question.

Tax Development Q1 2008 - Economic Stimulus - Chances of being audited

The most important IRS Tax Development in Q1 2008

Mike Habib, EA

myIRSTaxRelief.com

While the Economic Stimulus Act of 2008 was the most significant development in the first quarter of 2008, many other tax developments may affect you, your family, and your livelihood. The new law changes and other key developments are summarized below. Please contact us for more information about any of these developments and what steps you should implement to take advantage of favorable developments and to minimize the impact of those that are unfavorable.

Economic Stimulus Act. On Feb. 13, President Bush signed the “Economic Stimulus Act of 2008” (Stimulus Act) into law. The centerpiece of the Stimulus Act, which was designed to bolster the sagging economy, was a provision that puts extra cash into the hands of most Americans. Most will receive a rebate check in 2008 from the IRS based on the filing status and income stated on their 2007 return (which is filed in 2008). Some will get a tax credit in 2009 when they file their returns for tax year 2008, and still others (depending largely on income in tax years 2007 and 2008) may receive a combination of a rebate check in 2008 and an income tax credit in 2009. To receive the cash rebate, taxpayers, including many who wouldn't ordinarily have to file a return, must file a return for tax year 2007. Key provisions in the Stimulus Act include:

• Most taxpayers are to receive cash rebate payments, which typically will equal the amount of tax liability on the 2007 return, up to a maximum amount of $600 for individuals ($1,200 for taxpayers who file a joint return) and a minimum of $300 for individuals ($600 for taxpayers who file a joint return). There is also an additional $300 for each qualifying child. The rebates are reduced by 5% of adjusted gross income (AGI) in excess of $75,000 for individuals and $150,000 for those who are married and file jointly. Those individuals who have little or no tax liability may also qualify for a minimum payment of $300 ($600 if filing a joint return) if they file a tax return that reflects $3,000 or more in qualifying income (which includes Social Security benefits, railroad retirement benefits, and certain disability or survivors' benefits from the Veterans Administration).
• Expensing—the option to currently deduct the cost of business machinery and equipment—is made much more attractive. The amount that a taxpayer could otherwise expense, $128,000, has been increased to $250,000 for tax years that begin in 2008. And, the $510,000 overall investment limit (beyond which there's a phaseout of current expensing) has been increased to $800,000.
• In addition to the usual depreciation allowed for business property, taxpayers may take an extra “bonus” depreciation deduction for the first year certain property is placed in service. A bonus first-year depreciation deduction of 50% of adjusted basis is allowed for qualified property (most new personal property and software) acquired and placed in service after Dec. 31, 2007, and before Jan. 1, 2009. (The liberalized rules for writing off business autos are covered below.)
  

Zero tax on long-term capital gain and dividend income. Beginning this year and continuing through 2010, a zero tax rate applies to most long-term capital gain and dividend income that would otherwise be taxed at the regular 15% rate and/or the regular 10% rate (last year, a 5% rate applied to such income). This low rate has an impact not only on lower-bracket individuals but also, surprisingly, on some whose top dollars are taxed well in excess of 15%. The amount of income taxed at 0% depends on the interplay between an individual's filing status, his taxable income, and how much of that taxable income consists of long-term capital gain and qualifying dividend income.

$1 million deduction limit. Generally, a publicly held corporation's deduction for compensation paid during a tax year to its chief executive officer or any of its four highest paid officers is limited to $1 million. The IRS has formally ruled that compensation paid to an executive is not excepted from this limit as qualified performance-based compensation if the plan or contract under which it's paid also provides for payment to the executive on: (1) termination without cause or for the executive's resignation for good reason or (2) voluntary retirement. In a concession to taxpayers, the IRS will only apply this new interpretation of the rules prospectively.

Quicker deduction for payroll tax on bonuses and vacation pay. The IRS has allowed employers who use the accrual method of accounting and incur payroll taxes (Federal Insurance Contributions Act (FICA) tax and Federal Unemployment Tax Act (FUTA) tax) to take a deduction for bonuses and vacation pay in an earlier year than the year in which the amounts are paid in many cases. The IRS now allows these employers to use the recurring item accounting exception. In general, under this exception taxpayers may be able to currently deduct certain recurring liabilities that they pay on or before the earlier of when they must file their returns (including extensions), or the 15th day of the ninth calendar month after the close of the tax year.

Lifetime payouts to nonspouse IRA beneficiary. In a private letter ruling, the IRS has allowed a nonspouse beneficiary of an individual retirement account (IRA) to salvage lifetime payouts even though she failed an essential rule requiring distributions to begin by the end of the year following that of the IRA owner's death. Generally, where an IRA owner dies before he must start taking annual required minimum distributions, the IRA must be distributed to a nonspouse beneficiary either within five years of his death, or over the life or life expectancy of the designated beneficiary. To qualify for the latter alternative, the distributions must begin no later than one year after the deceased owner's death. However, the IRS allowed the beneficiary, who made up her missed annual required minimum distributions and paid a penalty excise tax, to avoid the tough five-year payout rule. This was an extremely favorable result for the taxpayer, allowing her to avoid quickly depleting the IRA (and by so doing, having to likely pay more taxes, sooner). The ruling illustrates the hazards of not receiving expert tax advice when dealing with post-death IRA distributions.

Trust's investment advice fees. The Supreme Court has held that investment advisory fees paid by a trust were deductible only to the extent that they exceeded 2% of the trust's adjusted gross income (AGI). Thus, such expenses didn't qualify for the exception to the 2% of AGI limit in the tax law for costs paid or incurred in connection with the administration of a trust or estate that wouldn't have been incurred if the property weren't held in the trust or estate. However, for the sake of administrative convenience, the IRS has provided that, for tax years beginning before Jan. 1, 2008, nongrantor trusts and estates will not have to “unbundle” a fiduciary fee (i.e., separate the fee into components that are subject to the deduction limit and those that aren't). As a result, for 2007 tax years, affected taxpayers can deduct the full amount of a bundled fiduciary fee without regard to the 2% floor.

Luxury auto depreciation limits for 2008. Under special “luxury automobile” rules, a taxpayer's otherwise available depreciation deduction for business autos, light trucks, and minivans is subject to additional limits, which operate to extend depreciation beyond its regular period. The IRS has released the inflation-adjusted depreciation limits for business autos, light trucks and vans (including minivans) placed in service in 2008—e.g., $2,960 for autos first place in service in 2008; $3,160 for light trucks or vans first place in service in 2008. The “luxury passenger auto limits” cap the otherwise allowable depreciation that can be claimed in a year. Generally, the maximum annual depreciation deduction limits for these vehicles are close to what they were for vehicles that were placed in service last year: the dollar limits for the first and second years for business autos, light trucks and vans are $100 lower than last year's figures. However, for vehicles that qualify, the Economic Stimulus Act of 2008 increases the otherwise applicable first-year limit by $8,000—e.g., $10,960 for autos first place in service in 2008; $11,160 for light trucks or vans first place in service in 2008.

Chances of being audited. The IRS has issued its annual data book, which provides statistical data on its fiscal year 2007 activities, including how many tax returns it examines (audits), and what categories of returns it focuses its resources on. Out of a total of 135 million individual returns filed in calendar year 2006, about 1,384,563 individual income tax returns (1.0%) were audited during fiscal year 2007, slightly more than those examined in the prior year. Of the 1.5 million individual farm returns that showed gross receipts from farming (Schedule F), only 5,705 (0.4%) were audited in 2007. For returns with total positive income of at least $200,000 and under $1 million, the audit rate was 2% for nonbusiness returns and 2.9% for business returns; for returns of $1 million or more, the audit rate was 9.3%. The audit rate for corporations with less than $10 million of assets was 0.9% (up from 0.8% in the prior year); and for corporations with $10 million or more of assets, it was 16.8% (down from 18.6%). The audit rate for S corporations was 0.5% (up from 0.38% for the prior year); and for partnerships it was 0.4% (up from 0.36%).

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Intellectual property contribution tax problem resolution

Final regs detail donee's filing requirements for qualified intellectual property contributions


T.D. 9392, 04/04/2008; Reg. § 1.6050L-2

Mike Habib, EA

MyIRSTaxRelief.com

IRS has issued final regs explaining the information return requirements for donees receiving net income from qualified intellectual property contributions made after June 3, 2004.

Background. A taxpayer's deduction for the donation of “qualified intellectual property” - patents, certain copyrights, trademarks, trade names, trade secrets, know-how, certain software, and similar property, other than property contributed to for the use of a private foundation—is limited to the donor's basis, if that is less than the property's fair market value at the time of the initial contribution. (Code Sec. 170(e)(1)(B)) Subject to limitations, the donor can take an additional deduction in the year of contribution and in succeeding years based on a sliding-scale percentage (from 100% to 10% depending on the year after the initial contribution) of the “qualified donee income” that the charitable donee receives or accrues from that contributed property. (Code Sec. 170(m)(1)) An additional deduction in any year is allowed only to the extent that the aggregate of the specified percentages of qualified donee income exceeds the initial deduction claimed by the donor for the intellectual property itself. (Code Sec. 170(m)(2))

A donee of qualified intellectual property who is notified by the donor that he intends to take the additional charitable deduction for “qualified donee income” must: (1) file an information return (Form 8899, Notice of Income from Donated Intellectual Property) for each of the donee's tax years showing the amount of any qualified donee income and (2) furnish the donee with a copy of the return. (Code Sec. 6050L)

In May of 2005, IRS issued temporary and proposed regs explaining how donees file this information return. These regs were generally effective for qualified intellectual property contributions made after June 3, 2004, but included several transition rules.

Final regs on donee's filing obligation. The final regs adopts the provision in the temporary and proposed regs with only minor changes. The final regs do not include the transition rules in the temporary and proposed regs, which are no longer necessary.

Under the final regs, if a charitable organization, other than a private foundation that doesn't qualify as a 50% charity, receives or accrues net income during a tax year from a qualified intellectual property contribution, it must make an annual information return at the time and on the form prescribed by IRS. A donee isn't required to file an information return if:

• the property isn't qualified intellectual property defined in Code Sec. 170(m)(8) (e.g., property for which the donor doesn't provide the required notice to the donee);
• the qualified intellectual property produced no net income for the donee's tax year;
• the qualified intellectual property contribution is for a tax year beginning after the expiration of the legal life of the donated qualified intellectual property; or
• the tax year begins more than 10 years after the date of the qualified intellectual property contribution. (Reg. § 1.6050L-2(a))

The information return must include:

• The donee's name, address, tax year, and employer identification number (EIN);
• The donor's name, address, and taxpayer identification number;
• A description of the qualified intellectual property in sufficient detail to identify the property received by the donee;
• The date of the contribution to the donee;
• The amount of donee's net income for the tax year that is properly allocable to the qualified intellectual property (determined without the Code Sec. 170(m) limitations that would exclude income not reported to the donee, income received ten years after the initial contribution, and income beyond the legal life of the qualified intellectual property); and
• Other information specified by the form or its instructions. (Reg. § 1.6050L-2(b))

The donee generally must file the information return (with a copy furnished to the donor) on or before the last day of the first full month following the close of the donee's tax year to which net income from the qualified intellectual property is properly allocable. (Reg. § 1.6050L-2(c), Reg. § 1.6050L-2(d)(2))

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