Cell Phone Deductibility

IRS discusses easing of cell phone recordkeeping requirements [Information Letter 2008-0012]:

The IRS has issued an information letter in response to a question regarding the noted difficultly that states and localities are having drafting cell phone policies that comply with IRS recordkeeping requirements.

Under IRC §162(a), individuals may take deductions for all ordinary and necessary expenses incurred in carrying on a trade or business. The expenses are considered tax-free working condition fringe benefits, not subject to FITW, FICA, and FUTA, if they are incurred by an employee on behalf of an employer. Cell phones are currently included in the definition of “listed property,” as defined in IRC §280F(d)(4).

Expenses related to listed property may not be deducted under IRC §274(d), unless the employee substantiates by adequate records, or by sufficient evidence corroborating the employee's own statement: (1) the amount of the expenses; (2) the time and place of the expenses; (3) the business purpose of the expenses; and (4) the business relationship to the employee of the persons involved in the expenses. In addition, employees must document their personal use of the property, and the employer must include such use in the employee's income.

In the information letter, the IRS acknowledges the difficulty in documenting business cell phone use. The IRS is considering various changes to the cell phone substantiation requirements. There is currently legislation in Congress that would remove cell phones from the definition of listed property and allow employers to utilize a de minimus personal use policy.

The IRS is also considering possible regulatory changes that would provide a more streamlined substantiation process for cell phones.

Unemployment Benefits Extended

New bill extends unemployment benefits for 13 weeks

The President has signed into law H.R. 2642, “The Supplemental Appropriations Act of 2008.”

Title IV of the bill authorizes an extension of unemployment insurance (UI) benefits. Individuals may be eligible for 13 weeks of extended benefits if they: (1) are fully or partially unemployed after July 5, 2008, (2) have exhausted their benefits in their regular UI claim, and (3) are ineligible to file a new claim.

The extension will be available to workers in all states, and can be used on top of the 26 weeks of benefits that typically are available. The maximum benefit is equal to the lesser of: (a) 50% of the maximum benefit that individuals received on their regular UI claim, or (b) 13 times the weekly benefit amount on their regular claim.

Extended benefits will be available through the week that begins June 29, 2009. The provision was included as part of an emergency war spending bill.

Business Economic Stimulus

Business Provisions of the Economic Stimulus Act of 2008

Mike Habib, EA

The Economic Stimulus Act of 2008 contains two provisions that provide tax benefits for businesses. The first provision increases the limit up to which a business can expense property purchased and placed in service during its 2008 tax year. The second provision provides an additional 50 percent special depreciation allowance for property acquired and placed in service during calendar year 2008.

Unlike the economic stimulus payments that millions of individuals have already received, the tax benefits for businesses are not automatic; businesses must act to take advantage of the new provisions by purchasing qualifying property.

The Joint Committee on Taxation estimates that businesses stand to lower their 2008 tax bills by roughly $45 billion as a result of the two business provisions in the Economic Stimulus Act of 2008; these provisions accelerate into 2008 the tax benefits that otherwise would not have been available until future years.

The following are some details about these two key tax benefits:

Section 179 Expensing

• In general, section 179 provides that, instead of depreciating property, a business with a sufficiently small amount of annual property purchases may choose to expense the cost of the property. For taxable years beginning in 2008, the Economic Stimulus Act increased the section 179 expensing limit allowing more property to be currently expensed.
• The Economic Stimulus Act increased the maximum section 179 expense deduction to $250,000 for qualified section 179 property that is placed in service in tax years that begin in 2008. This is a 95 percent increase from the previous limitation of $128,000.
• The Economic Stimulus Act also increased the total amount of qualifying property a taxpayer may purchase before the section 179 expensing limit begins to be reduced. Under the new law, the $250,000 deduction amount is reduced only when a business acquires more than $800,000 of qualifying property. Prior to changes made by the Economic Stimulus Act, the reduction began when a business acquired more than $510,000 of qualifying property.
• The new law does not alter the section 179 expense limit for sport utility vehicles, which remains at $25,000.
• More than 4.5 million small businesses claimed the section 179 expense deduction for tax year 2005, the most recent year for which this information is available. These businesses placed almost $44 billion of section 179 property in service in 2005 and claimed related deductions of approximately $41 billion (data derived from Depreciation and Amortization forms filed with Forms 1040).

Special Depreciation Allowance

• The Economic Stimulus Act also provided a 50 percent special depreciation allowance for property acquired and placed in service during 2008. Depreciation is an income tax deduction that allows a taxpayer to recover the cost or other basis of certain property over several years. It is an annual allowance for the wear and tear, deterioration or obsolescence of the property.
• Under the new law, a taxpayer is entitled to depreciate 50 percent of the adjusted basis (after subtracting any section 179 deduction taken on that property) of qualified property during the year the property is placed in service. For example, if the taxpayer purchased and placed in service in 2008 a single piece of property at a cost of $450,000 that qualified for section 179 expensing and the 50 percent special depreciation allowance, $250,000 of the cost could be immediately expensed (under section 179 ) and the remaining $200,000 of adjusted basis would be available for the 50 percent special depreciation allowance. The taxpayer would also be permitted to take regular depreciation on the remaining $100,000 of adjusted basis during that year. This is similar to the special depreciation allowance that was previously available for certain property placed in service generally before Jan. 1, 2005, often referred to as “bonus depreciation.”
• The types of property that qualify for the 50 percent special depreciation allowance are section 168 property with a recovery period of 20 years or less, off-the-shelf computer software, water utility property and qualified leasehold improvement property.
• To qualify for the 50 percent special depreciation allowance, a taxpayer must meet all of the following tests:
• The taxpayer must have acquired the property after December 31, 2007, and before Jan. 1, 2009. If a binding contract to acquire the property existed before Jan. 1, 2008, the property does not qualify for the special depreciation allowance.
• The property must be placed in service before Jan. 1, 2009 (before Jan. 1, 2010, for certain transportation property and certain property with a long productions period).
• The original use of the property must begin with the taxpayer after Dec. 31, 2007. In other words, the property must be “new” property.
• Prior to the enactment of the Economic Stimulus Act the total depreciation amount (including the section 179 deduction) a business could deduct for a passenger automobile was $2,960. The Economic Stimulus Act increased this limitation by $8,000. Therefore, the maximum limit is increased to $10,960 for automobiles for which the special bonus depreciation allowance is claimed.
• Prior to the enactment of the Economic Stimulus Act, the total depreciation amount (including the section 179 deduction) a business could deduct for a truck or van used in a business and first placed in service in 2008 was $3,160. The Economic Stimulus Act increased this limitation by $8,000. The new maximum limit is increased to $11,160 for trucks and vans for which the special bonus depreciation is claimed.

The Economic Stimulus Act is the most recent legislation that provides depreciation tax benefits. Previously, the Job Creation and Worker Assistance Act of 2002 allowed an additional first-year depreciation deduction equal to 30 percent of the adjusted basis of qualified property for property acquired on or after Sept. 11, 2001, and generally placed in service before Jan. 1, 2005. The Jobs and Growth Tax Relief Reconciliation Act of 2003 provided an additional first-year depreciation deduction equal to 50 percent of the adjusted basis of qualified property for property acquired after May 5, 2003, and generally placed in service before Jan. 1, 2005.

For professional tax advice contact us today.

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.

Military Personnel Tax Benefits

Pension plan benefits for military personnel 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 several important pension plan benefits for military personnel. Specifically, the Act makes the following pension plan liberalizations for members of the military and their families:

• 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.
• 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.
  

Other military tax benefits 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) contains a wide-ranging package of tax cuts for military personnel and veterans. While many of the military tax benefits are pension plan-related, several important changes are not. Specifically, the 2008 Heroes Act makes the following nonpension-related 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).
• Extends the limitations period for filing tax refund credit claims arising from Department of Veterans Affairs disability determinations. This provision is important because length-of-service-based military retirement benefits are included in income but veterans' benefits based on a service-connected disability are excluded. Where individuals receive includible retirement benefits and are later retroactively determined to be eligible for service-connected disability benefits, the retirement benefits attributable to the disability are retroactively excluded. Under pre-2008 Heroes Tax Act law, individuals may claim a refund of the tax paid on the retroactively excluded benefits, subject to the statute of limitations on filing a refund claim (generally, the claim must be filed within three years of the filing of the tax return or within two years of the payment of the tax, whichever expires later). Effective for claims filed after the enactment date, the Act extends the time period for filing a refund claim. For a determination after the enactment date, the period is extended until one year after the date of the disability determination (if later than the time periods allowed under current law). The change applies to any tax year which begins five years before the date of the determination or thereafter. For a determination after 2000, and on or before the enactment date, the refund period is extended until one year after the enactment date (if later than the time periods allowed under current law).
• Modifies the rules regarding differential pay. Some employers voluntarily agree to continue paying the compensation that service members would otherwise have received from the employer during their active duty. Under pre-2008 Heroes Act law, such “differential pay” isn't wages for federal income tax withholding purposes but under the new law is subject to withholding, effective for amounts paid after 2008. Additionally, effective for tax years beginning after 2008, differential pay will have to be treated as compensation for retirement plan purposes, and will qualify as compensation for purposes of the IRA contribution rules.
• 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).

Please keep in mind that this is only a summary of these changes in the new law. If you would like more details about these provisions or any other aspect of the new law, 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.

Triangular Reorganizations Tax Resolution

Temporary regs curb abuses in triangular reorganizations involving foreign corporations

T.D. 9400, 05/23/2008, Reg. § 1.367(a)-3T, Reg. § 1.367(b)-14T, Preamble to Prop Reg 05/23/2008

IRS has issued temporary (along with final and proposed regs) under Code Sec. 367(b) to curb abusive triangular reorganizations involving foreign corporations—sometimes referred to as “Killer B” transactions. The temporary regs implement the rules in Notice 2006-85 and Notice 2007-48, and their text serves as the text of the proposed regs.

Statutory background. A U.S. person's transfer of appreciated property (including stock) to a foreign corporation in connection with Code Sec. 332, Code Sec. 351, Code Sec. 354, Code Sec. 356, or Code Sec. 361 exchanges, generally is treated under Code Sec. 367(a)(1) as a taxable transaction, unless an exception applies. Code Sec. 367(b) provides that a foreign corporation is considered to be a corporation for purposes of these exchange provisions, except to the extent provided in regs issued to prevent tax avoidance.

No gain or loss is recognized to a corporation on the receipt of money or other property in exchange for stock of that corporation. (Code Sec. 1032) In the case of a forward triangular merger, a triangular C reorganization, or a triangular B reorganization, a parent's stock provided by it to its subsidiary—or provided directly to a target corporation or its shareholders on the subsidiary's behalf—under a reorganization plan is treated as a disposition by the parent of shares of its own stock. (Reg. § 1.1032-2(b)) However, if the subsidiary did not receive the parent's stock from the parent under a reorganization plan, it must recognize gain or loss on the exchange of its parent stock for the target's stock or assets. (Reg. § 1.1032-2(c)) The subsidiary does not recognize gain or loss on the parent's stock that it exchanges for the target's stock in a reverse triangular merger. (Code Sec. 361)

A corporation's distribution of property to its shareholder with respect to its stock is included in the shareholder's gross income to the extent the distribution is a dividend under Code Sec. 316 (which defines a dividend as a distribution out of a corporation's current and accumulated earnings and profits). (Code Sec. 301(c)(1)) To the extent the distribution is not a dividend, the shareholder reduces basis in the distributing corporation's stock, and any amount of the distribution in excess of the shareholder's basis is treated as gain from the sale or exchange of the corporation's stock. (Code Sec. 301(c)(2), Code Sec. 301(c))

Background on prior IRS notices. In Notice 2006-85, 2006-41 IRB 677, IRS announced that it would issue regs under Code Sec. 367(b) to curb abuses where triangular reorganizations involving foreign corporations had the effect of repatriating the subsidiary's foreign earnings to the parent without a corresponding dividend to the parent that would be subject to U.S. income tax (see Federal Taxes Weekly Alert 09/28/2006). The regs would treat the transfer of property from the parent to the subsidiary as a distribution of property under Code Sec. 301(c). IRS later issued Notice 2007-48, 2007-25 IRB 1428, to amplify and broaden the reach of Notice 2006-85 to cover transactions where the subsidiary acquires stock of its parent from a person unrelated to its parent, such as from the public on the open market (see Federal Taxes Weekly Alert 06/07/2007).

IRS has now issue final, temporary and proposed regs under Code Sec. 367(b) to address these other transactions. The temporary regs implement the rules in Notice 2006-85 and Notice 2007-48 , and their text serves as the text of the proposed regs. The final regs revise an existing final reg and add a cross-reference.

Temporary regs. IRS has issued temporary regs that apply to triangular reorganizations where P or S (or both) is foreign and, in connection with the reorganization, S acquires, in exchange for property, all or a portion of the P stock that is used to acquire T's stock or assets. The “in connection with” standard is a broad standard that includes any transaction related to the reorganization even if the transaction is not part of the plan of reorganization. For example, the temporary regs apply to a triangular reorganization regardless of whether P controls S (under Code Sec. 368(c)) when S acquires the P stock that is used in the reorganization. (Reg. § 1.367(b)-14T(a)(1))

The temporary regs make adjustments for P and S that have the effect of a distribution of property from S to P under Code Sec. 301. The amount of the deemed distribution is equal to the amount of money plus the fair market value of other property that S used to acquire P stock. For this purpose, “property” has the meaning in Code Sec. 317(a) , but includes any liability assumed by S in exchange for the P stock (notwithstanding Code Sec. 357(a)) and any S stock used by S to acquire the P stock from a person other than P. To the extent S buys P stock from a person other than P, immediately after taking into account the deemed distribution to P, P is deemed to contribute to S the property deemed distributed to P. (Reg. § 1.367(b)-14T(b)(1))

The deemed distribution is treated as a transaction separate from, and occurring immediately before, the triangular reorganization. Thus, P is not be treated as receiving the property from S in exchange for P stock, and the transfer of P stock in the triangular reorganization is subject to the generally applicable provisions, e.g., Reg. § 1.1032-2. (Reg. § 1.367(b)-14T(b)(2)) The deemed distribution is treated as a distribution for all purposes of the Code. (Reg. § 1.367(b)-14T(c)(1)) Similarly, a deemed contribution of property is treated as a contribution of property for all purposes of the Code. For example, appropriate adjustments to P's basis in the S stock and other affected items must be made according to applicable Code provisions. (Reg. § 1.367(b)-14T(c)(2))

Ordering rules generally require the deemed distribution and, in cases where S buys P stock from a person other than P, the deemed contribution to be taken into account before the transfers undertaken under the triangular reorganization. If P controls S (under Code Sec. 368(c)) at the time of the purchase, the deemed distribution and deemed contribution are treated as separate transactions occurring immediately before the purchase. If P doesn't control S (under Code Sec. 368(c) ) at the time that S purchases the P stock, the deemed distribution and deemed contribution are treated as separate transactions occurring immediately after P acquires control of S. Thus, in a transaction where S purchases the P stock from a person other than P, after taking into account the adjustments made under these temporary regs, S's purchase and transfer of P stock under the triangular reorganization are taken into account under generally applicable Code provisions, such as Code Sec. 304, Code Sec. 354, Code Sec. 356, Code Sec. 358, and Code Sec. 368. (Reg. § 1.367(b)-14T(b)(3))

Under the temporary regs, appropriate adjustments are made if in connection with a triangular reorganization, a transaction is engaged in with a view to avoid the purpose of the regs. (Reg. § 1.367(b)-14T(d)) For example, if S is a newly formed corporation and, in connection with the reorganization, P contributes to S another corporation with positive earnings and profits (S2) to facilitate S's purchase of the P stock or to facilitate the repayment of an obligation incurred by S to purchase the P stock, then, under the temporary regs, the earnings and profits of S may be deemed to include S2's earnings and profits. (T.D. 9400, 05/23/2008)

Effective date. For rules addressing transactions described in Notice 2006-85, the temporary regs are generally applicable to transactions occurring on or after Sept. 22, 2006. For rules addressing transactions described in Notice 2007-48, the temporary regs are generally applicable to transactions occurring on or after May 31, 2007. Other reg rules are generally applicable to transactions occurring on or after May 23, 2008. Limited transition relief applies. (Reg. § 1.367(b)-14T(e))

APA Tax Relief & Tax Resolution

IRS expands advance pricing agreement procedures to include other issues relevant to transfer pricing

Rev Proc 2008-31, 2008-23 IRB

In a Revenue Procedure, IRS has expanded the procedures under which taxpayers secure an advance pricing agreement (APA) to include additional types of issues that may be resolved in the APA process.

Background. An APA generally combines a voluntary agreement between a taxpayer and IRS on an appropriate transfer pricing methodology (TPM) for covered transactions with an agreement between the U.S. and one or more foreign tax authorities that the TPM is correct. This kind of bilateral APA assures the taxpayer that the income from the transactions will not be subject to double taxation by the U.S. and the foreign tax authority. IRS and taxpayers also may execute unilateral APAs, which are agreements establishing an approved transfer pricing methodology for U.S. tax purposes. A unilateral APA binds the taxpayer and IRS, but does not prevent foreign tax bodies from taking different positions. If a transaction covered by a unilateral APA is subject to double taxation as the result of an adjustment by a foreign tax administration, the taxpayer may seek relief by requesting that the U.S. Competent Authority consider initiating a mutual agreement proceeding, provided there is an applicable income tax treaty in force with the other country. The APA process is voluntary. Taxpayers submit an application for an APA, together with a user fee.

IRS has now updated Rev Proc 2006-9, 2006-2 IRB 278, which contains the procedures for applying for an APA.

Updated procedures. In Rev Proc 2008-31, IRS modifies the procedures in Rev Proc 2006-9 to state that the APA program also provides a process by which IRS and taxpayers may resolve other issues than transfer pricing arising under certain income tax treaties, the Code, or the regs for which transfer pricing principles may be relevant. For example, these issues would include: attribution of profits to a permanent establishment under an income tax treaty, determining the amount of income effectively connected with the conduct by the taxpayer of a trade or business within the U.S., and determining the amounts of income derived from sources partly within and partly without the U.S., as well as related subsidiary issues.

Tax Medicaid Rebates Adjustments

IRS clarifies ruling allowing drug manufacturers to subtract Medicaid rebates from gross receipts

Rev Rul 2008-26, 2008-21 IRB

In a revenue ruling that clarifies an earlier one issued in 2005 on the same subject, IRS concludes that Medicaid Rebates that a pharmaceutical manufacturer pays to State Medicaid Agencies are adjustments to the sales price in calculating gross receipts rather than ordinary and necessary business expenses that are deductible from gross income under Code Sec. 162.

Observation: In lieu of the foregoing conclusion, the earlier ruling (Rev Rul 2005-28, 2005-19 IRB 997) stated that Medicaid Rebates incurred by a pharmaceutical manufacturer are purchase price adjustments that are subtracted from gross receipts in determining gross income. Also, unlike Rev Rul 2005-28, the current ruling specifically states that its holding is limited to Medicaid Rebates that a pharmaceutical manufacturer pays pursuant to the Medicaid Rebate Program established by the Omnibus Budget Reconciliation Act of 1990.

Observation: IRS had reached the opposite conclusion in Field Service Advice 200101004 where it concluded that rebates paid by pharmaceutical manufacturers to state Medicaid agencies under the Medicaid Rebate Program couldn't be excluded from the manufacturer's gross sales as a discount or price adjustment. Had IRS not changed its view in Rev Rul 2005-28 and Rev Rul 2008-26, an issue could have arisen as to whether Code Sec. 162(c)(3) would bar any business expense deduction for the rebates. It provides that no business expense deduction is allowed for any rebate made by a provider of services, supplier, physician or other person who furnishes items or services for which payment is or may be made under the Social Security Act, or in whole or in part out of federal funds under a state plan approved under such act, if the rebate is made in connection with the furnishing of such items or services or the making or receiving of such payments.

Background on Medicaid rebates. The Omnibus Budget Reconciliation Act of 1990 (the Act) established the Medicaid Rebate Program to increase Medicaid beneficiaries' access to prescription drugs. Under the Act, pharmaceutical manufacturers must sign a Rebate Agreement with the Department of Health and Human Service (HHS) to gain access to the Medicaid-funded segment of the pharmaceutical market.

The Rebate Agreements require pharmaceutical manufacturers to pay Medicaid Rebates directly to each State Medicaid Agency. A Medicaid Rebate is a portion of the price paid by State Medicaid Agencies to retailers for covered outpatient drugs dispensed to Medicaid beneficiaries. The amount of the Medicaid Rebate is designed to ensure that the Medicaid Program is charged no more for covered outpatient drugs than any other purchaser.

Facts of ruling. M, which uses an accrual method of accounting and files returns on a calendar year basis, manufactures and sells prescription drugs. In '92, it entered into a “Rebate Agreement” with HHS. In 2005, the following events occur:

• M sells Product D, a prescription drug, to W, a wholesaler;
• W sells Product D to R, a retail pharmacy;
• R dispenses Product D to individual A, a Medicaid beneficiary, and then files a reimbursement claim with S, a State Medicaid Agency;
• S approves the claim and then reimburses R for the cost of Product D plus a dispensing fee; and
• M pays a Medicaid Rebate to S under the Rebate Agreement.

Background on tax treatment. In a manufacturing business, gross income means the total sales, less the cost of goods sold, plus any income from investments and from incidental or outside operations or sources. (Reg. § 1.61-3(a)) Ordinary and necessary expenses paid or incurred during the tax year in carrying on any trade or business are deductible. (Code Sec. 162)

In Pittsburgh Milk Co, (1956) 26 TC 707, the Tax Court addressed whether allowances, discounts, or rebates paid by a milk producer to certain purchasers of its milk, in willful violation of state law, are adjustments to the purchase price of the milk resulting in a reduced sales price, or ordinary and necessary business expenses under Code Sec. 162 (in which case no deduction would be allowed under Code Sec. 162(c)). The court found that the allowances were part of the sales transaction and concluded that gross income must be computed with respect to the agreed net prices for which the milk was actually sold. Thus, under Pittsburgh Milk, where a payment is made from a seller to a purchaser, and the purpose and intent of the parties is to reach an agreed upon net selling price, the payment is properly viewed as an adjustment to the purchase price that reduces gross sales.

Rev Rul 76-96, 1976-1 CB 23, concluded that an automobile manufacturer that offered rebates to retail customers who independently negotiated a purchase price with the dealer could deduct the rebates as ordinary and necessary business expenses under Code Sec. 162 .

Analysis. Rev Rul 2008-26 notes that the Medicaid Rebate is paid by M to S pursuant to the terms of the rebate agreement. Under the purpose and intent test of Pittsburgh Milk , the Medicaid Rebate is a factor used in setting the actual selling price, negotiated and agreed to before the sale to W takes place.

Observation: In Rev Rul 2005-28 the foregoing sentence read as follows: “Under the purpose and intent test of Pittsburgh Milk , the Medicaid Rebate is made with the purpose and intent of reaching an agreed upon net selling price, and is negotiated and agreed to before the sale to W takes place.”

Accordingly, as noted above, in language that varies somewhat from that in Rev Rul 2005-28, Rev Rul 2008-26 concludes that Medicaid Rebates that a pharmaceutical manufacturer pays to State Medicaid Agencies are adjustments to the sales price in calculating gross receipts rather than ordinary and necessary business expenses that are deductible from gross income under Code Sec. 162.

Effect on other rulings. Rev Rul 2008-26 clarifies and supersedes Rev Rul 2005-28. Rev Rul 2008-26 notes that Rev Rul 2005-28 suspended, in part, Rev Rul 76-96. Rev Rul 2008-26 then states that IRS is reconsidering whether a rebate of the type described in Rev Rul 76-96 is an ordinary and necessary business expense or, alternatively, is an adjustment to the sales price in calculating gross receipts. Therefore, pending IRS's reconsideration of the issue and publication of subsequent guidance, IRS will not apply, and taxpayers may not rely on, the conclusion of Rev Rul 76-96 that rebates made by the manufacturer are ordinary and necessary business expenses deductible under Code Sec. 162.

Observation: Using somewhat different language, Rev Rul 2005-28 also said that Rev Rul 76-96 could not be relied on pending its reconsideration by IRS.

Observation: Thus, while Rev Rul 2008-26 nominally involved a drug manufacturer, its scope is far broader as a result of the reconsideration of the stated conclusion in the earlier ruling.

Observation: Should IRS conclude that rebates are allowed only as an adjustment to the sales price and are not deductible as ordinary and necessary business expenses, this could actually be good for taxpayers because (1) they would not be faced with the bar on deductions under Code Sec. 162(c), and (2) they could qualify for a potentially larger research credit if the credit is reinstated and its amount is again determined with reference to a taxpayer's research expenditures as measured under a formula taking into account its gross receipts.

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.

TRUCKER TAX RELIEF & TRUCKER TAX PROBLEM RESOLUTION

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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.