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Individual health care mandate rules proposed  
April 2013

The IRS released proposed rules for the Sec. 5000A shared-responsibility payment—the penalty or tax imposed on individual taxpayers who do not obtain minimum essential health care coverage beginning in 2014 (the controversial “individual mandate”) (REG-148500-12). Separately, the IRS also issued final regulations defining affordable coverage for purposes of the premium tax credit available to individuals under Sec. 36B.

The individual mandate was upheld by the Supreme Court last summer as a permissible exercise of Congress’s taxing powers under the Constitution (see “Supreme Court Upholds Health Care Law,” JofA, Aug. 2012, page 12).

Under Sec. 5000A, starting next year, a taxpayer will be liable for the shared-responsibility payment if the taxpayer or any nonexempt individual whom the taxpayer may claim as a dependent for a tax year does not have minimum essential coverage in a month included in that tax year. Married taxpayers filing a joint return are jointly liable for the payment.

The proposed regulations cover the following topics:

Maintenance of minimum essential coverage and liability for the shared-responsibility payment. Prop. Regs. Sec. 1.5000A-1 defines minimum essential coverage and liability for the shared-responsibility payment, including for dependents.

Minimum essential coverage. Prop. Regs. Sec. 1.5000A-2 defines the different types of health plans that qualify as minimum essential coverage.

Exempt individuals. Prop. Regs. Sec. 1.5000A-3 defines who is exempt from the payment.

Computation of the shared-responsibility payment. Prop. Regs. Sec. 1.5000A-4 contains rules for computing the amount of the payment.

Administration and procedure. Prop. Regs. Sec. 1.5000A-5 includes when the payment is due, the prohibition against liens or levies for nonpayment, no criminal fines, and the IRS’s authority to offset overpayments of tax to collect the payment.

Minimum essential coverage is defined in the proposed regulations as coverage under a government-sponsored program (Medicare, Medicaid, Tricare, the Children’s Health Insurance Program, etc.), an eligible employer-sponsored plan (defined in Prop. Regs. Sec. 1.5000A-2(c)), a plan in the individual market (generally insurance through a health care exchange), a health plan grandfathered under the health care acts (the Patient Protection and Affordable Care Act, P.L. 111-148, and the Health Care and Education Reconciliation Act, P.L. 111-152), or other health benefits coverage that has been recognized as minimum essential coverage by the secretary of Health and Human Services (Prop. Regs. Sec. 1.5000A-2).

Exempt individuals include members of a religious sect whose members oppose government insurance benefits. These individuals must obtain an exemption certificate (Prop. Regs. Sec. 1.5000A-3(a)). As the frequently asked questions the IRS also released online (available at explain, the Social Security Administration administers the process for recognizing these groups under the law, which is already in effect for groups who object to Social Security benefits.

Other exempt individuals include:

  1. Members of health care sharing ministries, which are groups that share a common set of ethical or religious beliefs and share medical expenses among themselves (Prop. Regs. Sec. 1.5000A-3(b));
  2. Exempt noncitizens, meaning noncitizens, nonresident aliens, and people who are unlawfully present in the United States (Prop. Regs. Sec. 1.5000A-3(c));
  3. People in jail (Prop. Regs. Sec. 1.5000A-3(d));
  4. An individual who lacks affordable coverage (meaning the individual’s required contribution for minimum essential coverage exceeds 8% of the individual’s household income) (Prop. Regs. Sec. 1.5000A-3(e));
  5. Individuals whose household income is below the filing threshold in Sec. 6012(a)(1) (Prop. Regs. Sec. 1.5000A-3(f));
  6. Members of Indian tribes (Prop. Regs. Sec. 1.5000A-3(g));
  7. Individuals who obtain a hardship exemption certificate from an insurance exchange certifying that they have suffered a hardship that prevents them from obtaining coverage (Prop. Regs. Sec. 1.5000A-3(h)); and
  8. Individuals who were without coverage for less than three consecutive months (Prop. Regs. Sec. 1.5000A-3(j)).

The regulations are proposed to apply after Dec. 31, 2013, which is when the Sec. 5000A payment first applies. A public hearing on the proposed regulations is scheduled in Washington on May 29.

Final regs. on affordable coverage under the premium tax credit. At the same time, the IRS released a final regulation under Sec. 36B, the health care premium tax credit, which assists lower-income individuals in buying health insurance (T.D. 9611).

The final rules use the cost of the premium for self-only coverage to determine whether coverage is affordable and whether an individual qualifies for a premium tax credit, so that the individual will qualify only if the premium for self-only coverage exceeds 9.5% of the taxpayer’s household income. The IRS rejected comments that called for using the amount a taxpayer must pay for family coverage to determine affordability.

Simplified home office deduction safe harbor now available  
April 2013

In Rev. Proc. 2013-13, issued in January, the IRS gave taxpayers an optional safe-harbor method to calculate a deduction for expenses of a business use of a residence under Sec. 280A, effective for tax years beginning in 2013.

Individual taxpayers who elect this method can determine the deduction by multiplying the allowable square footage by $5. The allowable square footage is the portion of the dwelling used in a qualified business use, up to 300 square feet; thus, the maximum safe-harbor deduction is $1,500. The safe harbor is elected on a timely filed original tax return (instead of on Form 8829, Expenses for Business Use of Your Home, which is used for the actual-expense method), and taxpayers are allowed to change their treatment from year to year. However, the election made for any tax year is irrevocable.

No depreciation is allowed for the years in which the safe harbor is elected, but it is permitted in years in which the actual-expense method is used. The revenue procedure gives detailed examples of how depreciation is calculated in a year after the safe-harbor method is used.

To use the safe-harbor method, taxpayers must continue to satisfy all the other requirements for a home office deduction, including that the space be used exclusively for the qualified business purpose and that an employee qualifies for the deduction only if the office is for the convenience of the taxpayer’s employer.

The deduction under the safe-harbor method cannot exceed the amount of gross income derived from the qualified business use of the home, minus business deductions unrelated to the qualified business use of the home. Unlike the limitation under the actual-expense method, however, a taxpayer cannot carry over any excess to another tax year; nor can there be any carryover from an actual-expense method year to a safe-harbor year. Taxpayers sharing a home (for example, roommates or spouses, regardless of filing status), if otherwise eligible, may each use the safe-harbor method, but not for qualified business use of the same portion of the home. The revenue procedure contains detailed rules for use of the home for part of the year. Taxpayers who have a qualified business use of more than one home for a tax year may use the safe harbor for only one home and must use the actual-expense method for the other home or homes.

Release of dependency exemption trumps child support  
By Karyn Bybee Friske, CPA, Ph.D. and Darlene Pulliam, CPA, Ph.D.
April 2013

In two recent cases, the Tax Court ruled on the validity of a dependency exemption release to a noncustodial parent. Taken together, the cases illustrate how a properly executed and filed Form 8332, Release/Revocation of Release of Claim to Exemption for Child by Custodial Parent, is the key to releasing a claim of exemption and outweighs state court orders.

In Armstrong, the court denied the deduction and child tax credit to a noncustodial father who did not attach Form 8332 to his 2007 tax return. The taxpayer, Billy Armstrong, did attach a copy of an “arbitration award” indicating he would be entitled to the dependency exemption for one of his and his ex-wife’s two children if he stayed current with child support. Upon audit, he also provided a 2003 state court order that incorporated the arbitration award and a 2007 state court order signed by the ex-wife that explicitly required the ex-wife to provide him with an executed Form 8332 or its equivalent if his support payments were current, which they were. The IRS rejected his claim because the award and orders were conditioned upon current payment of child support. The majority opinion of the Tax Court agreed that the state court orders did not unconditionally declare that Armstrong’s ex-wife would not claim the exemption and therefore could not substitute for Form 8332.

A taxpayer is allowed a dependency exemption under Sec. 152 for a tax year for a qualifying child, who generally must have lived with the taxpayer for more than half of the year. However, under Sec. 152(e), a child may be treated as the qualifying child of the noncustodial parent when certain criteria are met, including that the custodial parent signs a written declaration (such as Form 8332) releasing claim to the exemption for the tax year, and the noncustodial parent attaches the signed declaration to his or her return. According to the regulations, a noncustodial parent may also rely on an alternative document, provided it conforms to the substance of Form 8332.

The Tax Court concluded that the ex-wife’s signature on the March 2007 state court order was a conditional statement that she would not claim the dependency exemption if the child support payments were current. For a document to comply with the substance of Form 8332 and Sec. 152(e), there must be an unconditional declaration releasing any claim for the deduction for the tax year. However, the court declined to impose an accuracy-related negligence penalty.

A dissenting opinion by Judge Mark V. Holmes joined by two other judges held that because Armstrong fulfilled the state court’s unambiguous condition for the exemption, its order should be considered as conforming to the substance of Form 8332. The dissent acknowledged, however, that the same answer might not hold for taxpayers in subsequent years, because for tax years beginning after July 2, 2008, Regs. Sec. 1.152-4(e)(1)(ii) requires any substitute for Form 8332 to be executed solely to serve as the written declaration and may not be a court order or decree or separation agreement.

In the other case, George, the Tax Court concluded that a signed Form 8332 was valid despite the taxpayer’s contention that her ex-husband was delinquent in his child support obligations that a state court order had required, as in Armstrong, as a condition to execute the form.

Rachel George, the custodial parent, executed a Form 8332 in compliance with the state court order in 2007. She believed the order to be improper, however, and claimed a dependency exemption deduction and a child tax credit for the child covered by the Form 8332 on her 2007 and 2008 tax returns. Her ex-husband also claimed the child as a dependent and attached the signed Form 8332 to his tax returns.

The Tax Court could not invalidate George’s signing of the release. She argued she had been forced to sign under threat of contempt, but that didn’t constitute duress, the court held. The court also stated that it lacked the power to correct the alleged errors of state family courts. According to the Tax Court, George’s position would undermine the intended certainty and clarity of Sec. 152(e) and would add great difficulty to the administration of the dependency exemption. As a result, George was denied the dependency exemption deduction and the child tax credit for the years for which she signed Form 8332.

The rules of Sec. 152 are clear, the court said, adding, “Our obligation to follow the statute as written applies whether the resulting disadvantage is suffered by a custodial parent who executed a Form 8332 but bore an undue and unintended burden of child support, or is instead suffered by a noncustodial parent who bore the burden of child support but did not receive an executed Form 8332.”

By Karyn Bybee Friske, CPA, Ph.D., Schaeffer Professor of Business Ethics and professor of accounting, and Darlene Pulliam, CPA, Ph.D., McCray Professor of Business and professor of accounting, both of the College of Business, West Texas A&M University, Canyon, Texas.

Golf course easement donation lands out of bounds  
By Charles J. Reichert, CPA
April 2013

The Tax Court disallowed a taxpayer’s deduction for a conservation easement because the taxpayer’s donated golf course was not a qualified real property interest. The court found that the golf course was not subject to a use restriction in perpetuity since the easement agreement permitted the taxpayer, with the approval of the charitable organization, to substitute other property in the future.

Taxpayers can deduct the value of a charitable contribution of a partial interest if the donated partial interest is a qualified conservation contribution. A qualified conservation contribution is a contribution of a qualified real property interest to a qualified organization exclusively for conservation purposes. Qualified real property interests are an entire interest in real property (other than some mineral interests), a remainder interest in real property, or a perpetual restriction on the use of the donated real property. In addition, a contribution will not be exclusively for conservation purposes unless the conservation purpose is protected in perpetuity.

In 1996, B.V. Belk Jr. and his wife, Harriet, transferred approximately 410 acres near Charlotte, N.C., to Olde Sycamore, their wholly owned LLC. Olde Sycamore built single-family homes and a 185-acre golf course on the property. In December 2004, Olde Sycamore entered into a conservation easement agreement with SMNLT, a nonprofit Sec. 501(c)(3) organization, covering the golf course; however, the agreement allowed Sycamore, after obtaining SMNLT’s approval, the right to future substitution of land adjacent to the golf course for golf course land. Any new land was required to have an area and value greater than or equal to the substituted land. Olde Sycamore claimed a charitable contribution of $10,524,000 on its 2004 federal income tax return, which passed through to the Belks’ individual return. The IRS disallowed the 2004 charitable contribution and related carryovers, which prompted the taxpayers to petition the Tax Court for relief.

Since the Belks did not transfer an entire interest or a remainder interest, the golf course could be a qualified real property interest only if it was subject to a use restriction granted in perpetuity. The court held that this was not the case because the easement agreement allowed parts of the golf course to potentially be substituted with property not covered by the easement.

The taxpayers argued that the substitution provision was irrelevant because it did not impair the conservation purpose of the easement. The court rejected this argument, stating the perpetual protection of the property’s conservation purpose is a separate and distinct requirement from the requirement that the property’s use must be perpetually restricted. The court further held that even if a property’s conservation purpose is perpetually protected, that does not imply that there is no need to perpetually restrict the use of the real property.

The court acknowledged that Regs. Sec. 1.170A-14(c)(2) allows property substitutions when the continued use of the property is impractical or impossible; however, those regulations do not allow substitution for other reasons and not for any reason, as in this case. Furthermore, the court stated that the property’s use must be restricted perpetually regardless of any agreement between the parties, and, therefore, SMNLT’s approval of any future substitutions was irrelevant.

Belk, 140 T.C. No. 1

By Charles J. Reichert, CPA, instructor of accounting, University of Minnesota–Duluth.

FATCA final regulations cover all the bases  
April 2013

The IRS issued final regulations providing rules on information reporting by foreign financial institutions (FFIs) and withholding on certain payments to FFIs and other foreign entities (T.D. 9610).

Under the Foreign Account Tax Compliance Act of 2009 (FATCA), enacted as part of the Hiring Incentives to Restore Employment Act of 2010, P.L. 111-147, U.S. withholding agents are required to withhold tax on certain payments to FFIs that do not agree to report certain information to the IRS regarding their U.S. accounts and on certain payments to certain nonfinancial foreign entities (NFFEs) that do not provide information on their substantial U.S. owners to withholding agents.

The regulations finalize the proposed rules issued in February 2012 (REG-121647-10), making a number of changes in response to comments. One area of simplification in the final regulations is the integration of model intergovernmental agreements (IGAs) into their reporting requirements. There are two types of IGAs: reciprocal agreements and nonreciprocal agreements (see “FATCA Gets Model Agreement,” Tax Matters, Oct. 2012, page 66), which are called Model 1 IGAs and Model 2 IGAs, respectively. A jurisdiction signing a Model 1 IGA agrees to adopt rules to identify and report information to the IRS that meets the standards in the Model 1 IGA. FFIs that are in Model 1 IGA jurisdictions report the information about U.S. accounts required by FATCA to their respective governments, which then exchange this information with the IRS. FFIs in Model 2 IGA jurisdictions must comply with the FATCA regulations except to the extent the relevant IGA provides otherwise.

The IRS announced that, to date, seven countries had entered into model agreements with the United States: Norway, Spain, Mexico, the United Kingdom, Ireland, Denmark, and Switzerland. Discussions with more than 50 countries are ongoing, and more agreements are expected to be signed in the near future.

In recognition of the burden that complying with FATCA entails, the final regulations, among many other things:

  • Phase in over an extended transition period the timelines for withholding, due diligence, and reporting and align them with the IGAs (see also “Tax Matters: FATCA Deadlines Delayed,” JofA, Jan. 2013, page 63).
  • Expand and clarify the types of payments subject to withholding, particularly for certain grandfathered obligations that are not subject to the rules and certain payments made by NFFEs.
  • Expand and clarify the treatment of certain low-risk institutions, such as government entities and retirement funds, provide that certain investment entities may be subject to being reported on by FFIs with which they hold accounts rather than being required to register as FFIs with the IRS, and clarify the type of passive investment entity that financial institutions must identify and report.
  • Streamline the compliance and registration requirements for groups of financial institutions, including commonly managed investment funds.

The regulations were effective Jan. 28, 2013.

Proposed regs. would govern employment tax liability of third-party agents  
April 2013

The IRS released proposed regulations (REG-102966-10) under Sec. 3504 (acts to be performed by agents) that would govern the liability for employment taxes when an employer designates an agent under a “service agreement” to pay its employees and to satisfy all employment tax obligations. Such agents include payroll service providers, employee leasing companies, and professional employer organizations.

The proposed rules are intended to assist taxpayers and the IRS in determining the parties’ employment tax obligations in a three-party arrangement in which a payer has represented to the employer that it will pay the employment taxes for wages or compensation it pays to employees for services the employees performed for the employer.

Generally, employment tax liability is determined under the Code and cannot be altered by an agreement between an employer and a third party. In limited circumstances, a third-party payer may be considered the person responsible for withholding and payment of employment taxes in addition to—or in lieu of—the employer. Under Sec. 3504, if a third party pays wages or compensation to employees who are employed by one or more employers, the IRS can designate that payer to perform acts required of employers under the Code.

Under the Sec. 3504 rules, agents use their own employer identification number (EIN) when filing one aggregate Form 941, Employer’s Quarterly Federal Tax Return (or Form CT-1, Employer’s Annual Railroad Retirement Tax Return), for all the employers for whom they act. The payers file Form 941, Schedule R, Allocation Schedule for Aggregate Form 941 Filers, to provide the breakdown for individual employers.

Under existing rules, payers and employers file Form 2678, Employer/Payer Appointment of Agent, with each Form 941. A payer that undertakes these obligations is liable for any tax or penalty that may apply, but the employer also remains liable.

The proposed regulations provide that, unless certain exceptions apply, a payer can be designated as an agent under Sec. 3504 to perform the acts required of an employer with respect to wages or compensation paid by the payer to any individual performing services for any client pursuant to a “service agreement” between the payer and the client. In that case, the IRS states that it will pursue recovery of unpaid taxes and penalties only once—from either the payer or the employer.

A service agreement is defined in the proposed rules as an agreement between an employer and payer in which the payer asserts it is the employer (or “co-employer”) of the individuals performing services for the employer; pays wages or compensation to the individuals; and assumes responsibility to collect, report, and pay, or assumes liability for, any employment taxes applicable for wages or compensation the payer pays to the individuals performing services for the employer (Prop. Regs. Sec. 31.3504-2(b)(2)).

The rules under the proposed regulations do not apply if the wages are reported on a return filed under the employer’s EIN, the payer is a common paymaster under Sec. 3121(s) or 3231(i), or the payer is the individuals’ employer (Prop. Regs. Sec. 31.3504-2(d)). Eight examples illustrate how these rules apply.

These rules will apply to wages or compensation a payer pays under a service agreement in quarters beginning on or after the date they are published as final in the Federal Register. In the meantime, the IRS is requesting comments, which must be received by April 29. In particular, the IRS asks for comments on (1) whether the definition of service agreement inappropriately results in a payer’s being designated (or failing to be designated) an agent under Sec. 3504; (2) whether additional exceptions are warranted; and (3) whether additional examples should be given.

Line items  
April 2013

New Consent Language Deadline Extended

In Rev. Proc. 2013-19, the IRS postponed until 2014 a requirement that practitioners use language mandated by Rev. Proc. 2013-14 to obtain taxpayers’ consent to disclose or use tax return information. The earlier revenue procedure, which was issued Dec. 26, 2012 (see “Tax Matters: Mandatory Language for Consents to Disclose, Use Taxpayer Information Modified,” March 2013, page 69), required use of modified mandatory language for consents obtained on or after Jan. 14, 2013. Under the extension, practitioners may use either the modified language or language previously authorized by Rev. Proc. 2008-35 until Jan. 1, 2014, when they must begin using the new language.

Appeal Lays Con Ed LILO to Rest

In an opinion that appears to close the door on lease-in, lease out (LILO) tax shelters once and for all, the Federal Circuit Court of Appeals reversed and remanded a case to the Court of Federal Claims, which had upheld the transaction (Consolidated Edison Co. of New York, No. 2012-5040 (Fed. Cir. 1/9/13)). In a departure from most recent case law, the lower court had held that the LILO transaction had economic substance and allowed Consolidated Edison (Con Ed) the rental deductions and interest expense it had claimed (Consolidated Edison Co. of New York, 90 Fed. Cl. 228 (2009); see previous Tax Matters coverage, “LILO Stands Up to Court Scrutiny,” Jan. 2010, page 61). This issue should not arise in the future because Sec. 470, which was enacted in 2004, specifically prohibits LILO transactions.

Con Ed, through a trust, entered an agreement with a Dutch utility to lease a 47.47% interest in an electric generating plant in the Netherlands and then sublease it back to the Dutch utility. If the Dutch utility did not exercise an option at the end of its sublease to purchase Con Ed’s remaining lease, Con Ed could either renew the sublease or require the Dutch utility to return its ownership interest in the Con Ed trust.

The IRS disallowed a claimed loss on the transaction, claiming the transaction lacked economic substance because Con Ed entered into it without any valid business purpose or reasonable expectation of making a profit beyond any tax benefits achieved. The Claims Court disagreed with the IRS and granted Con Ed’s refund claim. The government appealed.

The appeals court did not address the economic substance issue on which the lower court had based its decision and, instead, stressed that its recent decision in Wells Fargo & Co., 641 F.3d 1319 (Fed. Cir. 2011), compelled it to apply a substance-over-form analysis to Con Ed’s case. The Federal Circuit held that because there was undisputed evidence that the Dutch utility was reasonably likely to exercise the purchase option, the LILO transaction did not constitute a true lease, and Con Ed's rent deductions from the transaction should be disallowed.

The court applied a similar analysis to Con Ed’s deductions for interest expense from “loans” used to finance the transaction. According to the court, for the interest to be deductible, the loans must be genuine indebtedness. Finding that it was clear that the loans were not genuine indebtedness, the court held that Con Ed’s interest deductions from the LILO transaction should also be disallowed.

IRS: Reasonable Cause Requires Legal Inquiry

Although the Tax Court agreed with the IRS in Patel, 138 T.C. No. 23 (2012), that taxpayers improperly deducted the value of a house they donated to a fire department to burn for training, the court overturned the IRS’s imposition of an accuracy-related penalty against the taxpayers in the case.

In Action on Decision 2012-005 issued Jan. 17, the IRS said it will not acquiesce to the Tax Court’s finding in Patel that, with regard to the accuracy-related penalty under Sec. 6662, the taxpayers acted with reasonable cause and in good faith (see Tax Matters, “No Deduction for Bringing Down the House,” Oct. 2012, page 63).

On the charitable deduction, the court found that under state law, the taxpayers’ land included the house and any other structures and fixtures on it. Because the taxpayers retained title to the land after the fire department destroyed the house, if the donation was a real property interest at all, it was a partial interest. Finding that none of the categories qualifying as deductible contributions of partial interests in property under Sec. 170(f)(3)(B) applied, the court upheld the disallowance of the deduction.

Regarding the penalty, the court said that when the Patels filed the return at issue, in 2006, the legal issues were unsettled. In Scharf, T.C. Memo. 1973-265, the Tax Court had allowed a similar deduction, but for a contribution made before 1969, when Congress enacted the above restrictions on contributions of partial interests in property. After the Patels filed their return, the Tax Court held against taxpayers on similar facts in Rolfs, 135 T.C. 471 (2010), aff’d 668 F.3d 888 (7th Cir. 2012). Given the Patels’ facts and circumstances, including the uncertain state of the law at the time, the court said, they acted with reasonable cause and in good faith and were not liable for the penalty.

In the action on decision, the IRS said the court should not have concluded the uncertain state of the law was a factor supporting reasonable cause and good faith without considering whether the Patels investigated the current state of the law, including whether they sought competent professional advice. According to the IRS, “A taxpayer cannot act in good faith and have reasonable cause on the basis of the unsettled state of the law if the taxpayer was unaware of the state of the law and did not make reasonable attempts to become aware.”

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