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TAX MATTERS
IRS strikes out against Steinbrenner  
By Sharon Burnett, CPA, Ph.D. and Darlene Pulliam, CPA, Ph.D.
September 2013

In a family trust case, the U.S. District Court for the Middle District of Florida found in favor of the son of the New York Yankees' late owner, George Steinbrenner, by ruling that a claim for refund was timely filed and that the date of payment was the correct starting date for the statute of limitation. The court found that tax settlements made at the partnership level do not remain partnership items as they flow to other succeeding entities and mingle with other transactions and tax decisions.

Harold and Christina Steinbrenner were beneficiaries of a family trust that was an indirect partner in YankeeNets LLC through another partner, Yankees Holdings LP. In 2006, YankeeNets, Yankees Holdings, and the IRS settled a tax dispute over the tax treatment of a 2001 YankeeNets asset sale as a long-term capital gain. As part of the settlement, Yankees Holdings had to treat part of the long-term capital gain as ordinary income. The IRS formally accepted the settlement on March 1, 2007. In February 2008 the IRS adjusted YankeeNets’ partnership income for 2001 and 2002 and disallowed two deductions. A large net loss flowed through to the family trust for 2002. The IRS disallowed the distribution of the loss to the beneficiaries for 2002.

On Feb. 26, 2008, the IRS notified the Steinbrenners that they owed more than $500,000 in additional taxes for 2001. The additional taxes were paid in two payments in June and October 2008. The claim of refund in this case involves these two payments.

On June 3, 2009, the family trust amended the 2001 return and elected to carry back the net loss to that year that had been disallowed for distribution in 2002. On Aug. 14, 2009, the Steinbrenners claimed a refund from 2001 of about $585,000. In late December 2009 the IRS paid them a refund of $670,494 in tax and interest but then sued to recover it, stating that the refund claim had not been timely filed.

The primary issue was which statute of limitation applied—the general rules in Sec. 6511(a) or the more specific rules in Sec. 6511(g) for partnership items. If Sec. 6511(a) was correct, the two-year limitation window began on the date the tax was paid. If Sec. 6511(g) applied, then a claim of refund must have been filed two years from the date of the settlement (Sec. 6230(c)(2)(B)(i)). The settlement was entered into on March 1, 2007, so the Aug. 14, 2009, refund claim was late under Sec. 6230(c)(2)(B)(i). However, using the June and October 2008 payment dates as the starting point, the refund claim was well within the two-year time frame.

Sec. 6511(g) applies to any tax that is, or is attributable to, a partnership item. The trustee’s carryback of loss was not a partnership item under Sec. 6231(a)(3) since it was not “required to be taken into account for the partnership’s taxable year,” the court held. The IRS argued, however, that it was attributable to a partnership item, because “but for” the settlement agreement with Yankees Holdings (which determined the amount of partnership loss for YankeeNets in 2002) the overpayment of tax and refund claim would have never occurred.

The court rejected this argument as well, finding that there was no straight line of causation or attribution between the partnership item and the Steinbrenners’ refund. The chain of causation was interrupted, the court held, by the IRS’s independent action in denying distribution of loss by the trustee for 2002 and because the trustee had a choice among alternative courses of action (whether, for example, to contest the IRS’s determination for 2002 or carry back the loss to 2001 or to another year).

Next, the court considered the IRS’s alternative argument that the carryback was an “affected item” that was attributable to a partnership item. The court never explicitly decided whether the trustee’s loss carryback was an affected item, because the Taxpayer Relief Act of 1997, P.L. 105-34, removed the term “affected item” from Sec. 6230(d)(6). However, it determined that exception to the regular refund procedures in Secs. 6230(d)(6) and 6511(g) did not apply to affected items.

Finally, the court noted that a family trust beneficiary, not a partner, was claiming the refund. The beneficiary was not a party to the settlement, and the net loss carryback was not attributable to the Yankees Holdings settlement. The two-year settlement date limitation of Sec. 6230(c)(1)(B) was not applicable on its face or on the facts and circumstances of this action, the court held.

  Steinbrenner, No. 8:11-cv-2840-T-23AEP (M.D. Fla. 6/7/13)

By Sharon Burnett, CPA, Ph.D., associate professor of accounting, and Darlene Pulliam, CPA, Ph.D., Regents Professor and McCray Professor of Accounting, both of the College of Business, West Texas A&M University, Canyon, Texas.


TAX MATTERS
Vineyard and homes held unfeasible, erasing easement’s value  
By Charles J. Reichert, CPA
September 2013

The Tax Court disallowed a taxpayer’s charitable contribution deduction of a conservation easement because the taxpayer failed to show the easement had any value. According to the court, the taxpayer did not show that the highest and best use of the contributed property changed as a result of the contribution.

Taxpayers may deduct the fair market value of a conservation easement as a charitable contribution. Because comparable sales of easements are rare, the fair market value of an easement is often determined by comparing the fair market value of the property subject to the easement before and after the date the easement is created, considering its highest and best use. The highest and best use is its most profitable use and is presumed to be its current use. A proposed highest and best use may be used if the proposed use is reasonably probable in the near future, considering its economic feasibility and all existing laws and restrictions at the time of the contribution.

Michael Mountanos owned 882 acres of mostly undeveloped land in Lake County, Calif., which he used for recreational purposes. Because the property was landlocked, mostly by federal land managed by the Bureau of Land Management, access to the property required easements from the surrounding property owners. The Bureau of Land Management easement that provided access across the federal land restricted access to the property to single-family residential use. The property was also under a contract that limited its use and development under the Williamson Act, a California law designed to preserve agricultural and open space land. In 2005, Mountanos granted a conservation easement to the Golden State Land Conservancy and claimed a charitable contribution of $4,691,500 on his 2005 federal income tax return. The taxpayer deducted only $1,343,704 in 2005 because of the Sec. 170(b)(1)(B) limitation and carried the unused deduction over to his 2006, 2007, and 2008 returns. The IRS disallowed the deductions for 2006–2008, and the taxpayer petitioned the Tax Court for relief.

The taxpayer argued that the highest and best use of the property before the easement was as a 287-acre vineyard and a 595-acre residential development, and its highest and best use after the easement was as recreational property, resulting in a $4,691,500 difference in value. According to the court, neither the vineyard nor the residential development was a reasonably possible use of the property; therefore, neither could be the property’s highest and best use before the easement. Therefore, the easement had no value.  

The court held that a vineyard use was not reasonably probable because the taxpayer did not show that (1) the federal easement could be modified to permit access to a vineyard instead of single-family use, (2) there was enough water on the property to support a vineyard, (3) sufficient demand existed for 287 acres of vineyard-suitable property in Lake County, and (4) a vineyard was economically viable. In addition, the court held the property’s use as a subdivision was not reasonably probable in the near term, because such use would violate the Williamson Act.

The court also upheld the 40% gross valuation misstatement penalty for all three years, since Mountanos’s valuation of $4,691,500 was considered to be 400% or more of the correct valuation, in this case, zero.

  Mountanos, T.C. Memo. 2013-138

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


TAX MATTERS
IRS postpones employer health care penalty and information reporting  
By Sally P. Schreiber, J.D.
September 2013

The IRS postponed for one year the large-employer health care penalty and certain information-reporting rules that had been due to take effect starting Jan. 1, 2014. The delay was informally announced July 2 on a Treasury Department blog, followed a week later by Notice 2013-45, which postpones to 2015 the information-reporting rules under Secs. 6055 and 6056 and the Sec. 4980H shared-responsibility penalty, to give employers, insurers, and other providers more time to adapt their health coverage and reporting systems.

The transitional relief from information reporting under Sec. 6056 is expected to make it impractical to determine which employers owe shared-responsibility payments for 2014 under the employer shared-responsibility provisions. Accordingly, the IRS will not assess any employer shared-responsibility payments for 2014.

The postponement will have no effect on other provisions of the Patient Protection and Affordable Care Act, P.L. 111-148. These include the availability of the premium tax credit under Sec. 36B, which assists certain low- and moderate-income individuals who enroll in a qualified health plan through a health insurance exchange (and who are not eligible for employer coverage that is affordable and provides minimum value) in paying their premiums. It also does not affect the individual mandate under Sec. 5000A, which imposes a penalty on individuals who do not have minimum essential coverage and will apply, as scheduled, beginning in 2014 (see “Line Items: IRS Issues Guidance on Minimum Essential Health Coverage, Shared-Responsibility Penalty").

Treasury expects to publish proposed regulations implementing the Sec. 6055 information-reporting requirements for insurers, self-insuring employers, and other parties that provide health coverage, and the Sec. 6056 information-reporting requirements for employers that provide health coverage to their full-time employees. The proposed rules will reflect the transitional relief for the information-reporting rules for 2014.

Although the effective date for these provisions will be 2015, the government will encourage voluntary compliance in 2014 to prepare for full application of the rules in 2015 and allow “[r]eal-world testing of reporting systems and plan designs.” In the meantime, the IRS wants additional time to discuss the reporting requirements with stakeholders to enable it to simplify the requirements while ensuring that the law is being implemented effectively.

  Notice 2013-45

By Sally P. Schreiber, J.D., a JofA senior editor.


TAX MATTERS
Line items  
September 2013

Final Rules Issued on Accelerated Recognition of Deferred COD Income

The IRS issued final regulations on the rules to accelerate cancellation of debt (COD) income that taxpayers elected to defer over a five-year period when an applicable debt instrument was reacquired by the issuer or a related party in 2009 or 2010 (T.D. 9622 and T.D. 9623). An applicable debt instrument is one issued by a C corporation or any other person in connection with a trade or business that person conducts (Sec. 108(i)(3)).

These deferral rules were enacted by the American Recovery and Reinvestment Act of 2009, P.L. 111-5, to assist businesses having difficulties during the recession. Once an acceleration event occurs, however, taxpayers that elected to defer this income must recognize it. The regulations the IRS issued govern those accelerations.

T.D. 9622, which contains the rules that apply to C corporations, finalizes without any substantive changes temporary regulations (T.D. 9497) issued in 2010, while T.D. 9623 finalizes temporary rules (T.D. 9498) that apply to S corporations and partnerships, with some changes from the temporary regulations.

The regulations under T.D. 9622 require acceleration of deferred COD income by C corporations where the corporation:

  • Changes its tax status;
  • Ceases its corporate existence in a transaction to which Sec. 381(a) (corporate acquisition rules) does not apply; or
  • Engages in a transaction that impairs its ability to pay the tax liability associated with the deferred COD income.


Changes in the final regulations under T.D. 9623 include an example of how Sec. 108(i)(6) applies when partners must recognize deferred amounts under Sec. 752(b). The other change is to a section that excepts from the acceleration rules certain distributions to provide that the exception will not apply if the electing partnership has terminated.

IRS Issues Guidance on Minimum Essential Health Coverage, Shared-Responsibility Penalty

The IRS this summer issued Notice 2013-41, which defines minimum essential coverage under certain government health plans and other coverage for purposes of the Sec. 36B premium tax credit, and Notice 2013-42, which provides relief from the shared-responsibility penalty under Sec. 5000A for individuals who are eligible for coverage in plans that are not on a calendar year.

Notice 2013-41 announces newly finalized regulations published by the secretary of Health and Human Services (HHS) on June 26, which state that high-risk pools and self-funded health coverage that universities offer to students qualify as minimum essential coverage for a one-year transitional period in 2014. For plan years beginning on or after Jan. 1, 2015, sponsors of these plans must apply to HHS to have their coverage recognized as minimum essential coverage.

The notice also explains that individuals who qualify for the Children’s Health Insurance Program (CHIP) or Medicaid, both of which require participants in some states to pay premiums, are considered not eligible for health coverage subsidized by the premium tax credit during the “lockout” period during which they are not eligible to re-enroll in either program after they have failed to pay their premiums. However, individuals who are not eligible for CHIP because they must wait out an eligibility period are treated as not eligible for minimum essential coverage and therefore qualify for the tax credit.

In addition, the notice addresses coverage under certain government programs including Medicaid or Medicare.

Individuals also are considered to have minimum essential coverage under the following health care plans:

  • Medicare Part A coverage that requires premium payments;
  • State high-risk pools;
  • Student health plans; and
  • TRICARE military coverage.


For individuals whose employers’ health insurance plans are not on a calendar year, Notice 2013-42 provides transitional relief from the shared-responsibility penalty under Sec. 5000A if the employee chooses not to enroll in the employer's plan for the 2013–2014 plan year.

Noted in Passing

The IRS will no longer issue “comfort ruling” letters in most cases on whether transactions qualify for nonrecognition treatment under Sec. 332, 351, 355, or 1036 or as tax-free reorganizations under Sec. 368. Rev. Proc. 2013-32, issued June 25, stated that to conserve agency resources, the IRS is restricting such letter rulings to those involving “significant issues.” The revenue procedure did not define or give an example of a significant issue for this purpose, but it stated a change of circumstances arising after a transaction has been completed would not ordinarily be a significant issue, nor would most issues of fact that do not also present an issue of law. The revenue procedure amplifies and modifies Rev. Procs. 2013-1 and 2013-3 and applies to all ruling requests postmarked or, if not mailed, received after Aug. 23, 2013.

The AICPA Tax Executive Committee, in comments on proposed regulations (REG-130507-11) for the Sec. 1411 net investment income tax, made several general recommendations and 16 detailed ones suggesting areas for clarification and additional guidance. They include how to determine when income is derived “in the ordinary course of a trade or business” and thus exempt from application of the 3.8% tax. The letter is available at tinyurl.com/pdqjf3b.

The Eleventh Circuit affirmed the Tax Court’s holding that a poultry processor could not unilaterally change its purchase price allocations from two asset purchase agreements to allocations from a later cost-segregation study (Peco Foods, Inc., No. 12-12169 (11th Cir. 7/2/13), aff’g T.C. Memo. 2012-18; discussed in “Side Effects of Cost Segregation,” JofA, April 2012, page 48).


TAX MATTERS
IRS acquiesces to broader Tax Court review of innocent spouse cases  
By Dayna E. Roane, CPA/ABV, M.Tax.
September 2013

In a favorable development for taxpayers seeking innocent spouse equitable relief, the IRS announced that it will acquiesce to a Ninth Circuit holding (Wilson, 705 F.3d 980 (9th Cir. 2013), aff’g T.C. Memo. 2010-134) that allowed the Tax Court to consider newly developed information during trial. The IRS had argued previously that innocent spouse equitable relief cases should be tried based solely on information developed during the IRS’s administrative process.

Sec. 6015 affords relief from joint and several liability on a joint return to certain spouses and lays out the conditions under which this relief may be granted. Sec. 6015(e) allows the Tax Court to determine appropriate relief for an individual once a deficiency has been asserted under the general provisions of Sec. 6015(a) or in cases of an understatement of tax under Sec. 6015(b). In addition, taxpayers seeking equitable relief under Sec. 6015(f) may, under certain conditions, seek review by the Tax Court.

In this case, Karen Wilson, a high-school-educated clerk, petitioned the court to be relieved of self-reported liabilities resulting from her ex-husband’s Ponzi scheme. The IRS had denied Wilson’s request for equitable relief because, it contended, the fact that there was an outstanding balance owed on the couple’s 1998 return when they filed their 1999 return showed she did not reasonably believe the tax would be paid (a factor weighing against relief under Rev. Proc. 2000-15). At the time of her appeal hearing she was still living with her husband (although she had begun divorce proceedings) and did not respond to an Appeals officer’s requests for additional information. At the Tax Court trial, Wilson was allowed to provide additional testimony that convinced the court that relief from the joint liability was appropriate.

The IRS appealed, arguing that the court should apply an abuse-of-discretion standard of review and should not look outside the administrative record. The Ninth Circuit, however, noted that Sec. 6015(f) requires the Tax Court to take into account all facts and circumstances, and that previous cases (e.g., Porter, 130 T.C. 115 (2008) and 132 T.C. 203 (2009)) established that the court could weigh facts not considered during the original administrative process. The Eleventh Circuit reached the same conclusion in 2009, taking the broad view that a taxpayer is not appealing the IRS’s Sec. 6015(f) decision to the Tax Court but that the taxpayer is seeking Sec. 6015(e) relief from the Tax Court (Neal, 557 F.3d 1262 (11th Cir. 2009)). Thus, the court is not reviewing the IRS’s determination but making an independent determination that begins anew in the courtroom.

The IRS Office of Chief Counsel issued memorandum CC-2013-011 advising IRS attorneys to no longer argue that the Tax Court should apply an abuse-of-discretion standard of review or limit its review in innocent spouse cases to evidence in the administrative record. Attorneys should, however, “work with petitioners to stipulate to evidence in the administrative record that is relevant to the court’s determination. …”

This Action on Decision allows welcome flexibility to a taxpayer pursuing innocent spouse relief, especially in cases where spousal abuse and ongoing marital litigation is a factor.

  IRS Action on Decision 2012-07

By Dayna E. Roane, CPA/ABV, M.Tax., Perry & Roane PC, Niwot, Colo.


TAX MATTERS
No constructive dividend from services rendered at cost  
By Janet A. Meade, CPA, Ph.D.
September 2013

The Tax Court held that the sole owner of a construction corporation did not receive a constructive dividend in the amount of forgone profit when the corporation built a lakefront home for him and his wife at cost. The shareholder fully reimbursed the corporation for its costs, including overhead, and no corporate assets were diverted to or for his benefit. The court found that the corporation’s failure to charge the shareholder an amount equal to its customary profit margin was not a constructive dividend because it did not result in a distribution of property that reduced earnings and profits.

Sec. 316(a) defines a dividend as any distribution of property by a corporation to its shareholders out of earnings and profits. Sec. 301(b) provides that the amount of the distribution is equal to the distributed property’s fair market value on the distribution date. Case law has established that services provided by a corporation to its shareholders may, in some situations, constitute property. A constructive dividend arises when a corporation confers an economic benefit on a shareholder without the expectation of repayment.

Terry Welle was the sole owner of TWC, a construction company specializing in multifamily housing projects. In 2004, Welle and his wife began construction of a second home on lakefront property in Detroit Lakes, Minn. To keep track of material and other construction costs, Welle had TWC open a “cost plus” job account on its books. The Welles, however, acted as their own general contractor during construction, and they personally contacted all the subcontractors and vendors who built or supplied materials for the home.

During construction, TWC paid the subcontractors and vendors directly, and its crew framed the home. The Welles reimbursed TWC for the cost of its services, including overhead, but they did not pay the customary 6% to 7% profit margin that TWC used to calculate the contract price charged to unrelated customers. The IRS contended that Welle received a constructive dividend from TWC when it built the lakefront home for him without charging its standard profit margin.

In determining whether Welle received a constructive dividend equal to the forgone profit on construction of the home, the court looked at the benefit conferred on Welle by TWC and whether this benefit constituted a distribution of property that reduced the corporation’s earnings and profits. The court found that Welle at most used TWC as a conduit in paying subcontractors and vendors and that he fully reimbursed the corporation for all costs, including overhead, associated with the limited services he received from corporate employees. Thus, the provision of the services to Welle without charging the customary profit margin did not result in a distribution of property that reduced current or accumulated earnings and profits, as required by the Sec. 316(a) definition of a dividend. The court therefore concluded that Welle did not receive a constructive dividend when TWC provided services to him at cost because the reimbursement arrangement did not operate as a vehicle for the distribution of TWC’s earnings and profits.

  Welle, 140 T.C. No. 19 (2013)

By Janet A. Meade, CPA, Ph.D., associate professor, University of Houston.


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