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2008 Federal Tax Update: The Calm Before the Storm Rick J. Taylor, CPA

2008 Federal Tax Update: The Calm Before the Storm Rick J. Taylor, CPA

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2008 Federal Tax Update: The Calm Before the Storm Rick J. Taylor, CPA

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  1. 2008 Federal Tax Update: The Calm Before the Storm Rick J. Taylor, CPA 2008 Federal Tax Update: The Calm Before the StormRick J. Taylor, CPA

  2. All page numbers refer to Parts 1 and 2 of “2008 Federal Tax Update: The Calm Before the Storm” (November 6 and November 19, 2008; 227 pages) Rick J. Taylor. If you would like a copy of the entire outline, please send an email request – rtaylor@wipfli.com

  3. FIN 48 Delayed One More Year • The Financial Accounting Standards Board (FASB) has granted to all nonpublic entities a one-year deferral on implementing FIN 48 until fiscal years beginning after Dec. 15, 2008. Decrease in FMV of assets. • P. 195

  4. S Corp Open Account Debt • T.D. 9428, 10/17/2008; Reg. § 1.1367-2, Reg. § 1.1367-3. • Final regulations that limit open account debt and the basis adjustments for an S corporation's debt to its shareholder under Code Sec. 1367(b)(2). • $25,000 aggregate principal threshold amount per shareholder for open account debt. • P. 195

  5. Forgo Bonus and Accelerated Depreciation • Rev Proc 2008-65, 2008-44 IRB • Guidance on recently enacted Code Sec. 168(k)(4), which allows corporations to elect to treat certain unused research and alternative minimum tax (AMT) credits as refundable in lieu of claiming bonus and accelerated depreciation for “eligible qualified property.” • Elect to forgo bonus and accelerated depreciation and then will be able to claim unused credits from tax years beginning before Jan. 1, 2006. • P. 196

  6. Bad Loans Not Subject to 382 • Notice 2008-83, 2008-42 IRB. • For purposes of Code Sec. 382(h), any deduction properly allowed after an ownership change (as defined in Code Sec. 382(g)) to a bank with respect to losses on loans or bad debts (including any deduction for a reasonable addition to a reserve for bad debts) will not be treated as a built-in loss or a deduction that is attributable to periods before the change date. • P. 199

  7. Key Provisions - Bailout Bill • AMT exemption amounts for 2008 are increased to $46,200 for unmarrieds, to $69,950 for joint filers, and to $34,975 for marrieds filing separately • Research credit is retroactively extended to apply to amounts paid or incurred after Dec. 31, 2007 and before Jan. 1, 2010 • Alternative simplified research credit is increased to 14% for tax years ending after Dec. 31, 2008 (remains at 6% if no history) • Rule allowing tax-free treatment of IRA distributions donated to charity is extended to 2008 and 2009 • More-likely-than-not standard for preparer penalty for understatements due to unreasonable positions is replaced by substantial authority standard, except for tax shelters and reportable transactions • Most new farming machinery and equipment placed in service during calendar year 2009 is designated as MACRS 5-year property • P. 211- 227

  8. Key Provisions - Farm Bill • Two-year extension for favorable tax treatment (50% rather than 30% limit) of capital gain property donated for qualified conservation. • Limitation on deduction of farm losses. • Dollar thresholds for optional methods of computing net earnings from self-employment are increased and indexed. • Voluntarily pay SE tax to get increased SE benefits. • Added tax more than offset by benefit of earned income credit. • P. 201- 204

  9. Key Provisions - Housing Act • First-time homebuyers temporary refundable tax credit equal to 10 percent of the purchase price of a home, up to $7,500 ($3,750 for married individuals filing separately). • The credit begins to phase out for taxpayers with adjusted gross income in excess of $75,000 ($150,000 in the case of a joint return). • The credit is effective for homes purchased on or after April 9, 2008, and before July 1, 2009. • Unlike other credits, however, the first-time homebuyer credit must be repaid in equal installments over 15 years, essentially making it an interest-free loan from the government for most qualifying homeowners. • P. 205 - 211

  10. Favorable PAL Grouping • Candelaria v. United States, No. EP-06-CV-0126-KC (W.D. Tex. 10/5/07). • Real estate activity may be grouped with trade or business. • Reg. §1.469-4(c) provides that one or more trade or business activities or rental activities may be treated as a single activity if the activities constitute an “appropriate economic unit.” • P. 1

  11. IRS Ruling on Favorable PAL Grouping • TAM 200747018. • Truck leasing activity engaged in by a QSUB is a rental activity under §469, but it may be grouped with the trade or business activities of the S corporation’s other QSubs. • Since the S corporation’s shareholder materially participated in these other trade or business activities, the passive activity loss limitations did not apply to the rental activity. • P. 34

  12. “Item” Narrowly Defined • Capital One Financial Corporation v. Commissioner, 130 T.C. No. 11 (5/22/08). • Credit card issuer may not retroactively change its method of accounting for late-fee income on credit cards. • Excellent discussion of “item” which was narrowly defined. • Can adopt any acceptable method when encounter new “item.” • P. 3

  13. Accounting Method Rev. Proc. Upheld • Lehrer v. Commissioner, No. 06-75584 (9th Cir. 5/23/08). • The Ninth Circuit affirmed the Tax Court's denial of taxpayer’s attempted late mark-to-market election. • Rejected argument Rev. Proc. 99-17 is not an agency pronouncement carrying the force of law. • Taxpayer’s position that such an election can be made at any time after the relevant returns are filed, without seeking or qualifying for an extension, was unreasonable. • P. 4

  14. §481(a) Adjustment is BIG • MMC Corporation v. Commissioner, T.C. Memo 2007-354 (11/29/07). • Positive §481(a) adjustment resulting from change from mark-to-market method required under the 1998 RRA, was recognized built-in gain under §1374. • Incorrect decision. • If a change in method of accounting is from one permissible method of accounting to another permissible method (other than a change from cash to accrual method), the resulting §481(a) adjustment should not be built-in gain, by application of the accrual-method rule, even if the §481(a) adjustment relates to amounts attributable to a C year. • P. 4

  15. Investment Sub Respected • PSB Holdings, Inc. v. Commissioner, 129 T.C. No. 15 (11/1/07). • Bank is not required under §§265(b) and 291 to include a subsidiary investment company's tax-exempt obligations that were purchased and owned by the subsidiary, in calculating the bank's average adjusted bases of tax-exempt obligations. • IRS has indicated it intends to issue regulations that would require non-financial institution subsidiaries to be taken into account for purposes of §265(b) calculations. • P. 6

  16. §108(e)(5) is a Narrow Exception • Payne v. Commissioner, T.C. Memo. 2008-66 (3/18/08). • A taxpayer received cancellation of indebtedness income when he settled with a bank for less than the amount owed on his credit card. • Court refused to allow use of purchase money indebtedness exception included in §108(e)(5). • P. 6

  17. No Deduction for Loss of Customers • Technicolor USA Holdings, Inc. v. Commissioner, No. 07-2398 (3d Cir. 7/28/08). • A corporation could not take a deduction for the loss of relationships with its film processing customers because the client relationships had no useful life and, therefore, had a zero basis. • Valuation was not considered credible. • P. 7

  18. Ordinary Loss Abandonment Securities • T.D. 9386, 2008-16 I.R.B. (4/21/08). • Final regulations clarifying the tax treatment of losses from abandoned stock or securities under §165(g). • Loss established by the abandonment of a security that is a capital asset is treated as a loss arising from the sale or exchange of a capital asset on the last day of the tax year, unless §165(g)(3) (relating to certain worthless securities in a corporation affiliated with the taxpayer) applies. • Abandonment requires that the taxpayer permanently surrender and relinquish all rights in the security for no consideration. • P. 11

  19. Escrow Account Taxable Currently • T.D. 9413, 73 Fed. Reg. 39,614 (7/10/08). • Final regulations under §468B on the taxation of income earned on escrow accounts, trusts, and other funds used during deferred exchanges of like-kind property under §1031, and under §7872 on the treatment of below-market loans associated with like-kind exchanges. • Interest on a taxpayer's exchange funds is taxable in the year earned or credited, instead of when the interest is paid. • P. 12

  20. Rebates Reduce Gross Income • Rev. Rul. 2008-26, 2008-21 I.R.B. 985. • Medicaid rebates paid by a pharmaceutical manufacturer to a state Medicaid agency are adjustments to the sales price in calculating gross income. • Price adjustment is not an ordinary and necessary business expense. Instead, it is a deduction in arriving at gross income. • Lack of guidance as to the timing of recognition. • P. 15

  21. §118 Change is Account Method Change • Rev. Rul. 2008-30, 2008-25 I.R.B. 986. • Public utility’s change from treating payments received from customers as non-taxable contributions to capital to treating the payments as taxable customer connection fees is a change in method of accounting requiring the consent of the IRS. • Change only applies to timing differences and not something that results in permanent difference. • P. 16

  22. Pending Nonautomatic Changes • Rev. Proc. 2007-67, 2007-48 I.R.B. 1072. • Procedures for obtaining IRS consent to change an accounting method where a filed Form 3115, Application for Change in Accounting Method is pending in the National Office. • IRS acknowledgment that nonautomatic changes are taking too long and causing problems for taxpayers. • P. 17

  23. Safe-harbor §1031 Qualification • Rev. Proc. 2008-16, 2008-10 I.R.B. 547. • Safe harbor under which IRS will not challenge whether a dwelling unit qualifies as property held for productive use in a trade or business or for investment for purposes of §1031. • Relinquished property and replacement property owned for 24 months. • For 12 months before and after, property is rented to third party for FMV rental for at least 14 days. Personal days cannot exceed more than 14 days or 10% of days rented. • P. 18

  24. Accelerate FICA, FUTA and SUTA • Rev. Proc. 2008-25, 2008-13 I.R.B. 686. • Safe harbor method of accounting for taxpayers using an accrual method of accounting and incurring FICA and FUTA liabilities. • Automatic consent procedures to change to the safe harbor method of accounting. • §19.04 of the Appendix in Rev. Proc. 2008-52 extends the treatment to SUTA as well. • P. 21

  25. Automatic Method Changes • Rev. Proc. 2008-52 makes a number of significant changes to Rev. Proc. 2002-9 including: • Amplification of the requirements for a complete application (e.g., Form 3115); • Increase in number of changes qualifying for automatic change; • Clarifies need to include UNICAP considerations in determination of §481(a) adjustment; • P. 23

  26. Fiscal Yr Trap §179 Expense Confirmed • Rev. Proc. 2008-54, 2008-38 I.R.B. 722. • Increased §179 expensing election applies on a fiscal year basis. • Bonus depreciation applies on a calendar year basis. • Utilization of increased §179 deduction by fiscal year passthrough entity can result in loss of §179 deduction. • Fix by electing or revoke election on amended return. • P. 27

  27. Ptrship Exchange Qualifies for §1031 • PLR 200807005. • A taxpayer's receipt of all the interests in a partnership holding real property, through a disregarded entity created by the taxpayer to receive the real property, will qualify for like-kind exchange treatment. • This is the first ruling IRS addressed a taxpayer’s acquisition of 100% of the interest in a “regarded” partnership that holds replacement property for purposes of §1031. • Reinforces Rev. Rul. 99-6 (i.e., the acquirer is treated as acquiring the partnership property directly from the partners). • Taxpayer limited partner; SMLLC general. • P. 29

  28. Bank Not Disqualified Person • PLR 200803003 and 200803014. • A proposed qualified intermediary (QI) (that is a bank as defined in §581) will not be a “disqualified person” under Reg. §1.1031(k)-1(k), because the QI and its controlled group members provide investment advisory, brokerage, private planning, insurance, trust, and retail banking services for the proposed QI’s customers and clients. • P. 29

  29. Development Rights Like Kind Property • PLR 200805012. • A taxpayer's exchange of a parcel of real property for development rights was considered a like-kind exchange. • Development rights were real property under local law. • P. 30

  30. Incentive Payments Not Income • PLR 200816027. • Customers who received payments for participating in a promotion did not have to include the payments in their gross incomes because the payments represent a reduction in the purchase price. • P. 31

  31. Extension Documenting Success Fees • PLR 200817010. • Taxpayers granted extension to complete success-based fees documentation. • §263(a) and Reg. §1.263(a)-5(a) require capitalization of amts paid to facilitate acquisition transactions. • Under a special exception, success fee is an amount paid to facilitate the transaction except to the extent the taxpayer maintains sufficient documentation to show that a portion of the fee is allocable to activities that do not facilitate the transaction. • The documentation must be completed on or before the due date of the taxpayer’s timely filed original federal income tax return (including extensions) for the tax year during which the transaction closes. • P. 31

  32. All Events Test Not Met • CCM 200835019. • An accrual-based retailer could not treat its cash rebate liability as incurred on the date the product was sold to a customer because the liability was not fixed until the customer later mailed a properly completed rebate form with the necessary attachments. • P. 32

  33. Loss for Abandoned Transaction • TAMs 200749013 and 200749014 • §165 loss deduction allowed for transaction costs of abandoned transactions. • When a taxpayer investigates and pursues multiple separate transactions, costs properly allocable to any abandoned transactions are deductible even if some transactions are completed. • If the proposals are mutually exclusive alternatives, then no abandonment loss is proper unless all transaction proposals are abandoned. • Demonstrates IRS’ narrow view of what constitutes non-mutually exclusive transactions. • P. 35

  34. IRS Attacks Tool Reimbursement • CCA 200745018. • Tool reimbursement plan that recharacterized wages failed the business connection, substantiation, and return of excess payment requirements for an accountable plan and might have demonstrated a pattern of abuse. • In Rev. Rul. 2005-52, 2005-2 CB 423, IRS also attacked a tool allowance plan paid to auto mechanics based on estimated, rather than actual expenses, finding it failed the substantiation and return of excess payment requirements. • P. 35

  35. Ethanol Property 7 Yr • CCA 200835032 revoking CCA 200814025. • Earlier this year, IRS released CCA 200814025 that concluded assets used in an integrated facility for converting corn to bioethanol should be depreciated over seven years rather than over a five-year MACRS recovery period. • While Chief Counsel has withdrawn its memo, this appears to be for procedural rather than substantive reasons. • Published guidance will indicate that 7 yrs is correct. • P. 35

  36. Expansive §1031 Ruling • CCA 200836024. • Taxpayer may engage in a reverse like-kind exchange and a traditional deferred like-kind exchange using the same relinquished property in both exchanges. • P. 36

  37. Gift Card Income Mismatch • LAFA20082801F. • A subsidiary that managed corporation's gift card sales had income from the sale of those gift cards when its right to the sale proceeds was fixed and the amount could be determined with reasonable accuracy. • This occurred when the gift cards were purchased by a customer or reloaded by the subsidiary or a retail store. • The subsidiary could deduct the expense of the redeemed card when economic performance occurs, i.e., when the gift card customers redeemed the gift cards. • P. 37

  38. Location Incentives • Coordinated Issue Paper All Industries—State and Local Location Tax Incentives (LMSB-04-0408-023, 5/23/2008). • Location tax incentive, whether in the form of an abatement, credit, deduction, rate reduction, or exemption, is not an item of gross income under §61. • Incentive is a reduction of state or local tax expense. • Applies whether the taxpayer first pays the tax and then receives a rebate or refund, or pays the net. • Location tax incentive is not a nonshareholder contribution to capital under §118 that reduces a taxpayer's basis in assets under §362(c). • P. 38

  39. Charitable Contributions Challenged • Bergquist v. Commissioner, 131 T.C. No. 2 (7/22/08). • The Tax Court slashed the charitable contribution deductions claimed by a group of doctors and hit them with an accuracy-related penalty for gross valuation misstatements. • Doctors could not avoid penalties by relying on appraisal because the planned from the beginning to donate the stock on the brink of the consolidation as a way to reap a potential windfall. • Moreover, the court said that the doctors' knowledge of the letter from the tax-exempt entity, the fact that they were advised not to bring their own tax advisers to the stockholders meeting, and were directed to withhold information from their own tax advisers, should have put them on notice as to the inaccuracy of the claimed donations. • P. 41

  40. Business Use Required for §179 • Birdsill v. Commissioner, T.C. Summary 2008-55 (5/20/08). • Taxpayer was subject to recapture of §179 expense because he failed to comply with the strict substantiation requirements to prove that he used a vehicle more than 50 percent of the time for business. • P. 42

  41. Travel Expense Denied • Burski v. Commissioner, T.C. Summary 2007-212 (12/17/07). • The term “home” means a taxpayer’s principal place of business and not where the taxpayer’s personal residence is located, if different from the principal place of business. • An exception to the rule exists when a taxpayer accepts work away from the taxpayer’s personal residence and the work is temporary rather than indefinite (1 year or less). • P. 43

  42. Travel Expense Denied – 2 • Cornelius v. Commissioner, T.C. Summary 2008-42 (4/23/08). • Taxpayer could not deduct travel and meal expenses for work assignments in other cities because he was in each city for more than one year; however, a moving expense deduction could be appropriate. • P. 43

  43. Travel Expense Allowed • Estate of Lease v. Commissioner, T.C. Summary 2008-11 (1/30/08). • A millwright who had to find jobs far from his usual work area when work was scarce was entitled to a travel expense deduction for travel costs to the farther locations. • P. 45

  44. Travel Expense Denied - 3 • Walker v. Commissioner, T.C. Summary 2008-41 (4/22/08). • A Union electrician who worked sporadically up and down the east coast could not deduct his meals and lodging expenses as business expenses incurred while traveling away from home because they related to a period for which he had no tax home. • Taxpayer found to have no tax home. • P. 66

  45. Travel Expense Denied - 4 • Yanke v. Commissioner, T.C. Memo 2008-131 (5/15/08). • An individual who was training to become a journeyman electrical power lineman could not deduct expenses for travel, meals, and lodging relating to his training in California because he lacked a business reason for maintaining a tax home in another state. • Taxpayer did not have a reasonable business reason or justification for maintaining a tax home in Boise. • According to the court, when taxpayer enrolled in the lineman training program, he knew that for the next 3-1/2 years he would be working with contractors only in California and/or Nevada. • P. 68

  46. Leasing Arrangement Ignored • Doyle v. Commissioner, T.C. Summary 2008-107 (8/21/08). • Married taxpayers could not claim Schedule C deductions with respect to their claimed business of leasing out a truck where the lease agreement was really a financing arrangement that merely served to pass money between the bank and the supposed truck lessor. • IRS attack probably inspired by fact lease was to taxpayer’s father. • P. 44

  47. No Deduction for Alimony • Emmel v. Commissioner, T.C. Summary 2007-205 (12/6/07). • Payments a taxpayer made to his estranged wife under an oral agreement are not deductible as alimony because they were not required by a written divorce or separation instrument. • A divorce or separation agreement must be made in writing. A payment made pursuant to an oral agreement is not a payment made pursuant to a divorce or separation instrument unless there is some type of written instrument memorializing the agreement. • P. 45

  48. No Deduction for Alimony - 2 • Katchmeric v. Commissioner, T.C. Summary 2007-213 (12/19/07). • An individual was not entitled to an alimony deduction for payments made to his ex-wife before the entry of an order providing for alimony because the payments were not made pursuant to a written separation agreement. • P. 52

  49. No Deduction for Alimony - 3 • Rafferty v. United States, No. 07-cv-00903-EWN-BNB (D. Colo. 7/8/08). • A district court held that an ex-husband was not entitled to an alimony deduction for payments he deposited into the couple’s joint bank account after they separated because the amounts were paid prior to the execution of a written divorce or separation agreement. • P. 64

  50. No Deduction for Alimony - 4 • Raga v. Commissioner, T.C. Summary 2008-46 (4/29/08). • Unallocated payments an individual received from her ex-husband were alimony includible in her income because state law provided that the ex-husband's obligation to make the payments would end on her death. • P. 64