Tax Relief Blog

Ability to pay tax liability not relevant to determination of willfulness under Code Sec. 7202

U.S. v. Easterday (2008, CA9) 102 AFTR 2d ¶ 2008-5218

By a vote of two to one, a Ninth Circuit panel decision has upheld a district court's ruling that a defendant's ability to pay wasn't relevant to the determination of whether he willfully failed to collect or pay over tax under Code Sec. 7202. In so doing, the Ninth Circuit effectively repudiated a decision it handed down over 30 years ago on the issue of willfulness.

Background. Under Code Sec. 7202, a person who willfully fails to collect, truthfully account for, and pay over any tax is subject to criminal prosecution for a felony. The term "person" includes corporate officers and employees and partnership members and employees who, as such, are under a duty to collect and pay over withholding taxes.

Facts. Jack Easterday operated a chain of nursing homes in Northern California through a parent corporation (Employee Equity Administration, or EEA) and its subsidiaries. Between '98 and 2005, the total payroll tax liability for EEA and its subsidiaries was $44,864,162, of which $26,018,869 was paid. Although the companies' tax filings accurately stated their tax liabilities, Easterday, through the corporation, repeatedly failed to pay over to IRS the full amount of payroll taxes due. Although Easterday was cooperative with IRS and took full responsibility for the tax delinquency, his pattern of nonpayment continued. IRS sent Easterday's companies numerous notices requesting payment of the delinquent taxes. When those notices did not result in payment, IRS sent notices informing the companies of an intent to levy against their assets. IRS assessed liens against corporate accounts, but when payment was still not forthcoming, it eventually filed criminal charges. In 2005, Easterday was charged with 109 counts of failure to pay over taxes in violation of Code Sec. 7202, with each count representing a different quarter in which the taxes of EEA and its subsidiaries were deficient.

Before a district court, Easterday did not dispute that he failed to pay the taxes when due. His defense was simply that he lacked the financial ability to comply with his tax obligations. Witnesses testified that the nursing homes were struggling financially and he had trouble paying the bills, and that Easterday did not pay the payroll taxes because he used the money to pay other company bills in order to keep the nursing homes operational.

Easterday asked the district court to instruct the jury that to prove a willful failure to pay taxes, IRS had to prove that at the time the taxes were due, the taxpayer had the funds, and hence the ability to pay the obligation. Easterday's argument rested on U.S. v. Poll (1975, CA9) 36 AFTR 2d ¶ 75-5470, in which the Ninth Circuit held that a taxpayer's financial circumstances are relevant to the proof of willfulness under Code Sec. 7202. To establish willfulness, the Ninth Circuit held that IRS must show beyond a reasonable doubt that, at the time payment was due, the taxpayer had sufficient funds to enable him to meet his obligation or that the lack of sufficient funds on such date was created by, or was the result of, a voluntary and intentional act without justification in view of all the financial circumstances of the taxpayer. The court's holding was based on its belief that willfulness requires an evil motive or improper purpose.

The district court declined to give this instruction, on the ground that Poll had been repudiated by the Supreme Court's decision in U.S. v. Pomponio, 429 US 10 (1976) 38 AFTR 2d ¶ 76-5905. There, the Supreme Court ruled that willfulness in the context of the tax laws "simply means a voluntary, intentional violation of a known legal duty;" there is no requirement the government prove evil motive or improper purpose and want of justification. The court instructed the jury that the tax laws "do not permit an employer to choose to use the monies held in trust for the United States for other purposes, such as to pay business expenses." Following a six-day jury trial, Easterday was found guilty on 107 of 109 counts and sentenced to prison. He appealed to the Ninth Circuit, on the ground that the district court erred in declining to give the jury the Poll "ability to pay" instruction he requested.

Poll repudiated. Agreeing with the district Court, the Ninth Circuit held that the portion of its decision in Poll "which created an additional requirement of proving ability to pay has been undermined by the Supreme Court's subsequent decision in Pomponio. " The Ninth Circuit held that "insofar as Poll may be interpreted as requiring the government, in a failure to pay case under Code Sec. 7202, to prove that defendant had the money to pay the taxes when due, and allowing the defendant to defend on the ground that he had spent the money for other expenses, Poll is inconsistent with Pomponio. It is also inconsistent with common sense," because it would allow individuals to escape prosecution for willfully paying tax by dissipating their assets and asserting they had no assets to satisfy the debt.

The Ninth Circuit said that although it hasn't explicitly overruled Poll since it was issued, in the tax field "it now exists only as a nearly completely buried obstacle to traffic that generally has run over it or passed it by for more than thirty years." Poll wasn't consistent with the intervening authority of the United States Supreme Court that must control in Easterday's case.

The Ninth Circuit also concluded that it wasn't necessary to convene an en banc court to hold that its earlier Poll panel opinion was no longer binding authority for the proposition that a defendant's ability to pay his tax liability is relevant to the determination of willfulness under Code Sec. 7202.

A dissenting judge disagreed with the majority on procedural as well as substantive grounds.

Do you have a tax debt and can not pay? You have rights and options to settle your tax account. Contact us today to resolve your tax problems.

IRS Fact Sheet reviews whether a hobby is actually a for-profit endeavor [Fact Sheet 2008-23]:

Taxpayers must follow appropriate guidelines when determining whether an activity is engaged in for profit, such as a business or investment activity, or is engaged in as a hobby, IRS said in a new fact sheet published on the agency's Web site.

As described in the fact sheet, Code Sec. 183 --often called the hobby loss rule--limits deductions that can be claimed when an activity is not engaged in for profit. There are tax implications for incorrectly treating hobby activities as activities engaged in for profit, IRS stressed. The goal of the fact sheet is to provide information for determining if an activity qualifies as an activity engaged in for profit and what limitations apply if the activity was not engaged in for profit.

The fact sheet poses various questions to aid taxpayers in making an appropriate determination. It also provides details regarding deductions for hobby activities that are claimed as itemized deductions on Schedule A, Form 1040, U.S. Individual Income Tax Return.

The fact sheet can be found at http://www.irs.gov/irs/article/0,,id=186056,00.html

Have you been challenged by the IRS for schedule C? If you are facing an audit or a tax collection matter regarding your small schedule C business, we can help.

IRS explains how to claim credit for qualified fuel cell and qualified microturbine property A new Notice carries interim guidance on the terms and conditions that must be met by taxpayers that want to claim the Code Sec. 48 credit for fuel cells and microturbines.

Background. A taxpayer may be eligible to claim (on Form 3468) a number of energy credits, including the following credits added by the Energy Policy Act of 2005 (P.L. 109-58). In each case, the percentage is applied to the basis of eligible energy property placed in service during the year:

• 30% for qualified fuel cell property, (Code Sec. 48(a)(2)(A)(i)(I)) i.e., a fuel cell power plant with a nameplate capacity of at least 0.5 kilowatt of electricity using an electrochemical process, and an electricity only generation efficiency of greater than 30%. The credit can't exceed an amount equal to $500 for each 0.5 kilowatt of capacity. The credit isn't available after 2008. (Code Sec. 48(c))
• 10% for qualified microturbine property, (Code Sec. 48(a)(2)(A)(ii), Code Sec. 48(a)(3)(A)(iv)) i.e., a stationary microturbine powerplant with a nameplate capacity of less than 2,000 kilowatts, and an electricity only generation efficiency of not less than 26% at International Standard Organization conditions. A credit for qualified microturbine property can't exceed $200 for each kilowatt of the property's capacity. The credit is not available after 2008. (Code Sec. 48(c)(2))

No credit is allowed for property unless it is depreciable or amortizable; its construction, reconstruction or erection is completed by the taxpayer or, if acquired by the taxpayer, its original use begins with the taxpayer; and it meets the official quality and performance standards in effect at the time of acquisition. (Code Sec. 48(a)(3))

No credit is allowed for public utility property (Code Sec. 48(a)(3)) (except for certain qualified microturbine property used predominantly in a telephone or telegraph service business (Code Sec. 48(c)(2)(D)), or for property that also qualifies for the rehabilitation credit. (Code Sec. 48(a)(2)) If property is financed in whole or in part by subsidized financing or tax-exempt private activity bonds, the amount taken into account as qualified investment is proportionately reduced. (Code Sec. 48(a)(4))

New guidance. Rev Proc 2008-68 carries detailed guidance on the fuel cell credit and microturbine credit, including the technical conditions that must be met for property to qualify for the credit, how to compute the credit, and the circumstances under which the credit for either type of property is available to a lessor.

Rev Proc 2008-68, Sec. 3.04 refers taxpayers to the following sections of the regs for guidance on the following key definitional terms and conditions:

• whether the original use of property begins with the taxpayer is determined under the principles of Reg. § 1.48-2;
• whether depreciation (or amortization instead of depreciation) is allowable to the taxpayer is determined under the principles of Reg. § 1.48-1(b);
• the he year in which property is placed in service is determined under the principles of Reg. § 1.46-3(d); and
• the basis of property is determined under the principles of Reg. § 1.463-3(a) and Reg. § 1.463-3(c).

Tax problems? Get tax resolution today. We specialize in tax problem resolution and represent taxpayers before any taxing authority.

TIGTA reviews IRS methodology for selling seized property [Audit Report No. 2008-30-144]:

IRS management needs to provide better oversight to ensure that employees consistently follow the requisite procedures for the storage and sale of seized property, according to a recent audit by the Treasury Inspector General for Tax Administration (TIGTA).

As described in the audit, when a taxpayer owes delinquent tax and thorough consideration has been given to all aspects of the case and alternative collection methods, IRS can seize taxpayer property for payment of the tax. The seized property can be sold by public auction or by public sale under sealed bids.

In fiscal year 2007, 309 (or 46%) of the 676 seizures went to sale, with the proceeds amounting to $20.7 million. TIGTA based its conclusions on a review of a judgmental sample of 32 completed sales of seized property. "If procedures are not followed, theft, vandalism, and violations of taxpayer rights can occur, although we did not find any such instances in this review," TIGTA said.

The audit can be found at http://treas.gov/tigta/auditreports/2008reports/200830144fr.pdf

Tax Problem? Don't wait till the IRS seize your assets. Get tax resolution today!

To disclose or not to disclose, that is the question.

Hiding Income Offshore is not the way to go.

Mike Habib, EA

For years, offshore accounts have been a hot topic in popular culture and for the IRS; most recently Liechtenstein has been mentioned, however the IRS is interested in accounts anywhere in the world that generate income for US taxpayers. The IRS is particularly interested in locating those people trying to hide income in offshore accounts as well as the promoters of off-shore tax avoidance schemes.

Individuals continue to try to avoid paying US taxes by illegally hiding income in offshore bank and brokerage accounts or using offshore debit cards, credit cards, wire transfers, foreign trusts, employee leasing schemes, private annuities or life insurance plans.

US taxpayers are required to report all foreign financial accounts if their total value exceeds $10,000 at any point during a given year. Failure to report the accounts can result in a penalty of up to 50 percent of the amount in the accounts. Yikes!

Hiding or not reporting income from foreign sources may be a crime. And the IRS, along with its international partners is pursuing those who hide income or assets offshore to evade taxes. There are specially trained IRS examiners whose focus is to examine aggressive international tax planning, including the use of entities and structures established in foreign jurisdictions. The goal is simply to ensure that U.S. citizens and residents are accurately reporting their income and paying the correct tax.

In addition to reporting your worldwide income, you must also report whether you have any foreign bank or investment accounts. The Bank Secrecy Act requires that you file a Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (FBAR), if:

· You have financial interest in, signature authority, or other authority over one or more accounts in a foreign country, and

· The aggregate value of all foreign financial accounts exceeds $10,000 at any time during the calendar year.

Just in the past month a federal judge agreed to allow the IRS to serve legal papers on Swiss banking giant UBS AG in an expanding investigation of U.S. taxpayers who may have used overseas accounts to hide assets and avoid taxes. The summons is one that allows the IRS to investigate a full range of people as it is not limited to one particular individual. The investigation was started after a former UBS private banker pleaded guilty to defrauding the IRS, and claims that UBS has about $20 billion in assets in undeclared accounts for U.S. taxpayers.

UBS is cooperating with Swiss and U.S. investigations and will disclose records involving U.S. clients who might have broken tax laws.

The Treasury Department and the Internal Revenue Service recently announced their initiative to encourage the voluntary disclosure of unreported income hidden by taxpayers in offshore accounts. Under this new plan, eligible taxpayers have to pay back taxes, interest and accuracy and delinquency penalties, but will not face fraud and information return penalties. To obtain the benefits of the initiative, taxpayers will be required to disclose information about who promoted or solicited their participation in the offshore financial arrangement.

Do you have an offshore tax problem? Did you receive an opportunity letter? Contact us today to represent you before the IRS.

If It Seems Too Good to Be True, It Probably Is

Tax Return Preparer Fraud

Mike Habib, EA

Dishonest tax return preparers can cause many problems for taxpayers who fall victim to their schemes. These scam artists make their money in a number of ways including skimming a portion of their clients' refunds, charging a percentage of the return and charging inflated fees for return preparation services.

Return preparer fraud generally means the preparation and filing of false income tax returns by preparers who claim inflated personal or business expenses, false deductions, unallowable credits or excessive exemptions on returns prepared for their clients. Preparers may manipulate income figures to fraudulently obtain tax credits.

Sometimes, the client, or the taxpayer may not have knowledge of the false expenses, deductions, exemptions and/or credits shown on his or her tax return. When the IRS detects the false return, the taxpayer - not the return preparer - must pay the additional taxes and interest and may be subject to penalties.

When choosing a tax preparer, you should be as careful as you are when choosing a doctor or lawyer. Failure to do so could end up costing you a lot of money.

Here are some things to consider when hiring someone to prepare your tax return:

• Be cautious of tax preparers who claim they can obtain larger refunds than other preparers.
• Avoid preparers who base their fee on a percentage of the amount of the refund.
• Use a reputable tax professional who signs your tax return and provides you with a copy for your records.
• Find out the person's credentials. Only attorneys, certified public accountants (CPAs) and enrolled agents (EAs) can represent taxpayers before the IRS in all matters including audits, collection and appeals. Other return preparers may, on a limited basis, only represent taxpayers for audits of returns they actually prepared.
• Consider whether the individual or firm will be around to answer questions about the preparation of your tax return months, or even years, after the return has been filed.
• Review your return before you sign it and ask questions on entries you don't understand.
• No matter who prepares your tax return, you, the taxpayer, are ultimately responsible for all of the information on your tax return. Therefore, never sign a blank tax form.
• Find out if the preparer is affiliated with a professional organization that provides its members with continuing education and resources and holds them to a code of ethics.
• Ask questions. Do you know anyone who has used the tax professional? Were they satisfied with the service they received?

Remember that no matter who prepares your tax return, you, the taxpayer, are ultimately responsible for all of the information on your tax return.

If you suspect tax fraud, or are aware of a return preparer who is filing false returns, you can report this activity to the IRS, through Form 3949-A, Information Referral, by downloading it at www.IRS.gov, or by calling 1-800-829-3676 to order it by mail. You are not required to identify yourself, if you do - your identity will be kept confidential and you may even be entitled to a reward.

Are you a victim of tax preparer fraud? We have represented taxpayers who were victims of tax preparer fraud, and could represent you too. Call us today.

"In this world, nothing is certain but death and taxes." - Benjamin Franklin

Frivolous Arguments Don't Work

Mike Habib, EA

Yes, folks, it's a matter of fact. If you have earned income in the last year, you must file a tax return. There isn't a way around it. If someone is claiming that there is a way to get around it, they are mistaken and it could cost you plenty in penalties for following such advice - in fact up to $5,000. The Internal Revenue Service has recently expanded its list of frivolous legal positions that taxpayers should stay away from. The list of twenty-four different arguments breaks down into five different categories that include: The Voluntary Nature of the Federal Income Tax System, The Meaning of Income, The Meaning of Certain Terms Used in the Internal Revenue Code, Constitutional Amendment Claims and Fictional Legal Bases.

Under the category of "The Voluntary Nature of the Federal Income Tax System" the arguments range from "The filing of a tax return in voluntary," to "Payment of tax is voluntary," and "Taxpayers can reduce their federal income tax liability by filing a 'zero return'." There are additional arguments that have been put forth, but the bottom line is that the Federal Income Tax System is not voluntary. The system allows taxpayers to determine the correct amount of tax and complete the appropriate forms for filing their return rather than have the government determine the tax for them. If you think about it, this really is the preferential way for taxpayers to handle tax responsibility.

The interpretation of "The Meaning of Income," is also high on the list, but only includes three current arguments: "Wages, tips, and other compensation received for personal services are not income," "Only foreign-source income is taxable," and "Federal Reserve Notes are not income." Now seriously - wages, tips and other compensation for personal service are not income? It is the main source of income for the majority of the population. The official stance on this is that "Gross income, for federal tax purposes means all income from whatever source derived and includes compensation for services." Income is income - claim it, claim your deductions, and pay your taxes.

In the last three categories, there are claims that range from stating that a "Taxpayer is not a 'citizen' of the United States, thus not subject to the federal income tax laws," to "Taxpayers can refuse to pay income taxes on religious or moral grounds by invoking the First Amendment," and "A 'corporation sole' can be established and used for the purpose of avoiding income taxes." While there are additional arguments being put forth, it is best to use your good judgment and possibly take a look at the full list of arguments on the IRS website to ensure that you are not utilizing one that has been proven to be false.

The bottom line is this: there isn't a way around filing your tax returns. As a citizen of the United States, you are obligated to file tax returns. Our taxes fund programs beyond those which are controversial and may be used for justification of why an individual might not want to file his or her taxes. If you are being advised by a tax preparer to utilize one of the arguments considered to be frivolous by the IRS, both you and the preparer could be penalized. The complete list of frivolous arguments is on the IRS Web site at IRS.gov.

Unfiled tax returns? Back Taxes? Tax Problems? We specialize in tax problem resolution; contact us today for your free consultation.

Yes, we are all fed up with the cost of fuel.

No, I'm sorry to report, not everyone is eligible for the fuel tax credit.

Fuel Tax Credit Scams

Mike Habib, EA

The IRS has recently added fraud involving the fuel tax credit to the list of frivolous tax claims being put forth by individuals and businesses. The credit has very defined criteria and applies generally to farmers and fisherman who use fuel for off-highway business purposes. There are some individuals who are trying to claim the credit when in fact their occupation or income level makes the claim unreasonable. If you attempt to claim a tax credit or refund, and it is not justified, you can be liable for up to $5,000 in penalties.

The tax credit is a possibility under the right, and narrowly defined circumstances. Basically, it works like this:

A federal excise tax is imposed on gasoline ($.184 per gallon), clear diesel fuel ($.244 per gallon), and clear kerosene ($.244 per gallon). The amount of these taxes may be credited or refunded if these fuels are used in many types of off-road uses. Common off-road uses include use as heating oil, use in stationary engines, use in non-highway vehicles, and use in separate engines mounted on highway vehicles.

Generally, refunds may be claimed quarterly on Form 8849, Claim for Refund of Excise Taxes. Claims not made on Form 8849 may be claimed as income tax credit on Form 4136, Credit for Federal Tax Paid on Fuel. See the forms and their instructions for specific claim requirements.

Note that a credit or refund is not allowable for the following:

• Any use in the propulsion engine of a registered highway vehicle, even if the vehicle is used off the highway
• Any fuel that is lost or destroyed through fire, spillage, or evaporation
• Any use of dyed diesel fuel or dyed kerosene. In fact, you may be subject to a substantial penalty if you use dyed fuel as a fuel in a registered diesel-powered highway vehicle

There is also a specific scam that has been reported whereby a company representing itself as an accounting firm approaches a Canadian trucking company and suggests that the carrier may be entitled to a refund of the excise tax paid on fuel purchased in the U.S. The company itself only charges a percentage of the refund obtained to file the paperwork on behalf of the Canadian company. Unfortunately for the company being scammed, the refund on the tax is only intended for US companies. The IRS will often issue the refund and verify the validity of the application at a later date. The trucking company issues a check to the scam artists, who disappear afterwards. Once the IRS catches the fact that the refund was issued to a Canadian company, the company is expected to pay the refund back, with penalties and interest.

It is important that you look closely at the claim requirements on your tax forms to determine whether or not you are eligible to claim this credit. Since it is on the list of scams that the IRS is watching for, it would be wise to be sure it actually applies to your business before utilizing it.

Fuel Tax Problems? Excise Tax Problems? We represent taxpayers before the IRS and specialize in tax problem resolution.

JK Harris didn't provide promised services to Missourians who sought help with tax problems, Nixon says in lawsuit

"JK Harris promises it can help consumers who are having tax problems, but the Missourians who complained to my office told a different story - one of unreturned phone calls, lost paperwork, and a worse financial situation than when they started," Nixon said.

The JKH Web site tells consumers the company has a step-by-step strategy - known as "The Process" - to help consumers with their tax problems. According to JKH, "The Process" includes providing immediate relief to consumers by attempting to stop collection activities by the IRS; assigning a case specialist to review the consumer's information and begin work on resolving the customer's tax problems; and submitting an offer to the IRS to resolve the customer's tax problems.

Consumers complained to the Attorney General's Office that after they paid for debt relief services, JKH failed to follow "The Process" in handling customer cases. The consumers also reported that they often had to resend their financial disclosure information and supporting documentation because JKH kept losing their paperwork, and that they would learn that their assigned case specialists were no longer working on their files only by calling JKH for updates. Those consumers who requested full refunds from JKH because they didn't receive the promised services had those requests denied.

Also named as a defendant in Nixon's lawsuit was a business affiliated with JK Harris called Professional Fee Financing Associates LLC (PFFA), which makes consumer credit loans as part of the JKH contract process with its customers. Nixon said PFFA's forms fail to disclose to consumers crucial information about finance charges, payment schedules, the total number of payments, and the total price the consumers will have to pay. PFFA also does not have the required certificate of registration from the Missouri Division of Finance.

Nixon is asking the Jackson County Circuit Court to issue an order requiring JKH and PFFA to provide full restitution to all Missouri consumers from whom they have received payment who have been hurt by the defendants' deceptive practices. The lawsuit also asks for preliminary and permanent injunctions to prohibit the defendants from further violations of Missouri consumer protection laws, as well as for penalties and costs that the court deems appropriate.

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Tiered discount allowed in real estate FLP gift tax case In Astleford, a memorandum decision, the Tax Court permitted a taxpayer to apply a tiered discount in the context of a family limited partnership owning interests in real estate.

Facts. On 8/1/96, Mrs. Astleford formed the Astleford Family Limited Partnership ("AFLP") to facilitate the continued ownership, development, and management of various real estate investments and partnership interests she owned and to facilitate gifts that she intended to make to her three adult children. On the same day, Mrs. Astleford transferred to AFLP ownership of an elder care facility. Also on the same day, Mrs. Astleford gave each of her three children a 30% limited partner interest in AFLP and retained for herself a 10% general partner interest.

On 12/1/97, Mrs. Astleford made additional capital contributions to AFLP by transferring to AFLP a 50% interest in Pine Bend Development Co. ("Pine Bend"), a general partnership, and her interest in 14 other real estate properties. The Pine Bend general partnership agreement did not contain any provisions relating to the transfers of interests in Pine Bend or whether such transferred interests would be general partner or assignee interests. Pine Bend owned 3,000 acres of land of which 1,187 acres consisted of agricultural farmland ("Rosemount property").

As a result of the additional capital contributions made on 12/1/97, Mrs. Astleford's general partner interest in AFLP increased significantly, and her children's respective limited partner interests in AFLP decreased significantly. However, also on 12/1/97, Mrs. Astleford gave to each of her three children additional limited partner interests in AFLP. These gifts had the effect of reducing Mrs. Astleford's AFLP general partner interest back down to approximately 10% and increasing the children's AFLP limited partner interests back up to approximately 30% each.

On audit of the 1996 and 1997 gift tax returns, the IRS increased the fair market value of a number of the properties that were transferred to AFLP and also decreased the discounts for lack of control and lack of marketability that were applied to the interests transferred.

Analysis. There were three issues before the court: first, the value of the Rosemount property; second, whether the 50% Pine Bend interest should be valued as a general partner interest or as an assignee interest; and third, the amount of the discount for lack of control and lack of marketability that should apply to the gift of the 50% Pine Bend general partner interest and to the gift of the AFLP limited partner interests.

With respect to the Rosemount property, the valuation expert for Mrs. Astleford applied an absorption discount based on his opinion that a sale of the entire Rosemount property would flood the local market for farmland and would therefore reduce the per-acre price at which the Rosemount property could be sold. Believing that the Rosemount property would sell over the course of four years and would appreciate 7% each year, the expert performed a cash flow analysis using a present value discount rate of 25%.

The IRS's expert did not apply an absorption discount since he concluded that the entire Rosemount property likely could be sold in a single year without an absorption discount based on the fact that in 1970, the 3,000 acres of land (including the Rosemount property) had been purchased by Pine Bend in a single transaction. The IRS's expert also concluded that even if an absorption discount was appropriate, the 25% present value discount rate used by Mrs. Astleford's expert was excessive. The IRS's expert argued that the present value discount rate should track the 9.2% rate of return on equity which farmers in the area actually earned.

The court believed that due to the size of the Rosemount property in relation to the number of acres sold each year in the area, it was unlikely that all 1,187 acres of the Rosemount property would be sold in a single year without a price discount. However, the court also believed that the present value discount rate of 25% used by Mrs. Astleford's expert was unreasonably high because it relied on statistics relating to developers of real estate who expect greater returns given the greater risks involved in development. Since over 75% of the Rosemount property was leased to farmers, these rental payments would provide a source of future income to a prospective purchaser. The court found that given this low level of risk, a 10% rate of return would be sufficient to induce a purchase of the Rosemount property.

With respect to Pine Bend, the parties disputed the nature of the interest transferred by Mrs. Astleford to AFLP and therefore the appropriate amount of the discount for lack of control and lack of marketability that should apply. Because the other 50% general partner of Pine Bend did not consent to Mrs. Astleford's transfer of her general partner interest in Pine Bend to AFLP, Mrs. Astleford's expert treated the 50% Pine Bend interest transferred to AFLP as an assignee interest and applied a 5% discount. The position of Mrs. Astleford's expert was based on applicable state law that provided that a holder of an assignee interest has only a profits interest but no influence on management.

The court agreed with the IRS that the substance-over-form doctrine applied to treat the interest in Pine Bend that Mrs. Astleford transferred to AFLP as a general partner interest. The court based its conclusion on its finding that since Mrs. Astleford was the sole general partner of AFLP, she was essentially in the same management position relative to the 50% Pine Bend interest whether she is to be viewed as having transferred to AFLP a Pine Bend assignee interest (and thereby retaining Pine Bend management rights) or as having transferred those management rights to AFLP as a result of the transfer of a Pine Bend general partner interest (in which case she reacquired those same management rights as sole general partner of AFLP). The court also noted that the transfer documents treated Mrs. Astleford's Pine Bend transfer as a transfer of all of her rights and interests in Pine Bend, thereby suggesting that a general partner interest--not an assignee interest--was transferred.

Next, the court addressed the amount of the discount for lack of control and lack of marketability that should apply (1) to the limited partnership interests in AFLP given to Mrs. Astleford's three children, and (2) to the 50% Pine Bend general partnership interest she transferred to AFLP. In determining these discounts, Mrs. Astleford's expert relied on data for real estate limited partnerships ("RELPs") while the IRS's expert relied on data for real estate investment trusts ("REITs"). The court did not believe that either the RELP data or the REIT data was superior to the other. According to the court, RELPs more closely resembled AFLP, and the RELP secondary market is not so low as to render the available RELP data unreliable. However, the court also said that that the large number of REIT sales transactions tended to produce more reliable data compared to the limited number of RELP sales transactions. In addition, the court stated that the differences between REITs and AFLP may be minimized given the large number of REITs from which to choose comparables.

But REITs sometimes trade at prices higher than net asset value. The court recognized that this fact does not mean that a lack of control discount is nonexistent but suggests that a REIT's share price is in part affected by two factors, one positive (the liquidity premium) and one negative (lack of control). Therefore, in analyzing REIT comparables and their trading prices, the court found it is appropriate to quantify and then to reverse out of the trading prices, any liquidity premiums that are associated with REIT comparability data. The court stated that this calculation results in a REIT discount for lack of control that can be applied to the partner interests gifted.

To determine the appropriate liquidity premium to apply to the REIT, the court examined the difference in average discounts in private placements of registered and unregistered stock--reasoning that the difference represents pure liquidity concerns since a public market is available to owners of registered stock but not to the owners of unregistered stock. After performing these calculations, the court applied a lack of control discount of 16.17% for the 1996 gifts and a discount of 17.47% for the 1997 gifts of AFLP by Mrs. Astleford to her children.

With respect to the discount for lack of marketability, the expert for Mrs. Astleford applied a discount of 15% and the IRS expert applied a discount of 21.23% for the 1996 gifts. The court, without any discussion, used the higher discount applied by the IRS expert. For the 1997 gifts, the court applied a lack of marketability discount of 22%.

In valuing the 50% Pine Bend general partner interest, the IRS's expert concluded that because the Pine Bend partner interest was simply an asset of AFLP, the discounts he applied at the AFLP level obviated the need to apply an additional and separate discount at the Pine Bend level. The court disagreed and held that a 30% combined discount for lack of control and lack of marketability was appropriate. In a footnote, the court mentioned that the Tax Court has rejected multiple discounts in the context of tiered entities where the lower level interest constituted a significant portion of the parent entity's assets. However, in this case, the 50% Pine Bend interest constituted less than 16% of the net asset value of AFLP and was only one of 15 real estate investments that were held by AFLP.

Comments. Astleford is noteworthy for several reasons. First, this case demonstrates that the Tax Court in appropriate situations will allow substantial discounts. While the IRS has had victories in the context of Section 2036, if the taxpayer is able to satisfy the requirements of that section, substantial discounts will be available. Second, the court allowed discounts for lack of control and lack of marketability at both the subsidiary partnership level and at the parent partnership level. Third, Astleford illustrates that when large tracts of land are involved, practitioners should consider applying absorption discounts. Fourth, this case illustrates one method of determining the amount of the discount for lack of control when analyzing REIT data. While this case does not necessarily make new law, it reminds us of some concepts with which we should all be familiar.

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Deduction for cost of goods sold limited to negotiated discount price IRS concluded in this ILM that the step transaction doctrine applied to the repayment to companies of the difference between the full list price of merchandise and the negotiated discount price, and therefore the companies' deduction for cost of goods sold (COGS) was limited to the negotiated price.

Facts. U.S. companies paid the full list price for merchandise and were reimbursed for the difference between the full list price and the negotiated discount price.

IRS analysis. The Service concluded that this transaction met all three tests applied by the courts in determining whether the step transaction doctrine should be invoked:

(1) The end-result test. (2) The mutual interdependence test. (3) The binding commitment test.

The mutual interdependence test concentrates on the relationship between the steps (i.e., the steps so interdependent that the legal relations created by one step would have been fruitless without a completion of the series). The IRS concluded that the companies would not have paid full list price for the merchandise without knowing that they would be repaid and the true price would be the negotiated discount price. Therefore, the transaction satisfied the mutual interdependence test.

The third test requires that there be a binding commitment to take the later steps. The Service determined that the application of the step transaction doctrine was warranted because the companies were provided with price lists that they relied on when ordering and if they didn't receive the repayments as promised, they would have had legal standing to compel payment.

Because the step transaction doctrine applied, the companies could not deduct as COGS the full list price of the merchandise ordered, but were limited to the negotiated discount price.

Implications. The payment by the companies of full list price, followed by the receipt by the companies of a rebate (so as to reflect that the true cost to the companies of the merchandise was the negotiated price), apparently represented transactions that were closed rather than transactions that were still open. Had the right to the rebate, or the amount thereof, been in some way unknown or contingent, which was not the case here, the companies likely would have reported income from the rebate, reflecting that the companies understated income previously by overstating COGS. It is clear, based on the application of any of the tests under the step transaction doctrine, that both the right to, and the amount of, the rebate owed to the companies was established with certainty.

While the facts do not indicate why the inter-company transaction provisions of the consolidated return Regulations were implicated, the memorandum provides a useful, although brief, description of the three alternative tests under the step transaction doctrine and reminds taxpayers that satisfaction of any one of the three tests is sufficient for the step transaction doctrine to apply.

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Beneficial owners can deduct home mortgage interest and taxes The Tax Court held that taxpayers were entitled to deduct mortgage interest and real estate taxes they paid on property owned by their son, because they were the beneficial owners of the property.

The taxpayers resided at the property for all of 2003. During that time, title to the property was in the name of their son, as was the mortgage on the property. Their son had obtained a mortgage loan and took title to the house to procure it for the taxpayers who were unable to secure a loan because of financial difficulties. The son did not live on the property, and the taxpayers paid for all maintenance of, and taxes on, the property. Mortgage payments from 2001 until the time of the trial were made through Camrock General Engineering, Co. Camrock was the taxpayers' company; one taxpayer was its registered agent and the other its president. After the taxpayers moved from the residence, they served as landlords; they rented the property to a tenant and performed all services related to that tenancy

The taxpayers claimed on their 2003 federal income tax return deductions for home mortgage interest and real estate taxes of $3,522 and $3,194, respectively, on the residence property. The IRS contended that because the taxpayers had no legal obligation to make the mortgage payments and did not hold title to the property, they were not entitled to deduct the mortgage payments. The Service further argued that the taxpayers did not make the mortgage payments; the payments were made by Camrock.

The taxpayers claimed that although their son had legal title to the property, they owned Camrock, and through the company, they had assumed the mortgage from the outset. The payments were made from a bank account registered to the company, of which the taxpayers were signatories. The company was not an active business in 2003, but did have a bank account, which functioned as a personal account for the taxpayers.

Section 163(a) generally allows a deduction for all interest paid or accrued within the tax year on debt. However, under Section 163(h)(1), noncorporate taxpayers generally cannot deduct personal interest. Qualified residence interest is excluded from the definition of personal interest, and the deduction of qualified residence interest is allowed under Section 163(h)(3). The court pointed out that the debt must be the taxpayer's obligations and not an obligation of another. In Uslu, TC Memo 1997-551, the Tax Court held that when a residence was occupied exclusively by the taxpayers who made all mortgage payments, the debt may be found to rest solely on those taxpayers who were entitled to deduct the mortgage payments.

The Tax Court held that like the taxpayers in Uslu, the taxpayers in the present case were equitable and beneficial owners of the property. The court said that it was undisputed that the property was a "qualified residence" under Section 163(h)(4)(A), and thus the taxpayers were entitled to claim the mortgage interest deductions on the property. As with mortgage interest, the court has held that taxpayers who do not have legal title to property may still deduct property taxes under Section 164(a) if they establish equitable ownership of the property. Because the court found that the taxpayers were the equitable and beneficial owners of the property, the court said they were also entitled to their claimed deductions for real estate taxes.

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USA & Malta sign new income tax treaty

[U.S. Treasury Press Release, 8/8/08]:

The U.S. Treasury Department has announced that a new income tax treaty between the United States and Malta was signed on Aug. 8, 2008 . The treaty will have withholding tax ramifications for U.S. citizens working in Malta and citizens of Malta working in the United States. The treaty has 29 articles. Article 2 states that the treaty applies to federal income taxes under the Internal Revenue Code, but excludes Social Security and unemployment taxes. Article 14 covers income from employment. Generally, income earned by a U.S. or Malta resident is exempt from income tax in the other treaty country if the resident was not in that country for more than 183 days of the taxable year.

Article 15 covers directors' fees. It says that directors' fees and other compensation derived by a resident of a treaty country, for services rendered in the other treaty country, may be taxed in that other treaty country if the resident is serving in his capacity as a member of the board of directors of a company that is a resident of the other treaty country. There are special provisions for entertainers and sportsmen (see Article 16), government workers (see Article 19), and students and trainees (see Article 20). Article 26 calls for an exchange of information between the two countries to facilitate the administration of each country's tax laws.

The treaty will enter into force on the date of the exchange of instruments of ratification. With respect to withholding taxes, the treaty will apply to amounts paid or credited on or after the first day of the second month following the date on which the treaty enters into force.

The final version of the treaty can be found at http://www.ustreas.gov/press/releases/reports/usmalta%20agreement.pdf

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California LLC fee again held invalid

Ventas Finance I LLC v. Calif. FTB, Cal. Ct. App., Dkt. Nos. A116277; A117751, 08/11/2008

The California Court of Appeal once again has ruled invalid the state fee imposed on limited liability companies (LLCs) under former Rev. & Tax. Cd. § 17942 (the "§ 17942 fee"). Affirming the lower court, the Appeal Court held that the § 17942 fee as applied to Ventas, an LLC that conducted business in California and other states, was not fairly apportioned and, therefore, violated the Commerce Clause because the levy was based on total income without apportionment to income attributable to, or derived from, California sources. The court rejected the Franchise Tax Board's (FTB's) request for judicial reformation of the former statute to allow an apportioned fee refund since Ventas did business in California and other states unlike in the earlier Northwest case (that held the fee invalid) where the LLC conducted no California business. However, the court concluded that neither federal due process nor any principle of California law requires the FTB to refund the entire amount that Ventas paid. Consequently, the refund should be limited to the amount Ventas paid for the years in issue that exceeds the amount that would have been assessed, without violating the Commerce Clause, using a method of fair apportionment. The postjudgment order awarding attorney fees was also reversed, and remanded for the lower court to redetermine eligibility and the amount of reasonable fees in light of the partial reversal of the lower court's judgment.

No judicial reformation. Holding that the former § 17942 fee, as applied to Ventas, violated the Commerce Clause and due process (because it was based upon all income unapportioned to activities within California), the lower court had refused FTB's request to reform former § 17942 to add an apportionment mechanism because the legislative history showed that the legislature rejected including an apportionment mechanism, and neither the statute nor the legislative history contained any indication of the type of apportionment mechanism the legislature would have enacted. The lower court ordered that Ventas was entitled to a refund of the entire amount it paid pursuant to former § 17942. In its appeal to the appellate court, Ventas argued the litigation was necessary to address FTB's position that only those LLC's that had no income attributable to California sources were entitled to a full refund. In all other cases, FTB maintained that the appropriate remedy was to refund the difference between the amount the LLC paid and the amount it would have paid if former § 17942 included a fair apportionment mechanism. Ventas reasoned that this litigation conclusively resolved issues left unresolved after the Northwest case by establishing that former § 17942 could not be judicially reformed, and that any LLC who paid the levy was entitled to a full refund.

Apportioned fee refund. The Appeal Court ruled that FTB failed to establish the limited conditions that would support exercise of the power of judicial reformation, and declined to reform former § 17942 in the manner FTB suggested. The court, however, concluded that a refund of the entire amount Ventas paid pursuant to former § 17942 is not compelled by the Due Process Clause, or by any principle of state law. A refund of the difference between the amount Ventas paid and the amount it would have paid based upon income derived from or attributable to California sources, using a method of fair apportionment, would fully cure the Commerce Clause violation, ruled the court. This remedy does not place an unreasonable burden on Ventas because the parties had already agreed what Ventas's California apportionment percentage would have been for the years in issue, if this apportionment methodology were used. The court, therefore, reversed and remanded to the trial court for further proceedings to determine the amount of the refund.

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WASHINGTON (AP) -- A top IRS official promised Congress Tuesday that the agency "will do better" in collecting billions in taxes that businesses supposedly withheld from employees' paychecks but never remitted to the government.

Linda Stiff, a deputy Internal Revenue Service commissioner, agreed with senators -- who criticized the agency's enforcement efforts -- that the loss of about $58 billion in payroll taxes estimated to be owed the government is unacceptable. She said the IRS has made collecting those taxes a high priority.

While too high, the $58 billion "represents a snapshot of unpaid employment taxes" as part of a long-term improvement effort, Stiff testified at a hearing of the Senate Homeland Security Committee's investigative panel. "Our numbers show dramatic improvement in the last several years, but we know we still have a long way to go."

"We can and we will do better," Stiff said.

The IRS says it resolved 5.2 million delinquent cases in the fiscal year ending Sept. 30, compared with 3 million in 2002. At the same time, the agency has classified $30 billion of the unpaid payroll taxes as uncollectible, citing factors such as businesses becoming defunct or insolvent, according to a new report by congressional investigators.

The Government Accountability Office report found that the 1.6 million U.S. businesses owing income, Social Security and Medicare taxes from their payrolls as of Sept. 30, 2007, included a food service company that failed to pay $12 million while the owner diverted the money to buy luxury cars, planes and a mansion in a foreign country.

"This is the mother of all tax cheats. ... It's clear that tax cheats are living the high life at the expense of hardworking American taxpayers," Sen. Norm Coleman of Minnesota, the subcommittee's senior Republican, said at the hearing. At a time of widespread economic stress for ordinary Americans, seeing the conduct of cheating business owners stirs outrage, said Coleman, who requested the GAO study.

Given that $44 billion has been transferred over the past 10 years from general tax revenues to cover shortfalls in Social Security and Medicare, the business "deadbeats" are contributing to the insolvency of programs intended to help the nation's seniors, he said.

The $58 billion in unpaid payroll taxes covers 10 years. Beyond that, a statute of limitations generally kicks in and the money is permanently lost.

The report faulted the IRS for relying on voluntary compliance, even for the worst offenders. It said it takes the IRS 40 weeks, on average, to decide to pursue collection against offenders, and an additional 40 weeks to assess a penalty, called a Trust Fund Recovery Penalty.

The subcommittee's chairman, Sen. Carl Levin, D-Mich., said the IRS has failed to use effectively the enforcement tools available to it -- primarily filing tax liens against businesses and filing personal claims against company officers and owners.

"Many payroll-tax cheats have been allowed to repeatedly violate the law for years at a time, accumulating massive payroll-tax debts that can't ultimately be collected," he said.

Seventy percent of all unpaid payroll taxes are owed by businesses that have failed to remit them for more than a year, according to the GAO report. That means at least four violations by each business since taxes are remitted quarterly.

Levin said the IRS should develop an expedited process for filing liens and levying Trust Fund Recovery Penalties against businesses and key employees, and develop performance measures for payroll-tax collection by agency employees.

Associated Press writer Jim Abrams in Washington contributed to this report.

Government Accountability Office: http://www.gao.gov

Internal Revenue Service: http://www.irs.gov/

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IRS targets U.S. source income paid to foreign persons IRM 4.10.21, U.S. Withholding Agent Examinations - Form 1042

Mike Habib, EA

IRS has issued a new Internal Revenue Manual () section, IRM 4.10.21, U.S. Withholding Agent Examinations - Form 1042, on reporting and withholding requirements for U.S. source income that's paid to foreign persons.

Background. Certain income received by foreign persons is subject to U.S. gross basis taxation. The income must be U.S. sourced and fixed, determinable, annual or periodic; and it must not be included in the foreign person's gross income as effectively connected with any U.S. trade or business of that person. If these conditions are met, the income will generally be subject to the withholding rate under Code Sec. 1441 or Code Sec. 1442 (generally 30%). The withholding rate can be reduced or eliminated based on a treaty or Code section (e.g., the portfolio interest exception under Code Sec. 1441(c)(9)). Other exceptions also apply to when withholding is required for U.S. source fixed, determinable, annual or periodic income. (Reg. § 1.1441-2) The rules on when and how the tax is withheld and reported are covered in Code Sec. 1441 through Code Sec. 443 and Code Sec. 1461.

Commercial banks and brokerage firms are examples of financial institutions that act as U.S. withholding agents. Certain of these institutions act as intermediaries for their clients' investments in securities and deposits. As a result, these institutions may make investments and receive payments in a fiduciary or custodial relationship with their clients. For example, when a foreign person's account is credited by a broker-dealer with U.S. source fixed, determinable, annual or periodic income that the broker-dealer has received on the foreign person's behalf, the financial institution may have nonresident alien (NRA) reporting and withholding responsibilities for the income.

Guidance in IRM. In IRM 4.10.21.1, IRS explains the basic principles of reporting and withholding on U.S. source income that's paid to foreign persons and cover two types of U.S. withholding agent audits. The IRM provides general guidance for audits of U.S. financial institutions, which may have NRA withholding tax and reporting requirements in connection with their custodial or brokerage activities. The IRM also provides general guidance for audits of U.S. nonfinancial entities that may have NRA withholding and reporting responsibilities for their payments to foreign persons for obtaining services or other entitlements.

Form 1042, Annual Withholding Tax Return for U.S. Source Income of Foreign Persons, is the return used for reporting liability for NRA withholding tax, the amounts withheld, the reportable amounts paid to foreign persons and any credit claimed for amounts withheld by other withholding agents. This return is due on March 15th (or the next business day if the 15th falls out on a nonbusiness day) of the following year. IRM 4.10.21.1 stresses that Forms 1042 are required to be filed on a calendar year basis, and consolidation of separate legal entities for Form 1042 filing purposes is not allowed. For Forms 1042 filed before April 15 following the end of the calendar year, the form is considered filed on April 15 for purposes of the statute of limitations on assessment. (Code Sec. 6501(b)(2))

Form 1042-S, Foreign Person's U.S. Source Income Subject to Withholding, is an information reporting form that a withholding agent files with IRS and issues to each foreign recipient (NRA) of a reportable amount. It shows, among other things, the amount and type of income paid to the recipient, the tax withheld, and any applicable withholding exemption. Forms 1042-S should have the same due date as the Form 1042.

IRM 4.10.21.1 advises IRS examiners that Form 1099 reporting and backup withholding also needs to be considered as part of an integrated audit. Auditing Form 1042 information can result in collateral adjustments to Forms 1099 and 945 when, for example, persons classified as foreign by a withholding agent need to be reclassified as U.S. persons subject to backup withholding and Form 1099 reporting. Additionally, deficiencies in a withholding agent's Form 1042 related systems may indicate a generic problem in its tax reporting systems.

Gross income and net tax liability reported on Form 1042 should agree with the gross income and taxes withheld as determined by combining the amounts from all Forms 1042-S filed. To verify this, an examiner should obtain the taxpayer's reconciliation workpapers and Forms 1042-S. An examiner can also request a computer audit specialist () to perform a reconciliation in certain cases of payments contained in computer sensitive files.

IRM 4.10.21.1 can be found on the IRS web at http://www.irs.gov/irm/part4/ch09s24.html

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Court rebuffs IRS and allows policyholder to escape gain on demutualization

Eugene A. Fisher et al. v. U.S. (Ct Cl 8/6/2008) 102 AFTR 2d ¶ 2008-5150

The Court of Federal Claims has applied a variation of the open transaction doctrine with the result that a policyholder had no gain to report when it chose a cash option in connection with a demutualization of an insurance company. Under this option, the shares awarded to the policyholder were immediately sold by the company and the proceeds were then paid to the policyholder in cash. IRS said that the policyholder was taxable on the full amount of the gain without being able to allocate any of his basis in the contract to offset the sales proceeds. The Court allowed the policyholder to use his basis in the contract (which greatly exceeded the amount of the sales proceeds) to fully offset the proceeds and thus to report no gain.

Background on demutualizations. Mutual insurance companies are owned by their policyholders, whose "membership interests" give them the right to vote on corporate governance issues. Mutual insurance companies can only raise capital by retaining earnings or charging excess premiums. Stock insurance companies, on the other hand, are owned by their shareholders. They can raise capital more easily by selling stock on the open market. In addition, they can diversify more easily by creating upstream holding companies that can own subsidiaries engaged in other businesses.

An increasing number of mutual insurance companies have converted to stock companies to gain the capital raising and diversification opportunities enjoyed by stock companies. These demutualizations, as the conversions are called, can take different forms. One form is a full demutualization in which the company is transformed into a stock company and its surplus is distributed to policyholders as stock, cash or policy credits. Each policyholder's share of the distribution is determined under an allocation formula devised by the company and reviewed by state insurance regulators.

Facts. Before 2000, Sun Life Assurance Company (Sun Life) was a Canadian mutual life insurance and financial services company that conducted business in Canada, the U.S. and other countries. On June 28, '90, the Seymour P. Nagan Irrevocable Trust (the Trust) purchased a life insurance policy from Sun Life on Seymour Nagan and Gloria Hagan. The policy was for $500,000, with annual premiums at $19,764.

On Oct. 29, '99, Sun Life proposed a plan to its policyholders to demutualize. Under the plan, the policyholders would retain their insurance coverage at premiums that would be unaffected by the demutualization, but would receive shares of stock in a new holding company, Sun Life of Canada Holding Corp. (Financial Services), which would become the corporate parent of Sun Life. Under the plan, eligible policyholders--those that had policies in force as of Jan. 27, '98--did not have to take stock in exchange for their shares. Those in the U.S., for example, could elect to sell the shares issued in connection with a planned initial public offering, an option referred to as the "cash election."

On Dec. 15, '99, the demutualization plan was approved by the eligible policyholders and in early March of 2000, Sun Life began its initial public offerings and received various regulatory approvals to proceed with the demutualization. On May 19, 2000, IRS issued PLR 200020048, ruling that, under Code Sec. 354(a)(1), no gain or loss would be recognized by the Eligible Policyholders on the deemed exchange of their Ownership Rights solely for Company stock. IRS further concluded that the basis of the Company stock deemed received by the Eligible Policyholders in the exchange will be the same as the basis of the Ownership rights surrendered in exchange for such Company Stock, that is, zero. IRS did not rule on the tax treatment to be afforded the cash received in lieu of shares exchanged for ownership rights.

When the demutualization took effect, Trust received 3,892 shares of Financial Services stock in exchange for its voting and liquidation rights. At that time, Trust had paid premiums of over $194,000. Opting for the cash election, Trust permitted Sun Life to sell those shares on the open market for $31,759. It reported this amount, unreduced by any adjustment for any portion of its over $194,000 basis for premiums paid, on its federal income tax return for 2000 and paid the resulting tax of $5,725. It subsequently filed a claim for refund, which IRS denied. The matter ultimately wound up in the Court of Federal Claims where Trust took the position that it should be able to use $31,759 of its basis to offset the proceeds. This would result in no gain and a refund for Trust.

Background on basis and gain. Gross income includes gains derived from dealings in property. (Code Sec. 61(a)(3)) Under Code Sec. 1001(a), gain from the sale or other disposition of property is the excess of the amount realized on the disposition over the adjusted basis provided in Code Sec. 1011 for determining gain. Adjusted basis is usually cost (Code Sec. 1012) with certain adjustments not relevant in this case.

The rules become a bit more complicated when a taxpayer transfers only a portion of an asset previously-acquired. Then, the basis of the latter asset generally must be apportioned between the portions disposed of and retained. (Reg. § 1.61-6(a)) As established in numerous cases, this apportionment is done by dividing the cost basis of the larger property among its components in proportion to their fair market values at the time they were acquired.

Open transaction applied here. Under the open transaction doctrine, if the sale remains open, the deferred payments are applied in reduction of basis as received, and only when the amount received exceeds the basis is there a taxable gain. The Court of Claims concluded that a variation of the open transaction doctrine should be applied in this case as an exception to Reg. § 1.61-6(a). The facts in this case were different from the typical open transaction case where it is uncertain how much will be received for the stock or other item being sold. Here, that amount was determinable. In this case, the Court found that there was no way to determine the value of the ownership rights that were transferred. Since their value could not be determined, the Court felt it was proper to allow basis to be recovered fully against the cash received for the shares under a variation of the open transaction doctrine.

Bottom line. The Court said that, based on the record, it simply could not credit the zero valuation of the ownership rights, as put forth by IRS's experts. Rather, the record supported the opinion rendered by Trust's valuation expert that the value of the ownership rights was not discernible. This, in turn, led the Court, to conclude that Trust met its burden of proof in this case. The facts showed that this was an appropriate situation in which to apply the "open transaction" exception to Reg. § 1.61-6. That being the case, and the amount received by Trust being less than its cost basis in the insurance policy as a whole, the Court found that Trust did not realize any income on the sale of the stock in question and, therefore, was entitled to the requested refund.

Observation: While the tax dollars in this case were not large, the implications for the government can be huge if other taxpayers sue in the Court of Claims or if other courts follow its decision. IRS consistently issued private rulings to the effect that basis of a policyholder's membership interest is zero and thus, under Code Sec. 358(a)(1), the basis of stock received in exchange for the membership interest also is zero. The Court's decision turns this proposition on its head. Affected taxpayers who previously reported gain without applying any basis, if not time-barred, should file refund claims on the strength of the Court's decision. Those who have yet to file should apply basis to wipe out or reduce gain on the strength of the Court's decision while at the same time being mindful that IRS could appeal this case, possibly with success.

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New IRS settlement initiative for LILO and SILO transactions

Mike Habib, EA

IRS recently announced a settlement initiative for Lease-In/Lease-Out (LILO) and Sale-in/Lease-Out (SILO) transactions. Under this initiative, more than 45 of the nation's largest corporations that participated in these shelters will receive a letter with an offer. Shelter participants will have 30 days to make a decision to accept the offer. Taxpayers would have to concede 80% of certain claimed tax breaks but they would not be hit with accuracy-related penalties.

Background. LILOs and SILOs involved complex and convoluted purported leasing arrangements in which some of the nation's largest corporations supposedly leased or purchased large assets, such as foreign rail systems or sewer systems, and then immediately leased them back to their original owners. Companies engaging in these transactions improperly sought to defer tax for many years. IRS designated these transactions as "listed transactions". IRS also has been victorious in court cases, see, e.g., BB&T Corp. v. U.S., (CA 4) 101 AFTR 2d 2008-1933 and AWG Leasing Trust, KSP Investments, Inc. as Tax Matters Partner v. U.S. (DC Ohio 5/28/2008) 101 AFTR 2d ¶ 2008-857.

Settlement initiative. IRS has decided that the settlement initiative is the most effective way to resolve the many outstanding transactions that have yet to be fully examined and/or adjudicated. The IRS letters being sent to affected taxpayers get right to the point. They state that IRS is willing to resolve all LILO or, as applicable, SILO transactions entered into by the taxpayer based on the terms stated in the applicable Attachment 1 for the type of transaction involved. The taxpayer has 30 days to accept the settlement offer. In order to accept the offer, the taxpayer must advise IRS in writing of its acceptance of all of the terms stated in Attachment 1. The taxpayer must provide certain documents requested by IRS as shown in the applicable Attachment 2 for the transaction involved. This would have to be done within 30 days of accepting the offer. More documents might need to be submitted depending on the specific transactions. IRS will entertain no counterproposals. IRS will take appropriate actions for those declining the offer.

Under the settlement terms for LILOs, among other items, the taxpayer would agree to concede 80% of any claimed interest expense deduction, amortized transaction costs, and head lease rent expense for each tax year through 2007. IRS would agree to disregard 80% of any reported taxable rental income with respect to the taxpayer's LILO transactions for each tax year through 2007.

Likewise for SILOs, among other items, the taxpayer would agree to concede 80% of any claimed interest expense deduction, depreciation deduction, and amortized transaction costs for each tax year through 2007. IRS would agree to disregard 80% of any reported taxable rental income with respect to the taxpayer's SILO transactions for each tax year through 2007. The taxpayer also would agree to report in 2008, 80% of the OID accrued with respect to its SILO transactions for each tax year through 2007.

In both cases, taxpayers would not be liable for accuracy-related penalties under Code Sec. 6662 or Code Sec. 6662A .

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Proposed regs explain strict charitable contribution substantiation & appraisal rules Preamble to Prop Reg 08/06/2008; Prop Reg § 1.170A-15, Prop Reg § 1.170A-16, Prop Reg § 1.170A-17, Prop Reg § 1.170A-18

Mike Habib, EA

IRS has issued proposed regs explaining the charitable contribution substantiation changes made by the American Jobs Creation Act of 2004 (AJCA) and the Pension Protection Act of 2006 (PPA). The proposed regs, which would be effective for contributions made after the date final regs are issued, also would provide guidance on what constitutes qualified appraisals and qualified appraisers for purposes of the substantial rules for noncash gifts.

Background. As toughened by the AJCA and PPA, the following rules apply for cash and noncash charitable contributions:

• A taxpayer can't deduct any contribution of a cash, check, or other monetary gift unless he maintains as a record of the contribution a bank record or a written communication from the donee organization showing its name, plus the date and amount of the contribution. (Code Sec. 170(f)(17)) For contributions of property (other than cash), the taxpayer must have a receipt from the donee and keep records showing the donee's name and describing the gift.
• No charitable deduction is allowed for any (cash or property) contribution of $250 or more unless the taxpayer substantiates it by a contemporaneous written acknowledgment (not just a cancelled check) from the donee (or its agent). (Code Sec. 170(f)(8)(A)) Goods or services that have insubstantial value and certain annual membership benefits the charity provides to the taxpayer, the taxpayer's employees, or the partners of a partnership donor, in exchange for the contribution are disregarded in determining the $250 threshold.
• For noncash contributions that are:

(1) more than $500 but not more than $5,000, the donor must attach to its return a description of the contributed property. This requirement doesn't apply to a C corporation. (Code Sec. 170(f)(11)(B))

(2) more than $5,000 but not more than $500,000, the donor must obtain a "qualified appraisal" and attach to its return information about the property and appraisal (i.e., appraisal summary) as required by IRS. (Code Sec. 170(f)(11)(C))

(3) more than $500,000, the donor must attached a qualified appraisal to its return. (Code Sec. 170(f)(11)(D)) The above requirements in (2) and (3) don't apply to certain categories of contributions, including qualified vehicle donations. (Code Sec. 170(f)(11)(A)(ii)(I)) IRS will disallow a deduction for property contributed if the above reporting requirements aren't met unless the failure was due to reasonable cause. (Code Sec. 170(f)(11)(A))

• A qualified appraisal is one that is: (1) treated as a qualified appraisal under regs or other guidance issued by IRS, and (2) conducted by a qualified appraiser in accordance with generally accepted appraisal standards and any regs or other guidance issued by IRS. (Code Sec. 170(f)(11)(E)(i)) A qualified appraiser is an individual who has earned an appraisal designation from a recognized professional organization or has otherwise met minimum education and experience requirements under IRS regs; regularly performs appraisals for compensation; and meets any other such requirements prescribed by IRS. (Code Sec. 170(f)(11)(E)(ii)) However, an individual won't be considered a qualified appraiser for any specific appraisal unless he demonstrates verifiable education and experience in valuing the type of property subject to the appraisal, and hasn't been prohibited from practicing before IRS at any time during the three-year period ending on date of the appraisal. (Code Sec. 170(f)(11)(E)(iii)) A penalty is imposed under Code Sec. 6695A on any person who prepared the appraisal and who knew, or reasonably should have known, the appraisal would be used in connection with a return or claim for refund. Notice 2006-96, 2006-46 IRB 902, provided interim guidance on the new rules for appraisals and appraisers (see Federal Taxes Weekly Alert 10/26/2006)
• Special rules apply for charitable contributions of motor vehicles, boats and airplanes that aren't in the taxpayer's inventory or held for sale in the ordinary course of his business (qualified vehicle donations), if the donation's claimed value exceeds $500. (Code Sec. 170(f)(12))
• Deductions aren't allowed for contributions of clothing and household items (e.g., furniture, furnishings, electronics, appliances) that are not in good used condition or better. However, a deduction may be allowed if the amount claimed for the item exceeds $500 and the taxpayer includes a qualified appraisal of the item with his return. (Code Sec. 170(f)(16))

However, the need to obtain and retain a bank record or written communication would not apply to transfers to certain trusts (e.g., a charitable remainder annuity trust or a charitable remainder unitrust), or to unreimbursed expenses of less than $250 incurred by a donor incident to rendering services for a charity. (Prop Reg § 1.170A-15(e), Prop Reg § 1.170A-15(g))

Noncash substantiation requirements. The proposed regs would clarify that donors who make contributions of $250 or more but not more than $500 must obtain only a contemporaneous written acknowledgment, as required by Code Sec. 170(f)(8) and Reg. § 1.170A-13(f)), and needn't obtain any other written records. (Prop Reg § 1.170A-16(b)) The proposed regs explain in detail how donors making noncash contributions or more than $500 would have to complete Form 8283 (Noncash Charitable Contributions). They also would provide that the rules for substantiation that must be submitted with a return also apply to the return for a carryover year under Code Sec. 170(d). (Prop Reg § 1.170A-16(c) through Prop Reg § 1.170A-16(f)))

To satisfy the "reasonable cause" exception to the noncash substantiation requirements, a donor would have to submit with the return a detailed explanation of why the failure to comply was due to reasonable cause and not to willful neglect. He also would have to obtain a contemporaneous written acknowledgment and a qualified appraisal, if applicable. (Prop Reg § 1.170A-16(f)(6)) These rules would supersede Reg. § 1.170A-13(c)(4)(H), which provides that a taxpayer who fails to file an appraisal summary (Form 8283) with the return may provide it within 90 days of a request from IRS, and the deduction will be allowed if the donor's original failure to file the appraisal summary is a good faith omission. Consistent with the Congressional purpose for enacting Code Sec. 170(f)(11) to reduce valuation abuses, IRS anticipates that the "reasonable cause" exception would be strictly construed to apply only when the donor meets the requirements for the exception as specified in the regs. (Preamble to Prop Reg 08/06/2008)

Qualified appraisals. The proposed regs generally follow the guidance in Notice 2006-96, and would provide that a qualified appraisal is one prepared by a qualified appraiser in accordance with generally accepted appraisal standards, defined as the substance and principles of the Uniform Standards of Professional Appraisal Practice (USPAP), as developed by the Appraisal Standards Board of the Appraisal Foundation. (Prop Reg § 1.170A-17(a)) IRS says it's aware that some appraisers of historic conservation easements have stated that local ordinances restricting modifications of a facade should be disregarded because local governments do not enforce these ordinances. In IRS's view, an appraisal that does not take into account a local ordinance is not consistent with the substance and principles of USPAP. (Preamble to Prop Reg 08/06/2008)

The valuation effective date (the date to which the value opinion applies) generally would be the date of the contribution. Where the appraisal is prepared before the contribution date, the valuation effective date would have to be no earlier than 60 days before the date of the contribution and no later than the date of the contribution. The date the appraiser signs the appraisal report (appraisal report date) would have to be no earlier than 60 days before the contribution date and no later than the due date (including extensions) of the return on which the deduction is claimed or reported. (Prop Reg § 1.170A-17(a)(5)(i))

Qualified appraisers. Code Sec. 170(f)(11)(E) establishes minimum education and experience requirements for an appraiser generally, and requires verifiable education and experience in valuing the type of property subject to the appraisal. IRS says it is sufficient for an appraiser to satisfy the more stringent requirement of verifiable education and experience in valuing the type of property subject to the appraisal. Satisfaction of that requirement would also satisfy the minimum education and experience requirement. (Prop Reg § 1.170A-17(b), Preamble to Prop Reg 08/06/2008)

The proposed regs would provide that an individual has verifiable education and experience if he has successfully completed professional or college-level coursework in valuing the relevant type of property and has two or more years experience in valuing that type of property. Because significant education and experience are required to obtain a designation from a recognized professional appraiser organization, appraisers with these designations would be deemed to have demonstrated sufficient verifiable education and experience. Additionally, education would be defined broadly to include coursework obtained in an employment context, provided it is similar to an educational program of an educational institution or a generally recognized professional appraisal organization. (Prop Reg § 1.170A-17(b)(2))

Among other statutory requirements, a qualified appraiser must be an individual who "regularly performs appraisals for which the individuals receive compensation." (Code Sec. 170(f)(11)(E)(ii)(II)) IRS says the quoted term is generally encompassed by the experience requirement and does not need to be separately met. (Preamble to Prop Reg 08/06/2008)

Clothing and household items. The proposed regs would clarify that to qualify for the more-than $500 exception from the "good used condition or better requirement," a donor would have to submit with the return on which the deduction is claimed a qualified appraisal prepared by a qualified appraiser, and fill out Section B of Form 8283. (Prop Reg § 1.170A-18(b))

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Finance Chairman Baucus wants more action and details on IRS strategy to combat identity fraud [Press release dated Aug. 5]:

A recent IRS update on its Identity Protection Strategy has failed to satisfy the concerns of Sen. Max Baucus (D-MT), chairman of the Senate Finance Committee.

The report, submitted to Baucus on July 21 by IRS Commissioner Douglas Shulman, was provided in response to a request the senator made at a committee hearing held in April. It summarized IRS's efforts in three areas: assistance to taxpayers in resolving tax issues associated with identity theft; outreach to increase taxpayer awareness of identity theft; and prevention of identity theft by building programs to address the problem.

According to IRS, identity theft can have a negative effect on a taxpayer's tax account in one of two ways--a taxpayer's identity could be used to obtain a fraudulent tax refund and the stolen information could be used to obtain employment. "Identity theft is a growing and serious issue that victimizes too many Americans," Baucus said. "And while this report is full of good intentions, its actual treatment of the problem is tepid and insufficient."

The most notable improvement to IRS processes contained in the report, Baucus said, was that taxpayers will be able to preemptively "self-report" to the agency when their identities have been stolen. However, he added that he wants IRS to give him "clear, substantive answers on their strategic plan, and its implementation, to treat and resolve cases of identity theft."

Baucus outlined a number of concerns with the IRS strategy, including the following: lack of clarity regarding specific goals, measures and timetables; uncertainty regarding when the agency will be able to prevent recurring holds on taxpayer accounts; insufficient details to determine whether there will be a central point of accountability at IRS; and absence of information addressing whether the agency will contact taxpayers when someone files a tax return using their Social Security number.

"I intend to follow up with Commissioner Shulman to make certain that my expectations are clear," Baucus stressed. The Baucus press release and Shulman's letter with the accompanying report can be found at http://finance.senate.gov/press/Bpress/2008press/prb080508.pdf

IRS issues new version of Central Withholding Agreement form

Mike Habib, EA

The IRS has issued a June 2008 version of Form 13930, Application for Central Withholding Agreement.

Under IRC §1441(a), nonresident alien (NRA) individuals are subject to 30% withholding on the gross amount of interest, dividends, rent, salaries, wages, compensations, remunerations, and emoluments they receive from sources within the United States. However, under a central withholding agreement (CWA), withholding is computed on estimated net income rather than gross income, and at graduated tax rates afforded to U.S. resident aliens and U.S. citizens rather than at a 30% tax rate. The IRS will consider entering into a CWA with a nonresident entertainer or athlete if all of the requirements in Rev Proc 89-47, 1989-2 CB 598, are met.

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IRS may require reporting of PAL activity groupings

Mike Habib, EA

Notice 2008-64, 2008-31 IRB 268

A new notice requests comments regarding a proposal to require taxpayers to report to IRS their groupings and regroupings of activities and the addition and disposition of specific activities within their existing groupings of activities for purposes of the Code Sec. 469 passive activity loss () rules and PAL Reg. § 1.469-4.

Background. Code Sec. 469 generally provides that deductions from passive trade or business activities, to the extent they exceed income from all such passive activities (exclusive of portfolio income), may not be deducted against other income.

Under Code Sec. 469(b), disallowed losses and credits are treated as deductions and credits allocable to the activity in the next tax year.

Code Sec. 469(g)(1)(A) generally provides that if during the tax year a taxpayer disposes of his entire interest in any passive activity (or former passive activity), and all gain or loss realized on the disposition is recognized, the excess of (i) any loss from the activity for the tax year (determined after the application of Code Sec. 469(b), over (ii) any net income or gain for the tax year from all other passive activities (determined after the application of Code Sec. 469(b)), is treated as a loss which is not from a passive activity.

Reg. § 1.469-4 sets forth the rules for grouping a taxpayer's trade or business activities and rental activities for purposes of applying the passive activity loss and credit limitation rules.

Proposed reporting. IRS is considering whether to change the reporting requirements for taxpayer groupings under Code Sec. 469. Although IRS has considered a number of approaches, the proposal described in Notice 2008-64 would generally require taxpayers to report to IRS, as part of their regular annual return, changes to their groupings. The proposal would apply to all persons or entities to whom the rules in Reg. § 1.469-4 apply. It would not apply to persons or entities who have made the election in Reg. § 1.469-9(g), relating to real estate professionals.

Specifically, the proposal would require a statement with specified information as detailed in Notice 2008-64 to be filed with respect to these events:

• New groupings. A taxpayer would have to file a written statement with his original return for the first tax year in which one or more trade or business activities or rental activities are originally grouped as a single activity or as separate activities.
• Addition of new activities to existing groupings. Whenever a taxpayer adds a new trade or business activity or a rental activity to an existing grouping within a tax year, he would have to file a written statement with his original return for the tax year in which the new trade or business activity or rental activity is added to the existing grouping.
• Disposition of activities from existing groupings. Whenever a taxpayer disposes of a specific activity from an existing grouping within a tax year, he would have to file a written statement with his original return for the tax year in which the disposition of the specific trade or business activity or rental activity within the existing grouping occurs.
• Regroupings. Under Reg. § 1.469 -4(e)(2), if it is determined that the taxpayer's original grouping was clearly inappropriate or a material change in the facts and circumstances has occurred that makes the original grouping clearly inappropriate, the taxpayer would have to regroup the activities and file a written statement with his original return for the tax year in which the regrouping occurs.

Failure to report. In general, if a taxpayer failed to report, then each trade or business activity or rental activity would be treated as having been grouped as a separate activity for purposes of applying the passive activity loss and credit limitation rules.

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Presidential candidates discuss merits of increasing the Social Security tax:

Mike Habib, EA

With less than three months until the 2008 presidential election, both candidates have expressed their views about a possible Social Security tax increase. The Federal Insurance Contributions Act (FICA) imposes two taxes on employers, employees, and self-employed workers -- one for Old Age, Survivors and Disability Insurance (OASDI; commonly known as the Social Security tax), and the other for Hospital Insurance (HI; commonly known as the Medicare tax).

The FICA tax rate for employees and employers is 7.65% each -- 6.2% for OASDI and 1.45% for HI. There is a maximum amount of compensation subject to the OASDI tax (i.e., $102,000 in 2008), but no maximum for HI. Employers and employees will each pay a maximum OASDI tax of $6,324 in 2008. Recently, Democratic Sen. Barack Obama (D-IL) called for higher Social Security taxes on wage earners making greater than $250,000 annually. The tax would not apply to wages between the current cap and $250,000.

The Senator has not released any other specifics on how this tax would work but has stated that his plan would "allow us to extend the life of Social Security" without raising the retirement age or cutting benefits. Sen. John McCain's (R-AZ) position on a Social Security tax increase is less clear.

In an ABC interview on July 27th, McCain said that when it comes to fixing Social Security, "everything is on the table," including a possible payroll tax increase. However, in a campaign speech after the ABC interview, McCain promised to fix the Social Security system without raising taxes.

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Innocent spouse relieved of tax from embezzlement and forgery

Yakubik, TC Summary Opinion 2008-74

Mike Habib, EA The Tax Court recently held that the IRS abused its discretion in not granting equitable innocent spouse relief to a husband whose wife embezzled funds from her employer and forged checks taken from her stepfather.

Facts. The taxpayer was married throughout 2003 and divorced in 2005. During 2003, his wife was employed by an attorney as a paralegal. At some point during that year, she began to embezzle funds from her employer, write bad checks on a joint account held by the taxpayer and his wife, and forge checks belonging to her stepfather.

The wife was arrested for allegedly committing felonies and pled guilty to some of them, including forgery and embezzlement. On 12/1/03, she was sentenced to prison and ordered to pay restitution of $17,000 to her former employer and $3,000 to her stepfather. She remained incarcerated from 10/20/03 to 11/9/05.

On 3/8/04, the taxpayer and his wife filed a joint tax return for 2003. Although the wife was incarcerated at that time, she had executed a Form 2848, Power of Attorney and Declaration of Representative, that gave the taxpayer authority to act on her behalf for the 2003 tax year. He used this authority to file the joint return.

The joint return failed to include the amount the wife had embezzled and obtained by means of forgery. It also omitted wages the wife earned from her employment as a paralegal. Based on the income reported on the return, the couple qualified for an earned income credit; they would not have received the credit had they reported their full income. Consequently, the IRS issued a refund for $5,017.

The taxpayer received a Form W-2 from his wife's employer after the return was filed, but he did not file an amended return to include that income. The IRS examined the return and issued a deficiency notice in 2005. The taxpayer then requested relief from joint and several liability.

The IRS sent separate letters to each of the spouses indicating a preliminary determination to grant the taxpayer relief from liability under Section 6015(c) and to deny relief under Section 6015(f). The wife, as an intervenor, sent a letter to the IRS disagreeing with the determination. The IRS then issued a final notice of determination denying the taxpayer's request for innocent spouse relief under Sections 6015(b), (c), and (f). The taxpayer sought Tax Court review of this determination.

Section 6013(d)(3) provides that joint return filers are jointly and severally liable for the taxes due. Despite this, however, Section 6015 offers limited relief from joint and several liability. Section 6015(e)(4) gives the spouse who has not elected to request relief the right to intervene in the proceeding of a spouse who has sought relief.

Section 6015(b). To qualify for relief under Section 6015(b)(1), the requesting spouse must establish the following:

(1) A joint return was filed. (2) The understatement of tax was attributable to erroneous items of the nonrequesting spouse. (3) When the return was signed, the spouse seeking relief did not know, or have reason to know, of the understatement. (4) Taking into account all the facts and circumstances, it is inequitable to hold the spouse seeking relief liable for the deficiency in tax attributable to the understatement.

(5) The requesting spouse seeks relief within two years of the first collection activity.

Section 6015(c). Relief may be available under Section 6015(c) if the following requirements are met:

(1) At the time relief is requested, the taxpayer is no longer married to, or is legally separated from, the person with whom the joint return was filed.

(2) For the 12-month period preceding the request, the taxpayer did not live with the other person.

Section 6015(f). A third avenue for relief from joint and several liability is provided by Section 6015(f). It is available if these conditions are satisfied:

(1) Relief is not available to the taxpayer under Section 6015(b) or (c). (2) Taking into account all the facts and circumstances, it is inequitable to hold the taxpayer liable for any unpaid tax or deficiency.

(1) The spouses must be separated or divorced. The taxpayer had divorced, so this factor favors his request. (2) The spouse seeking relief will suffer economic hardship without relief. The court disagreed with the IRS's evaluation and found that the taxpayer would suffer economic hardship if relief were not granted. Thus, this factor favors the taxpayer.

(3) The spouse seeking relief did not know or have reason to know of the item giving rise to the deficiency. As stated above, the taxpayer had the requisite knowledge or reason to know. This supports the position of the IRS.

(4) The spouse not seeking relief had a legal obligation to pay the outstanding liability. This factor is neutral because the divorce agreement does not mention responsibility for payment of any outstanding taxes.

(5) The spouse seeking relief received a significant benefit from the item giving rise to the deficiency. The taxpayer used the refund to make restitution payments on the wife's behalf, pay past-due bills for rent and utilities, and purchase Christmas presents for her children. As such, this factor favors the taxpayer.

(6) The spouse seeking relief made a good faith effort to comply with income tax laws in later years. This factor is neutral because the taxpayer was in compliance.

(7) The spouse seeking relief was abused by the other spouse. No abuse was alleged, so this factor also is neutral. (8) The spouse seeking relief was in poor mental or physical health when signing the return or requesting relief. Here too the factor is neutral because no evidence indicated that the taxpayer suffered any ailment that affected his ability to pay the tax obligation.

For Innocent Spouse tax problem resolution CLICK HERE.

REIT changes in the 2008 Housing Act

Mike Habib, EA Included in the $15.1 billion of housing tax incentives in the recently enacted "Housing Assistance Tax Act of 2008" (the Housing Act) is a package of changes liberalizing the real estate investment trust (REIT) rules. Under these new provisions:

• Foreign exchange gains that a REIT generates from operating real estate outside of the U.S. generally will qualify under both REIT gross income tests.
• The limit on a REIT's ownership of taxable REIT subsidiaries (TRSs) increases from 20% to 25% of the REIT's gross assets.
• The safe harbor test for dealer sales is changed by reducing the holding period requirement from four years to two years and by allowing measurement of the 10% sales test by fair market value instead of tax basis.
• Health care facilities can be leased by a TRS to a REIT under the same rules that currently apply to lodging facilities.
• The new rules for REITs are generally effective for tax years beginning after the date of enactment. However, some of the effective dates are accelerated to apply to transactions entered into after the date of enactment, e.g,. dispositions tested under the dealer sales rules.

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Tightened home sale exclusion and other revenue raisers in the 2008 Housing Act

Mike Habib, EA To pay for the $15.1 billion of housing tax incentives in the recently enacted "Housing Assistance Tax Act of 2008" (the Housing Act), Congress passed several offsetting revenue raisers, including a requirement that banks provide information returns reporting annual credit card sales to IRS and to merchants, a provision requiring homeowners to pay tax on gains made from the sale of a second home to reflect the portion of time the home was used as a vacation or rental property, and a provision delaying for one year a "worldwide interest allocation provision" that would result in lower taxes for some multinational companies. Here are the details of these revenue-raising provisions.

Payment card and third party network information reporting For returns for calendar years beginning after 2010, the new law requires banks and online payment networks to file an information return with IRS reporting the gross amount of credit and debit card payments a merchant receives during the year, along with the merchant's name, address, and taxpayer identification number (TIN). Reporting is also required for third party network transactions. Information reporting for third party network transactions will be required only for merchants that have (1) annual credit and debit card transactions exceeding $20,000 in the aggregate, and (2) an aggregate number of such transactions during the year that exceeds 200.

Home sale exclusion rules tightened Most homeowners are aware of the home sale exclusion, a provision of the tax laws which provides that homeowners who sell their principal residence typically don't need to pay taxes on as much as $500,000 of their gain if they meet certain conditions. (The $500,000 exemption is the maximum exclusion for a married couple filing jointly; taxpayers filing individually get an exemption of up to $250,000.) To be eligible for the full exclusion, a taxpayer must have owned the home--and lived in it as his or her principal residence--for at least two of the five years prior to the sale. Because of the "principal residence" requirement, vacation or second homes normally don't qualify for the exclusion. However, in what some saw as a loophole, the law permitted taxpayers to convert their second home to their principal residence, live in it for two years, sell it, and take the full $250,000/$500,000 exclusion available for principal residences, even though portions of their gains were attributable to periods when the property was used as a vacation or second home, not a principal residence.

The new law closes that "loophole" by requiring homeowners to pay taxes on gains made from the sale of a second home to reflect the portion of time the home was not used as a principal residence (e.g, vacation or rental property). The amount taxed will be based on the portion of the time during which the taxpayer owned the home that the house was used as a vacation home or rented out. The rest of the gain remains eligible for the up-to-$500,000 exclusion, as long as the two-out-of-five year usage and ownership tests are met. The new law in effect reduces the exclusion based on the ratio of years of use as a principal residence to the total time of ownership. For example, if a taxpayer owned a vacation home for ten years, but lived in it as a principal residence only for the final two years prior to sale, the maximum available exclusion would be reduced by four-fifths. Accordingly, a $400,000 gain on the sale that would be eligible for the full exclusion under pre-Act law would be reduced by four-fifths, to $80,000.

The good news for current owners of second homes is that the new law is not retroactive. The tightening applies only to sales after 2008. Plus, any periods of personal or rental use before 2009 are ignored for purposes of the provision. Also, the new law doesn't change the rule that allows homeowners to take advantage of the home sale exclusion every two years. Taxpayers can still "home hop" with full tax exclusion if they only own one home at a time. Moreover, the taxpayer still qualifies for capital gain treatment on the amount of gain that cannot be excluded.

Delayed implementation of worldwide allocation of interest In 2004, Congress provided taxpayers with an election to take advantage of a liberalized rule for allocating interest expenses between U.S. sources and foreign sources for purposes of determining a taxpayer's foreign tax credit limitation. Although enacted in 2004, this election was not scheduled to be available to taxpayers until tax years beginning after 2008. The new law delays the phase-in of this new liberalized rule for two years (to tax years beginning after 2010). Special transition rules apply in the first year that the liberalized rule phases in.

I hope this information is helpful.

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Credit for first-time homebuyers in the 2008 Housing Act

• • Individuals may credit the lesser of $7,500 or 10% of the price paid for the home against tax owed in the year of purchase. The $7,500 maximum credit applies both to individuals and married couples filing a joint return. A married individual filing separately can claim a maximum credit of $3,750.
  • The credit phases out for individual taxpayers with modified adjusted gross income between $75,000 and $95,000 ($150,000-$170,000 for joint filers) for the year of purchase.
  • In the second year after purchase, taxpayers who took the credit must start adding the credit amount back into taxes paid incrementally over 15 years with no interest charge. This would work as follows. Suppose a first-time homebuyer purchases a home this coming December. He could claim a tax credit equal to 10 percent of the purchase price of the home or $75,000, whichever is smaller, on his 2008 tax return. Assuming for purposes of this example that the amount of his credit is $7,500, he then would be required to pay $500 (one-fifteenth of the credit) back on his 2010 tax return and on his return for each of the following 14 years.
  • If the taxpayer sells the home (or the home ceases to be used as the principal residence of the taxpayer or the taxpayer's spouse) prior to complete repayment of the credit, any remaining credit repayment amount is due on the tax return for the year in which the home is sold (or ceases to be used as the principal residence). However, the credit repayment amount may not exceed the amount of gain from the sale of the residence to an unrelated person. For this purpose, gain is determined by reducing the basis of the residence by the amount of the credit to the extent not previously recaptured. No amount is recaptured after the death of a taxpayer. In the case of an involuntary conversion of the home, recapture is not accelerated if a new principal residence is acquired within a two-year period. In the case of a transfer of the residence to a spouse or to a former spouse incident to divorce, the transferee spouse (and not the transferor spouse) will be responsible for any future recapture.
  • The tax credit is refundable, meaning that households with incomes too low to owe income taxes could benefit from it.
  • The credit applies to homes purchased on or after April 9, 2008 and on or before July 1, 2009. A special rule allows those who purchase a principal residence after Dec. 31, 2008, and before July 1, 2009, to treat the purchase as made on Dec. 31, 2008 (effectively allowing them to claim the credit on their 2008 returns rather than on their 2009 returns).
  • A taxpayer is considered a first-time homebuyer if the individual (and the individual's spouse if married) had no ownership interest in a principal residence in the U.S. during the 3-year period prior to the purchase of the home to which the credit applies.
  • No credit is allowed if the D.C. homebuyer credit is allowable for the taxable year the residence is purchased or a prior tax year, the taxpayer's financing is from tax-exempt mortgage revenue bonds, the taxpayer is a nonresident alien, the taxpayer disposes of the residence (or it ceases to be a principal residence) before the close of the tax year for which the credit otherwise would be allowable, or the home is acquired from certain related persons or by gift or inheritance.

Property tax deduction for non-itemizers in the 2008 Housing Act

Included in the $15.1 billion package of housing tax incentives in the recently enacted "Housing Assistance Tax Act of 2008" (the Housing Act) is a measure creating a new, temporary property tax deduction for non-itemizers (i.e., for taxpayers who claim the standard deduction rather than itemizing their deductions). Here is a brief overview of this new provision:

• The provision creates a new standard deduction for state and local real property taxes paid by non-itemizers. Since most homeowners who are paying on a mortgage have enough deductions (e.g., mortgage interest and property taxes) to justify itemizing them on their return, this new provision chiefly benefits homeowners who have paid off their homes.
• The deduction is available only for one year--for tax years beginning in 2008.
• The amount of deduction is as much as $500 for single filers and $1,000 for joint filers. Since this is a deduction and not a credit (i.e., a dollar-for-dollar reduction in tax liability), the actual tax benefit will not be substantial: $100 to a couple in the 10 percent tax bracket and $150 to a couple in the 15 percent bracket (and only $50 and $75, respectively, to singles in these brackets).

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IRS explains how to claim (or elect out of) 50% Kansas bonus depreciation Notice 2008-67, 2008-32 IRB

Mike Habib, EA

The Food, Conservation and Energy Act of 2008, popularly known as the Farm Act, provided temporary GO Zone-style tax relief for taxpayers in Kiowa County, Kansas, and surrounding areas, who were affected by the storms and tornadoes that began on May 4, 2007. This relief includes 50% bonus depreciation (Kansas additional first year depreciation) for qualified Recovery Assistance (RA) property placed in service by the taxpayer on or after May 5, 2007, during the tax year that includes May 5, 2007. IRS has issued detailed guidance explaining how to claim (or elect out of) this Kansas bonus depreciation.

Background. Section 15345(a) of the Farm Act provides that, with the exception of newly revised dates for determining the eligibility of the Kansas additional first year depreciation deduction for RA property, the rules for determining the eligibility of the Kansas additional first year depreciation deduction for RA property will be determined by following Code Sec. 1400N(d)(1) through Code Sec. 1400N(d)(5). RA property is depreciable property that meets all of five requirements set forth in Notice 2008-67, Sec. 2.02 , some of which incorporate principles from earlier IRS guidance on GO Zone bonus depreciation. For example, one requirement is that substantially all of the use of the property must be in the Kansas disaster area and in the active conduct of a trade or business in that area. For this purpose, rules similar to those in Notice 2006-77, 2006-2 CB 590, Sec. 3, apply for determining "substantially all" and "active conduct of a trade or business."

Notice 2008-67, Sec. 2.03, sets forth eight categories of depreciable property that are not eligible for the Kansas additional first-year depreciation.

Kansas disaster area. The counties in Kansas that comprise the Kansas disaster area are: Barton, Clay, Cloud, Comanche, Dickinson, Edwards, Ellsworth, Kiowa, Leavenworth, Lyon, McPherson, Osage, Osborne, Ottawa, Phillips, Pottawatomie, Pratt, Reno, Rice, Riley, Saline, Shawnee, Smith, and Stafford. ( Notice 2008-67, Sec. 2.04 )

Claiming bonus depreciation where a return has not been filed. If a taxpayer has not filed its federal tax return for the tax year that includes May 5, 2007, and wants to claim the Kansas additional first year depreciation for a class of property (as defined in Notice 2008-67, Sec. 4.02) that is RA property placed in service by the taxpayer on or after May 5, 2007, during the tax year that includes May 5, 2007, the taxpayer may claim the Kansas additional first year depreciation for that class of property on line 14 of Form 4562, Depreciation and Amortization, for the federal tax return for the tax year that includes May 5, 2007. If the RA property is listed property under Code Sec. 280F(d)(4), such as passenger automobiles or computers, the taxpayer may claim the Kansas additional first year depreciation for that listed property on line 25 of Form 4562, Depreciation and Amortization, for the federal tax return for the tax year that includes May 5, 2007. (Notice 2008-67, Sec. 3.02)

Claiming bonus depreciation where a return has been filed. If a taxpayer timely filed its federal tax return for the tax year that includes May 5, 2007, and did not claim on that return the Kansas additional first year depreciation for a class of property that is RA property placed in service by the taxpayer on or after May 5, 2007, during the tax year that includes May 5, 2007, but wants to do so, the taxpayer may claim the Kansas additional first year depreciation for that class of property under Notice 2008-67, Sec. 3.03 , provided the taxpayer did not make an election not to deduct the Kansas additional first year depreciation for the class of property under Notice 2008-67, Sec. 4.03 . The taxpayer has the option of claiming the Kansas additional first year depreciation for the tax year that includes May 5, 2007:

• by filing an amended federal tax return (or a qualified amended return under Rev Proc 94-69, 1994-2 CB 804, if applicable) on or before Dec. 31, 2009, for the tax year that includes May 5, 2007, and any affected subsequent tax year, and including the statement "Filed Pursuant to Notice 2008-67" at the top of any amended return (or qualified amended return);
• by filing a Form 3115, Application for Change in Accounting Method, with the taxpayer's timely filed federal tax return for the first tax year succeeding the tax year that includes May 5, 2007, if this return has not been filed on or before Aug. 11, 2008, and the taxpayer owns the property as of the first day of this tax year; or
• if the taxpayer's federal tax return for the first tax year succeeding the tax year that includes May 5, 2007, was filed on or before Aug. 11, 2008, by either (i) filing an amended federal tax return (or a qualified amended return) on or before Dec. 31, 2009, for the first tax year succeeding the tax year that includes May 5, 2007, attaching a Form 3115 to the amended federal tax return, and including the statement "Filed Pursuant to Notice 2008-67" at the top of any amended return (or qualified amended return); or (ii) filing a Form 3115 with the taxpayer's timely filed federal tax return for the second tax year succeeding the tax year that includes May 5, 2007, if the taxpayer owns the property as of the first day of this tax year. (Notice 2008-67, Sec. 3.03)

Except as provided in Notice 2008-67, Sec. 4.03(3), an election not to deduct the Kansas additional first year depreciation for any class of property that is RA property placed in service during the tax year must be made by the due date (including extensions) of the federal tax return for the tax year in which the RA property is placed in service by the taxpayer. Except as provided in Notice 2008-67, Sec. 4.03(2) and Notice 2008-67, Sec. 4.03(3), the election not to deduct the Kansas additional first year depreciation must be made in the manner prescribed on Form 4562, Depreciation and Amortization, and its instructions.

Notice 2008-67, Sec. 4.03(2), provides procedures for making the election not to deduct the Kansas additional first-year depreciation for returns for the tax year that includes May 5, 3007 that are filed on or after Aug. 11, 2008.

Notice 2008-67, Sec. 4.03(3), provides special rules for returns for the tax year that includes May 5, 3007 that are filed before Aug. 11, 2008 under which a taxpayer is considered to have made the election not to deduct the Kansas additional first-year depreciation.

For tax problem resolution CLICK HERE.

Doctors get socked with big tax and penalties for donations tied to consolidation of their practice

Berquistist and Kendrick, et al., (2008) 131 TC No. 2

Mike Habib, EA

The Tax Court has determined that doctors grossly overvalued charitable donations of stock in their medical professional service corporation (PSC) that arose in connection with a consolidation of their practices. Accordingly, it hit them with large deficiencies and substantial accuracy related penalties. The claimed value of the stock was $401.79 per share but the Tax Court found the value to be only $37 per share.

Facts. IRS determined deficiencies for tax years 2001 to 2002 for five doctors and an accountant, and additional deficiencies for 2003 for four of them. The primary issue was the fair market value (FMV) of stock in a medical PSC that was donated to a charitable professional service corporation. Parties in 20 related but nonconsolidated cases agreed to be bound by the stock valuation determination in this case and the penalties if the Court's holding on the penalties was the same for all parties.

From '94 to 2001, the five doctors practiced medicine as employees of and as stockholders in University Anesthesiologists, P.C. (UA), a medical PSC specializing in anesthesiology. From '94 to 2001 the accountant was the chief executive officer of and a stockholder in UA.

Through UA, the doctors provided medical services to patients of the Oregon Health & Science University Hospital (OHSU), a public teaching and research hospital in Portland, Oregon. UA was the exclusive provider of anesthesiology medical services to all OHSU hospitals and clinics.

Before the stock donation at issue, the doctors and the accountant each held 100 shares of UA's voting common stock which they purchased in '94 at $1 per share. In addition to UA, approximately 30 other medical practice specialty groups were affiliated with OHSU in a similar manner through separate medical professional service corporations.

In the late '90s and after careful consideration and discussion, because of perceived risks and management concerns associated with the many separate medical practice specialty groups that were providing (through their respective professional service corporations) medical services to OHSU hospitals and clinics, OHSU's executive management concluded that the consolidation into a single medical practice group, controlled and managed by a single PSC which in turn would be under OHSU's direct management and administration, would be required of all the different medical practice specialty groups that wished to continue to be affiliated with OHSU (the consolidation).

In '98 OHSU management formed the OHSU Medical Group (OHSUMG) as a Code Sec. 501(c)(3) tax-exempt professional service corporation to serve as the single consolidated medical group into which all of the then-extant 30 different medical practice specialty groups whose doctors were affiliated with OHSU would be consolidated.

A plan was hatched to reap large tax benefits by having the doctors donate their UA stock to OHSUMG.

In or around April 2001, an attorney for UA informed each UA stockholder of the steps to be taken to make the donation to OHSUMG of his or her UA stock and to claim a charitable contribution deduction for the donation. Under the plan outlined by the UA attorney, a new class of nonvoting UA stock would be issued through the distribution of a UA stock dividend. The attorney believed that this step was necessary to comply with Oregon law under which a majority of voting stock in a medical professional service corporation was required to be held by licensed Oregon doctors.

The attorney's plan then called for UA stockholders to donate their UA stock to OHSUMG in two stages. Before the consolidation they would donate to OHSUMG their newly created UA nonvoting stock and claim substantial charitable contribution deductions. After the consolidation they would donate to OHSUMG their UA voting stock and possibly claim additional charitable contribution deductions.

On their respective 2001 Federal income tax returns, using an appraisal-based per-share value of $401.79 for both the voting and the nonvoting shares, 26 of the 28 UA stockholders claimed charitable contribution deductions for the donation of their UA stock. The remaining two UA stockholders claimed no charitable contribution deduction for the donation of UA stock.

Before taking into account charitable contribution limitations, the doctors generally claimed charitable contribution deductions of $176,788 on their 2001 Federal income tax returns for their UA stock donations. Because of the limitations, a number claimed carryovers to subsequent years.

On audit of the various returns, IRS, determining that on the Sept. 14, 2001 donation date, the UA stock had no value and disallowed in their entirety the claimed charitable contribution deductions relating to the donation of UA stock.

Before trial and on the basis of an expert appraisal, IRS agreed that the UA stock had a value of $37 per voting share and $35 per nonvoting share and that charitable contribution deductions were allowable to that extent.

Court sides with IRS. The Tax Court observed that the dramatic difference between the doctors' experts' and IRS's expert's appraised value for the UA stock stemmed largely from the experts' respective conclusions as to the proper valuation premise--whether to value UA as a going concern. The Tax Court sided with IRS and concluded that as of the Sept. 14, UA should not be valued as a going concern. The donation of UA stock was driven by the imminent consolidation of UA (along with the other medical groups) into OHSUMG.

The Court then went on to analyze how the IRS expert arrived at the $37 and $35 values. Because the doctors did not show and the Court did not find flaw in IRS's expert's analysis, the Court concluded that the UA voting and nonvoting stock had a per-share value of $37 and $35, respectively, on the date in issue.

It also found that each doctor could be socked with a 40% undervaluation penalty under Code Sec. 6662(h) if his or her underpayment exceeded $5,000.

For tax problem resolution CLICK HERE.

No FUTA exemption for staffing company that was considered the employer for state UI purposes Chief Counsel Advice 200827007

Mike Habib, EA

The IRS has denied a federal unemployment tax (FUTA) exemption to a staffing company because it did not consider the company to be the common law employer of the workers in question

Facts. According to the IRS, the taxpayer conducted its operations in a manner similar to businesses commonly called employee leasing companies or professional employer organizations. The taxpayer offered client businesses multiple employee benefit and payroll services, including withholding, depositing, and reporting of all applicable federal and state employment-related taxes. The taxpayer filed Form 940, Employer's Annual Federal Unemployment (FUTA) Tax Return, and Form 941, Employer's Quarterly Federal Tax Return, for all of its clients on an aggregate basis, using its own name and employer identification number.

Law. The FUTA tax under IRC §3301 is imposed on every employer equal to a certain percentage of the wages that it pays with respect to employment. IRC §3306(b) provides that for FUTA purposes, the term "wages" means all remuneration for employment, with certain specified exceptions. IRC §3306(c) defines employment, in relevant part, as any service of whatever nature performed by an employee for the person employing him. Therefore, unless amounts paid are excepted from "wages," or the services performed are excepted from "employment," FUTA tax will apply.

In Rev Rul 54-471, 1954-2 CB 348, the IRS stated that the common law relationship of the parties determined whether an employment tax liability exists, even when a third party is involved in the payment of wages. A common law employer/employee relationship exists between an entity and individuals when the entity has the right to direct and control the performance of services by the individuals. Factors considered in determining whether an entity has an employer/employee relationship with workers include the nature and degree of financial and behavioral control that the entity has, and the relationship of the parties, including the relationship the parties believe they are creating.

The taxpayer filed a claim for refund of FUTA taxes, based on its belief that it was eligible for the FUTA exemption under IRC §3306(c). The taxpayer contended that it was the employer of its clients' workers because it was considered to be the employer for state unemployment tax purposes. The taxpayer's representative also asserted that the taxpayer was the employer of the workers in question because the taxpayer was the statutory employer of those workers under IRC §3401(d)(1).

Ruling. The IRS denied the taxpayer's refund claim because there was no evidence that the taxpayer was the common law employer of the workers in question. The IRS said that the facts provided with respect to how the taxpayer initiated its relationship with its clients, the range of businesses conducted by the clients, and the geographic dispersion of the clients, weighed against viewing the taxpayer as the common law employer. The IRS noted that: (1) the client company continued to control the daily performance of its workers' duties, and (2) the taxpayer did not provide employees with any specific instructions as to when, where, or how the work would be performed.

The IRS said that the fact that the taxpayer was considered the employer of the workers for state unemployment tax purposes had no effect on the determination of who was the employer of the workers for FUTA purposes. Similarly, the IRS ruling would not change even if the taxpayer was considered the statutory employer of the workers in question. FUTA liability, including the exception from FUTA provided under IRC §3306(c), is determined based on who is the common law employer.

Proposed revenue ruling gives green light to use of private trust companies Notice 2008-63, 2008-31 IRB

Mike Habib, EA

A new notice contains a proposed revenue ruling that would allow families to use private trust companies (PTCs) in their estate planning without adverse income, estate, gift or generation-skipping transfer (GST) tax consequences for the trust creators or beneficiaries in carefully defined situations. IRS requests comments on the proposed ruling.

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

Under the grantor trust rules of Code Sec. 671 to Code Sec. 679, the grantor, or another person, such as a beneficiary, is treated as the "owner" of all or part of the trust and taxed directly on the income of the trust to the extent of that "ownership" so long as the grantor or other person is not a foreign person.

Property subject to a general power of appointment created after Oct. 21, '42, is includible in the gross estate of the holder of the power if the decedent either: (1) has the power at the time of his death, and the interest subject to the power exists at the time of his death, or (2) exercised or released the power, in a testamentary manner, or the power lapsed. (Code Sec. 2041(a))

Detailed facts in the proposed ruling. The proposed ruling includes a set of fairly substantial general facts followed by even more detailed specific facts in each of two situations. Basically, a married couple, A and B, established separate irrevocable trusts for each of their three children, C, D and E, all of whom are married and have their own children. These individuals are collectively referred to as Family. The trustee of each trust has discretionary authority to distribute income and/or principal to the primary beneficiary during his lifetime and the primary beneficiary has a testamentary power to appoint the trust corpus to or for the benefit of one or more Family members and/or charities. Each trust also provides that the grantor, or the primary beneficiary if the grantor is not living, may appoint a successor trustee other than himself or herself if the current trustee either resigns or is no longer able to fulfill the duties of trustee.

In Situation 1, the trust is governed by the laws of State 1, a state that has enacted a PTC statute (Statute). Any PTC formed under Statute must create a Discretionary Distribution Committee (DDC) and delegate to the DDC the exclusive authority to make all decisions regarding discretionary distributions from each trust for which it serves as trustee. Statute does not restrict who may serve on the DDC, but provides that no member of the DDC may participate in the activities of the DDC with regard to any trust of which that DDC member or his or her spouse is a grantor, or any trust of which that DDC member or his or her spouse is a beneficiary. In addition, Statute provides that a DDC member may not participate in the activities of the DDC with respect to any trust with a beneficiary to whom that DDC member or his or her spouse owes a legal obligation of support.

In 2008, Family formed a PTC with governing documents creating a DDC that will make all decisions with respect to discretionary distributions from all trusts for which it serves as trustee, consistent with Statute. PTC becomes trustee of the above trusts and additional trusts created by A for his children.

In Situation 2, the facts are the same as in Situation 1, except that the PTC is formed in State 2, a state that has not enacted specific legislation governing the formation or operation of a PTC. PTC is established for the specific purpose of acting as the trustee for the various trusts established by members of Family. In each situation, Family owns all of the stock in PTC, either outright or through trusts and/or other entities. Each situation provides extremely detailed information concerning the DDC's powers and restrictions or lack thereof on who may serve as DDC.

Favorable rulings. The proposed revenue ruling concludes that neither the appointment nor the service of PTC as the trustee of a Family trust described in Situation 1 or Situation 2 will by itself:

• cause the value of the trust assets to be included in a grantor's gross estate under Code Sec. 2036(a) or Code Sec. 2038(a).
• cause the value of the trust assets to be included in a beneficiary's estate under Code Sec. 2041
• affect the exempt status of that trust if the trust is otherwise exempt from the GST tax under Reg. § 26.2601-1(b)(1)(i) (grandfather exception for trusts in existence on Sept. 25, '85), or change the inclusion ratio of a trust.
• cause any grantor or beneficiary of that trust to be treated as the owner of that trust or any portion thereof under Code Sec. 673, Code Sec. 676, Code Sec. 677, or Code Sec. 678. Whether any grantor is treated as an owner of the trust or any portion of it under Code Sec. 675 is a question of fact. Whether any grantor is treated as an owner of the trust or any portion thereof under Code Sec. 674 will depend upon the particular powers of the trustee and may depend upon the proportion of the members of the DDC with authority to act with regard to that trust who are related or subordinate to the grantor.

National Taxpayer Advocate annual report to Congress identifies priorities and issues for upcoming year [IR 2008-87]:

An annual report on the priority challenges and issues facing the Office of the Taxpayer Advocate (OTA) was delivered to Congress on July 8.

The report, National Taxpayer Advocate's 2009 Objectives Report to Congress, cited three areas for "particular emphasis" in fiscal year 2009, which begins on Oct. 1.

The first area concerns tax-related identity theft. This also was mentioned in the annual report for FY 2007 and IRS has taken a number of steps to improve its procedures, the report said. However, the OTA will work with IRS to improve the agency's procedures in this area.

The second area of concern relates to cancellation of debt income. Specifically, the OTA will expand "outreach and education to individuals who have lost their homes to foreclosure concerning the "cancellation of debt" tax consequences they face," the report said.

The third key area of concern relates to IRS collection practices. The OTA "remains concerned" about certain collection issues, including "resorting to seizures before all viable collection alternatives have been exhausted, under-utilization of partial-pay installment agreements, and excessive delays in collection that exacerbate taxpayer delinquency problems because of the accumulation of interest and penalties," the report said.

The report mentioned additional areas of emphasis, which included monitoring the private debt collection program, working with IRS to assist taxpayers with disproportionate tax liabilities due to alternative minimum tax resulting from the exercise of incentive stock options (known as "ISO/AMT" tax liabilities), and working with IRS to improve the correspondence examination program.