Cases and Rulings in National Income Tax Workbook

1. Cases and RulingsChapter 16pp. 607 - 684 2015 National Income TAX Workbook™

2. Introduction pp. 608 - 609 20% accuracy-related penalty for substantial understatement Exceptions to IRC §6662: “Substantial authority” for position or “Reasonable basis” for position with adequate disclosure on return

3. Standards of Authority If Chance of Winning Is:Your position is: • 0 - 5% = Frivolous • 20% = Reasonable Basiswith Disclosure • 33% = Realistic Possibility (AICPA) • 40% = Substantial Authority (IRS) • 50+% = More likely than not • IRC §6694 Preparer Penalties

4. Substantial Authority p. 609 Must believe that there is at least a 40% chance of winning the case on its merits. Substantial authority can exist for more than one position relating to same item. Code, regulations, IRS releases, court cases, treaties, congressional reports . . .

5. Reasonable Basis pp. 609 - 610 Less stringent standard than substantial. Some authority exists (20%) even if weight of contrary authority is greater. Disclosure required to avoid penalty if have only a reasonable basis. Disclosure on Form 8275 or 8275R.

6. Practitioner Note p. 609IRS Disclosure Standards • IRS Revenue Procedure each year: • 2015 – Rev Proc. 2015-16, 2015-7 IRB 596 • Which provides that some items are considered adequately disclosed on the return itself. • 2014 – Rev. Proc. 2014-15 • 2013 - Rev. Proc. 2012-15 • 2012 - Rev. Proc. 2011-15 • In addition, courts have ruled that alternate forms of disclosure in the tax return itself may be adequate to avoid IRC §§ 6662 & 6694 penalties.

7. Jurisdiction of Courts pp. 610 - 611 • Tax Court has nationwide jurisdiction. • Located in DC & travel to states. • Regular (or TC) case v TC Memo case. • District Court – Pay 1st ; File claim / suit for refund. • Circuit court jurisdiction is geographic, except for Federal Circuit; See map on page 610. • Tax Court must follow appellate decisions only for TPs within that court’s jurisdiction (Goldsen Rule) • Other circuit’s opinion has authority.

8. Organization of the Internal Revenue Code Fig 16.2; 16.3; 16.4 & 16.5 pp. 611 - 615 Pages 611 - 615 provide a list of the IRC Chapters and Regulation Sections.

9. Rulings and Cases Discussed Elsewhere in Text p. 607 - 608 Pages 607 - 608 provide a list and index of the Rulings and Cases and where they can be found in the Workbook (Text)

10. Reg-109187-11 p. 616 • Proposed Reg under §453B, IRC provides that: • Gain or loss is not recognized on disposition of an installment obligation if not recognized under another Code Section. • But, gain or loss is recognized on satisfaction of an installment agreement, such as when holder transfers it to the issuer for an equity interest in the issuer. • Gain or loss is recognized when an installment agreement is satisfied at other than face value or when obligation is distributed, transmitted, sold or disposed of.

11. Field Attorney Advice pp. 616 -617 • A nonexempt agricultural cooperative did not make per unit retains paid in money (PURPIM) with respect to grain purchases by a related LLC from the taxpayer’s patrons for purposes of the domestic production activity deduction.

12. In re Wilson 52 BR 635 (Bankr. ND Calif, 2015) p. 618 • TP filed 2008 tax return late in 2011 but did not pay the liability & did have an extension to 10-15-2009. • 7-24-2012 TP filed for bankruptcy. • Trustee paid the taxes but not the penalties. • IRS assessed penalties under 6651(a)(1), IRC. • TP argued penalties were “with respect to tax imposed” on 4-15-2009 filing date without extensions & so dischargeable since more than 3-years prior to bankruptcy petition. • IRS argued penalties not dischargeable because the 10-15-2009 extension date was within 3-years of bankruptcy petition………What say yee?

13. In re Wilson 52 BR 635 (Bankr. ND Calif, 2015) p. 618 • Federal taxes and penalties can be discharged if they are “imposed with respect to a transaction or event “ that occurred more than 3 years before the bankruptcy petition. • Court held the taxes and penalties are “imposed with respect to a transaction or event” that occurred on the due date for the return without extensions………4-15-2009. • Penalties were discharged by the Bankruptcy Court.

14. In re Fahey779 F 3d 1 (1st Cir 2015) pp. 618 - 619 • Failure to timely file State income tax returns prevented the discharge of State taxes in bankruptcy.

15. Yuska v CmmissionerTC Memo 2015-77 p. 619 • A post bankruptcy petition filing of a Notice of Determination Concerning Collection Actions violated the bankruptcy automatic stay.

16. Rev Proc 2015-37 pp. 619 - 620 • The IRS added a new area to the list for which it will not issue private letter rulings.

17. Reg-107595-11 pp. 620 - 622 • The proposed Regulation adds references to §1022 to various basis rules.

18. Bell V CommissionerTC Memo 2015-111 pp. 622 - 623 • Husband & wife formed a corporation & sold their sole proprietorship to the corporation. • Sales price was $250,000, payable at $10,000 monthly or more at 10% interest. • Purchase agreement signed but no note, collateral or appraisal of asset values. • Corporate stock was issued for $500 weeks later. • Individuals reported sale of assets as long term capital gain & corp amortized the purchase price over 5 years. • IRS treated transfer as capital contribution to corporation, installment payments as dividends & no amortization. • Sale or ontribution of capital? What say yee?

19. Bell V CommissionerTC Memo 2015-111 pp. 622 - 623 • The Court applied an 11-factor test to the facts. • Some factors supported both arguments but weight was on IRS side. • A couple of key factors: • Corp had no capital prior to sale. • Thinly capitalized corp could not get loan elsewhere. • The court concluded that: • The transfer was a contribution of capital &d not a sale. • The installment payments were distributions to the SHs. • Earnings & profits exceeded distributions so the distributions were dividends.

20. Letter Ruling 2015-22-001 p. 623 • Corporation failed to file & pay State taxes. • State administratively dissolved the corporation. • Corporation was later reincorporated. • IRS Ruling – • Corporation was not terminated for Federal tax purposes. • Corporation liable for taxes based on Federal status.

21. Coastal Heart Medical Group, Inc V Commissioner TC Memo 2015-84 p. 614 • An LLC member could not increase basis in an LLC interest for a personal guarantee of an equipment lease where the rented equipment was not LLC property.

22. Reg-151416 p. 625 • Proposed regulations prescribe the measurement of a partner’s interest in IRC §751 property (unrealized receivables and substantially appreciated inventory items) and described the effect of distributions.

23. Letter Ruling pp. 625 - 626 • The IRC §83(b) election is effective if the taxpayer filed the election with the iRS wihin 30 days of the date of the transfer of property but failed to attached the election to the annual return.

24. Prop Tres Reg §1.183 p. 626 • The IRS has issued proposed regulations allowing the IRC §83(b) election to be made by filing a written statement with the IRS.

25. Methvin V CommissionerTC Memo 2015-81 pp. 626 - 627 • The taxpayer received self-employment (SE) income from investments in oil and gas ventures.

26. Eaglehawk Carbon, Inc. v US122 Fed Cl 209 (20-15) p. 627 • S Corporations are entitled to interest on overpayments of taxes at the reduced interest rate for corporate tax overpayments exceeding $10,000

27. McMillan V CommissionerTC Memo 2015-109 p. 628 • A business deduction was allowed for 50% of legal fees from a suit involving the taxpayer’s residence where 50% of the residence was used for the taxpayer’s business.

28. Olive V Commissioner792 F.3d 1146 (9th Cir 2015) p. 628 • Taxpayer operated a legal medical marijuana dispensary in California. • Taxpayer deducted the expenses. • §280E provides an exception to §162 and prohibits deduction of expenses of a business trafficking in a controlled substance. • Marijuana is a controlled substance. • Deduction disallowed.

29. Chief Counsel Advice 2015-31-016 p. 629 • State of Washington imposed a 25% excise tax on marijuana which is legal in Washington. • §280E prohibits deduction of expenses in dealing with controlled substances like marijuana. • However §164 provides taxes are deductible & that any tax on disposition of property is a reduction in the amount realized. • Payment of tax is allowed to reduce amount realized on the sale of property. • Tax not considered a deduction but a reduction in amount realized and so allowed.

30. Chief Counsel Advice 2014-39-001 pp. 629 -630 • Restaurants that are subject to the uniform capitalization rules should not be forced to use the simplified production method for allocating kitchen labor costs if they implement a reasonable facts and circumstances method instead.

31. Chief Counsel Advice 2014-47-027 pp. 630 - 631 • A 52-53 week tax year is deemed to end on December 31, 2017, for purposes of the domestic production activities deduction.

32. Letter Ruling 2015-28-026 p. 631 • Taxpayer convicted under federal law for activities related to sale of an illegal product. • Taxpayer sentenced to jail, fined and required to pay restitution to the Government. • Taxpayer paid and deducted restitution payment. • §162 prohibits deduction of any fine or similar penalty paid to a Government for the violation of any law. • Repayment was a deductible ordinary and necessary business expense.

33. T.D. 9696 p. 631 • Final regulations provide safe harbor for treating local lodging expenses incurred for attendance at a business function as ordinary and necessary business expenses.

34. Central Motorplex, Inc V Commissioner TC Memo 2014-207 p. 632 - 633 • Corporations’ president managed business, hired and fired, etc. • Corporation’s secretary-treasurer was in charge of repair & maintenance of cars in inventory. • Another worker was in charging of picking up, delivering cars and securing plates & titles. • Corporation treated all 3 as independent contractors. • IRS held they were employees. • What say yee?

35. Central Motorplex, Inc V Commissioner p. 632 - 633 • Officers of corporations who perform just minor services for compensation are “statutory employees”. • President and Secretary-Treasurer were employees by statute. • Using common law factors court held third worker was an employee since president had control over worker, worker did not provide his own tools, worker was paid monthly, etc.

36. Notice 2015-6 p. 633 • The IRS published a notice of procedures for reporting by employers of sick pay paid by third payers.

37. Letter Ruling 2014-41-004 pp. 633 - 634 • Disability payments under a county ordinance qualify as worker’s compensation payments that are excludable from gross income.

38. McMillan v CommissionerTC Memo 2015-109 pp. 634 - 635 • Taxpayer was engaged in training, showing & breeding horses. • In 6 years had receipts in 1 year and over $154,000 in expenses. • No horses had been bred and did not own any horses in 2008 or 2009. • IRS argued in 6th year (2009) taxpayer did not have a going concern since he did not own, breed or train horses & did not compete in any shows. • Taxpayer said he trained horses in 2009 but lost all his training records.

39. McMillan v CommissionerTC Memo 2015-109 pp. 634 - 635 • Court considered the 9 factors to determine if a taxpayer is engaged in the activity for a profit…..§183, IRC. • Taxpayer’s intent is determinative. • Manner in which activity is carried on. • Expertise of TPs and advisors. • Time & effort expended by TPs on activity. • Will assets of activity increase in value. • Success of TP in this & other endeavors. • History of income and losses. • Amount of occasional profits. • Financial status of taxpayer. • Elements of personal pleasure.

40. McMillan v CommissionerTC Memo 2015-109 pp. 634 - 635 • Court concluded the taxpayer was not engaged in the activity for a profit & disallowed the expenses. • Taxpayer spent little time in the activity. • There were few or no assets to increase in value. • There were substantial losses & no profit years. • Taxpayer enjoyed riding. • No success in similar or other activities.

41. Wyatt V CommissionerTC Summary Opinion 2015-31 p. 635 • TP doctor agreed to work in rural area for additional pay from hospital. • Additional compensation was treated as loans which would be forgiven if the TP worked for an agreed period. • Agreement required TP to repay the compensation if he did not work for the agreed upon period. • TP worked the agreed period and loans forgiven. • Taxpayer argued the debt was nonrecourse, without any collateral and so he was not personally liable for it and so there was no cancellation of debt income. • Court held TP was personally liable & so had cancellation of debt income.

42. Chief Counsel Advice 2015-25-010 pp. 635 - 636 • LLC taxed as PS had 2 members. • LLC obtained one loan from a bank and another from a corporation. • The 2nd loan was secured by 2nd deed of trust subordinated to first bank loan, etc. • Foreclosure of property paid off bank loan. • 2nd loan cancelled, LLC recognized cancellation of debt income & passed through to members. • IRS said cancellation of debt income was income from a sale…..Why would IRS argue this? And, what is the answer?

43. Chief Counsel Advice 2015-25-010 pp. 635 - 636 • If the income was from a sale by the LLC the members cannot use §108 exceptions to exclude cancellation of debt from their individual income. • Chief Counsel concluded that taxpayer had no personal liability for the 2nd loan from the corporation. • Therefore the debt was nonrecourse and could not be collected from the LLC. • The cancellation was therefore not cancellation of debt income but income from a sale or disposition.

44. Domestic Production Activities DeductionLarge Business & International Directive 1-04-0315-001 pp. 636 - 637 • IRS provides information as to what is and what is not Manufacturing, Producing, Growing or Extracting (MPGE) for purposes of the Domestic Production Activity Deduction. • NOT MPGE are, for example: • Cutting blank keys. • Mixing base paint & color. • Applying garnishments to a cake not baked where sold. • Etc.

45. T.D. 9725 pp. 637 - 638 • Final regulations provide guidance under IRC §2010 and §2505 on the estate and gift tax applicable exclusion amount, the requirements for electing portability of a deceased spousal unused exclusion (DSUE) amount and the rules for the surviving spouse’s use of the DSUE amount.

46. Letter Ruling 2015-23-003 pp. 638 - 639 • An election to split gifts by a husband and wife was irrevocable where the time for determining whether split gift treatment was effective had expired.

47. Frequently Asked Questions on Estate Taxes pp. 639 - 640 • The IRS will issue estate tax closing letters only on request filed on or after 6-1-2015. • It will take about 4-months to issue a requested closing letter. • For estate tax returns filed before 6-1-2015 no request is needed & it will be 4 to 6 months for the letter to be issued. • See Fig 16.6, page 640 for estate returns filed between 1-1-2015 and 6-1-2015 where a closing letters will not be issued. • Questions – Call IRS at 866-699-4083.

48. Fargo V Commissioner TC Memo 2015-96 pp. 642 - 643 • The gain from the sale of commercial property from one of the taxpayer’s entities to their other entity produced ordinary income because the taxpayer held the property for sale in the ordinary course of business.

49. Estate of Menges V Commissioner114 AFTR 2d (RIA) 2014-6514 p. 643 • The beneficiary of an estate could not claim the first-time home buyer credit after disclaiming her interest and then acquiring the inherited home from the other beneficiaries.

50. Saenz V CommissionerTC Summary Opinion 2015-6 pp. 643 - 644 • On 2011 return taxpayer claimed: • An adult child as a dependent, • The adult child’s daughter as a dependent, • Earned income credit for both of above, • Additional child credit for the above granddaughter. • Both of above lived with and were supported by the taxpayer from Jan 2011 to Aug 2011. • After Aug 2011 both above lived with third party who claimed to be adult child’s common law spouse. • Third party agreed to be married to adult child 4-2012 when they signed their 2011 return. • What do you want to know? Does TP get dependents?