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  1. Example Title Screen # 1 2009 Federal Tax Update: Obama Holds His Fire while the IRS Tightens the Screws Rick J. Taylor, CPA November 5, 2009 1

  2. Overview • 2009 in a nutshell • What do we know for sure • Expiring provisions • Accounting methods • Individuals and trusts • Corporations, partnerships, LLCs • Retirement plans and estate planning • Procedures and penalties • 2009 Act • Inflation Adjustments • New Forms

  3. 2009 in a Nutshell • Emergency Economic Stabilization Act of 2008 October 3 – grab bag of incentives and extenders; 290 tax changes. • Election of New President and Democratic control of both houses of Congress. • American Recovery and Reinvestment Act of 2009 February 17 – “lack of stimulus-stimulus bill;” more than 300 changes • On the fly IRS guidance on a series of provisions included in the 2008 and 2009 Acts including COBRA continuance, first-time home buyer credit and NOL carryback. • Green Book Release May 11

  4. 2009 in a Nutshell • Foreign Bank Account Reporting June 12 conference call indicates reporting required for considerably more taxpayers than previously thought. • Wisconsin Budget Repair Bill • Health care bill bogs down Congress • Fairly routine filing season except for NOL rules and acceleration of due dates for trust and partnership returns. • Substantial increase in number of IRS audits opened – fewer closing. • Substantial increase in IRS and State notices particularly regarding nonresident withholding • Proposal to fund health care legislation with increase in top tax rate to 45%

  5. What Do We Know for Sure? • Federal and state income taxes are going up. • Expiration of Bush tax cuts will increase taxes no later than 2011. • Expiring provisions – see TaxThink • Substantial increase in Federal and state enforcement efforts. • Taxing authorities are taking positions that they know are wrong, but are too expensive to challenge. • Estate taxes are here to stay. • No one should sit around waiting for the economy to return – this may be the new normal.

  6. Expiring Provisions – 12/31/09 • Research credit • New markets credits • Five-year recovery period for farming business machinery and equipment. • 15-year straight-line cost recovery for qualified leasehold improvements, qualified restaurant buildings and improvements, and qualified retail improvements. • Accelerated depreciation for business property on an Indian reservation. • Expensing of “brownfields” environmental remediation costs.

  7. Expiring Provisions – 12/31/09 • Special depreciation allowance (50% of basis) for qualified property. December 31, 2010 for certain longer-lived and transportation property. • Election by corporations to accelerate AMT and research credits in lieu of special depreciation allowance. December 31, 2010 for certain longer-lived and transportation property. • Increase in §179 deduction limit and qualifying property phase-out threshold to $250,000 and $800,000, respectively. • Enhanced charitable deduction for contributions of food inventory.

  8. Expiring Provisions – 12/31/09 • Suspension of percentage-of-AGI limit on deductions for certain contributions of food inventory by qualified farmers and ranchers. • Enhanced charitable deduction for contributions of book inventories to public schools. • Enhanced charitable deduction for corporate contributions of computer equipment for educational purposes. • Basis adjustment equal to shareholder’s share of property’s adjusted basis when S corp makes charitable contributions of property

  9. Year End Planning • Opportunity to add value to clients struggling with economic downturn. • Increase or preserve clients’ cash. • Take advantage of expiring provisions. • Use expiring tax attributes. • Fix underpayments (IRA rollover, withhold 20%, replace withholding when rollover). • Proactively address issues that could result in IRS or state audit adjustments. • 263A noncompliance; gift certificate noncompliance; W-2 for partners noncompliance, Qsub and SMLLC payroll noncompliance, S corporation shareholder fringe benefits, charitable contribution substantiation (including private family foundations), research credit substantiation, back to back loan documentation

  10. Fundamentals • Accelerate income or defer? • Accelerate deductions or defer? • 3 Deduction hurdles: sufficient basis/at risk/material participation? • S corp open account debt (new regs reversing Brooks decision; $25,000 floor; prior open account debt terminated by regs)? • Activity/Groupings – 1.469-4; put info in returns. • Statutory limitations (e.g., 382, 56(d)(1)(A))

  11. Fundamentals • Recalculate estimated payments • Calculation of net earnings from self employment: • TAM 9750001 - Passive losses of a general partner from a trade or business activity are taken into account in computing net earnings from self-employment when allowed for income tax purposes. • Excludes NOL carrybacks and carryforwards §1402(a)(4). • Scrutinizing the book to tax reconciliation BEFORE year end (See Using the tax provision…On Balance 11/09 p. 28).

  12. Accounting Methods

  13. Canterbury Holdings - p.2 • Management fees and interest paid by an LLC in connection with its wholly owned subsidiary’s acquisition of another company were not currently deductible as ordinary and necessary. • The expenses were nondeductible capital contributions. • Taxpayers need to be reminded that deductions generally cannot be claimed for paying another’s expenses (even if would have been deductible by the other taxpayer). • Special rule applies where a partner pays partnership expenses.

  14. FedEx Corporation – p. 3 • FedEx could rely on the internal use software test in the 2001 final §41 regulations and the discovery test in the 2003 final regulations, which differed from the discovery test in the 2001 final regulations. • Court allowed taxpayer to “pick and choose” between different regulations. • Under “Chevron rule” regulations are given controlling weight unless they are “arbitrary, capricious and manifestly contrary to the statute.”

  15. FedEx Corporation – p. 3 • Proposed regs eliminated the requirement that qualified research must be undertaken to obtain knowledge that exceeds, expands, or refines the common knowledge of skilled professionals in a particular field of science or engineering. • Instead the regs provided the discovery test was met if research is undertaken to discover information that is technological in nature. • Final regs discovery test may be satisfied by research that is intended to eliminate certain uncertainty concerning development or improvement of a business component. • IRS continues to take unreasonable positions with respect to research credit claims. • WI is not even performing audit procedures/piggybacking with IRS • See McFerrin following on P. 11.

  16. Herman – p. 7 • Taxpayer could not deduct the value of a conservation easement that barred the development of part of the air rights over a historic structure. • The easement did not prevent the owner or subsequent purchasers from altering or even demolishing the existing building. • Although the IRS deserved to win in this case, the IRS continues to take unreasonable positions in this area. • Appraisal not earlier than 60 days prior; must be received by due date including extensions. • Specific requirements of appraisal – see §1.170A-13(c)(4). • Specific requirements of appraiser – see §1.170A-13(c)(5).

  17. Kiva Dunes, TC Memo 2009-145 • Tax Court valued conservation easement at approximately $28.7 million, which was less than taxpayer's $31.9 million claim, but well above IRS's $10 million estimate. • Taxpayer's expert's assumptions of number of lots available for sale, average lot price, and absorption rate were reasonable and supported by credible evidence of comparable sales and absorption data from local developments. • In contrast, IRS's expert based his analysis in part on erroneous interpretation of local zoning law and in part on unrealistic assumptions that weren't based on comparable lot characteristics. • The Court set out relevant computations and established redetermined value. • No gross or substantial valuation misstatement as IRS alleged on which to base §6662 penalty.

  18. Simmons, TC Memo 2009-208 • Taxpayer entitled to deductions for contributions of conservation easements on facades of two properties in Washington D.C. • Tax Court rejects taxpayer and IRS valuations and elects to provide its own. • Court accepted taxpayer’s claimed valued, less a 5% discount. • IRS argued there was zero deduction since there was no reduction in value.

  19. Warn Clients: IRS Will Challenge • You must tell clients that if they claim, IRS will challenge regardless of merit. • Theodore R. Rolfs litigation (Docket no. 9377-04) still not settled on house burning case. • Why does it take 4 years to decide a case very similar to a 1973 Tax Court case to which the IRS acquiesced? • Morris N. Scharf, TC Memo 1973-265, acquiescence AOD 1974 WL 36031. • See Courts to IRS: Ease Up on Conservation Easement Valuations McClure, Hollingworth, and Brown, August 10, 2009 Tax Notes. • IRS defended its position at ABA Tax Section meeting in Chicago. • ECC 200944043 email released 10/30/09 Treasury tells IRS to train its agents.

  20. Hopkins Partners et al– p. 8 • Partnership operating a hotel on land leased from a city could deduct as rent the cost of improvements that were credited towards its annual rent obligations. • The fact that the city was a tax-indifferent party did not matter; the rent-credit arrangement had a subjective business purpose and thus had economic substance. • Important – Tax exempt use property leased to a tax-exempt entity must be depreciated using ADS (SL over 5 yrs/12yrs/40yrs). In no event may life be less than 125% of lease term.

  21. LOAD, Inc. COAD, Inc. - p.9 • Costs of a seller of manufactured homes for placing the homes on retail sales lots so that local independent salespersons could sell them were includable in inventory under §263A and not currently deductible under §162. • The inventory exception for on-site storage costs was inapplicable because those costs must relate to property sold by a taxpayer “exclusively” to retail customers. • IRS is currently scrutinizing §263A compliance; recheck client compliance and suggest use of the automatic change provisions of Rev. Proc. 2008-52 to get audit protection and a 4 year spread.

  22. McFerrin v U.S. – p.11 • 5th CA held that a taxpayer’s expenditures may qualify for the §41 research credit even though detailed records were not kept allocating the expenditures to the research activities. • Sent back to District court so it could apply the Cohan rule (testimony and other evidence). • IRS has a policy of simply denying claims that are not supported by W-2s and other contemporaneous evidence including project folders. • In Eustace, TC Memo 2001-66 aff’d (2002, CA 7), the Tax Court refused to apply the Cohan rule to make a reasonable allocation of salaries to claimed research activities.

  23. Research Credit Tips • To develop successful R&D tax credit claims: • Do not overcomplicate the process. • Track qualified expenses as soon as they take place. • Identify all employees involved in the research and development process. • Explain why projects qualify. • Do not wait until the end of the year to “look back” and identify qualified R&D expenses. • Follow a logical process for how expenses were identified.

  24. Ocmulgee Fields, Inc. – p 14. • Taxpayer could not avoid like-kind exchange related party rule by using qualified intermediary • Taxpayer had to recognize gain on its exchange even though it intended to effect a like-kind swap with non-related third party • Critical that neither related party “cashes out” their investment (if continue to hold like-kind property, gain should be deferred). • If either ends up with cash, there will be gain recognition on both properties.

  25. Ocmulgee Fields, Inc. – p 14. • 9th CA upheld Teruya Brothers (p. 17 following) a few days earlier. • Because Teruya involved a prearranged transaction, the 9th CA decision was not unexpected. • However, now advisors have to be aware that every transaction in which replacement property is acquired from a related party will run afoul of §1031(f). • This is an issue often missed by practitioners. • Related party defined broadly §267(b) and §707(b)(1) (family and generally more than 50% owned entities).

  26. Robinson Knife – p 16. • Corporation that manufactured kitchen knives and tools had to capitalize under §263A royalties it paid under trademark licensing agreements. • Court further found that IRS properly allocated these royalties to corporation’s ending inventory using simplified production method in the §§263A Regs. • If IRS can show taxpayer is using an inappropriate §263A method, it can require a change to the method that it selects. • IRS will select the method that produces the most income for the taxpayer – simplified production with simplified service cost method using the production cost allocation ratio!

  27. Teruya Brothers – p. 17 • 9th CA Court of Appeals held that taxpayer could not avoid the like-king-exchange related-party rule by using qualified intermediary. • Taxpayer had to recognize gain on its exchanges. • This was a prearranged transaction, but the taxpayer thought that it could avoid §1031(f) by using a qualified intermediary. • In Rev. Rul. 2002-83 and LTR 9748006 IRS had indicated that adding a QI did not cause §1031(f) to be inapplicable.

  28. Trinity Industries – p. 19 • Accrual method corporation had to accrue the full contract price for barges it built for two customers, including deferred payments, in the year of delivery. • Taxpayer could not postpone including amounts in income because the buyers were withholding the deferred payments to offset claims related to other contracts. • All events test and not receipt determine when taxable.

  29. Trinity Industries – p. 19 • Taxpayer does not have to accrue unpaid income if the obligor disputes the validity of the claim – Ryan, TC memo 1988-12 aff’d. sub nom. Lamm (CA 8, 1989), 63 AFTR 2d 90-1235. • Accrual may also not be required if the income was of doubtful collectability or it was reasonably certain that it would not be collected as of the time the taxpayer’s right to receive the income arose – Harmont Plaza, Inc. (1975), 64 TC 632 aff’d (CA 6, 1977), 39 AFTR 2d 77-834. • Right to income generally fixed no later than when the product is installed, tested and operating properly (even if there is no formal acceptance).

  30. Vainisi – p. 20 • 20% reduction in interest expense deduction for qualified tax-exempt obligations under §291(a)(3) applied to a qualified subchapter S subsidiary bank. • S corporation banks that do not have a holding company do not appear to be bound by the Vainisi case.

  31. Reg-130200-08 – p. 21 • Proposed regs simplify the election to claim reduced research credit under §280C(c)(3). • Proposed regs clarify that each member of controlled group or trade or business under common control with other trades or businesses can make election (i.e., all members not bound) • Regs would apply to tax years ending on or after date that final regs are published.

  32. Reg-130200-08 – p. 21 • No regular tax saving result from the election, but because the credit is not taken into account in computing AMT, AMT can be saved by making the election since the taxpayer’s income subject to AMT would be reduced by the full research expense deduction. • Cannot make the election on an amended return. IRS has been assessing penalties when this practice is found. • WI - Pass-through entities as well as their partners, members and shareholders, are not eligible to claim the research credit. • WI – Use of Alternative Incremental Credit may produce better, larger credit.

  33. Rev Rul. 2009-9 - p. 26 • Pro-taxpayer comprehensive guidance for many investors caught in Ponzi-style fraud. • Allows losses to be claimed as ordinary losses-not subject to capital loss limit. • Itemized deduction: • not subject to the 2% floor; • not subject to overall limit on itemized for high income taxpayers; and • reduces AMT income. • Theft loss can be carried back 3 in lieu of 2, plus can treat as sole proprietorship and carryback up to 5 if qualify under $15 million test. • Could file amended returns to remove fictional income. Courts have allowed; IRS dislikes.

  34. Rev Rul. 2009-9 - p. 26 • The loss can be taken in the year of discovery, but if the taxpayer has a claim for reimbursement for which there is a reasonable prospect of recovery no portion of the loss for which there is a prospect of recovery is deductible. • Only delays the deduction with respect to the portion of the loss for which there is a reasonable prospect of recovery.

  35. Rev. Proc. 2009-20 – p. 31 • Optional “safe harbor” treatment • Taxpayer must be a “qualified investor” (if invested in fund or other entity that in turn invested in the fraudulent arrangement (i.e., feeder fund), then not a qualified investor, but the fund or separate entity may qualify. • Under safe harbor, the year of discovery is generally the year charged (rather than year discovered). • Loss limited to 95% of the qualified investment if not pursuing any potential third-party recovery • 75% of qualified investment if pursuing or intends to pursue potential third-party recovery.

  36. Rev. Proc. 2009-20 – p. 31 • Qualified investment is: • Total cash invested over all years; plus • Amount of income reported (including years closed by statute of limitations), reduced by • The amount of cash withdrawn. • Deduction must be reduced by any actual recovery received or any potential insurance or Securities Investor Protection Corporation (SIPC) recovery (i.e., generally $500,000 per customer). • Recoveries above 5%/25% taxable. • Must attached required statement. • No amended returns to remove fictional income – thus no interest from IRS.

  37. Should you use safe harbor? • Generally best to use the safe harbor. • Defers only 5%/25% of the deduction while eliminating the need to establish a position as to reasonable recoveries. • May allow for use of the provisions permitting NOL carrybacks up to 5 years. • IRS will probably challenge amended returns removing fictional income (CCA 200305028, CCA 200451030, CCA 200811016). • Yr of loss may be different(discovery vs. indictment). • Less IRS interest.

  38. Rev Proc 2008-72 – p. 29 • Optional mileage allowance for owned or leased autos (including vans, pickups, or panel trucks) is 55¢ per mile for business travel after 2008. • Reduction of 3.5¢ from 58.5¢ allowance for business mileage in last six months of 2008. • In addition, rate for using car to get medical care or in connection with move that qualifies for moving expense deduction is 24¢ per mile/down 3¢ from the 27¢ per mile allowance for last half of 2008.

  39. Rev Proc 2009-24 – p. 32 • Inflation-adjusted depreciation limits for business autos, light trucks and vans (including minivans) placed in service in 2009 and annual income inclusion amounts for such vehicles first leased in 2009. • Maximum annual depreciation limits for autos are same as they were for vehicles placed in service last year but dollar limits for light trucks and vans are lower than last year’s figures. • For qualifying vehicles, American Recovery And Reinvestment Act of 2009 increases applicable first-year limit by $8,000.

  40. Rev Proc 2009-33 – p. 34 • Explains changes made by 2009 Act to §168(k)(4) election that allows corporations to chose not to claim 50% additional first year depreciation deduction for certain property placed in service before January 1, 2010, and instead to increase their §38(c) business credit limit and §53(c) AMT credit limit. • Taxpayers making this election forego 50% bonus depreciation deduction and instead increase the limitation on the use of research credits and minimum tax credits. • The increase is treated as a refundable credit. • Generally limited to 6% of credits carryforwards for taxable years beginning prior to 1/1/2006.

  41. Rev Proc 2009-39 – p. 38 • Revised Rev. Proc. 2008-52, automatic change in accounting method. • Makes additional changes automatic including the change from capitalizing repair and maintenance costs to treating them as ordinary business expenses; includes changes involving the unit of property. • Changes in treatment of tenant allowances. • Changes in the treatment of supplies on hand. • Includes other automatic changes and technical changes involving when a taxpayer is considered under audit. • Announcement 2009-67 (p. 44), IRS makes numerous corrections to this Rev. Proc.

  42. Notice 2009-64 – p. 42 • Proposed revenue ruling concludes that assets used to convert corn to ethanol should be treated as having 10-year class life under §168 depreciation rules. • They have recovery period of 7 years under §168 MACRS rules and 10 years for purposes of ADS rules. • Would only apply for assets placed in service on or after date the final revenue ruling is published.

  43. Notice 2009-64 – p. 42 • Proposed revenue ruling concludes that assets used to convert corn to ethanol should be treated as having 10-year class life under §168 depreciation rules. • They have recovery period of 7 years under §168 MACRS rules and 10 years for purposes of ADS rules. • Would only apply for assets placed in service on or after date the final revenue ruling is published.

  44. PLR 200846021 – p. 44 • Accrual method employer could currently deduct payments for medical and dental services to employees under self-insured medical/dental plans even when some payments were made more that 2 ½ months after end of tax year in which services were provided. • Ability to accelerate is available only if employer uses a third-party administrator. • Automatic change #42, §19.01 of Rev. Proc. 2008-52.

  45. PLR 200852013 – p. 45 • Business buyer of term interest in building and land may depreciate the portion of basis in the interest that is allocable to land over period of term. • Portion of basis in interest that is allocable to buildings is depreciable under regular MACRS depreciation rules of §168 as if taxpayer owned the assets directly (same class lives – buildings, land improvements etc).

  46. PLR 200852013 – p. 45 • Portion allocated to land depreciated ratably over the term of the lead interest. • Sellers, remaindermen and purchaser of term interest were unrelated. • No depreciation deduction for any part of term interest (i.e., depreciable property or land) if remainder interest held by a related party. • No depreciation deduction for term interest if split nondepreciable property into a term and remainder interest and then retains the term.

  47. PLR 200901008 – p. 46 • IRS has ruled privately that buyer’s holding period for remainder interest that will not become possessory interest for 50 years begins the day after interest is purchased. • Holding period rules: • Holding period real property begins on the day following that on which title passes • Stock’s holding period begins on the day following the day of acquisition and ends on (and includes) the day of disposition. • For securities traded on an established securities market, the holding period begins on the day after the “trade date” and ends on the date of disposition. The “settlement date” is ignored. • Don’t forget to get LT treatment must hold for MORE than one year!

  48. CCA 200848001 – p. 61 • Taxpayer cannot use change in method of accounting procedures to change way in which it determines placed-in-service date for depreciation purposes for its special tools. • Property is considered placed in service when it is in a condition or state of readiness and available for a specially assigned function 1.168-2(l)(2). • 199916040 an asset can be considered placed in service prior to its actual use if it is in a state of readiness. • Reg. § 1.446-1(e)(2)(ii)(d)(3)(v) provides that a change in placed-in-service date is not a change in method of accounting; but can probably “shoehorn” as a change if planned.

  49. CCA 200911006 – p. 64 • Intangibles such as trademarks, mastheads, etc. that can be valued separately and apart from goodwill qualify as like-kind property for §1031 purposes. • This is complete reversal of position IRS had previously taken. • CCA declares IRS should not follow its position in PLR 200602034 and LAFA 20074401F.

  50. CCA 200913011 – p. 64 • A casino-hotel complex, casino and all hotel rooms are functionally interdependent and comprised a single unit of real property for purposes of Reg. §1.263A-10 of UNICAP rules. • Casino owner could not treat each hotel room as separate unit of property and stop capitalizing interest when it deemed that construction on the room was completed on a floor-by-floor basis. • The example in the regs indicating separate floors of a 10-story condo were functionally independent was not applicable.