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We hope you find our complimentary issue of Parker's Federal Tax Bulletin informative. Parker's Tax Research Library gives you unlimited online access to 147 client letters, 22 volumes of expert analysis, biweekly bulletins via email, Bob Jennings practice aids, time saving election statements and our comprehensive, fully updated primary source library.

Federal Tax Bulletin - Issue 101 - November 6, 2015


Parker's Federal Tax Bulletin
Issue 101     
November 6, 2015     

 

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 1. In This Issue ... 

 

Tax Briefs

Certain Redemptions of Frequent Flyer Miles May Be Exempt from Excise Tax; Exempt Organization's Weekly Fundraiser Was an Unrelated Business; Settlement Proceeds Were Not Tax Exempt Under "Origin of the Claim" ...

Read more ...

2015 Year-End Tax Planning for Businesses

The second installment of Parker's annual two-part series on year-end tax planning recaps 2015's major changes affecting business, and strategies clients can use to minimize their business' 2015 tax bill. The online version of the article includes links to sample year-end client letters for individuals and businesses.

Read more ...

Bipartisan Budget Act Avoids Government Shutdown, Replaces TEFRA Partnership Audit Procedures

On November 2, President Obama signed into law the Bipartisan Budget Act of 2015 (2015 BBA), which will fund the government through the 2017 fiscal year and avoids a repeat of the 2013 government shutdown. The law repeals TEFRA partnership audit procedures and replaces them with a single centralized audit system, eliminates Obamacare's automatic enrollment requirement for employers with more than 200 employees, and makes several other tax changes. P.L. 114-74 (11/2/2015).

Read more ...

Fifth Circuit Affirms Bright Line Test on Use of Completed Contract Method by Developers

The Fifth Circuit affirmed a Tax Court decision holding that a developer's contracts were not home construction contracts and, thus, gain or loss from such contracts could not be reported using the completed contract method. The court relied on the fact that the taxpayer did not build homes on the land it sold, and qualifying dwelling units did not exist at the time of the sales. Howard Hughes Company, LLC v. Comm'r, 2015 PTC 387 (5th Cir. 2015).

Read more ...

Acquisition Cost of Internet Domain Names Must Generally be Capitalized and Amortized  

The cost of purchasing an Internet domain name is not a currently deductible business expense but instead is generally capitalizable under Code Sec. 263 and amortizable under Code Sec. 197. CCA 201543014.

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No Gift Tax on Transfer of Stock to Settle Bona Fide Dispute Over Family Business

The Tax Court held that a transfer of stock, as part of a settlement, to a trust for the benefit of a decedent's children was not a taxable gift. The court found that recognition by the decedent's father and brother that he was the outright owner of a portion of the disputed shares constituted full and adequate consideration for the transfer, which was made in the ordinary course of business. Est. of Redstone v. Comm'r, 145 T.C. No. 11 (10/25/15).

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Donations Paid in "Cause Marketing" Program Are Deducible as Business Expenses

Donations of sales proceeds by a business to organizations described in Code Sec. 170(c) are deductible under Code Sec. 162(a) as business expenses to the extent not disallowed by other provisions of Code Sec. 162 and to the extent they are not contributions under Code Sec. 170. CCA 201543013.

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IRS Provides Roadmap for Tax Audits of Entertainment Industry

The IRS has updated the Entertainment Industry Guide, which provides IRS auditors with guidance on what to look for and ask about when auditing taxpayers with entertainment-related deductions. Entertainment Industry ATG (2015).

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Law Partner Can't Avoid Taxes on Distributive Shares Paid Out in Later Years

Even though a law partner left his law firm in an earlier year, he remained a partner of the firm until he received his final distribution and thus owed taxes on amounts paid to him in later years. Brennan v. Comm'r, 2015 PTC 381 (9th Cir. 2015).

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AICPA Has Standing to Challenge the IRS's Voluntary Tax Return Preparer Program; Lower Court Reversed

The AICPA adequately challenged that the IRS's voluntary return preparer program will subject AICPA members to an actual or imminent increase in competition and it therefore has standing to pursue its challenge. American Institute of Certified Public Accountants v. IRS, 2015 PTC 391 (D.C. Cir. 2015).

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IRS Reduces PTIN Application and Renewal Fees, Vendor Fees Increased

The IRS has issued temporary regulations that reduce the PTIN application and renewal fee from $50 per application or renewal to $33. Separate third-party vendor fees have increased, however, to $17 per application or renewal (up from $14.25 for original applications and $13 for renewals). T.D. 9742 (10/30/15).

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 2. Tax Briefs 

 

Excise Tax

Certain Redemptions of Frequent Flyer Miles May Be Exempt from Excise Tax: In Notice 2015-76, the IRS announced that it is considering excluding from the Code Sec. 4261(a) excise tax certain amounts attributable to mileage awards (sometimes referred to as "frequent flyer miles") that are redeemed other than for the taxable transportation of persons by air (e.g. for gift cards, magazine and newspaper subscriptions, free hotel nights, and items from the airline's shopping catalog). The notice invites public comments on issues that should be addressed in future guidance.

 

Exempt Organizations

Exempt Organization's Weekly Fundraiser Was an Unrelated Business: In TAM 201544025, the IRS ruled that exempt organization's weekly public event was not substantially related to the organization's exempt purpose and was an unrelated trade or business. The organization maintained an alumni association for a community college and raised almost all of its revenue from vendors who paid fees to sell merchandise at the event. The IRS noted that to be substantially related, the event must contribute importantly to exempt purposes other than through the production of income.

 

Gross Income and Exclusions

Settlement Proceeds Were Not Tax Exempt Under "Origin of the Claim": In Lawson v. Comm'r, T.C. Memo. 2015-211, taxpayers argued that settlement proceeds for claims against their bank were a return of funds improperly taken, and thus were not taxable under the "origin of the claim" doctrine. The Tax Court noted that the agreement did not specify a nontaxable reason for a settlement, and was silent as to whether the payment was to restore funds or was to dispose of the lawsuit. Thus, the court held the IRS properly included the proceeds as unreported income.

Overstated COGS Not Omitted Income For S Corp Shareholder: In CCA 201543015 the IRS advised that overstated cost of goods sold (COGS) did not result in unreported income to an S corporation shareholder. The IRS noted that because the amount of pass-through income that constitutes "omitted income" for purposes of the Code Sec. 6501(e)(1) six-year statute of limitations is the amount of gross receipts omitted on Form 1120S, rather than the understatement of ordinary business income, there was no omission of income.

No-Fault Benefits for Birth-Related Brain Damage Excludable From Income: In PLR 201544019, the IRS ruled that payments provided by a state-created plan to parents of children who have sustained a birth-related neurological injury are excluded from the recipient's gross income under Code Sec. 104(a)(3). The IRS noted that under Rev. Rul. 73-154, disability benefits received under a no-fault insurance contract are amounts received through accident or health insurance for personal injury or sickness within the meaning of Code Sec. 104(a)(3).

 

Insurance Companies

Loss Payment Patterns and Discount Factors for 2015 Released: In Rev. Proc. 2015-52, the IRS prescribes the loss payment patterns and discount factors for the 2015 accident year. These factors will be used to compute discounted unpaid losses under Code Sec. 846.

Salvage Discount Factors for 2015 Released: In Rev. Proc. 2015-54, the IRS prescribes the salvage discount factors for the 2015 accident year. These factors must be used to compute discounted estimated salvage recoverable under Code Sec. 832.

 

Liens and Levies

Discharge of Liabilities in Bankruptcy Renders Tax Lien Moot: In Trumbly v. Comm'r, T.C. Memo. 2015-207, the Tax Court found an IRS determination to sustain a notice of federal tax lien was inapplicable because the taxpayer's liabilities were discharged in bankruptcy. Thus, the IRS could not pursue collection of the liabilities.

 

Penalties

No Double Taxation Where Taxpayer Liable for Restitution and Penalties: In Clues v. Comm'r, T.C. Memo. 2015-209, a taxpayer challenged a notice of determination, arguing that she should not be liable for both trust-fund-recovery penalties and a nearly $1.4 million criminal-restitution sentence for failure to pay the employment taxes of her staffing agency. The Tax Court sustained the IRS's determination, noting that because the restitution payment would reduce the assessed penalties once non-trust-fund taxes were paid, there was no danger of double taxation.

 

Procedure

Representatives Can't Sign Power of Attorney Forms for Each Other: In CCA 201544024, the IRS advised that a Form 2848, Power of Attorney and Declaration of Representative, should be rejected as to a representative who did not personally sign the form because the representative must provide the requested declaration and it is impermissible for one representative to sign on behalf of another.

 

Retirement Plans

IRS Reminds Retirees to Take Required IRA Distributions: In IR-2015-122, the IRS reminded taxpayers born before July 1, 1945, that they generally must receive payments from their IRAs and workplace retirement plans by Dec. 31, 2015. Known as required minimum distributions (RMDs or MRDs), these payments normally must be made by the end of 2015, but those who reached age 70 1/2 during 2015 can wait until as late as April 1, 2016.

 

Tax Practice

IRS Reminds Tax Return Preparers of Limited Practice Changes: In IR-2015-123, the IRS notes that, effective for tax returns and claims for refunds prepared and signed after Dec. 31, 2015, the limited right to represent clients before the IRS held by non-credentialed preparers will be accorded to only those preparers participating in the IRS Annual Filing Season Program (AFSP). To participate in the ASFP, non-credentialed tax return preparers must complete either 15 or 18 hours of continuing education (CE) from IRS-approved CE providers by Dec. 31, 2015.

 

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 3. In-Depth Articles 

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2015 Year-End Tax Planning for Businesses

The second installment of Parker's annual two-part series on year-end tax planning recaps 2015's major changes affecting business, and strategies clients can use to minimize their business' 2015 tax bill. The online version of the article includes links to sample year-end client letters for individuals and businesses.

Introduction

Once again practitioners find themselves nearing the end of the year and wondering what Congress will do as far as extending important tax breaks for businesses. Extender legislation aside, there have been some tax developments this year of which practitioners should be aware.

The following article on year-end planning for businesses is the second of two installments in Parker's year-end tax planning series. An in-depth look at year-end planning for individuals appeared in the October 23, 2015 issue of Parker's Federal Tax Bulletin.

CLIENT LETTERS for both individuals and businesses are available online now:

Practice Aid: See ¶320,131 for a comprehensive year-end letter for individuals. For a comprehensive year-end planning letter for businesses, see ¶320,130.

It's important that practitioners meet with clients before the end of the year, not only to review projections of their business's net income for 2015 and ensure that estimated tax payments are in line with those projections, but also to nail down any end-of-the-year actions that may be appropriate to reduce their 2015 tax liability. At the same time, practitioners can discuss next year's income projections and plan the quarterly estimated tax payments for 2016. The following is a recap of changes affecting businesses in 2015, and a discussion of some tax strategies that practitioners may want to consider.

Code Sec. 179 Expensing

One of the biggest tax benefits to a business is the Section 179 deduction, which allows taxpayers to write off property purchases that would otherwise be capitalized and depreciated. At the end of 2014, last-minute legislation extended the generous deduction of prior years to property purchased in 2014. As a result, a business was eligible to expense up to $500,000 of qualified property placed into service in 2014 (i.e., the Section 179 deduction). Currently, for property placed in service in 2015, the Section 179 expense deduction is capped at $25,000. It's still worthwhile for practitioners to evaluate whether it's appropriate for their clients to increase capital improvement purchases to take advantage of this deduction.

There is currently a bill before the Senate (S. 1946, The Tax Relief Extension Act of 2015) which, if passed by Congress and signed into law, will extend to 2015 and 2016 the Section 179 deduction allowed to businesses in 2014.

Retroactive 2014 Bonus Depreciation

The IRS has recently issued guidance on how fiscal year taxpayers can retroactively elect to take the 50-percent bonus depreciation deduction for qualified property placed in service during the 2014 portion of fiscal years beginning in 2013. The guidance, which additionally addresses carrying over disallowed Code Sec. 179 deductions for qualified real property, applies to taxpayers who filed their 2013 returns (or 2014 short year returns) before enactment of last year's tax extenders bill on December 19, 2014. Practitioners should consider meeting with eligible clients to discuss the possibility of electing the retroactive bonus depreciation.

Vehicle Deductions and Substantiation

Expenses relating to vehicles used in a business can add up to major deductions. The deductible vehicle expenses of a business are generally calculated using one of two methods: the standard mileage rate method or the actual expense method. If the standard mileage rate is used, parking fees and tolls incurred for business purposes can be added to the total amount calculated.

Since the IRS tends to focus on vehicle expenses in an audit and disallow them if they are not property substantiated, taxpayers should ensure that the following are part of their tax records with respect to each vehicle used in their businesses: (1) the amount of each separate expense with respect to the vehicle (e.g., the cost of purchase or lease, the cost of repairs and maintenance); (2) the amount of mileage for each business or investment use and the total miles for the tax period; (3) the date of the expenditure; and (4) the business purpose for the expenditure. The following are considered adequate for substantiating such expenses: (1) records such as an account book, diary, log, statement of expense, or trip sheets; and (2) documentary evidence such as receipts, canceled checks, bills, or similar evidence.

Records such as an account book, diary, log, statement of expense, or trip sheet are considered adequate to substantiate the element of an expense only if the records are prepared or maintained in such a manner that each recording of an element of the expense is made at or near the time the expense is incurred.

S Shareholder Salaries

The IRS is scrutinizing the salaries, or lack thereof, paid to S shareholder-employees. Some S shareholders prefer to take money out of an S corporation as a distribution rather than a salary on which employment taxes must be paid. The IRS has been going after such shareholders. Thus, taxpayers actively involved in an S corporation must be paid a "reasonable compensation" for their services. The key to establishing reasonable compensation is determining what type of work the taxpayer did for the S corporation as an employee-shareholder. For clients in this situation, practitioners need documentation of the factors that support the salary the client is being paid.

Retirement Plans

While a taxpayer's business is not required to have a retirement plan, taxpayers may want to consider adding one. By starting a retirement savings plan, taxpayers not only help their employees save for the future but also attract and retain qualified employees. Such plans offer tax savings to businesses because employer contributions are deductible from the business's income. Additionally, a tax credit is available to small employers for the costs of starting a retirement plan.

Changes Made to Tax Return Due Dates

A new law changed the due date for partnership and C corporation tax returns. It also extended the automatic extension for corporate income tax returns from three to six months. The changes generally apply to tax years beginning after 2015.

The due date for partnership returns has been moved up to coincide with the due date of S corporation returns. Thus, partnership returns are now due by the 15th day of the third month after the close of the partnership tax year. The change is meant to help individual partners avoid having to file an extension because partnership K-1s don't generally arrive until after the April 15 due date for individual tax returns.

The due date for filing a C corporation return has been changed from the 15th day of the third month (i.e., March 15 for a calendar year corporation) to the 15th day of the fourth month (i.e., April 15 for a calendar year corporation). However, there is an exception for C corporations with a June 30 fiscal year. The due date for filing a June 30 C corporation return remains the 15th day of the third month following the end of the year (i.e., September 15) for the next 10 years. All other changes are effective for tax years beginning after 2015.

Overstating Basis of Property Sold Can Extend Statute of Limitations

The same new law overrides a Supreme Court decision that was favorable to taxpayers. The new law extends the statute of limitations from three years to six years in cases where a taxpayer overstates the basis in property sold and thus understates the gain on the sale. The change applies to (1) returns filed after July 31, 2015, and (2) returns filed on or before July 31 if the statute of limitations (determined without regard to the change) for assessment of the taxes with respect to which such return relates has not expired as of such date.

Tax Extender Legislation

As previously mentioned, tax extender legislation is before the Senate and, if signed into law, will extend the increased Code Sec. 179 deduction limitations to 2015 and 2016. Another large tax break included in the legislation is bonus depreciation. Bonus depreciation allows a 50-percent additional first year depreciation deduction for qualified property acquired by a taxpayer after 2007 and placed in service by the taxpayer before 2014. This benefit was extended at the last minute in 2014 to businesses who placed property in service before January 1, 2015 (before January 1, 2016, for certain longer-lived and transportation assets) and also allowed a business to elect to accelerate some AMT credits in lieu of taking the bonus depreciation.

Currently, there is no provision for taking bonus depreciation for assets placed in service in 2015. However, under proposed legislation (S. 1946), the bonus depreciation deduction would be extended to property placed in service in 2015 and 2016. Other items in the legislation that, if passed and signed into law, will be extended through 2015 and 2016 include the following:

  • the classification, for depreciation purposes, of certain race horses as three-year property;
  • accelerated depreciation of qualified leasehold improvements, qualified restaurant buildings and improvements, and qualified retail improvements;
  • the classification, for depreciation purposes, of motorsports entertainment complexes as seven-year property;
  • accelerated depreciation of business property on Indian reservations;
  • the deduction for charitable deductions of food inventory by taxpayers other than C corporations;
  • the election to expense mine safety equipment;
  • the expensing allowance for certain film and television productions and the cost of live theatrical productions;
  • the deduction for income attributable to domestic production activities in Puerto Rico;
  • tax rules relating to payments between controlled foreign corporations and dividends of regulated investment companies;
  • the subpart F income exemption for income derived in the active conduct of a banking, finance, or insurance business;
  • the tax rule exempting dividends, interest, rents, and royalties received or accrued from certain controlled foreign corporations by a related entity from treatment as foreign holding company income;
  • the 100 percent exclusion from gross income of gain from the sale of small business stock;
  • the basis adjustment rule for stock of an S corporation making charitable contributions of property;
  • the reduction to five years of the recognition period for the built-in gains of S corporations; and
  • tax incentives for investment in empowerment zones.

Contracts Involving Regular Performance of Services

A new safe harbor is available for accrual method taxpayers who have contracts under which services are provided to them on a regular basis (for example, contracts for janitorial or I.T. services). Under the safe harbor, a taxpayer can potentially accelerate deductions related to the cost of such services in situations where the services are either recurring in nature or are expected to be performed within 3 1/2 months of the end of the tax year.

If a client has contracts with service providers who perform regular and routine services that qualify for the safe harbor, practitioners should discuss the possibility of making an accounting method change in order to take advantage of the accelerated write-offs.

[Return to Table of Contents]

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Bipartisan Budget Act Avoids Government Shutdown, Replaces TEFRA Partnership Audit Procedures

On November 2, President Obama signed into law the Bipartisan Budget Act of 2015 (2015 BBA), which will fund the government through the 2017 fiscal year and avoids a repeat of the 2013 government shutdown. Unlike recent budget deals, this one had far less drama and was passed by Congress well ahead of the last-minute deadline other budgets had bumped against. The law repeals TEFRA partnership audit procedures and replaces them with a single centralized audit system, eliminates Obamacare's automatic enrollment requirement for employers with more than 200 employees, and makes several other tax changes. P.L. 114-74 (11/2/2015).

I. Changes to Partnership Audit Provisions

With respect to partnership audit rules, the 2015 BBA repeals the voluntary centralized audit procedures for electing large partnerships, as well as the TEFRA procedures (i.e., rules adopted as part of the Tax Equity and Fiscal Responsibility Act of 1982). Under the new system, the audit and adjustments of all partnership items are generally determined at the partnership level, although an opt-out provision to the new rules is available for certain partnerships.

Observation: Under the new rules, distinctions among partnership items, non-partnership items, and affected items no longer exist.

The changes to the audit rules are designed as revenue provisions related to tax compliance. According to the Joint Committee on Taxation, the repeal of the TEFRA partnership audit procedures is expected to increase revenues by over $9.3 billion in the next ten years.

Current Rules

Under current law, the manner in which an audit and redetermination of tax of partnership activities are determined depends upon the number of partners in a partnership and whether the partnership has elected to avail itself of certain special procedures. As a result, there are three different regimes for auditing partnerships.

First, for partnerships with 10 or fewer partners, the IRS generally applies the audit procedures for individual taxpayers. Thus, the IRS audits the partnership and each partner separately.

Second, for partnerships with more than 10 partners, the IRS conducts a single administrative proceeding under the TEFRA rules to resolve audit issues of partnership items that are more appropriately determined at the partnership level than at the partner level. Under TEFRA, once the audit is completed and the resulting adjustments are determined, the IRS recalculates the tax liability of each partner in the partnership for the particular audit year.

Third, partnerships with 100 or more partners can elect to be treated as electing large partnerships (ELPs) for reporting and audit purposes. A distinguishing feature of the ELP audit rules is that unlike the TEFRA audit rules, partnership adjustments generally flow through to the partners for the year in which the adjustment takes effect, rather than the year under audit. As a result, the current-year partners' share of current-year partnership items of income, gains, losses, deductions, or credits are adjusted to reflect partnership adjustments relating to a prior-year audit that take effect in the current year. The adjustments generally do not affect prior-year returns of any partners (except in the case of changes to any partner's distributive share).

New Law

The 2015 BBA repeals the TEFRA and ELP rules and streamlines the partnership audit rules into a single set of rules for auditing partnerships and their partners at the partnership level. Under the streamlined audit approach, the IRS will examine the partnership's items of income, gain, loss, deduction, credit and partners' distributive shares for a particular year of the partnership (i.e., the "reviewed year"). Any adjustments are taken into account by the partnership, and not the individual partners, in the year that the audit or any judicial review is completed (i.e., the "adjustment year"). Partners would not be subject to joint and several liability for any liability determined at the partnership level.

The new law gives partnerships the option of demonstrating that an adjustment would be lower if it were based on certain partner-level information from the reviewed year rather than imputed amounts determined solely on the partnership's information in such year. As an alternative to taking the adjustment into account at the partnership level, a partnership can issue adjusted information returns (i.e., adjusted Form K-1s) to the reviewed year partners, in which case those partners would take the adjustment into account on their individual returns in the adjustment year through a simplified amended-return process. The practical effect of this rule is that partnerships generally will no longer issue amended Form K-1s after the partnership return is filed, but instead will use the adjusted Form K-1 process for prior year adjustments.

According to Robert Kane, Sr. Tax Director, RSM US LLC, "if the partnership doesn't issue adjusted K-1s and instead pays the tax itself, any new partners who were not partners in the year to which the adjustment applies will bear the tax cost. This is because the additional tax is leveled in the adjustment year, and not the reviewed year. Alternatively, if the partnership issues adjusted K-1s to the partners in the reviewed year, those partners are responsible for the additional tax. The IRS will need to issue additional guidance addressing this issue."

Notes Kane, "[p]artnerships will need to review their operating agreements to ensure the agreements spell out the process for determining whether the partnership will pay any additional tax liability or will push the liability down to partners via the adjusted K-1 process."

Opt-Out Provision

Similar to the current rule excluding small partnerships from the TEFRA provisions, the new law allows partnerships with 100 or fewer qualifying partners to opt out of the new rules, in which case the partnership and partners will be audited under the general rules applicable to individual taxpayers. In order to qualify for this opt-out provision, the partners must be either individuals, C corporations, a foreign entity that would be treated as a C corporation if it were a domestic entity, an S corporation, or an estate of a deceased partner. The election must be made with a timely filed return for the tax year it is to be effective and include a disclosure of the name and taxpayer identification number of each partner in the partnership, and each partner must be notified of the election.

In the case of an S corporation partner, the partnership will only be treated as meeting the requirement for opting out if the partnership discloses the name and taxpayer identification number of each person with respect to whom the S corporation is required to furnish a statement for the tax year of the S corporation ending with or within the partnership tax year for which the election out of the new law is elected.

Notes Kane, "[p]artnerships that have other partnerships as partners, in other words tiered arrangements, are not eligible for the opt-out process. So that eliminates a lot of partnerships from this provision. However, the new law allows room for the IRS to identify by regulations or other guidance additional partners to which the opt-out provision may apply."

Effective Date and Early Election of Changes

The changes relating to the partnership audit provisions generally apply to returns filed for partnership tax years beginning after December 31, 2017. This should give the IRS time to issue the additional guidance necessary to address all the issues that will emerge as a result of the new law.

However, except for the election relating to the opt-out provision, a partnership may elect to apply the new partnership audit rules to any return of the partnership filed for partnership tax years beginning after November 2, 2015, and before January 1, 2018.

Practice Tip: Should partnerships make the early election? Says Kane, "TEFRA is a tough audit process. For example, for partnerships that have 100 or fewer partners, the IRS is required to notify each partner at the beginning and at the end of the partnership audit and recalculate each partner's liability. Additionally, the IRS has run into significant statutes of limitation issues as a result of failing to properly identify a TEFRA partnership. As a result, you have less partnership audits. Congress sees getting rid of TEFRA as a revenue raiser because there will be more partnership audits and more money flowing into the Treasury. By making an early election into the non-TEFRA rules, a partnership may be increasing its chances of being audited." However, Kane added, "[l]arge partnerships typically take conservative positions so they don't end up sending amended K-1s to 100 partners and the IRS may find there is not a lot of money to be made by more partnership audits."

II. Changes to "Family Partnership" Rules in Code Sec. 704(e)

Current Rules

Currently, Code Sec. 704(e) is titled "Family partnerships." Under Code Sec. 704(e)(1), a person is recognized as a partner in a partnership if the person owns a capital interest in a partnership in which capital is a material income-producing factor, whether or not such interest was obtained by purchase or by gift.

The predecessor of this provision was enacted in 1951 to prevent the IRS from denying partner status to a taxpayer who shared actual ownership of the partnership's income-producing capital on the basis that the interest was acquired from a family member. According to the legislative history, Code Sec. 704(e)(1) was intended to make clear that, however the owner of a partnership interest may have acquired such interest, the income is taxed to the owner, if he is the real owner. If the ownership is real, it does not matter what motivated the transfer or whether the business benefitted from the entrance of the new partner.

Observation: The problem with Code Sec. 704(e)(1) was that its scope was not entirely clear. Some read it as doing nothing more than stating the general principle that income derived from capital is taxed to the owner of the capital. Others read it as providing an alternative test as to what constitutes a "partner" by treating the holder of a capital interest as a partner without regard to how the term is defined in Code Sec. 761. The argument was that if a partner holds a capital interest in a partnership, the partnership must be respected regardless of whether the parties demonstrated that they joined together to conduct an active trade or business.

New Law

The new law revises Code Sec. 704(e)(1) and clarifies that, by adding a new sentence to Code Sec. 761(b), Congress did not intend for the family partnership rules to provide an alternative test for determining whether a person is a partner in a partnership. Congress intended the rule in Code Sec. 704(e) to merely explain that a family member who received, via gift, a capital interest in a partnership, where capital is a material income-producing factor (as opposed to services), should be respected as a partner in the partnership and should be taxed on the income from that partnership. Thus, the determination of whether the owner of a capital interest is a partner is made under the generally applicable rules defining a partnership and a partner.

Effective Date

The changes to Code Sec. 704(e) and Code Sec. 761(b) relating to family partnerships and partnership interests created by gift apply to partnership taxable years beginning after December 31, 2015.

III. Repeal of ACA Automatic Enrollment Requirements

Under the Affordable Care Act (ACA), employers with more than 200 employees were required to automatically enroll new full-time equivalents into a qualifying health plan if offered by that employer, and to automatically continue enrollment of current employees. Employers were also required to provide adequate notice and the opportunity for an employee to opt out of any coverage in which he or she was automatically enrolled.

The Departments of Labor, Health and Human Services, and the Treasury stated in a 2010 FAQ that employers were not required to comply with automatic enrollment until regulations were issued. As of the enactment of the 2015 BBA, such regulations had not been issued.

The 2015 BBA repeals the automatic enrollment provisions added by the ACA, effective November 2, 2015.

IV. Other Changes

Other changes in the law made by the 2015 BBA include:

(1) A modification of the fixed premium that single-employer pension plans pay annually to the Pension Benefit Guarantee Corporation;

(2) A change to the criteria for determining whether a defined benefit pension plan has credible information to use mortality tables separate from those prescribed by regulations;

(3) An extension on current funding stabilization percentages for valuing defined benefit pension plan liabilities; and

(4) Authorization to use automated telephone equipment to call cell phones for the purpose of collecting debts owed to the U.S. government.

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Fifth Circuit Affirms Tax Court's Bright Line on Use of Completed Contract Method by Developers

The Fifth Circuit affirmed a Tax Court decision holding that a developer's contracts were not home construction contracts and, thus, gain or loss from such contracts could not be reported using the completed contract method. The court relied on the fact that the taxpayer did not build homes on the land it sold, and qualifying dwelling units did not exist at the time of the sales. Howard Hughes Company, LLC v. Comm'r, 2015 PTC 387 (5th Cir. 2015).

Background

In 2007 and 2008, The Howard Hughes Company, LLC (HHC) and its subsidiaries were in the residential land development business. They generated revenue primarily by selling property to builders who would then construct and sell homes. The land HHC sold was part of a large master-planned community known as Summerlin. Summerlin is divided into three geographic regions, each of which was further divided into villages averaging about 500 acres. Those villages were further divided into parcels, or neighborhoods, which contained the individual lots.

Sales by HHC generally fell into one of four categories: (1) pad sales; (2) finished lot sales; (3) custom lot sales; and (4) bulk sales. In a pad sale, HHC, after dividing the village into parcels, constructed the entire infrastructure in the village up to a parcel boundary. HHC then sold the parcel to a buyer, usually a homebuilder, who was responsible for the entire infrastructure (such as streets and utilities) within the parcel and subdividing the parcel into lots. In a finished lot sale, HHC also divided the village into parcels, constructed any additional needed parcel infrastructure, divided the parcels into lots, and sold the neighborhoods to a buyer, usually a homebuilder. In both the pad sales and the finished lot sales, HHC contracted with homebuilders through building development agreements (BDA).

Custom lot sales were essentially the same as finished lot sales, except that HHC sold the individual lots. The buyers of these individual lots were individuals who were contractually bound to build a residential dwelling unit. Finally, in a bulk sale, HHC sold entire villages to purchasers, who would then be responsible for subdividing the village into parcels and lots and for constructing all of the infrastructure improvements within the village.

The BDAs, loan agreements, governmental laws, and other legal obligations required HHC to build infrastructure and common improvements in Summerlin, such as parks, roadways, and water and sewer systems. Some of these improvements were necessary for construction of the dwelling units. In addition, HHC monitored and maintained approval control over all construction in Summerlin, including construction of the dwelling units. HHC did not build homes, perform any home construction work, or make improvements within the boundaries of any lots in Summerlin.

In 2007 and 2008, HHC used the "completed contract method" of accounting in computing gain or loss from their long-term contracts for the sale of residential real property in Summerlin. By using this method, HHC deferred reporting income on a contract for the sale of land until the contract was "complete," i.e., until the year in which HHC's incurred costs reached 95 percent of their estimated contract costs.

Observation: HHC's method of accounting was in contrast to the general method of reporting income under long-term contracts, the "percentage of completion" method. The percentage of completion method requires a taxpayer to recognize gain or loss annually in proportion to the progress the taxpayer has made during the year toward completing the contract.

The IRS disagreed with HHC's method of accounting and issued notices of deficiency for the 2007 and 2008 tax years, changing the method of accounting and increasing taxable income.

Tax Court Opinion

Code Sec. 460 requires taxpayers to account for long-term contracts under the percentage of completion method and generally prohibits the use of the completed contract method, subject to certain exceptions. One such exception is for "home construction contracts." Under Code Sec. 460(e)(6)(A), a contract is a home construction contract if it satisfies a two-prong test. Under that test, 80 percent of its costs must come from building, construction, reconstruction, rehabilitation, or integral component installation with respect to (1) dwelling units, and (2) improvements to real property directly related to and located on the site of such dwelling units.

The Tax Court held that HHC's contracts were long-term contracts within Code Sec. 460 but were not "home construction contracts" that would permit the use of the completed contract method. The lack of any home construction activity on the part of HHC was particularly important to the Tax Court.

The court found HHC's costs did not come within the first prong of Code Sec. 460(e)(6)(A), because HHC did not engage in any activities attributable to the construction of the dwelling units. The court determined HHC's contract costs also did not come within the second prong of Code Sec. 460(e)(6)(A) because the costs were not incurred for improvements "on the site of such dwelling units," a phrase which the court interpreted to mean "the individual lot."

The Tax Court concluded its opinion by drawing a bright line, under which a contract could qualify as a home construction contract only if the taxpayer builds, constructs, reconstructs, rehabilitates, or installs integral components to dwelling units or real property improvements directly related to, and located on, the site of such dwelling units.

Fifth Circuit Affirms Tax Court

On appeal, the Fifth Circuit affirmed the Tax Court, holding that HHC's contracts were not "home construction contracts", thereby making HHC ineligible to use the completed contract method of accounting.

As the Tax Court recognized, the Circuit Court said, Code Sec. 460(e)(6)(A) creates an 80 percent test that allows a contract to qualify as a home construction contract if 80 percent of its costs come from construction activities directed toward the two prongs of the statute.

The Circuit Court noted the Tax Court held that the first prong applies only if the taxpayer builds, constructs, reconstructs, rehabilitates, or installs integral components to dwelling units, and found that a plain reading of the statute supported that holding. Because the first prong refers to activities with respect to dwelling units, and since a dwelling unit is "a house or apartment used to provide living accommodations" (as defined in Code Sec. 168(e)(2)(A)(ii)(I)), the court stated that necessarily means that a taxpayer seeking to use the completed contract method must be engaged in construction, reconstruction, rehabilitation, or installation of an integral component of a home or apartment. Because the costs HHC incurred were not the actual homes' structural, physical construction costs, or were not related to work on dwelling units, the court determined HHC did not come within the first prong.

The Circuit Court found the Tax Court correctly rejected HHC's argument that it fell within the second prong, because HHC's construction activities for common improvements were not located on the site of such dwelling units. The court agreed with the Tax Court's holding that the word "site" in the statute meant a single site of a building otherwise described as a "lot." Because HHC never made improvements on the lots where homes were built, the Circuit Court concluded that HHC's construction activities did not come within the plain language of the statute.

HHC also argued that they could use the completed contract method as the result of Reg. Sec. 1.460-3(b)(2)(iii), which provides, in general, that taxpayers include in the cost of the dwelling units their share of costs the taxpayer reasonably expects to incur for any common improvements that benefit the dwelling units. HHC argued that this regulation allowed them to count their common improvement costs in the 80 percent test since it directly referred to the type of "common improvements" they constructed.

The Tax Court noted, the Circuit Court said, that the regulation required that the taxpayer must have at some point incurred some construction cost with respect to the dwelling unit to include common improvement costs in the dwelling unit cost. The Circuit Court stated the plain text refers to the "costs of the dwelling units," which meant that there must be dwelling unit costs before taxpayers can count their common improvement costs towards the 80 percent test. Because HHC had no dwelling unit costs in which to include the common improvement costs, the Circuit Court found the Tax Court correctly rejected this argument.

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Acquisition Cost of Internet Domain Names Is Generally Amortizable; No Current Deduction Allowed

The cost of purchasing an Internet domain name is not a currently deductible business expense but instead is generally capitalizable under Code Sec. 263 and amortizable under Code Sec. 197. CCA 201543014.

The correct tax treatment for the cost of purchasing an Internet domain name has been the subject of confusion among practitioners because of a lack of guidance in this relatively new and emerging tax area. Practitioners have been unsure whether the costs of acquiring domain names were currently deducible under Code Sec. 162 as trade or business expenses or were capitalized under Code Sec. 263 and either depreciable under Code Sec. 167 or amortizable under Code Sec. 197. The IRS Office of Chief Counsel (IRS) has now addressed the issue and nixed the idea that the expenses are currently deductible. In CCA 201543014, the IRS addressed the following three issues:

(1) Whether costs incurred by a taxpayer to acquire a generic Internet domain name (generic domain name) or a non-generic Internet domain name (non-generic domain name) from the secondary market for use in the taxpayer's trade or business are deductible under Code Sec. 162 or are required to be capitalized under Code Sec. 263(a)?

(2) If costs incurred by a taxpayer to acquire a non-generic domain name from the secondary market for use in the taxpayer's trade or business are required to be capitalized under Code Sec. 263(a), are these capitalized costs amortized under Sec. 197?

(3) If costs incurred by a taxpayer to acquire a generic domain name from the secondary market for use in the taxpayer's trade or business are required to be capitalized under Code Sec. 263(a), are these capitalized costs amortized under Code Sec. 197?

Observation: A generic domain name is not a company or product name, but rather describes a product or service using generic terms people associate with the topic. By contrast, a non-generic domain name is usually a company or product name. Besides providing the domain name holder's Internet address, a non-generic domain name is used to identify the particular good, service, and/or business that is associated with the website.

For the first two issues, due to a lack of facts, the IRS made the following assumptions: (a) each purchased domain name was associated with a website already constructed and would be maintained by the acquiring taxpayer; and (b) the taxpayer purchased the generic domain names for use in its trade or business either to generate advertising revenue by selling space on the website or to increase its market share by providing goods or services through the website.

With respect to the first issue, the IRS noted that Reg. Sec. 1.263(a)-4(b)(1)(i) generally provides that a taxpayer must capitalize an amount paid to acquire an intangible asset. Reg. Sec. 1.263(a)-4(c)(1) provides that a taxpayer must capitalize amounts paid to another party to acquire an intangible from that party in a purchase or similar transaction and provides examples of intangibles requiring capitalization under this rule. One such example is a trademark. Thus, capitalization is required for an amount paid to another party to acquire a domain name that meets the definition of a trademark (as defined in Reg. Sec. 1.197-2(b)(10)), and is also required for an amount that is paid to acquire a domain name simply because the domain name is an intangible asset. Capitalization is required, the IRS concluded, regardless of whether the acquired domain name is a generic or non-generic domain name.

With respect to the second issue, the IRS advised that if the non-generic domain name is registered as a trademark or functions as a trademark, the capitalized costs of acquiring such a non-generic domain name from the secondary market for use in the acquiring taxpayer's trade or business meets the definition of a trademark and constitutes an amortizable Code Sec. 197 intangible. Alternatively, if the non-generic domain name does not meet the definition of a trademark in Reg. Sec. 1.197-2(b)(10) but will be used by the acquiring taxpayer in its trade or business to provide goods or services through a website that is already constructed and will be maintained by the acquiring taxpayer, the IRS advised that the capitalized costs of acquiring such a non-generic domain name meets the definition of a customer-based intangible in Reg. Sec. 1.197-2(b)(6) and constitutes an amortizable Sec. 197 intangible.

With respect to the third issue, the IRS concluded that if the generic domain name is associated with a website that is already constructed and will be maintained by the acquiring taxpayer, and the taxpayer acquired the generic domain name for use in its trade or business either to generate advertising revenue by selling space on the website or to increase its market share by providing goods or services through the website, the capitalized costs of acquiring such a generic domain name meets the definition of a customer-based intangible in Reg. Sec. 1.197-2(b)(6) and constitutes an amortizable Code Sec. 197 intangible.

Finally, the IRS said that if a purchased domain name is not an amortizable Code Sec. 197 intangible, then the domain name is an intangible asset subject to Code Sec. 167. The 15-year safe harbor provided in Reg. Sec. 1.167(a)-3(b), the IRS noted, does not apply because the acquired domain name is an intangible described in Reg. Sec. 1.263(a)-4(c). Therefore, such domain name is amortized under Code Sec. 167 only if the taxpayer can show a limited useful life pursuant to Reg. Sec. 1.167(a)-3(a). For purposes of Code Sec. 167, the IRS observed, the estimated useful life of an asset is not necessarily the useful life inherent in the asset but is the period over which the asset may reasonably be expected to be useful to the taxpayer in its trade or business or in the production of its income. Because a business usually intends to use a domain name for an indeterminable period of time, the IRS opined that the registration period of a domain name subject to Code Sec. 167 is not its useful life for purposes of Code Sec. 167.

For a discussion of the amortization of intangible, see Parker Tax ¶95,110.

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No Gift Tax on Transfer of Stock to Settle Bona Fide Dispute over Family Business

The Tax Court held that a transfer of stock, as part of a settlement, to a trust for the benefit of a decedent's children was not a taxable gift. The court found that recognition by the decedent's father and brother that he was the outright owner of a portion of the disputed shares constituted full and adequate consideration for the transfer, which was made in the ordinary course of business. Est. of Redstone v. Comm'r, 145 T.C. No. 11 (10/25/15).

Background

A family feud involving billionaire Sumner Redstone, his brother, Edward, and their father, Mickey, resulted in a June 30, 1972, settlement in which stock in the family owned business, National Amusements, Inc. (NAI), was distributed to Edward after he was forced out of NAI. In that settlement, the parties agreed that NAI would purchase for $5 million the 66 2/3 shares Edward was deemed to own. The settlement agreement further required Edward to execute irrevocable declarations of trust for the benefit of his children, Ruth Ann and Michael. As a result, 33 1/3 shares of NAI that Edward claimed belonged to him were transferred to a trust for the benefit of his children. Under the agreement, Sumner was named the sole trustee of each trust. Edward executed two assignments, each transferring 16 2/3 shares of NAI stock to Sumner as trustee of the respective trusts.

Edward did not file a federal gift tax return for the second quarter of 1972. In his and his accountants' view, the NAI shares that he transferred to the Michael and Ruth Ann Trusts did not constitute a taxable gift. In 2010, apparently as a result of certain litigation, Edward's 1972 transfer of stock came to the attention of the IRS. Edward died in 2011. In 2013, after an audit, the IRS issued Edward's estate a notice of deficiency determining a deficiency of approximately $738,000 in federal gift tax for the calendar quarter that ended June 30, 1972. The IRS also assessed various penalties.

Analysis

Under Code Sec. 2501, a gift tax is imposed on the transfer of property by gift. However, under Reg. Sec. 25.2511-1(g)(1), the gift tax does not apply to a transfer for a full and adequate consideration in money or money's worth, or to ordinary business transactions.

The Tax Court held that Edward's estate did not owe gift tax on the 1972 transfer because Edward received full and adequate consideration for the transfer: namely the recognition that he was the outright owner of 66 2/3 NAI shares and the payment of $5 million for those shares. According to the court, the IRS's argument focusing on whether the transferees (i.e., Michael and Ruth Ann) provided consideration for the transfer was not the question that Reg. Sec. 25.2511-1(g)(1) asks. It asks, the court noted, whether the transferor (and not the transferee) received full and adequate consideration in money or money's worth (adequate consideration).

The court cited its decision in Beveridge v. Comm'r, 10 T.C. 915 (1948), in which the IRS had argued that a $120,000 transfer by a mother to her daughter, who was estranged from the family after marrying a man that her mother disliked, was a taxable gift because it was made to secure the release of unproven claims which had no ascertainable value. The Tax Court disagreed, finding that the mother had received, as consideration for the transfer, a release from unliquidated claims and that this release had recognizable monetary value. Thus, the court concluded that the mother's $120,000 transfer to her daughter was not a gift but was for adequate consideration. The Tax Court noted that it has ruled similarly in other cases involving arm's-length transfers of property in settlement of genuine disputes between family members.

Further, the court observed that a transfer of property is regarded as occurring in the ordinary course of business and thus is considered to have been made for adequate consideration, if certain elements are satisfied. The court noted that, under Reg. Sec. 25.2512-8, the transfer must have been:

(1) bona fide;

(2) transacted at arm's length; and

(3) free of donative intent.

In applying this standard to settlements of family disputes, the court noted that it has identified certain subsidiary factors that may also be relevant, such as whether a genuine controversy existed between the parties; whether the parties were represented by and acted upon the advice of counsel; whether the parties engaged in adversarial negotiations; whether the value of the property involved was substantial; whether the settlement was motivated by the parties' desire to avoid the uncertainty and expense of litigation; and whether the settlement was finalized under judicial supervision and incorporated in a judicial decree.

The Tax Court found no indication that the dispute within the Redstone family that was resolved in 1972 was a sham designed to disguise a gratuitous transfer to Edward's children. All the elements of arm's-length bargaining, the court stated, existed in this case. The court found that Edward acted as one would act in the settlement of differences with a stranger and his transfer of shares in trust for his children was an arm's-length transaction. The court also noted that, although donative intent is not prerequisite to a gift, the absence of donative intent is essential for a transfer to be treated as made in the ordinary course of business. The Tax Court concluded that Edward's transfer of stock to his children represented the settlement of a bona fide dispute, was made at arm's length, and was free from any donative intent, and thus met the criteria for a transaction in the ordinary course of business.

For a discussion of transfers subject to gift tax, see Parker Tax ¶221,510.

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Donations Paid in "Cause Marketing" Program Are Deducible as Business Expenses

Donations of sales proceeds by a business to organizations described in Code Sec. 170(c) are deductible under Code Sec. 162(a) as business expenses to the extent not disallowed by other provisions of Code Sec. 162 and to the extent they are not contributions under Code Sec. 170. CCA 201543013.

A taxpayer, engaged in the business of providing certain services, has operated Program X since its incorporation. Funds from Program X are donated to certain recipients, including organizations that are exempt from federal income tax as well as other non-profit and for-profit entities. One past recipient was engaged in limited political activity and was exempt from federal income tax but not described in Code Sec. 170. The taxpayer's customers do not have a right to a share of the amounts in Program X. Thus, the customers do not have control over the funds such that the taxpayer is the agent of the customer or is acting as a mere conduit for the dispersal of these funds. The taxpayer believed that the establishment of Program X enhances and increase its business, and had a reasonable expectation of commensurate financial return for its donations through Program X.

Observation: Program X appears to be a "cause marketing" program, which is defined as a type of marketing involving the cooperative efforts of a for-profit business and a non-profit organization for mutual benefit. An example would be a business promoting the fact that $2 of each sale of a particular item will be contributed to a specific charity.

In CCA 201543013, the IRS Office of Chief Counsel (IRS) addressed four issues relating to the taxpayer's operation of Program X. The first issue was whether amounts remitted as part of the taxpayer's Program X to various organizations were paid by the taxpayer or by its customers. The IRS noted that, as a general matter, a taxpayer may not deduct payments voluntarily made on another's behalf, even where there is a moral obligation to do so. In the instant case, the IRS advised that it did not appear that the funds in Program X belong to and are donated by the taxpayer's customers.

The second issue was, assuming the taxpayer paid amounts to tax exempt charitable and educational organizations (described in Code Sec. 170) as part of Program X, whether such amounts are deductible as ordinary and necessary business expenses under Code Sec. 162. The IRS advised that because the taxpayer had a reasonable expectation of commensurate financial return for its donations through Program X, its donations to organizations described in Sec. 170(c) are deductible under Code Sec. 162(a) as business expenses to the extent not disallowed by other provisions of Code Sec. 162 and to the extent they are not contributions under Code Sec. 170.

The third issue was, assuming the taxpayer paid amounts as part of Program X to exempt organizations not described in Code Sec. 170, whether such amounts are deductible as ordinary and necessary business expenses under Code Sec. 162. The IRS advised that, in the absence of facts indicating otherwise, the donation expenses are deductible under Code Sec. 162(a) subject to applicable limitations (e.g., no deduction is allowed under Code Sec. 162(e) for amounts paid in connection with influencing legislation).

The last issue was whether amounts paid as part of Program X to organizations that conducted lobbying activities are deductible as ordinary and necessary business expenses under Code Sec. 162. The IRS advised that, while the nature or extent of these organizations' lobbying activities was not clear, the taxpayer's donation to these organizations is not a direct communication with members or employees of a legislative body or other government officials, and so is not itself a lobbying communication under Reg. Sec. 1.162-29(b). Reg. Sec. 1.162-29(b) provides the rules for determining whether an activity is considered influencing legislation for purposes of the nondeductibility rules under Code Sec. 162(e). According to the IRS, even with further factual development, it seemed unlikely that any of these donations could be lobbying activities covered by Reg. Sec. 1.162-29.

For a discussion of the general rules relating to charitable deductions, see Parker Tax ¶84,105. For a discussion of rules relating to the deductibility of lobbying and political expenses, see Parker Tax ¶93,505.

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IRS Provides Roadmap for Tax Audits of Entertainment Industry

The IRS has updated the Entertainment Industry Guide, which provides IRS auditors with guidance on what to look for and ask about when auditing taxpayers with entertainment-related deductions. Entertainment Industry ATG (2015).

In 1995, the IRS issued an audit guide called the Market Segment Specialization Program for Entertainment. Last month, the IRS updated that guide and gave it a new name, The Audit Guide for the Entertainment Industry. The Entertainment Industry Guide (EIG) is particularly useful for practitioners with clients who have entertainment-related deductions since it provides a roadmap for what auditors will be looking at with respect to a client's return. While generally following the format of the 1995 MSSP, the EIG has been expanded to include guidance issued since 1995 and to include the following new chapters:

  • Music Business
  • Songwriters
  • Publishers
  • Live Performers
  • Producers
  • Managers
  • Videos
  • Employment Tax

The Income Issues chapter includes a new section dealing with the tax treatment of advances under Rev. Proc. 2004-34, which provides a method of accounting under which accrual method taxpayers may defer inclusion of certain advance payments in gross income until the year after the year the payment is received. However, the EIG notes, advances paid to authors, songwriters, etc. cannot be deferred. The EIG cites as an example a publisher signing a contract with a writer, under which the writer is advanced $250,000. A cash basis writer must include the $250,000 in income in the year received. An accrual basis taxpayer must recognize the $250,000 upon the earlier of receipt, payment being due, or when earned. The publisher must capitalize the $250,000 as a production cost and allocate it to costs of goods sold as the book is published and sold.

The Capitalization and Cost Recovery Issues chapter has been expanded to cover the recently revised regulations under the uniform capitalization rules (UCR) of Code Sec. 263A and includes a discussion of Reg. Sec. 1.263A-2(a)(3)(i) (dealing with costs required to be capitalized by producers), Reg. Sec. 1.263A-2(a)(3)(ii) (dealing with pre-production costs), and Reg. Sec. 1.263A-2(a)(3)(iii) (dealing with post-production costs). The section dealing with exemptions from the UCR for qualified creative expenses paid or incurred by certain freelance authors (non-employees), photographers, and artists has been expanded to include definitions of these categories. However, citing TAM 9643003, the EIG notes that expenses that are directly tied to the creative item of a writer, photographer, composer, or artist may still require capitalization.

A section was also added to the Capitalization and Cost Recovery chapter addressing the election a taxpayer can make under Notice 88-62 to aggregate and capitalize all qualified creative costs, and to amortize and deduct 50 percent of such costs in the year incurred and 25 percent in the succeeding two tax years. Other additions to the chapter include a section on when an asset is considered placed in service , a section on the income forecast method, a section detailing the rules for taking an abandonment loss.  

The chapter also discusses Rev. Proc. 2004-36, which allows film producers to amortize certain creative property costs ratably over a 15-year period beginning in the year the creative property costs are written off for book purposes under AICPA Statement of Position (SOP) 00-2, Accounting by Producers or Distributors of Film. With respect to abandonment losses, the EIG cites Rev. Rul. 2004-58 and notes that putting a script on the shelf for a while with the possibility of selling it at a later date, is not considered an abandonment. In addition, merely not attempting to exhibit a film is not abandoning it, since it may still be exploited in the future. In order to be eligible for an abandonment loss, a taxpayer must show intent to abandon and make an affirmative act of abandonment in such a manner that the asset is not retrievable.

The Personal Issues Chapter has been expanded to include a summary of court cases relating to the nondeductibility of personal expenses that pertain specifically to the entertainment industry. The chapter notes that bodyguards and home security are deemed to be personal expenses. The fact that the taxpayer is in a high profile profession is still a matter of personal choice and does not convert a personal security expense into a business expense. According to the EIG, such expenses do nothing to increase the income of the taxpayer and provide a personal benefit of "peace of mind."

Finally, in the Other Issues chapter, additional material was added to the Home Office section, including a discussion of Rev. Proc. 2013-13, which allows a simplified method of calculating the home office deduction.

For a discussion of the rules relating to the capitalization of expenses for freelance authors, photographers, and artists, see Parker Tax ¶242,475.

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Law Partner Can't Avoid Taxes on Distributive Shares Paid Out in Later Years

Even though a law partner left his law firm in an earlier year, he remained a partner of the firm until he received his final distribution and thus owed taxes on amounts paid to him in later years. Brennan v. Comm'r, 2015 PTC 381 (9th Cir. 2015).

Stephen Brennan was a partner in Cutler & Company, LLC, a limited liability company that elected to be taxed as a partnership. Brennan agreed in October 2002 to relinquish his interest in Cutler and withdraw from the company. In return, he received rights to about 45 percent of the proceeds of an account sale arranged as part of his withdrawal. Those proceeds were received in 2003 and 2004. Cutler filed 2003 and 2004 tax returns showing Brennan as a partner and indicating that he had earned about $571,000 in long-term capital gains in 2003 and $426,000 in 2004. Brennan did not report receiving the capital gains during those years.

Brennan argued that, for tax purposes, his status as a partner of Cutler ended in 2002 and, therefore, he did not realize any capital gains income from the Cutler account sale in 2003 or 2004. The IRS countered that Brennan was a Cutler partner for tax purposes for 2003 and 2004 and, therefore, was required to take into account his distributive share of the capital gains income from the account sale.

Citing Reg. Sec. 1.761-1(d), the Tax Court held that, for tax purposes, Brennan remained a Cutler partner during 2003 and 2004 because the final distributions to him had not been made. Therefore, he owed taxes on his distributive share of the account sale proceeds distributed to him in 2003 and 2004. Brennan appealed.

The Ninth Circuit affirmed the Tax Court's decision. Code Sec. 736, the Ninth Circuit observed, governs the tax treatment of payments made in liquidation of the interest of a retiring partner and Reg. Sec. 1.761-1(d) provides that payments that terminate a partner's entire interest in a partnership by means of a series of distributions, to the partner by the partnership, are taxed as a distributive share to the recipient until the final distribution has been made. The Ninth Circuit agreed that, for federal tax purposes, Brennan remained a Cutler partner during 2003 and 2004 because the final distributions had not been made. Thus, he owed taxes on his distributive share of the sale proceeds received in 2003 and 2004.

For a discussion of the tax treatment of payments to a retiring partner, see Parker Tax ¶23,550.

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AICPA Has Standing to Challenge the IRS's Voluntary Tax Return Preparer Program; Lower Court Reversed

The AICPA adequately challenged that the IRS's voluntary return preparer program will subject AICPA members to an actual or imminent increase in competition and it therefore has standing to pursue its challenge. American Institute of Certified Public Accountants v. IRS, 2015 PTC 391 (D.C. Cir. 2015).

Background

The tax return preparer market consists of four groups: (1) CPAs; (2) lawyers; (3) enrolled agents; and (4) unenrolled preparers. CPAs and lawyers are subject to state professional licensing regimes, and enrolled agents are licensed by the IRS and subject to various IRS requirements, including continuing education courses and an exam. The first three groups are also subject to IRS Circular 230, which includes rules and disciplinary procedures for practice before the IRS. By contrast, unenrolled preparers are subject to less stringent regulation. Although they, like all tax return preparers, must obtain a Preparer Tax Identification Number and list that number on every return they sign, they have no obligation to take courses or pass an exam.

In 2011, the IRS issued the Registered Tax Return Preparer (RTRP) rules. These rules would have required unenrolled preparers to become "registered tax return preparers" in order to continue assisting clients with their tax returns. Under the rules, preparers would have had to complete 15 hours of continuing education training annually, pass a written exam, and subject themselves to portions of Circular 230.

Three unenrolled preparers challenged the RTRP rules, arguing that they exceeded the authority given to the IRS to regulate the practice of representatives of persons before the Department of the Treasury. In Loving v. IRS, 2013 PTC 10 (D. D.C. 2013), aff'd 2014 PTC 73 (D.C. Cir. 2014), a district court agreed and permanently enjoined the IRS from enforcing the RTRP rules against unenrolled preparers. The district court subsequently modified its order to clarify that nothing in the injunction required the IRS to dismantle its entire scheme because the IRS could "choose to retain the testing centers and some staff, as it is possible that some preparers may wish to take the exam or continuing education even if not required to." In 2014, the D.C. Circuit affirmed the district court's decision, but said nothing about either the district court's clarification of its injunction or the permissibility of the RTRP rules remaining in place on a voluntary basis.

Subsequently, the IRS adopted a new program, the Annual Filing Season Program (AFSP). The AFSP offers preparers who, among other things, complete required continuing education, pass an exam, and subject themselves to portions of Circular 230, a "Record of Completion." In addition, the IRS lists participating preparers in its online "Directory of Federal Tax Return Preparers," which also includes CPAs, lawyers, and enrolled agents. The AFSP is a voluntary program and no tax return preparer is required to participate.

AICPA Contests IRS Annual Filing Season Program

The AICPA challenged the program before the D.C. district court, arguing that the voluntary program exceeds the IRS's statutory authority and that, in adopting it, the agency acted arbitrarily and capriciously and failed to comply with required notice and comment procedures. Anticipating an argument that it lacked standing to challenge the program, the AICPA alleged that the AFSP harms its members in three ways: (1) by confusing consumers and causing competitive harm; (2) by imposing regulatory burdens on unenrolled preparers that some of the AICPA's members' employ; and (3) by increasing the regulatory burden on AICPA members.

In 2014, in AICPA v. IRS, 2014 PTC 555 (D. D.C. 2014), the district court dismissed the AICPA's challenge. The AICPA appealed to the D.C. Circuit.

D.C. Circuit Finds AICPA Has Standing to Challenge the Voluntary Program

The D.C. Circuit reversed the lower court's decision and held that the AICPA adequately challenged that the AFSP will subject its members to an actual or imminent increase in competition and that it therefore has standing to pursue its challenge. The court, citing its decision in American Library Association v. FCC, 401 F.3d 489 (D.C. Cir. 2005), said that associations have representational standing to challenge a rule if: (1) at least one of their members has standing to sue in her or his own right; (2) the interests the association seeks to protect are germane to its purpose; and (3) neither the claim asserted nor the relief requested requires the participation of an individual member in the lawsuit.

The court noted that the AICPA's members will face intensified competition as a result of the AFSP. Specifically, participating unenrolled preparers will gain a credential and a listing in a government directory. The link between the government-backed credentials offered to unenrolled preparers and the reputational benefit they will enjoy, the court said, was hardly speculative. Indeed, the court noted, the reputational benefit is the very point of the AFSP. As the IRS Commissioner himself explained, the AFSP allows participants to stand out from the competition by giving them a recognizable record of completion that they can show to their clients.

The court agreed that the AFSP harms AICPA members competitively. The court found nothing at all speculative about the AICPA's contention that unenrolled preparers with government-backed credentials will be better able to compete against other credentialed preparers, and especially against uncredentialed employees of AICPA members. Nor did the court see anything speculative about the allegation that CPAs and their firms are more likely to lose business to an unenrolled preparer with a Record of Completion and a listing in the government directory than to an unenrolled preparer with no credentials at all.

The court rejected the IRS's argument that the AFSP makes clear that preparers may not use the term "certified," "enrolled," or "licensed" to describe a Record of Completion or in any way imply an employer/employee relationship with the IRS or make representations that the IRS has endorsed the tax return preparer. Without violating any of these restrictions, the court noted, participating preparers remain free to tell potential clients that they have a Record of Completion demonstrating that they satisfied the AFSP's educational requirements and passed the test.

For a discussion of the IRS's voluntary annual filing season program, see Parker Tax ¶271,160.

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IRS Reduces PTIN Application and Renewal Fees, Vendor Fees Increased

The IRS has issued temporary regulations that reduce the PTIN application and renewal fee from $50 per application or renewal to $33. Separate third-party vendor fees have increased, however, to $17 per application or renewal (up from $14.25 for original applications and $13 for renewals). T.D. 9742 (10/30/15).

Pursuant to Reg. Sec. 1.6109-2(a), all tax return preparers must have a preparer tax identification number (PTIN) and include it on any tax return or claim for refund prepared for compensation.

The application and renewal procedures to obtain a PTIN are contained in Form W-12, IRS Paid Preparer Tax Identification Number (PTIN) Application and Renewal, and the Form W-12 Instructions. The annual PTIN application and renewal period generally begins in the fall (on October 15 in previous years) of the year preceding the filing season to which the PTIN relates.

A third-party vendor, rather than the IRS, processes applications to obtain or renew a PTIN and charges a processing fee in addition to the user fee charged by the government.

Temporary regulations issued as T.D. 9742 reduce the original $50 user fee to apply for or renew a PTIN to $33 for both initial PTIN applications and renewals. The IRS notes that this reduction came about after a re-calculation of its cost of providing services under the PTIN application and renewal process.

Individuals who apply for or renew a PTIN, online or by mail, will continue to pay a fee directly to a third-party vendor to process the applications, which is separate from the IRS user fee. The vendor fee is increasing from $14.25 for original applications and $13 for renewal applications to $17 for original applications and $17 for renewal applications.

The fee changes are applicable for all PTIN applications filed on or after November 1, 2015.

For a discussion of the PTIN requirement, see Parker Tax ¶ 275,100.

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