Current Developments MSCPA Federal Tax Committee Mark H. Misselbeck, C.P.A., Presenter October 19, 2010

1.) Federal Taxes Weekly Alert, Key 2011 tax items as calculated by RIA based on inflation data

The standard deduction, exemption amount, and other tax items are adjusted annually for cost-of-living increases. The adjustments are based on the average Consumer Price Index (CPI) for the 12-month period ending the previous Aug. 31. The Aug. 2010 CPI has been released by the Labor Department. (U.S. Department of Labor, Consumer Price Index (for all-urban consumers), 9/17/2010) Us- ing the CPI for Aug. 2010, released on Sept. 17, 2010 (and the preceding 11 months), RIA has calculated 2011 indexed amounts for several tax items, as set forth below. However, RIA has calculated adjustments for fewer items than in past years because of the con- tinuing uncertainty posed by Congressional inaction on the sunset provision of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA, P.L. 107-16 ). Under the sunset, the provisions of EGTTRA, other than those made permanent or extended by subsequent legislation, don't apply to tax years beginning after 2010. Rather, under the sunset, the Internal Revenue Code of '86 will be applied and administered to tax years beginning after 2010 as if the provisions of, and amendments made by, P.L. 107-16 had never been enacted. (Sec. 901(b) of P.L. 107-16 )

RIA observation: As of now, the Code is slated to revert to its status before the enactment of PL 107-16, except for those provi- sions made permanent or extended by subsequent legislation. Thus, unless Congress acts, the tax rates for individuals and estates and trusts will revert to their EGTRRA levels. For example, the top tax rate will be 39.6%, and, for individuals, the 10% rate will disap- pear. Absent Congressional action, a number of other items will revert to pre-EGTRRA levels. Congress may act to keep some items at current levels. However, which items, if any, will be protected remains unclear. Given this uncertainty, with the exception of the standard deduction, inflation projections are not provided for items impacted by the sunset, which are separately listed below. A more detailed discussion of many items impacted by the sunset (both items that are indexed for inflation and those that are not) may be found at Weekly Alert ¶ 39 07/22/2010 and ¶ 2 .

RIA observation: IRS is required to officially release the 2011 adjustments by Dec. 15, 2010. However, this deadline may be hard for IRS to meet if Congress doesn't timely act to address the EGTRRA sunset.

Standard deductions. The basic standard deduction for 2011 will be:

Joint return or surviving spouse $11,600*(up from $11,400 for 2010) Single (other than head of household $5,800 (up from $5,700 for 2010) or surviving spouse) Head of household $8,500 (up from $8,400 for 2010) Married filing separate returns $5,800* (up from $5,700 for 2010)

*If the EGTRRA sunset kicks in, the standard deduction for married taxpayers filing jointly (and qualified surviving spouses) will be 167% of the standard deduction for single taxpayers. The standard deduction for married taxpayers filing separately would continue to be one-half of the standard deduction for joint filers.

For an individual who can be claimed as a dependent on another's return, the basic standard deduction for 2011 will be $950 (same as for 2010), or $300 (same as for 2010) plus the individual's earned income, whichever is greater. However, the standard deduction may not exceed the regular standard deduction for that individual.

For 2011, the additional standard deduction for married taxpayers 65 or over or blind will be $1,150 (up from $1,100 for 2010). For a single taxpayer or head of household who is 65 or over or blind the additional standard deduction for 2011 will be $1,450 (up from $1,400 for 2010).

Kiddie tax. The exemption from the kiddie tax for 2011 will be $1,900 (same as for 2010). A parent will be able to elect to include a child's income on the parent's return for 2011 if the child's income is more than $950 and less than $9,500 (same as for 2010).

AMT exemption for child subject to kiddie tax. The AMT exemption for 2011 for a child subject to the kiddie tax will be the lesser of (1) $6,800 (up from $6,700 for 2010) plus the child's earned income, or (2) $33,750 (same as for 2010).

1 RIA observation: In past years, Congress increased the regular (and not inflation adjusted) AMT exemption amounts when they were about to revert to lower levels.

Personal exemption amount. The personal exemption amount for 2011 will be $3,700 (up from $3,650 for 2010).

RIA observation: The minimum gross income thresholds for filing will also increase for 2011 since they are based on the basic standard deduction, the additional standard deduction, and the exemption amounts.

Interest exclusion for higher education. The interest on U.S. savings bonds redeemed to pay qualified higher education expenses may be tax-free. The exclusion is phased-out for certain higher income individuals. The phase-out level is adjusted annually for cost- of-living increases. The phase-out for 2011 will begin at modified adjusted gross income above $71,100 ($106,650 on a joint return). For 2010, the corresponding figures are $70,100 and $105,100.

Qualified transportation fringe benefits. For 2011, an employee will be able to exclude up to $230 (same as for 2010) a month for qualified parking expenses, and up to $120 a month (down from $230) of the combined value of transit passes and transportation in a commuter highway vehicle.

Education credits. For 2011, the Hope (for 2009 and 2010 called the American Opportunity Credit) and Lifetime Learning credits phase out ratably for taxpayers with modified AGI of $51,000 to $61,000 ($102,000 to $122,000 for joint filers). For 2011, the Hope credit will be 100% of up to $1,200 of qualified higher education tuition and related expenses plus 50% of the next $1,200 such ex- penses.

For 2010, the American Opportunity Credit (formerly called the Hope Credit) phased out ratably for taxpayers with modified AGI of $80,000 to $90,000 ($160,000 to $180,000 for joint filers). For 2010, the Lifetime Learning credit phased out ratably for taxpayers with modified AGI of $50,000 to $60,000 ($100,000 to $120,000 for joint filers).

For 2010, the American Opportunity Credit (formerly called the Hope Credit) was 100% of up to $2,000 of qualified higher educa- tion tuition and related expenses plus 25% of the next $2,000 of such expenses.

Adoption credit. An individual is allowed a credit against income tax (and AMT) for qualified adoption expenses. The total ex- penses that may be taken as a credit for all tax years with respect to the adoption of a child by the taxpayer will be limited to $13,360 for 2011 (up from $13,170 for 2010). For 2011, the credit for the adoption of a special-needs child will be $13,360 under Code Sec. 36C(a)(3) , regardless of the extent to which the taxpayer has qualified adoption expenses (up from $13,170 for 2010).

The credit will begin to phase out at AGI of $185,210 (up from $182,520 for 2010). The phaseout will be complete at $40,000 above the threshold.

Adoption exclusion. Similar inflation adjustments and phaseout rules apply for purposes of the exclusion for employer-provided adoption assistance. The total amount excludable per child (whether or not he has special needs) will be limited to $13,360 for 2011 (up from $13,170 for 2010). Note that the exclusion for the adoption of a child with special needs applies regardless of whether the employee has qualified adoption expenses.

MAGI limits for making deductible contributions by active plan participants to traditional IRAs. In general, an individual who isn't an active participant in certain employer-sponsored retirement plans, and whose spouse isn't an active participant, may make an annual deductible cash contribution to an IRA up to the lesser of: (1) a statutory dollar limit (for 2011, $5,000, increased to $6,000 for those age 50 or older), or (2) 100% of the compensation that's includible in his gross income for that year. If the individual (or his spouse) is an active plan participant, the deduction phases out over a specified dollar range of modified adjusted gross income (MAGI).

For taxpayers filing joint returns, the otherwise allowable deductible contribution will be phased out ratably for 2011 for MAGI be- tween $90,000 and $110,000 (up from $89,000 and $109,000 for 2010).

For 2011, for single taxpayers and heads of household, the otherwise allowable deductible contribution will be phased out ratably for MAGI between $56,000 and $66,000 (same as for 2010). For married taxpayers filing separate returns, the otherwise allowable de- ductible contribution will continue to be phased out ratably for MAGI between $0 and $10,000 (same as for 2010).

2 For a married taxpayer who is not an active plan participant but whose spouse is such a participant, the otherwise allowable deducti- ble contribution will be phased out ratably for 2011 for MAGI between $169,000 and $179,000 (up from between $167,000 and $177,000 for 2010).

MAGI limits for making contributions to Roth IRAs. Individuals may make nondeductible contributions to a Roth IRA, subject to the overall limit on IRA contributions. The maximum annual contribution that can be made to a Roth IRA is phased out for taxpayers with MAGI over certain levels for the tax year. For taxpayers filing joint returns, the otherwise allowable contributions to a Roth IRA will be phased out ratably for 2011 for MAGI between $169,000 and $179,000 (up from between $167,000 and $177,000 for 2010). For single taxpayers and heads of household it will be phased out ratably for MAGI between $107,000 and $122,000 (up from $105,000 and $120,000 for 2010). For married taxpayers filing separate returns, the otherwise allowable contribution will continue to be phased out ratably for MAGI between $0 and $10,000 (same as for 2010).

Saver's credit. For tax years beginning in 2011, an eligible lower-income taxpayer can claim a nonrefundable tax credit for the ap- plicable percentage (50%, 20%, or 10%, depending on filing status and AGI) of up to $2,000 of his qualified retirement savings con- tributions, as follows:

... Joint filers: $0 to $34,000, 50%; $34,000 to $36,500, 20%; and $36,500 to $56,500, 10% (no credit if AGI is above $56,500). ... Heads of households: $0 to $25,500, 50%; $25,500 to $27,375, 20%; and $27,375 to $42,375, 10% (no credit if AGI is above $42,375). ... All other filers: $0 to $17,000, 50%; $17,000 to $18,250, 20%; and $18,250 to $28,250, 10% (no credit if AGI is above $28,250).

By way of comparison, for tax years beginning in 2010, an eligible lower-income taxpayer can claim a nonrefundable tax credit for the applicable percentage (50%, 20%, or 10%, depending on filing status and AGI) of up to $2,000 of his qualified retirement savings contributions, as follows:

... Joint filers: $0 to $33,500, 50%; $33,500 to $36,000, 20%; and $36,000 to $55,500, 10% (no credit if AGI is above $55,500). ... Heads of households: $0 to $25,125, 50%; $25,125 to $27,000, 20%; and $27,000 to $41,625, 10% (no credit if AGI is above $41,625). ... All other filers: $0 to $16,750, 50%; $16,750 to $18,000, 20%; and $18,000 to $27,750, 10% (no credit if AGI is above $27,750).

Items impacted by EGTRRA sunset. Calculations were not done in this article for the following items, which will be impacted by the EGTRRA sunset if Congress does not act:

... Phaseout of personal exemptions. ... Tax rate schedules (but see ¶ 12 ). ... Reduction of itemized deductions. ... Earned income tax credit. ... Refundable child credit. RIA observation: The regular child credit, which has not been indexed, also will drop if the EGTTRA sunset kicks in, see Weekly Alert ¶ 39 07/22/2010 . ... Student loan interest deduction.

RIA observation: For Senate passed legislation that would increase the expensing limit and investment based phaseout dollar amount for both 2010 and 2011, see ¶ 2.

A number of tax figures are adjusted each year for inflation based on the average Consumer Price Index (CPI) for the 12-month pe- riod ending the previous Aug. 31. The Aug. 2010 CPI has been released by the Labor Department. (U.S. Department of Labor, Con- sumer Price Index (for all-urban consumers), 9/17/2010) Using the CPI for Aug. 2010 (and the preceding 11 months), RIA calculated and reported in a separate article (see ¶ 43) the increases for 2011 to the standard deduction, the personal exemption, and a number of other items. This article provides RIA-calculated adjustments for 2011 for health, charitable, compliance and special entity items. Adjustments for the first two items that follow are based on the medical care component of the CPI.

Long-term care premiums. Amounts paid for insurance that covers qualified long-term care services are treated as medical ex- penses up to specified dollar limits that vary with the age of the taxpayer as of the close of the tax year. For a taxpayer age 40 or younger, the 2011 limit will be $340 (up from $330 for 2010); more than 40 but not more than 50, $640 (up from $620 for 2010); 3 more than 50 but not more than 60, $1,270 (up from $1,230 for 2010); more than 60 but not more than 70, $3,390 (up from $3,290 for 2010); and more than 70, $4,240 (up from $4,110 for 2010).

Payments received under qualified long-term care insurance. Amounts received under a qualified long-term care insurance con- tract are generally excludable as amounts received for personal injuries and sickness, subject to a per diem limitation, which will be $300 in 2011 (up from $290 for 2010).

Archer MSAs. For Archer medical savings account (MSA) purposes, in 2011, a “high deductible health plan” will be a health plan—

• with an annual deductible of at least $2,050 and not more than $3,050 (up from $2,000 and $3,000 for 2010), in the case of self-only coverage, and • with an annual deductible of at least $4,100 and not more than $6,150 (up from $4,050 and $6,050 for 2010), in the case of family coverage, and • under which the annual out-of-pocket expenses required to be paid (other than for premiums) for covered benefits doesn't exceed— ... $4,100 (up from $4,050 for 2010) for self-only coverage, and ... $7,500 (up from $7,400 for 2010) for family coverage.

Insubstantial benefit charitable contribution limitation. Certain de minimis benefits provided by a charity to a donor don't affect the donor's charitable contribution deductions. Under these rules, charitable contributions will be fully deductible in 2011 if (1) the donor makes a minimum payment of $48.50 ($48 for 2010) and receives certain benefits with a cost of not more than $9.70 ($9.60 for 2010) or (2) the charity mails or otherwise distributes free unordered “low-cost articles” with a cost of not more than $9.70 ($9.60 for 2010). In addition, charitable contributions will be fully deductible if the benefit received by the donor isn't more than the lesser of $97 (up from $96 for 2010) or 2% of the amount of the contribution.

Dues paid to agricultural or horticultural organizations. Annual dues not exceeding $148 for 2011 (up from $146 for 2010) for membership in an agricultural or horticultural organization won't be unrelated business income despite any benefits or privileges to which members of the organization will be entitled.

Reporting exemption for exempt organizations with lobbying expenditures. For 2011, social welfare, agricultural and horticul- tural organizations are exempt from the requirement that they report to their members the portion of their dues allocable to lobbying if 90% or more of their annual dues are received from persons, families, or entities who pay dues of $103 or less (up from $101 for 2010).

Maximum hourly fee for attorneys under Code Sec. 7430(c)(1) . The maximum hourly amount allowed for attorney's fees to a prevailing party under Code Sec. 7430(c)(1) will be $180 an hour for fees incurred in 2011 (same as for 2010).

Mechanics' lien priority over tax liens. The holder of a lien for $6,990 or less for the repair or improvement of a personal residence will have priority over notices of tax liens filed in 2011. This is up from $6,890 for 2010.

Sales price priority over tax liens. A nondealer purchaser of household goods, personal effects, etc. will be protected against a tax lien filed in 2011 if the sales price is not over $1,400 (up from $1,380 for 2010).

Property exempt from levy. The value of property exempt from levy under Code Sec. 6334(a)(2) (fuel, provisions, furniture, and other household personal effects, as well as arms for personal use, livestock, and poultry) may not exceed $8,370 for levies in 2011 (up from $8,250 for 2010). The value of property exempt from levy under Code Sec. 6334(a)(3) (books and tools necessary for the trade, business, or profession of the taxpayer) may not exceed $4,180 for levies issued in 2011 (up from $4.120 for 2010).

Using the CPI for Aug. 2010 (and the preceding 11 months), RIA calculated and reported in a separate article (see ¶ 43) the increases for 2011 to the standard deduction, the personal exemption, and a number of other items. This article provides RIA-calculated ad- justments for 2011 for transfer tax and foreign items.

Gift tax annual exclusion. For gifts made in 2011, the gift tax annual exclusion will be $13,000 (same as for gifts made in 2010).

Special use valuation reduction limit. For estates of decedents dying in 2011, the limit on the decrease in value that can result from the use of special valuation will be $1,020,000 (up from $1,000,000 for 2009, when the estate tax was last imposed).

4 Determining 2% portion for interest on deferred estate tax. In determining the part of the estate tax that is deferred on a farm or closely-held business that is subject to interest at a rate of 2% a year, for decedents dying in 2011 the tentative tax will be computed on $1,360,000 (up from $1,330,000 for 2009) plus the applicable exclusion amount.

RIA observation: The two preceding items are included on the assumption that the estate tax returns in 2011.

Increased annual exclusion for gifts to noncitizen spouses. For gifts made in 2011, the annual exclusion for gifts to noncitizen spouses will be $136,000 (up from $134,000 for 2010).

Reporting foreign gifts. If the value of the aggregate “foreign gifts” received by a U.S. person (other than an exempt Code Sec. 501(c) organization) exceeds a threshold amount, the U.S. person must report each “foreign gift” to IRS. (Code Sec. 6039F(a)) Dif- ferent reporting thresholds apply for gifts received from (a) nonresident alien individuals or foreign estates, and (b) foreign partner- ships or foreign corporations. For gifts from a nonresident alien individual or foreign estate, reporting is required only if the aggre- gate amount of gifts from that person exceeds $100,000 during the tax year. For gifts from foreign corporations and foreign partner- ships, the reporting threshold amount will be $14,375 in 2011 (up from $14,165 for 2010).

Expatriation. Under a mark-to-market deemed sale rule, all property of a covered expatriate is treated as sold on the day before the expatriation date for its fair market value. However, for 2011, the amount that would otherwise be includible in the gross income of any individual under these mark-to-market rules is reduced by $636,000 (up from $627,000 for 2010).

Foreign earned income exclusion. The foreign earned income exclusion amount increases to $92,900 in 2011 (up from $91,500 in 2010).

It is projected that if the current rates are extended for all taxpayers, the rate brackets and "break points" in each category of filer will remain the same for 2011.

Document Header Checkpoint Contents Federal Library Federal Editorial Materials Federal Taxes Weekly Alert Newsletter Pre- view Documents for the week of 09/23/2010 - Volume 56, No. 38 Articles Key 2011 tax items as calculated by RIA based on infla- tion data (09/23/2010) © 2010 Thomson Reuters/RIA. All rights reserved.

2.) Federal Tax Day - Current,I.4IRS Notice Allows Various Methods for Measuring Ownership Changes Under Code Sec. 382, IRS Official Says, (Sep. 22, 2010)

Notice 2010-50, I.R.B. 2010-27, 12 (TAXDAY, 2010/06/14, I.4), confirms that a variety of methods for measuring ownership changes under Code Sec. 382 are acceptable, an IRS official stated on September 21 at a program sponsored by the D.C. Bar. The guidance reduces the impact of fluctuating stock values and the uncertainties created for determining ownership changes.

The IRS will accept any reasonable attempt to measure increases in ownership, provided the method is used consistently, Mark Jennings of the IRS Office of Associate Chief Counsel (Corporate) told practitioners. Each year that there is an ownership shift, tax- payers must use the same method to measure the change in values, Jennings said. Once there has been an ownership change, the tax- payer can "start over" and can use a different method of determining ownership changes, according to Jennings.

The IRS has requested comments before it issues regulations on the approaches taken by taxpayers to compare stock values, Jennings noted. He said that the IRS is examining whether there should be just one method or multiple methods in the regulations. If the regu- lations were to permit more than one method, another issue is whether the taxpayer could shift methods from year to year. The IRS is also concerned that any guidance be administrable. If the regulations allow multiple methods, it can be burdensome on both taxpayers and the IRS to "run the numbers" for so many methods.

Jennings explained that Notice 2010-50 allows a taxpayer to choose a method that produces an ownership change. He also said that fluctuations in value do not themselves produce a testing date. The methods reducing the impact of fluctuations are based on the stock’s historical value when purchased, but a new purchase must be counted at current value and cannot be altered to reflect the stock’s historic value, Jennings said.

Code Sec. 382 limits the amount of net operating losses (NOLs) that a corporation can claim if the corporation has undergone an ownership change. This results from a transfer of stock that causes one or more 5-percent shareholders to increase their ownership in the loss corporation by more than 50 percentage points over a three-year testing period. The tax code says that fluctuations in stock value should not cause an ownership change.

5 Mark Hoffenberg of KPMG LLP, Washington, D.C., who moderated the program, said that the existing regulations seem to count fluctuations in value, by tracking fair market value and triggering ownership changes. The full value method described in Notice 2010-50 is based on fair market value.

The IRS has issues private letter rulings that allow taxpayers to eliminate fluctuations, Hoffenberg said. Notice 2010-50 allows tax- payers to use variations of the hold constant principle to eliminate the impact of fluctuations. This method establishes the value of shares on the date the share is acquired, relative to other classes of stock, and factors out fluctuations in the value of stock held by passive shareholders.

Michael Wilder of McDermott, Will & Emery LLP, Washington, D.C., also participated in the program, discussing the treatment of certain debt cancellations when a parent corporation holds a note from its wholly owned subsidiary. The treatment depends on the application of various provisions under Code Sec. 108(e), whether the subsidiary is solvent or insolvent, whether stock is issued as part of the transaction, and whether the note is cancelled or retained.

By Brant Goldwyn, CCH News Staff

Notice 2010-50,Internal Revenue Service, (Jun. 11, 2010)

Notice 2010-50, I.R.B. 2010-27, June 11, 2010.

[Code Sec. 382]

Loss corporations: Ownership change triggering limitation on losses: Multiple classes of stock: Fluctuations in relative value: Guidance. –

The IRS has provided guidance concerning how to measure an owner shift in a loss corporation, for purposes of applying the Code Sec. 382 limitation on the use of net operating losses (NOLs), when the loss corporation has more than one class of stock outstanding whose values fluctuate relative to each other. The guidance addresses two methodologies for measuring value. These include the "full value methodology", in which value of all shares is measured by "marking" the shares to value on every testing date, but daily fluctuations in value between testing dates are ignored, and the "hold constant principle" (HCP) that looks to the relative value of a tested share on its acquisition date and only marks acquired shares to value. Until addi- tional guidance is issued, the IRS will not challenge any reasonable application of either the full value methodology or the HCP provided that a single methodology is applied consistently to the extent specified. Back references: ¶17,115.40 and ¶17,115.45.

I. Background

A. Overview of § 382(l)(3)(C)

Many of the critical determinations under § 382 depend upon the value of the stock owned by a particular shareholder. For example, whether an ownership change under § 382(g) occurs depends upon whether one or more 5-percent shareholders have increased their ownership in the loss corporation by more than 50 percentage points. Such ownership determinations are by reference to value; i.e., the relative fair market value of the stock owned to the total fair market value of the corporation's outstanding stock. See § 1.382- 2(a)(3)(i) of the Income Tax Regulations.

Section 382(l)(3)(C) provides that, except as provided in regulations, any change in proportionate ownership of the stock of a loss corporation attributable solely to fluctuations in the relative fair market values of different classes of stock shall not be taken into ac- count. The regulations under § 382 do not provide any specific guidance on § 382(l)(3)(C). Instead, § 1.382-2T(l) sets forth a heading and a reservation: “ Changes in Percentage Ownership which are attributable to fluctuations in value.—[Reserved.]”

The Treasury Department (Treasury) and the IRS are aware that taxpayers employ a number of different methodologies in interpret- ing and applying § 382(l)(3)(C). For example, some taxpayers have interpreted more general provisions of the regulations to require the valuation of all outstanding shares of stock of a corporation on every testing date. See §§ 1.382-2(a)(3)(i) and 1.382-2T(c)(1). Under this interpretation, the effect of § 382(l)(3)(C) is limited to ensuring that a testing date does not occur solely by virtue of a fluc- tuation in the relative values of different share classes. For purposes of this notice, such a valuation of all shares on every testing date is referred to as a “Full Value Methodology.” Other taxpayers have interpreted § 382(l)(3)(C) more broadly, factoring out fluctua- tions in value on a testing date based upon relative value ratios among different classes of stock established at the time a particular share of stock was acquired. There are variations in the methods that apply this view, described in more detail below, but the essential principle upon which the broader interpretation is based is that, as to a particular share, value ratios between and among various 6 classes of stock are fixed, or “held constant,” on the date a particular share is acquired (hereafter, the “Hold Constant Principle,” or “HCP”). The remainder of this section describes the government's understanding of the Full Value Methodology, the Hold Constant Principle, and two methodologies that implement the HCP.

B. Full Value Methodology

Under a Full Value Methodology, the determination of the percentage of stock owned by any person is made on the basis of the rela- tive fair market value of the stock owned by such person to the total fair market value of the outstanding stock of the corporation. Thus, changes in percentage ownership as a result of fluctuations in value are taken into account if a testing date occurs, regardless of whether a particular shareholder actively participates or is otherwise party to the transaction that causes the testing date to occur; es- sentially, all shares are “marked to market” on each testing date.

Example 1. Upon formation, corporation X issues $20 of convertible preferred stock to A and issues two shares of common stock to B for $80, such that A and B own 20 percent and 80 percent, respectively, of X. The fortunes of X deteriorate, and, two years later, when the common stock has a value of $2.50 per share and the preferred stock has a value of $20, B sells one share of common stock to C. At the time of B's sale to C, X is a loss corporation. On that testing date, A will be treated as increasing its proportionate interest from 20 percent to 80 percent ($20/$25) under the Full Value Methodology as a result of the upward fluctuation in value of the pre- ferred stock relative to the common stock.

As Example 1 illustrates, an ownership change under § 382 would occur as a consequence of the sale of stock worth 10% of the loss corporation's value because a stake originally representing 20% of the corporation's value has fluctuated upward to 80% on the test- ing date, for a cumulative shift of 70 percentage points. The Full Value Methodology is a narrow interpretation of § 382(l)(3)(C), but it may be viewed as giving effect to the statutory language by not requiring value marks more frequently than each testing date (e.g., daily fluctuations in value between various classes are ignored, where such fluctuations occur between testing dates).

C. Hold Constant Principle

Broadly stated, under the Hold Constant Principle, the value of a share, relative to the value of all other stock of the corporation, is established on the date that share is acquired by a particular shareholder. On subsequent testing dates, the percentage interest repre- sented by that share (the “tested share”) is then determined by factoring out fluctuations in the relative values of the loss corporation's share classes that have occurred since the acquisition date of the tested share. Thus, as applied, the HCP is individualized for each ac- quisition of stock by each shareholder. Moreover, the ownership interest represented by a tested share is adjusted for the dilutive ef- fects of subsequent issuances and the accretive effects of subsequent redemptions following the tested share's acquisition date.

Example 2. Upon formation, corporation X issues $20 of convertible preferred stock to A and issues two shares of common stock to B for $80, such that A and B own 20 percent and 80 percent, respectively, of X. The fortunes of X deteriorate, and, two years later, when the common stock has a value of $2.50 per share and the preferred stock has a value of $20, B sells one share of common stock to C. At the time of B's sale to C, X is a loss corporation. On that testing date, although A actually owns 80% of the value of X, A will be treated as owning 20% of the value of X for purposes of § 382(g), under the Hold Constant Principle.

As Example 2 illustrates, A would still be treated as owning 20 percent of X on the testing date because the HCP hypothesizes that (for purposes of determining A's percentage ownership) the common stock and the preferred stock maintain the relative values that existed on the acquisition date of the tested share (here, each share held by A). The only share that is “marked” to value is the one share acquired by C, representing only 10% of the corporation's equity value on the date of acquisition. Thus, no ownership change under § 382 would occur as a consequence of the acquisition of that share by C. The Hold Constant Principle may thus be viewed as giving effect to the statutory language of § 382(l)(3)(C) by factoring out fluctuations in the value of stock held by passive sharehold- ers across multiple testing dates. The “factoring out” process generally continues for a particular share until the holder is no longer treated as owning the tested share for § 382 purposes (e.g., the holder engages in affirmative activity such as a taxable sale). What follows is a description of two methodologies that implement the HCP.

1. Alternative Methodology 1: Look Back from Testing Date

One methodology for implementing the Hold Constant Principle is to recalculate the hold constant percentage represented by a tested share to factor out changes in its relative value since the share's acquisition date (hereafter, “Alternative 1”). This methodology was described by a commentator in 2005. See generally Mark R. Hoffenberg, Owner Shifts and Fluctuations in Value: A Theory of Rela- tivity, 106 Tax Notes 1446 (March 21, 2005). Generally, this methodology calculates the percentage interest represented by a tested share on a testing date, beginning with the value of the tested share on the testing date, and then making adjustments based on the changes in relative value of the tested share to the value of all the stock of the loss corporation that have occurred since the tested share's acquisition date.

7 2. Alternative Methodology 2: Ongoing Adjustments from Acquisition Date

The second methodology for implementing the HCP tracks the percentage interest represented by a tested share from the date of ac- quisition forward, adjusting for subsequent dispositions and for the subsequent issuance or redemption of other stock (hereafter, “Al- ternative 2”). Generally, the increase in percentage ownership represented by the acquisition of a tested share during the testing pe- riod is established on the date the tested share is acquired. This increase is reduced (but not below zero) for subsequent dispositions of shares by the owner. To the extent the particular shareholder is not engaging in acquisitions or dispositions, the percentage owner- ship calculation “rolls over” from one testing date to another. Whereas under Alternative 1, the loss corporation generally determines the relative value of shares of its stock at the beginning of the testing period, or an earlier date, this may not be necessary under Al- ternative 2. Thus, Alternative 2 may involve fewer calculations on a particular testing date than Alternative 1.

3. Common Elements of Both HCP Methodologies a. Acquisitions

Under either Alternative 1 or Alternative 2, the loss corporation determines, on each testing date during a testing period, the value of a tested share acquired on that testing date as compared to the value of all the stock of the loss corporation on that date (i.e., neither alternative factors out value fluctuations for actual acquisitions). b. Dispositions and sourcing

Under either of the HCP alternative methodologies, a shareholder's increase in proportionate interest during a testing period will be reduced by share dispositions. The government is aware of at least two methods to account for dispositions in such cases. One method may account for the effect of a share disposition based upon the percentage ownership that the sold share represents on the date of its disposition (as opposed to the percentage represented by that share on its acquisition date) (a “fair market value ap- proach”). Another method may account for the effect of a share disposition based upon the percentage ownership that the sold share represented on another testing date during the testing period upon which the selling shareholder acquired shares. As one example, if the shares disposed of are being offset against shares of another class acquired during the testing period, the percentage offset could be determined as of the date the other class was acquired (a “share equivalent approach”). The results obtained would be as if sold shares were converted into a share-equivalent number of shares of the acquired class.

Example 3. A purchases 10 shares of X's common stock for $10 on testing date 1, when each share of common stock represents one percent of X. X is a loss corporation. On testing date 1, A also holds 2 shares of participating preferred stock, with each share valued at $2 and each preferred share representing 2 percent of X. On testing date 2, A disposes of one share of the preferred stock. Under a share-equivalent approach, A may be considered to have disposed of two shares of common stock, which is the common share equivalent of one share of preferred stock as determined on the acquisition date of the common stock.

If a taxpayer determines the effect of a share disposition based upon the percentage represented by the sold share on the share's ac- quisition date, under either of the two methodologies, the taxpayer must also determine the source of shares disposed of where a 5- percent shareholder has had multiple acquisitions and dispositions of loss corporation stock. For example, tested shares of a single class likely will represent different percentages of a loss corporation depending upon when the tested shares were acquired. In these cases, taxpayers may treat sold shares as being sourced pro rata from all acquisitions, as being sourced first from the most recent ac- quisition (“LIFO”), or as being sourced first from the first acquisition (“FIFO”). c. Redemptions and issuances

Section 382 takes into account not only trading in loss corporation shares, but also the redemptions and issuances of shares, for pur- poses of tracking changes in percentage ownership by 5-percent shareholders. For this purpose, a redemption may be analogized to a pro-rata acquisition by non-redeeming shareholders of the redeemed shares, while an issuance may be analogized to a pro-rata sale of shares by shareholders holding stock immediately before the issuance to those shareholders acquiring shares in the issuance. There are a variety of possible approaches in applying the HCP to stock redemptions and issuances.

In a redemption, § 382 views the remaining shareholders as having acquired a greater interest in the corporation with respect to their shares held immediately after the redemption. Applying the HCP, the size of this acquisition for each shareholder could be deter- mined either by reference to current values at the time of the redemption or relative values in effect when the non-redeemed share- holders established their positions.

8 In an issuance, § 382 views the interest in the corporation held by pre-existing shareholders with respect to their preexisting shares as being reduced. In applying the HCP, the effect of the issuance on preexisting shares, could also be determined by reference to current or relative historical values.

Whether current or historical values are used in determining the effect of subsequent redemptions or issuances can make a substantial difference in the amount of the owner shifts determined for 5-percent shareholders. Moreover, even if historical values are used, the use of one HCP alternative versus another can produce differing results. See generally NYSBA Tax Section, Report on the Treatment of Fluctuations in Value under Section 382(l)(3)(C), Dec. 22, 2009, reprinted in 2009 TNT 245-16 (Example 5 in the report).

Finally, §§ 1.382-3(j)(3) and (5) contain a special rule for determining the effects of certain cash issuances. Sections 1.382-3(j)(2) and (5) contain a special rule for determining the effect of certain small issuances. The issues discussed in this notice are relevant in determining the amount of exempted stock under the cash issuance rule, and the allocation of exempted stock among direct public groups under both rules. d. Non-disposition transactions

For purposes of applying a method based on the HCP, an owner of loss corporation stock is not treated as disposing of or acquiring loss corporation stock to the extent the owner remains treated as an owner of the loss corporation, or its successor, under § 382 and the regulations thereunder. See generally § 1.382-2T(h)(2) (relating to constructive stock ownership); § 1.382-2T(f)(18)(iv) (stock of the loss corporation, as the context may require, includes any indirect interest in the loss corporation); § 1.382-2T(j)(2)(iii)(B)( 1)( i) (relating to equity structure shifts). In these cases, the original acquisition date and other hold constant characteristics are preserved. Thus, for example, if a shareholder exchanges loss corporation stock for other loss corporation stock in a value-for-value recapitaliza- tion, the stock received in the exchange would retain the same hold-constant characteristics as the surrendered shares. This principle also applies to reorganizations described in § 1.382-2T(j)(2)(iii)(B)( 1)( i) and holding company formations.

II. Guidance

Because of the complexity of the issues involved in measuring owner shifts of loss corporation stock where fluctuations in value are present, the IRS and Treasury have determined that it is appropriate to accept taxpayers' reasonable attempts to measure increases in ownership where fluctuations in value are present. Accordingly, the IRS will not challenge any reasonable application of either a Full Value Methodology or the HCP, provided that a single methodology (as described below) is applied consistently to the extent re- quired in this Notice. The IRS and Treasury believe that each of the HCP alternative methodologies discussed in section I above— including the common elements of both for dealing with various transactions such as issuances and redemptions—are reasonable ap- plications of the HCP.

Taxpayers may rely on the guidance provided in this notice until such time as the IRS and Treasury issue additional guidance under § 382(l)(3)(C).

A. Acquisitions

All reasonable applications of either the Full Value Methodology or the HCP must determine the increase in ownership represented by the acquisition of a share of stock by dividing the fair market value of that share on the acquisition date by the fair market value of all of the outstanding stock of the loss corporation on that date. For this purpose, an acquisition does not include a deemed acquisition of stock by non-redeeming shareholders resulting from a redemption. In addition, under a HCP methodology, an acquisition is not an event upon which the acquiring shareholder marks to fair market value other shares that it holds.

However, the IRS and Treasury view any alternative treatment of an acquisition as inconsistent with § 382(l)(3)(C). For example, the IRS intends to challenge a methodology that fixes the relative fair market value of a class of preferred stock to common stock on the issue date of the preferred stock, regardless of the actual value of either class on the subsequent date that a shareholder whose per- centage ownership is being computed acquires a share of either such class of stock.

B. Consistency

In general, a taxpayer may employ any methodology that is a reasonable application of either a Full Value Methodology or the HCP in determining when an ownership change has occurred. For prior years, a taxpayer may change its methodology by amending re- turns. However, a taxpayer must generally employ a single methodology consistently to all testing dates in a “consistency period.” With respect to a particular testing date (the “current testing date”), the consistency period includes all prior testing dates, beginning with the latest of—

9 (1) the first date on which the taxpayer had more than one class of stock;

(2) the first day following an ownership change; or

(3) the date six years before the current testing date.

In some cases, a methodology implementing the HCP may treat as the acquisition date for a tested share a date that is later than the date the share was actually acquired. The issuance of a second class of stock generally establishes the acquisition date for the preex- isting class as well as the second class. Moreover, taxpayers may substitute certain other dates, if later, for the date shares were ac- quired, such as, if used consistently: May 6, 1986; January 1, 1987; or the beginning of the testing period.

C. Closed Years

Notwithstanding the foregoing, a taxpayer may not employ a methodology in a year not barred by the statute of limitations (an “open year”) if using that methodology would have changed the taxpayer's Federal income tax liability for a year barred by the statute of limitations (a “closed year”) in the consistency period, unless the position taken in the closed year is not consistent with any reason- able methodology. A taxpayer taking a position in a closed year that is not consistent with any reasonable methodology may adopt any single methodology that is a reasonable application of either the Full Value Methodology or the HCP, regardless of whether use of that methodology would have changed its liability in a closed year, provided that the adopted methodology is applied consistently to the greatest extent permitted by the statute of limitations.

The effect of the consistency period rule is that a taxpayer generally is free to adopt any reasonable methodology as long any incon- sistent returns in the consistency period can be and are amended. In addition, there is no necessary correlation between the start of a consistency period, which governs the taxpayer's choice of methodology, and the acquisition date for shares of stock, which is an element of HCP methodologies.

D. Single Methodology

For purposes of this Notice, a “single methodology” means a methodology that applies a consistent treatment to a given situation, even on different testing dates (e.g., applying a LIFO convention for all share disposition sourcing determinations if using an HCP al- ternative). A single HCP methodology might treat the accretive effect of redemptions differently from other acquisitions but should not treat the dilutive effect of issuances differently from other dispositions. To determine the amount of exempted stock pursuant to the cash issuance exception of § 1.382-3(j)(3), a taxpayer using an HCP methodology may either use the hold constant percentages determined for its direct public groups under its methodology or the percentages determined based upon current values. Allocations of exempted stock under § 1.382-3(j)(5) (relating to the small issuance and cash issuance exceptions) should be determined under that same methodology.

III. Request for Comments

The IRS and Treasury plan to issue proposed or temporary regulations on the application of § 382(l)(3)(C) in fluctuation in value situations, and request comments on that subject, including the issues addressed in this notice.

A. Threshold Question

The threshold question is whether interpreting § 382(l)(3)(C) broadly to require rules for factoring out fluctuations in value, such as may be done through methodologies employing the HCP, is appropriate in light of the purposes of § 382 and administratively viable.

The primary purpose of § 382's loss limitation rules is to preserve the integrity of the carryover provisions. The carryover provisions perform a needed averaging function by reducing distortions caused by the annual accounting system. If carryovers can be transferred in a way that permits a loss to offset unrelated income, no legitimate averaging function is performed. The loss limitation rules of § 382 generally apply when shareholders who bore the economic burden of a corporation's pre-change loss no longer hold a controlling interest in the corporation. In such a case, the possibility arises that new shareholders will contribute income producing assets (or di- vert income producing opportunities) to the loss corporation, resulting in a greater utilization of the loss corporation's pre-change losses than would have been the case had there been no ownership change. See Staff of the Joint Comm. on Taxation, 100th Cong., 1st Sess., General Explanation of the Tax Reform Act of 1986 288 (Comm. Print 1987).

The application of the HCP could result in the avoidance of an ownership change, even though the shareholders who did not bear the economic burden of the loss corporation's pre-change loss have assumed a controlling interest in the loss corporation. Consider, for example, a case in which the value of a loss corporation's common stock declines steeply in relation to the relative value of its voting 10 preferred stock, permitting preferred shareholders who bought in with a 10 percent interest (by value) to obtain a 90 percent interest (by value), while being “held constant” at 10 percent. In such a case, arguably, there is the heightened possibility that a pre-change loss could be offset against unrelated income. For example, the preferred shareholders could enhance their controlling position by causing a recapitalization in which they obtain the majority of the common stock and, thereby, a significantly greater potential to par- ticipate in the growth of the company. Thereafter, they could contribute income producing assets (or built-in gain assets) to the loss corporation in order to offset resulting income (or gain recognized) against the corporation's loss attributes (provided the value of the stock issued in exchange for the contributed assets was insufficient to cause an ownership change). A similar opportunity to avoid the application of § 382 could present itself to shareholders who bought the common stock when it represented 10 percent of the value of the loss corporation, followed by a large upward fluctuation in its relative value.

On the other hand, arguably Congress enacted § 382(l)(3)(C) because it did not view owner shifts and possibly ownership changes at- tributable to valuation changes with as much policy concern as it viewed acquisitions. By limiting the operation of the statute to test- ing dates, Congress may have expressed a greater tolerance for shifts in corporate ownership that would have occurred even in the absence of events giving rise to a testing date. In a period of broad-based economic growth, where all other factors are equal, it can be expected that common stock will increase in value relative to preferred stock, which effect alone could result in owner shifts and possibly ownership changes. The converse result can be expected in a period of broad-based economic contraction. Arguably, in most of such cases, the shareholders considered to have acquired a greater percentage of the loss corporation's stock do not thereby have a greater incentive to contribute income producing assets to the loss corporation. The IRS and Treasury appreciate any comments on this threshold question.

B. Possible Application of the HCP

Part II of this notice permits broad application of the HCP until such time as future guidance is provided. If application of the HCP is to be required or permitted in future guidance, comments are requested as to whether to continue to permit the use of a range of methodologies to implement the HCP (and, if so, how broad a range) or to require that a particular HCP methodology (or methodolo- gies) be used. The IRS and Treasury would appreciate any comments regarding which methodology or methodologies best imple- ment the HCP from the standpoint of theory, practicality, and administrability.

Under an alternative approach, the HCP could be applied only in limited circumstances, such as to protect a loss corporation's ability, in the event of bankruptcy, to make use of the special provisions of §§ 382(l)(5) and (6). The IRS and Treasury request comments on whether it would be appropriate to limit the HCP to special circumstances and how the HCP might be applied in those situations.

Comments are also requested as to the appropriate methodologies for dealing with—(i) the deemed acquisition by non-redeeming shareholders occurring as a result of a redemption, (ii) the deemed disposition by preexisting shareholders occurring as a result of the issuance of other shares, (iii) the amount of stock exempt under the cash issuance exception of § 1.382-3(j)(3), and (iv) the allocation of exempt stock to direct public groups under the cash and small issuance exceptions of § 1.382-3(j)(5). Comments are requested as to the extent to which appropriate methodologies applied to the above enumerated items ought to be applied consistently to said items.

C. Instructions

Comments should include a reference to Notice 2010-50 Send submissions to Internal Revenue Service, Attn: CC:PA:LPD:PR Room 5203 ( Notice 2010-50), P.O. Box 7604, Ben Franklin Station, Washington, D.C. 20044 or hand-deliver comments Monday through Friday between the hours of 8:00 a.m. and 4:00 p.m. to Courier's Desk, Attn: CC:PA:LPD:PR Room 5203 ( Notice 2010-50), Internal Revenue Service, 1111 Constitution Avenue, NW, Washington, DC 20224. Alternatively, comments may be sent electronically via the following email address: [email protected]. Please include the notice number 2010-50 in the subject line of any electronic communication. All materials submitted will be available for public inspection and copying.

©2010 Wolters Kluwer. All rights reserved.

3.) WORKERS WERE EMPLOYEES, NOT INDEPENDENT CONTRACTORS - Bruecher Foundation Services, Inc., 105, AFTR2d 2020 (CA-5, 2010)

The Fifth Circuit in Bruecher Foundation Services, Inc., 105, AFTR2d 2020 (CA-5, 2010), held that workers used by the taxpayer in its business were the taxpayer's employees for employment tax purposes, and not independent contractors..

The taxpayer was a corporation wholly owned by its president. Its business consisted primarily of residential foundation repair and grading projects. In its tax filings, the taxpayers recognized two employees, its president and a secretary, and treated workers who performed manual labor involved in the foundation repair as independent contractors.

11 In 2002, the IRS audited the taxpayer and determined that the workers in question were actually employees and were improperly classified as independent contractors. It did not notify the taxpayer that it was conducting the audit and did not provide the taxpayer with notice of the worker classification safe harbor under section 530 of the Revenue Act of 1978 as required by law. The audit summary did apprise the taxpayer of the Service's conclusion that the taxpayer was not entitled to the safe harbor because it failed to file Form 1099s for the workers at issue.

The IRS determined that the taxpayer had an obligation to have paid taxes on the workers' wages under the Federal Unemployment Tax Act (FUTA) and the Federal Insurance Contributions Act (FICA), and to have withheld and remitted specified amounts of the workers' anticipated federal income taxes. The Service calculated that the taxpayer owed $7,524 in FUTA taxes and $38,403 in FICA taxes and employee withholding for the 1999 and 2000 tax years. In 2005, it assessed the employment taxes, penalties, and interest against the taxpayer who argued that the workers were not employees. The IRS rejected the taxpayer's claim, issued a tax lien against the taxpayer, and executed a levy against the taxpayer's bank account. The taxpayer filed Form 1099s for each of the workers and then filed suit in district court, which concluded that the workers were the taxpayer's employees. The court denied the taxpayer's mo- tion for summary judgment on the ground that it had complied with the section 530 safe harbor.

The taxpayer challenged the district court's decision on three grounds:

(1) The court erred in concluding that it was not entitled to rely on the section 530 safe harbor.

(2) The government should have been assigned the burden of proof because the IRS had failed to comply with the advance notice procedures of section 530

(3) The court's conclusion that the workers were employees was incorrect.

The section 530 safe harbor provides employers with protection from employment tax assessments resulting from good-faith misclas- sification of employees as independent contractors, provided that employers meet certain requirements, including filing all required tax and information returns with the IRS. The government argued that the taxpayer could not avail itself of the safe harbor because it did not file its Form 1099 returns for the workers in dispute until two days before filing suit in district court—after the IRS had as- sessed the tax, denied the taxpayer's administrative claims, and begun collection enforcement. The taxpayer argued that statutory lan- guage imposed no time deadline by which to file the returns.

The Fifth Circuit agreed with the government; the taxpayer could not successfully raise the safe harbor because it filed the Form 1099s after the IRS assessed the taxes at the conclusion of the administrative process. The taxpayer conceded that it was not entitled to the protection of the safe harbor until it filed the Form 1099s. Because at the time the tax was assessed it had not done so, the ap- pellate court said the assessment was correct when made, and the taxpayer could not complain in federal court of an “error” the IRS did not make.

The Fifth Circuit found that there was no basis for reversing the usual burden of proof as a remedy for the Service's failure to provide the section 530(e)(1) notice. The court said the resolution may have been different if the taxpayer asserted a violation of its due proc- ess right stemming from the lack of notice. That was not the case here; the taxpayer was apprised of the Service's determination that the safe harbor did not apply at the conclusion of the audit, which allowed the taxpayer ample opportunity for administrative relief on those grounds.

Finally, the Fifth Circuit examined the factors set out by the Supreme Court in Silk, 35 AFTR 1174, 331 US 704, 91 L Ed 1757, 1947-2 CB 167 (1947), to determine whether a worker is an employee or independent contractor:

(1) Degree of control. The taxpayer retained a significant level of control over its workers' schedules and ability to perform foundation repair jobs, and where it did not exercise control, it retained the right to do so (supports employment).

(2) Opportunities for profit and loss. The workers could not profit or suffer a loss from their work with the taxpayer; the taxpayer paid the workers by the hour at the end of the week, even if the job was not completed (strongly supports employ- ment).

(3) Investment in facilities. The taxpayer provided the workers all the tools and equipment necessary to perform their jobs (strongly supports employment).

(4) Permanency of relation. Although some workers' relationship with the taxpayer was not continuing, other workers did have a continuing relationship. The workers were free to terminate their relationship with the taxpayer at any time (neutral).

12 (5) Skill required. Some aspects of the taxpayer's work involved skill, but other tasks did not (including digging holes below foundations), and some workers had no relevant skills when they began work with the taxpayer (supports employment).

(6) Whether the workers were in business for themselves. When the workers worked for the taxpayer, they did not work for others (strongly supports employment).

Based on these factors, of which five out of six favored employment and the sixth was neutral) the Fifth Circuit agreed with the dis- trict court that the workers were the taxpayers' employees.

Document Header Checkpoint Contents Federal Library Federal Editorial Materials WG&L Journals Practical Tax Strate- gies/Taxation for Accountants (WG&L) Practical Tax Strategies 2010 Volume 85, Number 03, September 2010 Recent Develop- ments WORKERS WERE EMPLOYEES, NOT INDEPENDENT CONTRACTORS, Practical Tax Strategies, Sep 2010 © 2010 Thomson Reuters/RIA. All rights reserved.

4.) Some of the more prominent items from the Small Business Act are:

Extended Bonus Depreciation for 2010 and increased and Section 179 limits for 2010 and 2011 are included in the Act. The former will work for any business, while the latter will only work for profitable C corps - S corps. that are profitable with add-back of share- holder salaries, to the extent of that pre-salary profit. The Section 179 limit is increased to $ 500,000 and the phase out limit is in- creased to $ 2,000,000. Also, real property improvements that qualify for the 15 year depreciation lives will now qualify for Section 179 write-off - leasehold improvements under a lease obligation, restaurant and retail space improvements.

Business Credits may be carried back 5 years, provided there is tax that was paid to be recaptured by the client. Available to business with average gross receipts of less than $ 50 million. Credits for these taxpayers may offset AMT as well as regular tax, without the limitation on the first $ 25,000 and 25% of the excess. Larger business are limited to the 1 year carry back and the tax limitations. Partners and S corporation S/Hs must meet the gross receipts test at the individual level.

The S corporation Built In Gains tax period is shortened to 5 years, instead of the historical 10 year period, provided the fifth year occurs prior to 2011.

The Start-Up Cost immediate write-off limitation is increased to $ 10,000 and the phaseout is raised a starting level of $ 60,000.

Cell phones and other personal communications devices have been removed from the "listed property" category.

Qualified small business stock (Section 1202) acquired after date of enactment and before 1/1/2011 will qualify for 100% exclusion of gain from its sale, PROVIDED it has been held for five (5) years to date of sale - the exclusion will NOT affect AMT for such stock.

Self-employeds will be allowed to deduct health insurance against their self-employment income for purposes of SE tax computa- tions, beginning with their 2010 tax year.

Individual landlords will be subject to Form 1099 reporting for expenses relating to their rental properties (over $ 600 paid for ser- vices), beginning in 2011. Exceptions are provided for de minimis rents (to be set by IRS), and for rentals by active duty service per- sons and intelligence community operatives who are renting their principal residences on a temporary basis.

The three tier penalty structure for late filing/failure to file Forms 1099 are doubled, while the maximum annual penalty limits are substantially increased:

First tier - late filing after the due date, but not more than 30 days after the due date = $ 30/form: maximum increased from $ 75,000 to $ 250,000

Second tier - late filing more than 30 days after the due date, but before August 1 = $ 60/form: maximum increased from $ 150,000 to $ 500,000

Third tier - late filing after August 1 = $ 100/form - maximum increased from $ 250,000 to $ 1,500,000

Intentional failure to file = minimum penalty of $ 250/form

13 Qualified small filers - average gross receipts of not more than $ 5,000,000 the maximums would be "capped" at $ 75,000, $ 2000,000 and $ 500,000, respectively.

Cellulosic Biofuel Producers may earn a non-refundable tax credit of $ 1.01/gallon of qualified cellulosic biofuel. Excluded are "black liquor", crude tall oil and other corrosive fuels.

5.) IRS finalizes and liberalizes Schedule UTP for reporting uncertain tax positions Ann. 2010-75, 2010-41 IRB; Ann. 2010-76, 20-1041 IRB; IR 2010-98

IRS has released a final Schedule UTP (Form 1120), Uncertain Tax Position Statement, and final instructions for it, along with an announcement detailing many liberalizations IRS has made in response to comments including a five-year phase-in of the reporting requirement based on a corporation's asset size. A separate announcement details how IRS has modified its policy of restraint to ad- dress practitioner concerns. In addition, to allay concerns over how IRS will use the reported information, IRS has issued a directive to the field. These and other items are covered in a news release consisting of prepared remarks of IRS Commissioner Doug Shulman to the American Bar Association. This article covers the liberalizations to the Schedule UTP. A separate article (see ¶ 19) covers the modifications to the policy of restraint and the field directive.

Background. In a series of announcements starting with Ann. 2010-9, 2010-7 IRB , IRS announced that it was developing a schedule requiring certain business taxpayers to report uncertain tax positions on their tax returns and requested comments by Mar. 29, 2010 (see Weekly Alert ¶ 10 01/28/2010). In April, IRS released draft schedule UTP accompanied by draft instructions, along with Ann. 2010-30, 2010-19 IRB detailing the draft schedule and requesting comments. See Weekly Alert ¶ 12 04/22/2010.

In September, IRS issued a proposed reg giving it the regulatory underpinning to require certain corporations to attach Schedule UTP to their returns. See Weekly Alert ¶ 6 09/09/2010.

Favorable changes to draft schedule and instructions. The final schedule and instructions require certain corporations with audited financial statements to file Schedule UTP, Uncertain Tax Position Statement, beginning with the 2010 tax year. IRS expects to final- ize the proposed regs later this year.

Ann. 2010-75 reveals that the final schedule and instructions make a number of significant changes to the April draft in order to ad- dress burden and other concerns expressed by commentators. Major changes include the following:

• a five-year phase-in of the reporting requirement based on a corporation's asset size;

• no reporting of a maximum tax adjustment;

• no reporting of the rationale and nature of uncertainty in the concise description of the position; and

• no reporting of administrative practice tax positions.

Five-year phase-in. In Ann. 2010-9, IRS originally proposed that the reporting requirement apply to business taxpayers with total as- sets of at least $10 million. Subsequently, in Ann. 2010-30, IRS announced that the types of corporations required to file the schedule initially would be limited to corporations that issue audited financial statements (or that have tax positions for which a related party records a reserve in an audited financial statement) and file Form 1120, U.S. Corporation Income Tax Return; Form 1120-F, U.S. In- come Tax Return of a Foreign Corporation; Form 1120-L, U.S. Life Insurance Company Income Tax Return; or Form 1120-PC, U.S. Property and Casualty Insurance Company Income Tax Return.

A number of commentators recommended that IRS either increase the $10 million total asset threshold permanently or during a tran- sition period to allow many organizations additional time to implement the reporting requirement. The final schedule and instructions generally retain the previously announced filing requirements regarding types of corporations required to complete the schedule for 2010 tax years. Accordingly, public or privately held corporations that issue or are included in audited financial statements and that file a Form 1120, Form 1120-F, Form 1120-L, or Form 1120-PC must report their uncertain tax positions on Schedule UTP if they satisfy the total asset threshold. However, IRS has implemented a five-year phase-in of the Schedule UTP for corporations with total assets under $100 million. Corporations that have total assets equal to or exceeding $100 million must file Schedule UTP starting with 2010 tax years. The total asset threshold will be reduced to $50 million starting with 2012 tax years and to $10 million starting with 2014 tax years.

No reporting of maximum tax adjustment. The draft schedule and instructions proposed that the corporation report a maximum tax adjustment for each tax position listed on the schedule, other than transfer pricing and other valuation positions. The maximum tax 14 adjustment was defined in the draft instructions as the maximum U.S. federal income tax liability for the tax position if the position were not sustained upon IRS examination. The draft instructions also provided the corporation a choice of ranking transfer pricing and other valuation positions based on the federal income tax reserve or an estimate of the adjustment to federal income tax that would result if the position were not sustained.

Many comments recommended eliminating the proposed requirement to report the maximum tax adjustment for each tax position. Many expressed concern that this amount would be unduly burdensome to compute, would provide IRS with misleading information about the riskiness of the position and its magnitude, and would not be a meaningful basis upon which to determine the issues or re- turns to examine.

In response, IRS has removed the proposed requirement to report the maximum tax adjustment. Instead, the final schedule and in- structions require a corporation to rank all of the reported tax positions (including transfer pricing and other valuation positions) based on the U.S. federal income tax reserve (including interest and penalties) recorded for the position taken in the return, and to designate those tax positions for which the reserve exceeds 10% of the aggregate amount of the reserves for all of the reported posi- tions. This method does not require disclosure of the actual amounts of the tax reserves.

Commentators also noted the difficulty of computing the maximum tax adjustment for tax positions for which no reserve was created based on an expectation to litigate the position. The instructions address this by providing that no size needs to be determined with respect to these tax positions and that they can be assigned any rank by the corporation.

No reporting of rationale and nature of the uncertainty. The proposed requirement to include the rationale and nature of the uncer- tainty in the concise description has been eliminated. The instructions now require a concise description of the tax position, including a description of the relevant facts affecting the tax treatment of the position and information that reasonably can be expected to ap- prise IRS of the identity of the tax position and the nature of the issue. The final instructions make clear that a corporation need not include an assessment of the hazards of a tax position or an analysis of the support for or against the tax position.

No reporting of administrative practice tax positions .IRS has eliminated the proposed requirement to report tax positions for which no reserve was created due to a widely-understood administrative practice. However, IRS will continue to explore ways to assess the impact of these tax positions on overall tax compliance.

Other clarifications. The final instructions reflect a number of other clarifications. For example, they clarify that:

... The schedule seeks the reporting of tax positions consistent with the reserve decisions made by the corporation for au- dited financial statement purposes. ... Corporations are not required to report tax positions that are either immaterial under applicable financial accounting stan- dards or are sufficiently certain so that no reserve is required under those standards. ... Schedule UTP requires the reporting of U.S. federal income tax positions but not foreign or state tax positions. ... A tax position is reported on Schedule UTP once (1) a reserve for a tax position is recorded and (2) a tax position is taken on a return regardless of the order in which those two events occur. ... Corporations report their own tax positions on Schedule UTP and do not report the tax positions of a related party. ... Tax positions taken in years before 2010 need not be reported in 2010 or a later year even if a reserve is recorded in au- dited financial statements issued in 2010 or later. ... Worldwide assets are used to determine whether a corporation that files a Form 1120-F (including a protective return) must file Schedule UTP.

Coordination with Forms 8275 and 8886. The final Schedule UTP instructions state that a complete and accurate disclosure of a tax position on the appropriate year's Schedule UTP will be treated as if the corporation filed a Form 8275, Disclosure Statement, or Form 8275-R, Regulation Disclosure Statement, regarding the tax position and that a separate Form 8275 or 8275-R need not be filed to avoid certain accuracy-related penalties with respect to that tax position. Consistent with Notice 2010-62, 2010-40 IRB (see Weekly Alert ¶ 19 09/16/2010), in the case of a transaction that is not a reportable transaction, IRS will treat a complete and accurate disclosure of a tax position on Schedule UTP as satisfying the disclosure requirements of Code Sec. 6662(i).

References: For reporting uncertain tax positions, see FTC 2d/FIN ¶ S-4462; TaxDesk ¶ 816,030; TG ¶ 5809.

Document Header Checkpoint Contents Federal Library Federal Editorial Materials Federal Taxes Weekly Alert Newsletter Pre- view Documents for the week of 09/30/2010 - Volume 56, No. 39 Articles IRS finalizes and liberalizes Schedule UTP for reporting uncertain tax positions (09/30/2010) © 2010 Thomson Reuters/RIA. All rights reserved.

6.) New policy of restraint on uncertain tax positions document requests and audit guidelines Ann. 2010-76, 2010-41 IRB

15 IRS is expanding its policy of restraint in connection with the requirement that certain corporations must file Schedule UTP, Uncer- tain Tax Position Statement. IRS has announced that it will forgo seeking particular documents that relate to uncertain tax positions and the workpapers that document the completion of Schedule UTP. These new policies will be incorporated into Internal Revenue Manual (IRM) 4.10.20. In addition, a new Large Business and International Division (LB&I) Directive reflects IRS intentions to go lightly on UTP audits.

For a discussion of the final Schedule UTP (Form 1120), Uncertain Tax Position Statement, and Instructions, as well as an An- nouncement detailing the many liberalizations IRS has made (including a five-year phase-in of the reporting requirement based on a corporation's asset size), see ¶ 10.

Background. Schedule UTP requires certain corporations to provide a concise description of each uncertain tax position for which the corporation or a related entity has recorded a reserve in its financial statements, or for which no reserve has been recorded because of an expectation of litigation. These uncertain tax positions are identified by corporations during the process of preparing financial statements under applicable accounting standards, such as FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109 (FIN 48). In reviewing and verifying financial statements for compliance with FIN 48, independent auditors may ask for copies of legal opinions and other documents in order to understand transactions, to understand the legal bases for the treatment of transactions, and to determine the adequacy of reserves for contingent tax liabilities.

Guidelines on document requests. Under Ann. 2010-76 's new policy of restraint, if a document is otherwise privileged under the at- torney-client privilege, the tax advice privilege in Code Sec. 7525 , or the work product doctrine and the document was provided to an independent auditor as part of an audit of the taxpayer's financial statements, IRS will not assert during an examination that the privilege has been waived by the disclosure.

However, this approach will not apply if either (1) the taxpayer has engaged in any activity or taken any action, other than those de- scribed above, that would waive the attorney-client privilege, the Code Sec. 7525 tax advice privilege, or the work product doctrine; or (2) a request for tax accrual workpapers is made under IRM 4.10.20.3 because unusual circumstances exist or the taxpayer has claimed the benefits of one or more listed transactions.

Under current procedures, IRS examiners request tax reconciliation workpapers as a matter of course. (IRM 4.10.20.3) Ann. 2010-76 provides that the taxpayer may redact the following information from any copies of tax reconciliation workpapers relating to the preparation of Schedule UTP it is asked to produce during an examination:

... working drafts, revisions, or comments concerning the concise description of tax positions reported on Schedule UTP; ... the amount of any reserve related to a tax position reported on Schedule UTP; and ... computations determining the ranking of tax positions to be reported on Schedule UTP or the designation of a tax position as a Major Tax Position.

Other than requiring the disclosure of the information on the schedule, the requirement to file Schedule UTP doesn't affect the policy of restraint.

IRS notes that Ann. 2010-76 describes IRS's policy for seeking certain documents from taxpayers and third parties during an exami- nation. It doesn't create or imply the application of the attorney-client privilege, the Code Sec. 7525 tax advice privilege, or the work product doctrine to any document of any taxpayer or third party.

New audit guidelines. Evidence of IRS's intention to tread lightly with regards to Schedule UTP, can be seen in a new LB&I Direc- tive instructing IRS examiners on audit technique. LB&I examiners are told to approach UTPs on audit keeping in mind their respon- sibility to apply the law as it currently exists, without bias in favor of the government. Examiners must conduct their examinations with the understanding that UTPs are uncertain for a number of reasons, including ambiguity in the law and a lack of published guid- ance on issues. This means, the Directive states, that items disclosed on a Schedule UTP may or may not require an examination or an audit adjustment by the examiner. While the Schedule UTP is intended to expedite the return selection and issue identification processes, it doesn't serve as a substitute for other examination tools or for the independent judgment of the examiner, and it shouldn't be used to shortcut other parts of the audit process or the careful and considered examination of issues and an objective application of the law to the facts.

The Directive advises that the Schedule UTP is intended to advance discussions with the taxpayer on important issues to earlier in the exam process. Examiners need to engage with taxpayers early to eliminate uncertainty as quickly as possible, whenever possible. Ex- aminers should continue to use the tools available to them to accomplish this. Further, LB&I examiners should discuss the issues dis- closed on the Schedule UTP in advance of issuing the initial information document requests (IDRs). In addition, guidance, such as Ann. 2010-76 , will be given to examiners on how the policy of restraint will apply to Schedule UTP reporting.

16 References: For reporting uncertain tax positions, see FTC 2d/FIN ¶ S-4462; TaxDesk ¶ 816,030; TG ¶ 5809.

Document Header Checkpoint Contents Federal Library Federal Editorial Materials Federal Taxes Weekly Alert Newsletter Pre- view Documents for the week of 09/30/2010 - Volume 56, No. 39 Articles New policy of restraint on uncertain tax positions docu- ment requests and audit guidelines (09/30/2010) © 2010 Thomson Reuters/RIA. All rights reserved.

7.) Federal Tax Day - Current,J.3Minister’s Unsubstantiated Vehicle and Travel Expenses Disallowed; Penalties Imposed (Ro- zar, TCS), (Sep. 28, 2010) Code Secs. 162, 274 and 6662

Business expense deductions claimed by a "minister of religion" for car and truck expenses and travel, meals, and entertainment were disallowed for lack of adequate substantiation. The adequate records requirements of Code Sec. 274 were not satisfied by a "ministry driving log" which contained no explanation of the purpose for the taxpayer’s daily trips and expenses. Imposition of the accuracy- related penalty for negligence and substantial understatement of tax was sustained. Back references: 2010FED ¶8590.60, ¶8590.60, ¶14,417.275 and ¶39,651G.302.

G.A. Rozar, TC Summary Opinion 2010-145

• Tax Research Consultant

o CCH Reference – TRC BUSEXP: 24,804CCH Reference – TRC PENALTY: 3,106.

Tax Court Small Tax Cases (Current), Gary Allen Rozar and Misa Rozar v. Commissioner., U.S. Tax Court, T.C. Summary Opinion 2010-145, (Sept. 27, 2010)

Gary Allen Rozar and Misa Rozar v. Commissioner.

Docket No. 15145-09S. Filed September 27, 2010.

[Code Secs. 162, 274 and 6662]

Tax Court: Summary opinion: Business expenses: Vehicle expenses: Travel expenses: Failure to substantiate: Accuracy- related penalty: Negligence: Substantial understatement .–

Business expense deductions claimed by a "minister of religion" for car and truck expenses and travel, meals, and entertainment were disallowed for lack of adequate substantiation. The adequate records requirements of Code Sec. 274 were not satisfied by a "ministry driving log" which contained no explanation of the purpose for the taxpayer’s daily trips and expenses. Imposition of the accuracy- related penalty for negligence and substantial understatement of tax was sustained. — CCH.

PURSUANT TO INTERNAL REVENUE CODE SECTION 7463(b), THIS OPINION MAY NOT BE TREATED AS PRECEDENT FOR ANY OTHER CASE.

Gary Allen Rozar and Misa Rozar, pro sese; Jeffrey W. Belcher, for respondent.

DEAN, Special Trial Judge: This case was heard pursuant to the provisions of section 7463 of the Internal Revenue Code in effect when the petition was filed. Pursuant to section 7463(b), the decision to be entered is not reviewable by any other court, and this opinion shall not be treated as precedent for any other case. Unless otherwise indicated, subsequent section references are to the In- ternal Revenue Code in effect for the years at issue, and Rule references are to the Tax Court Rules of Practice and Procedure.

Respondent determined for 2006 a deficiency of $5,564 in petitioners' Federal income tax and an accuracy-related penalty under sec- tion 6662(a) of $1,112.80. Respondent determined for 2007 a deficiency of $4,681 in petitioners' Federal income tax.

The issues for decision are whether petitioners have properly substantiated deductions claimed on Schedules C, Profit or Loss From Business, on their Federal income tax returns for 2006 and 2007 and whether petitioners are liable for the accuracy-related penalty for 2006. 1

Some of the facts have been stipulated and are so found. The stipulation of facts and the exhibits received in evidence are incorpo- rated herein by reference. Petitioners resided in California when the petition was filed.

17 Background

Gary Allen Rozar (petitioner) at the time of trial had been a minister of religion for over 20 years. He was a missionary for 10 years and traveled to every continent except South America. Petitioner wife was a teacher and waitress.

Petitioners filed a Form 1040, U.S. Individual Income Tax Return, jointly for 2006 reporting on Schedule C gross income of $100, car and truck expenses of $21,197, travel, meals, and entertainment expenses of $1,289, and other expenses of $4,960, for a net loss of $27,346. 2 Petitioners jointly filed their Federal income tax return for 2007 reporting on Schedule C gross income of $800, car and truck expenses of $20,564, insurance expenses of $3,500, repairs and maintenance expenses of $1,850, supplies expenses of $590, and other expenses of $3,525, for a net loss of $29,229.

Petitioners later submitted to respondent Forms 1040X, Amended U.S. Individual Income Tax Return, for 2006 and 2007 on which they claimed to have “Grossly over-stated our income for the year”. The amended returns showed all income and tax liability amounts as zero. Attached to the returns were Forms W-2, Wage and Tax Statement, that had been altered to show zero wages. Al- though petitioners reported for 2006 total credits for tax payments of $2,462, including Federal withholding tax of $2,412, the Form 1040X for 2006 claimed Federal withholding tax payments and a refund of $6,373.

Petitioners filed a second Form 1040X for 2007 that claimed a refund of Federal withholding taxes of $6,493 despite having reported Federal withholding taxes of $2,468 on their original return.

Discussion

Generally, the Commissioner's determinations in a notice of deficiency are presumed correct, and the taxpayer has the burden of proving that those determinations are erroneous. See Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). In some cases the burden of proof with respect to relevant factual issues may shift to the Commissioner under section 7491(a). Because petitioners have not satisfied the requirements of section 7491(a), the burden of proof does not shift to respondent.

Section 162 generally allows a deduction for ordinary and necessary expenses paid or incurred during the taxable year in carrying on a trade or business. Generally, no deduction is allowed for personal, living, or family expenses. See sec. 262. The taxpayer must show that any claimed business expenses were incurred primarily for business rather than personal reasons. See Rule 142(a). To show that an expense was not personal, the taxpayer must show that the expense was incurred primarily to benefit his business, and there must have been a proximate relationship between the claimed expense and the business. Walliser v. Commissioner, 72 T.C. 433, 437 (1979).

Where a taxpayer has established that he has incurred a trade or business expense, failure to prove the exact amount of the otherwise deductible item may not always be fatal. Generally, unless prevented by section 274, we may estimate the amount of such an expense and allow the deduction to that extent. See Finley v. Commissioner, 255 F.2d 128, 133 (10th Cir. 1958), affg. 27 T.C. 413 (1956); Cohan v. Commissioner, 39 F.2d 540, 543-544 (2d Cir. 1930). In order for the Court to estimate the amount of an expense, however, we must have some basis upon which an estimate may be made. See Vanicek v. Commissioner, 85 T.C. 731, 742-743 (1985). With- out such a basis, an allowance would amount to unguided largesse. See Williams v. United States, 245 F.2d 559, 560 (5th Cir. 1957).

Petitioner testified that petitioners were “scammed” into filing the amended returns showing zero amounts for income and tax. Peti- tioner further testified that they have lost all of their tax records for 2006 and 2007 except for the 2006 “driving log”. He testified that “We have nothing to show for 2007, and we have no other [sic] to show for 2006 than the driving log.” Petitioner called it the “min- istry driving log”.

Petitioners have failed to provide the Court with sufficient evidence on which to base an estimate of deductions for business expenses other than those represented by the ministry driving log.

The ministry driving log purports to cover the period of January 3 through September 18, 2006. It indicates that petitioner generally drove between 276 and 301 miles 4 or 5 days a week, every week, throughout those months. Although the listed mileage varies, every trip is listed as starting in Costa Mesa, then continuing to Bonita, San Bernardino, and Huntington Beach, California. There is no explanation for the purpose of the trips, nor was there any testimony putting the locations in context.

Certain business expense deductions described in section 274 are subject to strict rules of substantiation that supersede the doctrine in Cohan v. Commissioner, supra. See sec. 1.274-5T(c)(2), Temporary Income Tax Regs., 50 Fed. Reg. 46017 (Nov. 6, 1985). Section 274(d) provides that no deduction shall be allowed with respect to: (a) Any traveling expense, including meals and lodging away from home; (b) any item related to an activity of a type considered to be entertainment, amusement, or recreation; or (c) the use of any “listed property”, as defined in section 280F(d)(4), 3 unless the taxpayer substantiates certain elements.

18 For an expense described in one of the above categories, the taxpayer must substantiate by adequate records or sufficient evidence to corroborate the taxpayer's own testimony: (1) The amount of the expenditure or use based on the appropriate measure (mileage may be used in the case of automobiles); (2) the time and place of the expenditure or use; (3) the business purpose of the expenditure or use; and in the case of entertainment, (4) the business relationship to the taxpayer of each expenditure or use. See sec. 274(d).

To meet the adequate records requirements of section 274(d) a taxpayer must maintain some form of records and documentary evi- dence that in combination are sufficient to establish each element of an expenditure or use. See sec. 1.274-5T(c)(2), Temporary In- come Tax Regs., supra. A contemporaneous log is not required, but corroborative evidence to support a taxpayer's reconstruction of the elements of expenditure or use must have “a high degree of probative value to elevate such statement” to the level of credibility of a contemporaneous record. Sec. 1.274-5T(c)(1), Temporary Income Tax Regs., 50 Fed. Reg. 46016 (Nov. 6, 1985).

Petitioners' ministry driving log does not meet the requirements of section 274(d). Petitioners did not adequately substantiate the business expense deductions they claimed on their Schedules C for 2006 and 2007.

Respondent's adjustments for 2007 are sustained. Respondent's adjustments to Schedule C for 2006 are sustained except to the extent of $4,960 as described supra note 2.

Section 7491(c) imposes on the Commissioner the burden of production in any court proceeding with respect to the liability of any individual for penalties and additions to tax. Higbee v. Commissioner, 116 T.C. 438, 446 (2001); Trowbridge v. Commissioner, T.C. Memo. 2003-164. In order to meet the burden of production under section 7491(c), the Commissioner need only make a prima facie case that imposition of the penalty or addition to tax is appropriate. Higbee v. Commissioner, supra at 446.

Respondent determined that petitioners are liable for an accuracy-related penalty under section 6662(a). Section 6662(a) imposes a 20-percent penalty on the portion of an underpayment attributable to any one of various factors, including negligence or disregard of rules or regulations and a substantial understatement of income tax. See sec. 6662(b)(1) and (2). “Negligence” includes any failure to make a reasonable attempt to comply with the provisions of the Internal Revenue Code, including any failure to keep adequate books and records or to substantiate items properly. See sec. 6662(c); sec. 1.6662-3(b)(1), Income Tax Regs. A “substantial understate- ment” is an understatement of income tax that exceeds the greater of 10 percent of the tax required to be shown on the return or $5,000. See sec. 6662(d)(1)(A); sec. 1.6662-4(b), Income Tax Regs.

Section 6664(c)(1) provides that the penalty under section 6662(a) shall not apply to any portion of an underpayment if it is shown that there was reasonable cause for the taxpayer's position and that the taxpayer acted in good faith with respect to that portion. The determination of whether a taxpayer acted with reasonable cause and in good faith is made on a case-by-case basis, taking into ac- count all the pertinent facts and circumstances. Sec. 1.6664-4(b)(1), Income Tax Regs. The most important factor is the extent of the taxpayer's effort to assess his proper tax liability for the year. Id.

Petitioners deducted business expenses which they failed to substantiate with adequate books and records. The Court concludes that respondent has produced sufficient evidence to show that the imposition of the accuracy-related penalty under section 6662(a) is ap- propriate.

Petitioners did not show that their failure to properly substantiate their business expense deductions was due to reasonable cause and in good faith. Respondent's determination of the accuracy-related penalty under section 6662(a) for 2006 is sustained.

To reflect the foregoing,

Decision will be entered under Rule 155.

Footnotes

1 Adjustments to petitioners' self-employment tax deductions and self-employment taxes are computational and will be resolved consistent with the Court's decision.

2 The adjustments in the statutory notice for 2006 are overstated. The statutory notice includes an adjustment of $4,960 to other ex- penses both in the total adjustment for “Sch C1 - All Expenses” of $27,346 as well as in a separate adjustment for “Sch C1 - Other Expenses”. The adjustment for “Sch C1 - All Expenses” should be reduced by $4,960 or the adjustment to “Sch C1 - Other Ex- penses” should be eliminated.

3 "Listed property” includes any passenger automobile. Sec. 280F(d)(4)(A)(i).

19 © 2010 Wolters Kluwer

8.) Final regs explain new tax return preparer identifying number requirements Preamble to TD 9501, 09/28/2010, Reg. § 1.6109-2

IRS has issued final regs under Code Sec. 6109 providing guidance on the new, post-2010 requirement for tax return preparers to ob- tain and furnish a preparer tax identification number (PTIN) on tax returns and claims for refund of tax that they prepare. The regs, which are effective on Sept. 30, 2010, largely adopt proposed regs issued earlier this year and reject numerous commentator requests to limit the scope of the PTIN requirement. For companion regs establishing a new user fee for PTINs and the procedure for obtain- ing a PTIN, see ¶ 21.

Background. Under Code Sec. 6109(a)(4) , any return or claim for refund prepared by a tax return preparer must include the identify- ing number for securing the proper identification of the preparer, his employer or both. Reg. § 1.6109-2(a)(2) provides that the identi- fying number of an individual tax return preparer is that individual's social security number (SSN), or such alternative number as may be prescribed by IRS in forms, instructions, or other appropriate guidance.

At the end of 2009, IRS released a 50-page study on the U.S. return preparer industry which carries detailed recommendations for new standards (registration, competency testing, continuing education, ethical standards), see Weekly Alert ¶ 31 01/07/2010). See Publication 4832, Return Preparer Review (Rev. 12-2009).

Earlier this year, IRS issued proposed regs explaining the new PTIN requirements for tax return preparers (see Weekly Alert ¶ 13 04/01/2010). Now, IRS has essentially finalized the proposed regs, and, in doing so, rejected many of the criticisms that had been leveled against the approach it took in proposed regs.

Here's a summary of what the final regs provide.

Requirement to use a PTIN. For tax returns or refund claims filed after Dec. 31, 2010, the identifying number that a tax return pre- parer must include with the preparer's signature on tax returns and refund claims is his PTIN or such other number as IRS prescribes in forms, instructions, or other guidance. Tax return preparers won't be able to use a SSN as a preparer identifying number unless specifically prescribed by IRS in forms, instructions, or other guidance. (Reg. § 1.6109-2(a)(2))

The regs don't distinguish between domestic or foreign tax return preparers. IRS recognizes that foreign preparers don't know how to obtain a PTIN and says that it intends to issue transitional guidance before Dec. 31, 2010, explaining how foreign and other preparers who don't have SSNs can obtain a PTIN. (Preamble to TD 9501, 09/28/2010) See ¶ 21 for guidance on applying for a PTIN for appli- cants without a SSN.

For tax returns or claims for refund filed before Jan. 1, 2011, a tax return preparer's identifying number remains the preparer's SSN or PTIN. (Preamble to TD 9501, 09/28/2010)

Who can obtain a PTIN. Beginning after Dec. 31, 2010, all tax return preparers must have a PTIN or other IRS-authorized identifica- tion number. To obtain a PTIN or other prescribed identifying number, a tax return preparer must be an attorney, certified public ac- countant, enrolled agent, or registered tax return preparer authorized to practice before IRS under 31 USC § 330. (Reg. § 1.6109- 2(d)) However, IRS may prescribe exceptions to the PTIN requirements, including the requirement that an individual be authorized to practice before IRS before receiving a PTIN or other prescribed identifying number, as necessary in the interest of effective tax administration. IRS may also specify specific returns, schedules, and other forms that qualify as tax returns or claims for refund for purposes of the regs. (Reg. § 1.6109-2(h))

IRS rejected calls to exempt (or grandfather) from the PTIN requirement state licensed tax return preparers, and to exempt return preparers of long-standing or those who prepare a small number of tax returns. IRS concluded that tax return preparers who prepare tax returns and claims for refund for compensation should be subject to uniform standards of qualification and practice, and that tax- payers should be assisted by tax return preparers subject to the same Federal regulations, regardless of a taxpayer's state of residence or variable circumstances such as the size of the business or the number of years a tax return preparer has been in the industry. (Pre- amble to TD 9501, 09/28/2010)

The regs don't cover tax return preparation software, as developers of such software aren't return preparers. (Preamble to TD 9501, 09/28/2010)

20 IRS concluded that arrangements for tax return preparation as part of a sales transaction are inherently agreements to prepare tax re- turns for compensation, notwithstanding any claim by tax return preparers that the tax return or refund claim preparation is not sepa- rately compensated. As a result, an individual who, in connection with a sale of goods or services, prepares all or substantially all of a tax return or claim for refund filed after Dec. 31, 2010, and does not furnish a valid PTIN on the tax return or claim for refund may be liable for the Code Sec. 6695(c) penalty, unless the failure to furnish a valid PTIN was due to reasonable cause and not due to willful neglect. (Preamble to TD 9501, 09/28/2010)

Who is a tax return preparer. For purposes of the requirement to obtain a PTIN, a tax return preparer is any individual who is com- pensated for preparing, or assisting in the preparation of, all or substantially all of a tax return or claim for refund of tax. Factors to consider in determining whether an individual is a tax return preparer include, but are not limited to:

... the complexity of the work performed by the individual relative to the overall complexity of the tax return or claim for re- fund of tax; ... the amount of the items of income, deductions, or losses attributable to the work performed by the individual relative to the total amount of income, deductions, or losses required to be correctly reported on the tax return or claim for refund of tax; and ... the amount of tax or credit attributable to the work performed by the individual relative to the total tax liability required to be correctly reported on the tax return or claim for refund of tax. ( Reg. § 1.6109-2(g) )

Under the final regs, preparing a form, statement, or schedule, such as Schedule EIC (Form 1040), Earned Income Credit, may con- stitute the preparation of all or substantially all of a tax return or claim for refund based on the application of the above factors. (Reg. § 1.6109-2(g))

Like the proposed regs, the final regs provide that a tax return preparer for purposes of the PTIN rule excludes an individual who is not defined as a nonsigning tax return preparer in Reg. § 301.7701-15(b)(2). That reg defines a nonsigning tax return preparer as any tax return preparer who, while not a signing tax return preparer (the individual who has the primary responsibility for the overall sub- stantive accuracy of the preparation of a tax return or claim for refund of tax), prepares all or a substantial portion of a tax return or claim for refund. (Reg. § 1.6109-2(g), Preamble to TD 9501, 09/28/2010) A tax return preparer also does not include an individual described in Reg. § 301.7701-15(f) (such as volunteers, those who do tax counseling for the elderly, those preparing returns for their employers, those preparing returns for free). (Reg. § 1.6109-2(g))

Four examples help explain who is a tax return preparer. They make it clear that someone who inputs client data into computer soft- ware but doesn't exercise any discretion or judgment about the underlying tax positions is not a tax return preparer. However, that person must get a PTIN if he also interviews clients, obtains information from them to prepare a return, and figures the amount and character of return entries and whether the client's information is sufficient for return preparation. (Reg. § 1.6109-2(g), Exs. 1 and 2)

If a signing tax return preparer has an employment arrangement or association with another person, then that other person's employer identification number (EIN) must also be included on the tax return or refund claim. (Preamble to TD 9501, 09/28/2010)

IRS rejected requests from commentators in the industry and the Chief Counsel for Advocacy of the Small Business Administration to exempt tax return preparers who don't sign returns or refund requests, and act under the supervision of signing preparer who re- views the return or refund claim. IRS said that granting the requests would have meant exempting a sizeable segment of tax return preparers and thereby undercut effective oversight by IRS of the tax return preparer community. (Preamble to TD 9501, 09/28/2010)

RIA observation: However, in IR 2010-99, issued at the same time as the final regs, IRS said it was considering exempting from the new return preparer testing and education requirements those who engage in return preparation for someone else. See ¶ 21.

Other rules. Under Reg. § 1.6109-2(e), IRS may designate an expiration date for any PTIN other prescribed identifying number and may further prescribe the time and manner for renewing a PTIN or other prescribed identifying number, including the payment of a user fee. Additionally, IRS may provide that any identifying number it issued before the Sept. 30, 2010, effective date of the regs will expire on Dec. 31, 2010, unless properly renewed as specified by IRS.

Under Reg. § 1.6109-2(f), as prescribed in guidance, IRS may conduct a Federal tax compliance check on a tax return preparer who applies for or renews a PTIN or other prescribed identifying number.

References: For who is a tax return preparer, see FTC 2d/FIN ¶ S-1117; United States Tax Reporter ¶ 77,014.24; TaxDesk ¶ 867,002; TG ¶ 71753. For the return preparer penalty, see FTC 2d/FIN ¶ V-2631; United States Tax Reporter ¶ 66,944; TaxDesk ¶ 867,019; TG ¶ 71769.

21 Document Header: Checkpoint Contents Federal Library Federal Editorial Materials Federal Taxes Weekly Alert Newsletter Pre- view Documents for the week of 09/30/2010 - Volume 56, No. 39 Articles Final regs explain new tax return preparer identifying number requirements (09/30/2010) © 2010 Thomson Reuters/RIA. All rights reserved.

9.) Regs set user fee to apply for or renew preparer tax ID; online registration up and running T.D. 9503, 09/28/2010; Reg. § 300.9; IR 2010-99

IRS has issued final regs that establish a new annual user fee for individuals who apply for or renew a tax return preparer tax identifi- cation number (PTIN). IRS has also announced that the new online application system to obtain a PTIN is now available. Applicants will pay a $64.25 fee to obtain a PTIN ($50 user fee + $14.25 for the third-party vendor to operate the online system and provide cus- tomer support). For companion regs on the need for tax return preparers to obtain and use a PTIN, see ¶ 3.

Background on user fees in general. The Independent Offices Appropriations Act of '52 (IOAA), which is codified at 31 U.S.C. 9701, authorizes agencies to prescribe regs establishing user fees for services provided by the agency. Such regs are subject to the policies of the President, which are currently set out in the Office of Management and Budget Circular A-25 (OMB Circular), 58 FR 38142 (July 15, '93). The OMB Circular requires agencies seeking to impose user fees for providing special benefits to identifiable recipients to calculate the full cost of providing those benefits.

Background on PTINs. Under Code Sec. 6109(a)(4), any return or claim for refund prepared by a tax return preparer must include the identifying number for securing the proper identification of the preparer, his employer or both. Reg. § 1.6109-2(a)(2) provides that the identifying number of an individual tax return preparer is that individual's social security number, or such alternative number as may be prescribed by IRS in forms, instructions, or other appropriate guidance. Currently IRS issues preparer tax identification num- bers (PTIN) without charging a user fee.

At the end of 2009, IRS released a 50-page study on the U.S. return preparer industry which provided detailed recommendations for new standards (registration, competency testing, continuing education, ethical standards), see Weekly Alert ¶ 31 01/07/2010. On Mar. 26, 2010, IRS issued Prop Reg § 1.6109-2, effective when finalized, which for returns or claims for refund filed after Dec. 31, 2010, would require tax preparers to apply for and regularly renew their PTIN as IRS may prescribe in forms, instructions, or other guidance, see Weekly Alert ¶ 13 04/01/2010. These regs have now been finalized, essentially without change. See ¶ 3.

On July 23, 2010, IRS issued proposed regs that would establish a nonrefundable $50 user fee for persons applying for or renewing a PTIN, which represents the government's cost for processing the PTIN application, see Weekly Alert ¶ 2 07/29/2010. Shortly thereaf- ter, IRS announced in August of 2010, that the new online application system for compensated tax return preparers was expected to go live in mid-September. The launch of this new system and the proposed user fees were dependent on the publication of final regs on the PTIN requirement, see Weekly Alert ¶ 16 08/26/2010.

Final regs. After considering public comments, IRS adopted without modification the proposed regs that establish a $50 user fee to apply for or renew a PTIN, recovering the full cost to IRS for administering the PTIN application and renewal program. (Reg. § 300.9) IRS also adopted without modification the proposed regs reorganizing the effective date provisions under Reg. § 300.0 through Reg. § 300.8.

Under the final regs, all tax return preparers — including tax return preparers who are licensed as an attorney, certified public ac- countant (CPA), or enrolled agent — must pay a user fee to apply for or renew a PTIN. IRS noted that having a PTIN is a special benefit that allows specified tax return preparers to prepare all or substantially all of a tax return or refund claim for compensation. The OMB Circular encourages user fees for government-provided services that confer special benefits on identifiable recipients over and above those benefits received by the general public. Under the OMB Circular, absent special approval, IRS must recover the full costs for providing the special benefits associated with a PTIN. For the PTIN application and renewal program to be self-sustaining, IRS must charge the $50 user fee to recover the costs of providing the special benefits associated with PTIN.

T.D. 9503, 09/28/2010, noted that the vendor's fee, currently set at $14.25, covers the costs incurred by the vendor to administer the application and renewal process. These costs are separate from the costs to IRS for administering the PTIN application and renewal program, which are recovered in the $50 user fee. Under the vendor's contract with IRS, the vendor's fee is reviewed and approved by IRS.

The third party vendor is statutorily and contractually obligated to protect all personally identifiable information. The vendor faces significant consequences for the unauthorized inspection or disclosure of confidential tax information.

Effective date. The regs are effective Sept. 30, 2010 (the publication date). IRS said the regs must be effective significantly in ad- vance of the beginning of the 2011 filing season to enable it to charge a user fee to recover the cost of administering the program for

22 the 2011 Federal tax filing season. For all tax return preparers to receive a PTIN before the 2011 filing season, IRS must begin regis- tering preparers as quickly as possible.

Online registration system. All paid tax return preparers who prepare all or substantially all of a tax return are required to use the new registration system to obtain a PTIN. Access to the online application system will be through the Tax Professionals page of https://www.irs.gov. Individuals who currently possess a PTIN will need to reapply under the new system but generally will be reas- signed the same number. (IR 2010-99)

Receipt of a PTIN will be immediate after successful online registration. Alternately, a preparer can submit a paper application on Form W-12, IRS Paid Preparer Tax Identification Number Application, with a response time of four to six weeks (this form is not yet available on IRS's website). Before registration, applicants should consider that the date the PTIN is assigned is established as the an- nual renewal date.

Individuals without a Social Security number will also need to provide one of the following: Form 8945, PTIN Supplemental Appli- cation for U.S. Citizens Without a Social Security Number Due to Conscientious Religious Objection, or Form 8946, PTIN Supple- mental Application for Foreign Persons Without a Social Security Number.

IRS has set up a special toll-free telephone number, 1-877-613-PTIN (7846), that tax professionals can call for technical support re- lated to the new online registration system.

Testing and continuing education requirements. IRS notes that under proposed regs, attorneys, CPAs and enrolled agents would not be subject to additional testing or continuing education requirements in order to obtain a PTIN, see Weekly Alert ¶ 3 08/26/2010. Pending finalization of guidance, IRS has under serious consideration extending similar treatment to those who engage in return preparation under the supervision of someone else (for example, some employees who prepare all or substantially all of the return and work in certain professional firms under the supervision of one of the above individuals who signs the return).

IRS will provide further guidance in the coming months, and continues to seek feedback. On the continuing education requirements, IRS recognizes the need to have transition rules in place and plans to issue additional guidelines by the end of the year. (IR 2010-99)

References: For preparers' duty to furnish an identification number, see FTC 2d/FIN ¶ S-1522; United States Tax Reporter ¶ 61,094.

Document Header: Checkpoint Contents Federal Library Federal Editorial Materials Federal Taxes Weekly Alert Newsletter Pre- view Documents for the week of 09/30/2010 - Volume 56, No. 39 Articles Regs set user fee to apply for or renew preparer tax ID; online registration up and running (09/30/2010) © 2010 Thomson Reuters/RIA. All rights reserved.

10.) Connecticut DRS Issues Bright Line Test and Guidance on Economic Nexus for Income Taxes by Teresa Callahan, Esq. (RIA)

The Connecticut Department of Revenue Services (DRS) has issued a publication providing guidance on economic nexus legislation, which became effective and applicable to tax years beginning on or after January 1, 2010. Under the economic nexus standard, any corporation, partnership or S corporation deriving income from Connecticut sources or that has substantial economic presence in the state, without regard to physical presence and to the extent allowed by the U.S. Constitution will be liable for Connecticut income taxes. Economic presence is evidenced by the purposeful direction of business toward Connecticut, examined with regard to the fre- quency, quantity and systematic nature of the company's economic contacts with the state. The publication provides a bright line test for determining when the frequency, quantity and systematic nature of the business' contacts with Connecticut will cause the business to have economic nexus. ( Connecticut Informational Publication 2010(29), 09/23/2010 .)

Bright line test. Under the examples of purposeful direction of business activities provided in the new publication, an out-of-state corporation with no office or employees in the state that engages in active solicitation of Connecticut residents and generates signifi- cant receipts attributable to Connecticut customers will have economic nexus with the state. However, a bright line test is provided for determining when the frequency, quantity and systematic nature of the contacts will result in nexus. Under the bright line test, a corporation, partnership or S corporation that is not otherwise subject to income taxation or a requirement to file a tax return in Con- necticut will be deemed not to have economic nexus for a taxable year, if its receipts from business activities attributable to Con- necticut sources are less than $500,000 during the taxable year. The determination as to whether a pass-through entity, including, but not limited to, partnerships and S corporations, satisfies the bright line test will be made at the entity level. The publication states that the bright line test does not preclude the Commissioner from contending that a company, partnership or S corporation has an obliga- tion to file a return or pay a tax under Chapter 208 or Chapter 229 of the Connecticut General Statutes as a matter of law other than economic nexus.

23 Licensing of intangible property rights. The in-state ownership and use of intangible property, such as trademarks or trade names, may create economic nexus if the intangible property generates gross receipts within Connecticut including through a license or fran- chise or a contract with an in-state company provided the bright line test is met. For example, if an out-of-state corporation with no office or employees in Connecticut licenses a corporation to use its trademark in its Connecticut business operations and the out-of- state corporation is paid a fee based on the licensee's gross sales in Connecticut, the licensor will be considered to have nexus with Connecticut if it derives receipts in excess of $500,000 under the license agreement with the licensee corporation.

Passive investment activity. Income arising from passive investment activity will not create economic nexus. For example, if an out- of-state corporation that does not have any other assets, operations or activities in Connecticut, derives $500,000 from a bank account and an investment account at a Connecticut-based financial institution, it will not have economic nexus in Connecticut.

Public Law 86-272. According to the publication, federal Public Law 86-272 (15 U.S.C. §§ 381-384) will provide protection to businesses that have economic nexus with Connecticut. P.L. 86-272 restricts a state from imposing an income tax on income derived within its borders from interstate commerce, if the only business activity within the state consists of the solicitation of orders for sales of tangible personal property, which orders are to be sent outside the state for acceptance or rejection, and, if accepted, are filled by shipment or delivery from a point outside the state. P.L. 86-272 protection is not afforded to transactions other than sales of tangible personal property and does not apply to taxes that are not based on income.

Transactions with related members. Except for the licensing of intangible property, transactions between related members will not create economic nexus. For example, if an out-of-state headquarters corporation, not otherwise subject to Connecticut income taxa- tion, provides legal and accounting services to its wholly owned Connecticut subsidiary, the out-of-state headquarters corporation will not be subject to Connecticut corporation business tax because the provision of such services does not constitute the conduct of business under the economic nexus provisions.

Document Header Checkpoint Contents State & Local Tax Library State & Local Taxes Weekly Newsletter 2010 10/04/2010 - Volume 21, No. 40 Articles Connecticut DRS Issues Bright Line Test and Guidance on Economic Nexus for Income Taxes (10/04/2010) © 2010 Thomson Reuters/RIA. All rights reserved.

11.) Trust Interest Should Not Have Been Included in Offer-in-Compromise Calculation

In Dalton, 135 TC No 20, Tax Ct Rep Dec (RIA) 135.20, 2010 WL 3719274, the Tax Court concluded that the IRS abused its discre- tion when it rejected the taxpayers' offer-in-compromise based on the Service's determination that the offer did not include in the tax- payers' assets a nominee interest in a property held by a trust.

The husband and wife taxpayers operated a demolition business that ran into financial difficulties in 1996, resulting in its failure to pay withholding taxes. The IRS recorded assessments against the taxpayers for trust fund recovery penalties of $262,163 under Sec- tion 6672. As a result of these business reversals, the taxpayers lost their home and moved in with the husband's parents on property that the taxpayers had previously transferred to the husband's father, who in turn transferred the property to a trust 11 years before the trust fund recovery penalties at issue arose. The joint living arrangement was an oral agreement under which the taxpayers managed the property, paid rent to cover overhead expenses (such as mortgage debt service and property taxes), and paid directly their cost of occupancy.

The taxpayers submitted a $5,000 offer-in-compromise to the IRS in December 1999. The offer was rejected on the grounds that an acceptable offer would need to include an "alter ego" interest in the property of the trust, for a total offer of at least $240,576. In July 2004, the IRS issued separate final notices of intent to levy to the taxpayers for $400,000. The taxpayers requested a collection due process hearing.

The taxpayers argued that the Service's determination was an abuse of discretion because they did not in fact retain a nominee inter- est in the trust property after the trust was created and so did not have to include the trust property in their assets for purposes of the offer-in-compromise. As part of the proceeding, the Office of Chief Counsel issued an advisory opinion that concluded a nominee re- lationship did in fact exist between the trust and the taxpayers. The Appeals Office sustained the levy action.

The Tax Court concluded that the IRS abused its discretion in rejecting the taxpayers' offer-in-compromise. After examining all of the facts and circumstances surrounding the property, the court concluded that the taxpayers' treatment of the trust property was in- sufficient to create a nominee interest. The trust was validly created under Maine law. All of the transfers of the property occurred and were recorded at least ten years before the trust fund recovery penalties arose. There was no evidence that the transfer was made to hide assets from creditors. The taxpayers were solvent at the time of the transfer and did not become insolvent as a result of it. Fur- thermore, they moved to the property only after financial reversals. Therefore, they did not have an interest in the property that con- stitutes property or rights to property to which a federal tax levy could attach under either Maine law or a federal factors analysis.

24 Document Header Checkpoint Contents Federal Library Federal Editorial Materials WG&L Journals Journal of Taxation (WG&L) Journal of Taxation 2010 Volume 113, Number 04, October 2010 Recent Developments Trust Interest Should Not Have Been Included in Offer-in-Compromise Calculation, Journal of Taxation, Oct 2010 © 2010 Thomson Reuters/RIA. All rights re- served

12.) Such a Deal! $45 Payment May Defer $85 Million Tax Bill

EDITED BY SHELDON I. BANOFF, J.D., AND RICHARD M. LIPTON, J.D.

This column provides an informal exchange of ideas, questions, and comments arising in everyday tax practice. Readers are invited to write to the editors: Sheldon I. Banoff, Suite 1900, 525 West Monroe Street, Chicago, Illinois 60661-3693, Shel- [email protected], and Richard M. Lipton, 130 East Randolph Drive, Chicago, Illinois 60601, Rich- [email protected].

A recently reported art "find" illustrates how a $45 payment could defer (perhaps permanently) at least $85 million in income taxes. It also illustrates how a small difference in the economics can (and should continue to) make a huge potential income tax difference, even after this year's "clarification" of the economic substance doctrine in Section 7701(o). (For more on this development, see Lip- ton, "‘Codification’ of the Economic Substance Doctrine—Much Ado About Nothing?," 112 JTAX 325 (June 2010).)

To highlight the difference, let's first tee up a hypothetical fact pattern and then compare the reported facts.

The hypothetical. In 2000, a California construction worker (whom we'll call "Nick") arrived at a garage sale 15 minutes after it had ended and the property owner had abandoned all of the unsold items down at the street curb (for pick-up by the garbage collector the next day). Nick inspected the mound of abandoned property, and selected a trove of old glass negatives. He was attracted to the nega- tives because they contained views of Yosemite National Park.

After a couple of years, Nick's suspicions were aroused, and he decided to store the negatives in a bank vault and hired an attorney to authenticate them. (The date that Nick first showed or gave the negatives to his attorney was sometime between 2007 and 2010.) The attorney brought them to an art appraiser, who concluded in 2010 that they were negatives of the early work of a highly esteemed American photographer (whom we'll call "Ansel"). The negatives were conservatively estimated to have a current value of $200 mil- lion. Nick has tried to contact the original owner (the garage-sale seller who abandoned the negatives) after learning of the negatives' true value but has had no success.

Nick then consulted a tax attorney in 2010, who gave him news—bad, good, and bad. The first bad news is that the negatives are tax- able as a "treasure trove" at ordinary income rates at the time they came into Nick's undisputed possession. The second bad news is that if Nick cannot prove the negatives came into his undisputed possession in a year for which Nick's statute of limitations has closed, then the amount reportable into income might approach or equal $200 million.

The tax attorney's first good news is that if Nick can prove (ultimately to the IRS and the courts) that he came into undisputed posses- sion of the negatives in a tax year for which Nick's statute of limitations has run, Nick will not need to report any taxable income (but will have a zero basis in the negatives). More good news: assuming Nick proves he came into undisputed possession more than one year before he sells the negatives (were he to do so), Nick presumably would qualify for favorable long-term capital gains rates then applicable to sales of collectibles (currently 28%), as Nick is not now (and assuming he would not then be) a dealer in such collecti- bles.

Nick has bank vault receipts, but cannot prove his undisputed possession of the negatives until the year he showed them to his attor- ney—a tax year that is still open. Nick is advised he must report the value of the negatives into income in that year. Bad news! If the reportable value was $200 million, then Nick might owe in the vicinity of $85 million in federal and California income taxes.

Of course, Nick may be able to substantiate a very low reportable value, based on a valuation methodology (e.g., the willing buyer- willing seller standard), given the willing garage-sale seller had walked away from the property as being worthless after the sale. As the identity and authenticity of the negatives were unknown in 2000 by Nick, the garage-sale seller, and (presumably) everyone else, the Service would have a most difficult time successfully arguing that the reportable value approached or was equal to $200 million in 2000.

The "facts." The facts of the art "find" as recently reported are even more fascinating—and tax-wise, potentially far more favorable.

A trove of old glass negatives that allegedly were bought at a garage sale in 2000 for $45 by California construction worker and painter Rick Norsigian reportedly has been authenticated as the lost work of famed nature photographer Ansel Adams (yes, that 25 Ansel) worth at least $200 million, according to Rick's attorney Arnold Peter and art appraiser David Streets. (For purposes of this column, we assume that the negatives are undisputedly authentic.) A team of experts reportedly concluded after an exhaustive, six- month examination that the 65 negatives are Adams's early work, which were believed to have been destroyed in a 1937 fire at his Yosemite National Park studio. See Hoag (AP), "$45 Garage Sale Find Worth $200 Million," Chicago Sun-Times, 7/28/10, page 3. As reported, Rick bought the negatives in 2000 at a Fresno garage sale after bargaining down the seller to $45. He bought the nega- tives because they contained views of Yosemite, but Rick never suspected they might be from Adams, whose images of the national park are world famous. Rick stored the negatives in a bank vault and hired attorney Peter to authenticate them. (The date that Rick first showed the negatives to his attorney is not identified in the article.) Rick said the man who sold him the negatives said he bought them in the 1940s from a salvage warehouse in Los Angeles. Rick has tried to contact the original seller after learning of the nega- tives' true value but reportedly has had no success.

Adams, best known for his striking black-and-white photographs, mainly landscapes of the American West, died in 1984 at age 82.

If Rick can prove his purchase, tax advisors likely would conclude that Rick recognized no taxable income on the acquisition of the valuable negatives either in 2000, at which time he came into undisputed possession of the negatives, or when he later learned of their extreme value after the experts' exhaustive examination. Why? Because Rick did not actually acquire them as treasure trove (unlike "poor" hypothetical Nick). Rather, Rick negotiated a purchase price of $45 on an arm's-length basis from an unrelated third party (the garage-sale seller).

Even though neither party had full knowledge or information as to the identity or value of what was being sold, the tax consequences should remain the same as would apply to any other garage-sale purchase from an unrelated third party having no other transactions with the buyer: Rick as buyer obtained a $45 tax basis for the amount he paid, and his holding period in the negatives commenced then.

Like every other law-abiding garage-sale seller, Rick's seller undoubtedly and dutifully would have reported $45 of proceeds as the amount realized for the negatives under Section 1001 and taxable gain on his 2000 Form 1040 (the year of sale of the negatives to Rick) to the extent that the $45 sales price was greater than the garage-seller's original cost basis (when he bought them in the 1940s from the salvage warehouse).

What is the net federal income tax result of all this to Rick? By spending $45, he:

• Avoided recognizing ordinary income under the treasure trove doctrine. • Acquired a $45 tax basis in the negatives. • Can defer the gain until ultimate sale, at which time he will have a long-term holding period.

Moreover, if Rick were to have the misfortune (but good transfer tax fortune) of dying during 2010 and Congress does not reinstate the estate tax to include his date of death, Rick will have escaped estate taxes and his heirs could indefinitely defer income taxes (as his heirs will take a $45 carryover basis under the temporary 2010 regime) if they do not have a taxable disposition of the negatives.

At worst, if Rick is fortunate enough to live well beyond 2010 and then ultimately sell the trove of old glass negatives for a price in the vicinity of their appraised value, Rick (having held the negatives for more than one year) should qualify for favorable long-term capital gains rates then applicable to collectibles (currently 28%), assuming Rick neither now nor then is a dealer in such collectibles.

Rick's substantial income tax savings by having paid $45 (instead of recognizing ordinary income for treasure trove purposes, as hy- pothetical Nick would have) are magnified by his state income tax savings. Indications from the story are that Rick was and is a Cali- fornia resident, and that the transaction (if taxable as treasure trove) would have been income reportable in California. As California generally follows the federal income tax regime, Rick would have been subject to California income taxes on the value of the treas- ure trove, in the same tax year that it was deemed to be recognized as ordinary income for federal tax purposes. The highest marginal California income tax rate exceeds 10%, which would have generated $20 million of additional income taxes. (For purposes of this discussion, we are disregarding any local taxes that also might apply.)

Our discussion of treasure trove may remind some of our readers of prior Shop Talk columns dealing with the potential application of the treasure trove doctrine to valuable baseballs that became famous (e.g., Mark McGwire's 62nd home run) or infamous (e.g., the so- called "Bartman Ball" allegedly interfered with and dropped by Cubs fan Steve Bartman). See Shop Talk, "McGwire's 62nd Home Run: IRS Bobbles the Ball," 89 JTAX 253 (October 1998); "More on Historic Homers: Is There ‘Zero Basis’ for Avoiding Taxable Income?," 89 JTAX 318 (November 1998); "More on Historic Homers: Do Auction Prices Control?," 90 JTAX 189 (March 1999); and "Contested Historic Homers: What Are the Tax Consequences?," 98 JTAX 189 (March 2003). Also see IR-98-56, 9/9/98.

26 Since there is a massive tax difference between our Nick hypothetical and the Rick facts, one might speculate that the IRS and Cali- fornia Franchise Tax Board would demand clear and convincing evidence that Rick indeed purchased the negatives and did not ac- quire them as treasure trove. If Rick issued his check at the garage sale ten years ago marked "payment for Yosemite Park photo glass negatives" and retained the cancelled check (or a copy thereof), it could go a long way towards proving his case. (It is unlikely that the garage-seller furnished Rick with a notarized bill of sale or other paperwork which Rick retained these ten years, which would be even better evidence than a cancelled check.)

Since Rick's seller is nowhere to be found (unless the news of Rick's windfall or this column causes him to surface), Rick's evidence as to his purchase may be difficult to prove. (One would assume that Rick's statements to his attorney about the origin of his find would not be dispositive or given great weight.) To state the "negative," however, it may be nearly impossible for the Service to dis- prove Rick's story.

Assume for the sake of discussion that Rick's "find" is not treated for tax purposes as a purchase, but rather is subject to the treasure trove doctrine. When would Rick recognize ordinary income? Would it be:

• In 2000, when Rick acquired the glass negatives? • In 2002 (i.e., "a couple of years later") when Rick's suspicions were aroused? • At the time Rick moved the negatives to a bank vault, perhaps because he thought they had substantial value? • At the time that the experts initiated their examination of the 65 negatives? • At the time (six months later) that the experts concluded the negatives are indeed Adams's early work, and thus ex- tremely valuable? • At the time that the art appraiser estimated the negatives' value at $200 million? • Or at some future date, when Rick ultimately disposes of the negatives and fixes their value in an arm's-length (and taxable) sale?

The proper time for reporting taxable income is not when later converted into cash but rather as soon as the property is in the finder's undisputed possession. Reg. 1.61-14(a) provides that "[t]reasure trove, to the extent of its value in United States currency, constitutes gross income for the taxable year in which it is reduced to undisputed possession."

IRS Publications 17 and 525 both provide that if a taxpayer finds and keeps property that does not belong to him or her, which has been lost or abandoned ("treasure-trove"), it is taxable to the taxpayer at its FMV in the first year it is in the taxpayer's undisputed possession. See, e.g., Cesarini, 26 AFTR 2d 70-5107, 428 F2d 812 (CA-6, 1970), aff'g 23 AFTR 2d 69-997, 296 F Supp 3 (DC Ohio, 1969).

If Rick can establish the negatives were acquired by him (and reduced to his "undisputed possession") in 2000, the proper valuation date would appear to be during Rick's 2000 tax year, and the value would be reportable at that time. A much lower valuation (i.e., prior to authentication) would then be appropriate. Valuation should be determined "without regard to subsequent illuminating events." See Diehl, 460 F Supp 1282 (DC Tex., 1976), aff'd 43 AFTR 2d 79-495, 586 F2d 1080 (CA-5, 1978).

What valuation approach would be appropriate if Rick's "find" is treated as subject to the treasure trove doctrine (and is not treated for tax purposes as a purchase)? In other words, what is "the extent of [the photographic negatives'] value in United States currency," as provided in Reg. 1.61-14(a), quoted above? If the negatives are taxable at FMV in 2000, what exactly does that mean, in this situa- tion? For federal tax purposes, the "fair market value" of an asset is "the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of rele- vant facts." See Reg. 1.170A-1(c)(2) (emphasis added); see also, e.g., Cartwright, 31 AFTR 2d 73-1461, 411 US 546, 36 L Ed 2d 528, 1973-1 CB 400 (1973); Bogdanski, Federal Tax Valuation (Thomson Reuters/WG&L, 2006 and 2009 Cum. Supp. No. 2), ¶ 2.01[1], pages 2-3 and 2-4.

A key element may be the answer to the question, "what constitutes ‘reasonable knowledge’?" The actual knowledge of the buyer or seller (here, akin to the knowledge of the garage-sale seller and Rick) as to the facts relating to the negatives may not represent the level of knowledge that the hypothetical willing buyer and seller are deemed to have. Reasonable knowledge is a level of awareness that usually falls somewhere between perfect knowledge and complete ignorance—even if the actual owner of the property is at one extreme or the other. See Bogdanski, supra, ¶2.01[2][c][v], page 2-47. Thus, if a seller or buyer lacks reasonable knowledge of the circumstances surrounding the property on the date at which it is being valued, the price that such a party receives or pays (here, seller received and Rick paid zero) is not good evidence of FMV. See, e.g., Lackey, TC Memo 1977-213, PH TCM ¶77213 (a chari- table contribution case); Bogdanski, supra, ¶2.03[3][a], pages 2-47 and 2-48. Reasonable knowledge is presumed in the valuation process even when the actual owner of the property in question is in fact unaware of facts in placing value on the valuation date. See Bogdanski, supra.

27 Does this mean that all antique hunters and bargain-hunting garage-sale buyers have income on purchase of a valuable (but unknown) antique or item? Clearly not. The Seventh Circuit, in American National Bank and Trust Company, 43 AFTR 2d 79-1297, 594 F2d 1141 (CA-7, 1979), stated in fn. 2: "Two conceptions of value are possible. First it is apparent that an asset always has some theoreti- cal, underlying value which is revealed or made apparent by subsequent events. For example, an unsigned painting by Botticelli lan- guishing in a second hand art shop with a minimal price tag always had the same inherent value which it acquires when the creator of the painting is later discovered. In a second sense, however, value is a practical process, always changing in accord with the price that it will yield on the market at a given time. In this sense, the undiscovered Botticelli has a value far less than its 'inherent' value. The Code and the Regulations clearly enshrine the second sense of value ... and we are thus in accord with the statements of the previ- ously cited authorities [omitted here] that subsequent events have little worth in determining prior value."

Also see Korson, TC Memo 1998-132, RIA TC Memo ¶98132, which held that the value of numismatic materials should not be in- creased to reflect their "unknown importance." The court reasoned that if the proposed adjustment in value "simply reflects the fact that the coin ledgers might turn out to be more valuable once their importance became known, we do not see how it affects their fair market value before their importance became known" (emphasis added).

Would the valuation of Rick's treasure trove be different if he had suspicions at the time he acquired the photo negatives that they might be Ansel Adams's work? We are not aware of any case law on point. In Doherty, 73 AFTR 2d 94-1126, 16 F3d 338 (CA-9, 1994), the facts calling into question the authenticity of a purported Charles M. Russell painting "were in existence" on the valuation date. The court concluded it was appropriate to take authenticity questions into account when valuing the donated painting for chari- table contribution purposes. There, doubts about genuineness arose from the quality and condition of the painting itself, rather than the subsequently revealed information about the painter or his works. The Supreme Court's definition of FMV spelled out in Cart- wright, supra, focuses on both seller and buyer having reasonable knowledge of all relevant facts, and requires that the views of both hypothetical persons must be taken into account. Reference to the buyer's actual knowledge (much less mere suspicions) seems con- trary to the proper determination of FMV on a hypothetical sale of the property.

Assuming that Rick reported some value for the negatives on his 2000 Form 1040 return, even at a figure that is just a wisp of the current appraised value, then (unless Rick's statute of limitations remains open for 2000) the IRS cannot now contend that Rick's "find" had value that is reflective of the 2010 appraisal. If Rick failed to report the value of the negatives on his 2000 Form 1040 but otherwise filed a valid return for that year, the statute of limitations (be it three years or six, depending on the amount of his underre- porting of gross income in 2000) presumably already would have run (unless Rick agreed to extend it). In that event, no adjustment to Rick's 2000 tax return could be made. Although he would then have a zero basis in the negatives, he would have established a long-term holding period, again assuming he can prove his undisputed possession of the negatives in 2000.

As we reported in a series of columns, the Bartman Ball saga, involving a collectible worth a little more than $100,000, took many strange bounces. We have a feeling that the ownership, taxation, and disposition of Rick's Ansel Adams glass negatives also will be noteworthy and perhaps have Ansel-lary tax consequences as time goes on. Indeed, certain Adams Family heirs alleged that Rick had monstrously misidentified the identity of the negatives, likely leaving Rick in the dark as to the legitimacy of his "find." If that turns out to be true, we suspect the "Adams Family Values" of Rick's negatives might approximate his original $45 purchase price, rather than the reported $200 million appraisal. The potential tax consequences to Rick of the Adams Family's allegations will be covered in a future Shop Talk column (we regret leaving our readers in the Lurch until then).

Document Header Checkpoint Contents Federal Library Federal Editorial Materials WG&L Journals Journal of Taxation (WG&L) Journal of Taxation 2010 Volume 113, Number 04, October 2010 Columns Such a Deal! $45 Payment May Defer $85 Million Tax Bill, Journal of Taxation, Oct 2010 © 2010 Thomson Reuters/RIA. All rights reserved.

13.) Federal Tax Day - Current, J.2 IRS Could Adjust Open Tax Year to Account for Income from Closed Years; Coordination of Related S Corporations’ Income and Deductions Was Change in Accounting Method (Bosamia, TCM), (Oct. 8, 2010)

http://prod.resource.cch.com/resource/scion/document/default/%28%40%40FTD01+P20101008- J.2%29ftd0109013e2c867656d9?cfu=TAA

Married taxpayers’ income from an open year could be adjusted to take account of income arising from closed years. The taxpayers were the sole shareholders of two S corporations, one of which was a retail seller of merchandise it acquired from the other. The re- tail corporation used the accrual method of accounting so it could claim a cost-of-goods-sold adjustment for the merchandise, even though it never actually paid for it. The wholesale corporation used the cash method, so it never had to report income from its ac- counts receivable from the retail corporation.

For the open tax year and several previous closed years, the IRS determined that the retail corporation could not claim cost of goods sold for the merchandise until the wholesale corporation included income from the sales in its income. This determination amounted

28 to a change in the treatment of a material item because it affected the timing of the taxpayers’ deduction. Thus, the IRS could make an adjustment to the open year that arose from the closed years.

R.J. Bosamia, TC Memo. 2010-218, Dec. 58,352(M)

Other References:

Code Sec. 267 CCH Reference - 2010FED ¶14,161.10 Code Sec. 481 CCH Reference - 2010FED ¶22,277.565 Tax Research Consultant CCH Reference – ACCTNG: 21,152 CCH Reference – TRC SALES: 39,100

Tax Court Memoranda (Current), Ramesh J. and Pragati Bosamia v. Commissioner., U.S. Tax Court, CCH Dec. 58,352(M), T.C. Memo. 2010-218, T.C.M., (Oct. 7, 2010)

Ramesh J. and Pragati Bosamia v. Commissioner.

U.S. Tax Court, Dkt. No. 27960-08, TC Memo. 2010-218, October 7, 2010.

[Appealable, barring stipulation to the contrary, to CA-5.—CCH.]

[Code Secs. 267 and 481]

Deductions: Related parties: Accrual method: Change in accounting methods: Statute of limitations.–

Married taxpayers’ income from an open year could be adjusted to take account of income arising from closed years. The taxpayers were the sole shareholders of two S corporations, one of which was a retail seller of merchandise it acquired from the other. The re- tail corporation used the accrual method of accounting so it could claim a cost-of-goods-sold adjustment for the merchandise, even though it never actually paid for it. The wholesale corporation used the cash method, so it never had to report income from its ac- counts receivable from the retail corporation. For the open tax year and several previous closed years, the IRS determined that the re- tail corporation could not claim cost of goods sold for the merchandise until the wholesale corporation included income from the sales in its income. This determination amounted to a change in the treatment of a material item because it affected the timing of the taxpayers’ deduction. Thus, the IRS could make an adjustment to the open year that arose from the closed years.—CCH.

L. Don Knight, for petitioners; Sara W. Dalton, for respondent.

Ps' S corporation (S1) purchased inventory from Ps' other S corporation (S2) on credit. S1, using the accrual method of tax account- ing, reduced its sales by cost of purchased goods in the year of purchase, whereas S2, using the cash method of accounting, would not report income from the sales to S1 until the year that S2 was paid. For 2004 R determined that S1 is not entitled to reduce its sales by the cost of purchases from S2 until S2 reports the corresponding income. R also made a sec. 481, I.R.C., adjustment to Ps' income to account for the deductions taken in years prior to 2004 even though the period for assessment had expired in some of the years. For all of the years under consideration, S1 did not pay S2 and no sales income was reported by S2 although S1 reduced its income in each year by the amount of the purchases from S2.

Held: Sec. 481, I.R.C., applies and adjustments can be made for closed prior years as part of R's 2004 determination.

NIMS, Judge: Respondent determined a $295,818 deficiency in petitioners' 2004 Federal income tax and a $59,163.60 accuracy- related penalty under section 6662(a). In this fully stipulated case, the issue framed by the parties is whether respondent may use section 481 to make an adjustment to petitioners' income for 2004 that arises from closed years.

Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the year in issue, and all Rule refer- ences are to the Tax Court Rules of Practice and Procedure.

29 Background

This case was submitted fully stipulated pursuant to Rule 122. The stipulations of the parties, with accompanying exhibits, are incor- porated herein by this reference. Petitioners resided in Texas when they filed their petition.

Petitioners were the sole shareholders of India Music, Inc. (India Music), and Houston-Rakhee Imports (HRI). India Music and HRI were both S corporations.

India Music purchased most of its inventory from HRI on credit, creating an account payable to HRI. India Music used the accrual method of accounting and therefore annually subtracted from its gross receipts the yearly increase in the account payable to HRI even though no payments were made in 7 years. India Music accordingly claimed cost of goods sold of $353,339, $11,062, $147,138, $79,336, $69,478, $217,226, and $23,351 for the years 1998, 1999, 2000, 2001, 2002, 2003, and 2004, respectively. HRI, using the cash method of accounting, reported no income from its sales to India Music for the years 1998 through 2004.

On August 14, 2008, respondent issued petitioners, for their tax year 2004, a notice of deficiency in which it was determined that In- dia Music was not entitled to claim cost of goods sold for 1998 through 2004 until such time as the sales were included in HRI's in- come. When the 2004 notice of deficiency was issued, respondent was barred from assessing income tax deficiencies for petitioners' 1998 through 2002 tax years (closed years) because of the expiration of the 3-year period for assessment under section 6501(a). Re- spondent, however, made a section 481 adjustment of $877,581 to petitioners' 2004 income, reflecting the total of India Music's claimed cost of goods sold for 1998 through 2003. 1 Respondent thus determined for petitioners' 2004 tax year a $295,818 deficiency and a $59,163.60 accuracy-related penalty under section 6662(a).

Discussion

The parties submitted the case fully stipulated and have framed the issue very narrowly. They agree that India Music may not reduce income in the amounts of the purchases from HRI until the sales representing those purchases have been included in HRI's income. They disagree only as to whether respondent may make a section 481 adjustment which takes into account the inventory or cost of goods sold adjustments from petitioners' closed years. We confine our opinion to that issue.

If we hold that respondent may make an adjustment for petitioners' 2004 tax year based on cost of goods sold adjustments for closed years, then petitioners concede that they are liable for the full amount of the deficiency and penalty.

Section 481(a) permits adjustments to prevent omissions or duplications when a taxpayer changes a method of accounting. The ad- justment may include amounts attributable to taxable years for which assessment is barred by the expiration of the period for assess- ment. Graff Chevrolet Co. v. Campbell, 343 F.2d 568, 572 (5th Cir. 1965); Hamilton Indus., Inc. v. Commissioner, 97 T.C. 120, 125 (1991). Respondent contends that a change in accounting method occurred when India Music was required to postpone the realization of its cost of goods sold.

We agree. “A change in method of accounting to which section 481 applies includes a change in the overall method of accounting for gross income or deductions, or a change in the treatment of a material item.” Sec. 1.481-1(a)(1), Income Tax Regs. “A material item is any item that involves the proper time for the inclusion of the item in income or the taking of a deduction.” Sec. 1.446-1(e)(2)(ii)( a), Income Tax Regs. We have previously indicated that a change made to comply with section 267(a)(2) is a change in the treatment of a material item. See Summit Sheet Metal Co. v. Commissioner, T.C. Memo. 1996-563. In Summit Sheet Metal, the taxpayer sought to change the year it deducted bonuses to its officers from the year the bonuses were authorized to the year of payment. The taxpayer argued that this change was merely a correction required to comply with section 267(a)(2) rather than a change of accounting method. We held that the change affected the timing of a deduction and that it was a change in the treatment of a material item.

Petitioners contend that an accounting change made in order to comply with section 267(a)(2) is not a change in the treatment of a material item because section 267 may in some cases affect more than just the timing of a deduction. Petitioners express their con- tention as follows:

More specifically, although Section 267 typically results in a timing difference, it can also permanently disallow a deduction be- tween “related parties” as that term is used in Section 267(b). For example, if India Music were to go out of business and fail to pay HRI for the accrued expenses owing to HRI, India Music would never be permitted to deduct the corresponding expense item. This disallowance would arise solely by virtue of Section 267. In the absence of Section 267, however, India Music would be allowed the deduction in the current year irrespective of events occurring in later years.

Petitioners' contention, however, is incorrect. In analyzing the hypothetical situation petitioners propose, it becomes apparent that their analysis is faulty because the section 267 adjustment simply causes a delay or timing difference. The parties agree that section

30 267 requires the postponement of India Music's deductions. India Music's failure to pay HRI is the proximate cause of the “disallow- ance” or inability to claim the “deductions”. Uniquely, petitioners control both the purchaser and the seller and have exercised their discretion to delay payment, causing the deferral of India Music's “deductions”. Petitioners' hypothetical is incomplete and does not support their position.

Petitioners also argue that section 267 preempts section 481 and prevents a section 481 adjustment arising from closed years. In sup- port, petitioners cite Tate & Lyle, Inc. & Subs. v. Commissioner, 87 F.3d 99 (3d Cir. 1996), revg. and remanding 103 T.C. 656 (1994). Petitioners' reliance on that case is misplaced. In Tate & Lyle, the Court of Appeals for the Third Circuit considered the issues of whether section 1.267(a)-3, Income Tax Regs., was valid and whether retroactive application of that regulation violates the Due Process Clause of the Fifth Amendment. The opinion of the Court of Appeals does not refer to or consider section 481. The holding in Tate & Lyle does not provide a basis for petitioners' argument that a section 481 adjustment based upon adjustments from a closed year is prohibited.

Accordingly, we hold that section 481 applies and that petitioners are therefore liable for the deficiency and section 6662(a) accu- racy-related penalty.

To reflect the foregoing,

Decision will be entered for respondent

Footnotes

1 India Music's purchases from HRI for 1998 through 2003 actually total $877,579. The record does not explain the $2 discrep- ancy.14.) Employer's reporting of health insurance coverage on Forms W-2 is optional for 2011 Notice 2010-69, 2010- 44 IRB, IR 2010-103

IRS has announced that employers won't have to report the aggregate cost of employer-sponsored group health plan coverage on Forms W-2 issued for 2011. Reporting for 2011 will be optional, and employers taking advantage of the reprieve will not be treated as having failed to meet the Code Sec. 6051 wage and tax statement reporting requirements or be subject to any penalties. IRS antici- pates issuing guidance on this reporting requirement before the end of this year.

Background. For tax years beginning on or after Jan. 1, 2011, Code Sec. 6051(a)(14), which was added by §9002 of the Patient Pro- tection and Affordable Care Act of 2010 (Health Care Act, P.L. 111-148, 3/23/2010), generally provides that the aggregate cost of the applicable employer-sponsored health insurance coverage (as defined in Code Sec. 4980I(d)(1)) must be reported on Form W-2. For this purpose, the aggregate cost is to be determined under rules similar to the rules of Code Sec. 4980B(f)(4), referring to the definition of the “applicable premium” under the rules providing for COBRA continuation coverage.

Interim relief. Notice 2010-69 provides interim relief to employers with respect to reporting the cost of coverage under an employer- sponsored group health plan on Form W-2 under Code Sec. 6051(a)(14). Specifically, Notice 2010-69 provides that reporting the cost of this coverage is not mandatory for Forms W-2 issued for 2011. IRS has determined that this relief is necessary to provide em- ployers with the time they need to make changes to their payroll systems or procedures in preparation for compliance with the new reporting requirement.

In addition, IRS announced that it has issued a draft Form W-2 for 2011. The draft Form W-2 includes the codes that employers may use to report the cost of coverage under an employer-sponsored group health plan. IRS will be publishing guidance on the new re- quirement later this year. IRS stresses that the amounts reportable are not taxable, and that the new reporting requirement is intended to be informational only and to provide employees with greater transparency into overall health care costs. (IR 2010-103)

RIA observation: For tax years beginning after Dec. 31, 2017, Form W-2 reporting of health insurance coverage will take on practical importance. Under Code Sec. 4980I, a 40% nondeductible excise tax will be levied on insurance companies and plan admin- istrators for employer-sponsored health coverage to the extent that annual premiums exceed $10,200 for single coverage and $27,500 for family coverage. An additional threshold amount of $1,650 for single coverage and $3,450 for family coverage will apply for re- tired individuals age 55 and older and for plans that cover employees engaged in high risk professions.

References: For reporting of health insurance on Form W-2, see FTC 2d/FIN ¶ S-3152; United States Tax Reporter ¶ 60,514; TaxDesk ¶ 812,002; TG ¶ 60301.

31 Document Header Checkpoint Contents Federal Library Federal Editorial Materials Federal Taxes Weekly Alert Newsletter Pre- view Documents for the week of 10/14/2010 - Volume 56, No. 41 Articles Employer's reporting of health insurance coverage on Forms W-2 is optional for 2011 (10/14/2010) © 2010 Thomson Reuters/RIA. All rights reserved.

15.) Federal Tax Day - Current,I.3Final Basis and Sales Broker Reporting Regulations Released (IR-2010-104; Notice 2010-67; T.D. 9504) , (Oct. 13, 2010)

The IRS has released final regulations governing basis and sales reporting by securities brokers. The final regulations reflect amend- ments to the Code made by the Energy Improvement and Extension Act of 2008 (P.L. 110-343) that require securities brokers to re- port a customer’s adjusted basis in sold securities and to classify gain or loss as long- or short-term. The regulations also provide guidance for taxpayers to compute the basis of certain stock by averaging and reflect amendments that provide brokers and others un- til February 15 to furnish certain information statements to customers and the IRS. The regulations affect brokers and custodians that make sales or transfer securities on behalf of customers, issuers of securities, and taxpayers that purchase or sell securities.

Among other things, the regulations describe who is subject to the reporting requirements, which transactions are reportable and what information needs to be reported. Besides providing numerous examples, the regulations adopt a number of comments and sugges- tions received in response to the proposed regulations that were issued in December 2009.

Form 1099-B, Proceeds from Broker and Barter Exchange Transactions, will be expanded in 2011 to include the cost or other basis of stock and mutual fund shares sold or exchanged during the year. Stock brokers and mutual fund companies will use this form to make these expanded year-end reports. The expanded form will also be used to report whether gain or loss realized on these transac- tions is long- or short-term. The expanded form, to be used beginning with calendar-year 2011 sales, must be filed with the IRS and furnished to investors in early 2012.

The IRS also announced penalty relief for brokers and custodians for reporting certain transfers of stock in 2011. The notice provides transitional relief from the information reporting requirements in Code Sec. 6045A that apply to transfers of securities by brokers and other custodians beginning in 2011. The notice provides that, solely for 2011 stock transfers described in the notice, the IRS will not assert penalties for failure to furnish a transfer statement under Code Sec. 6045A and that the transferred stock may be treated as a noncovered security upon its subsequent sale or transfer.

IR-2010-104, 2010FED ¶46,475

Notice 2010-67, 2010FED ¶46,476,

T.D. 9504, 2010FED ¶47,034

Other References:

• Code Sec. 6045A

o CCH Reference - 2010FED ¶35,933.08

• Tax Research Consultant

o CCH Reference – TRC FILEBUS: 9,256 o CCH Reference – TRC FILEBUS: 9,380

ADVANCE RELEASE Documents, Notice 2010-67,Internal Revenue Service, (Oct. 13, 2010)

2010FED ¶46,476

Broker/Dealers: Basis reporting requirements: Sales reporting requirements: Penalty waiver

Part III - Administrative, Procedural, and Miscellaneous

Information Reporting Requirements Relating to Transfers of Securities

Notice 2010-67 32 PURPOSE

This notice provides transitional relief from the information reporting requirements in section 6045A of the Internal Revenue Code (“Code”) that apply beginning in 2011 to transfers of securities by brokers and other custodians. The notice provides that, solely for transfers of stock in 2011 described in the notice, the Internal Revenue Service will not assert penalties for failure to furnish a transfer statement under section 6045A and that the transferred stock may be treated as a noncovered security upon its subsequent sale or transfer.

BACKGROUND

Section 403 of the Energy Improvement and Extension Act of 2008, Div. B of Pub. L. No. 110-343, 122 Stat. 3765, enacted on Oc- tober 3, 2008, added sections 6045(g), 6045A, and 6045B to the Code. Section 6045(g) provides that, in the case of a covered secu- rity, every broker required to report the gross proceeds from the sale of the security under section 6045(a) must also report the cus- tomer's adjusted basis in the security and whether any gain or loss with respect to the security is long-term or short-term. The report- ing is generally done on Form 1099-B, “Proceeds from Broker and Barter Exchange Transactions.” A covered security includes all stock acquired beginning in 2011 except stock in a regulated investment company for which the average basis method is available and stock acquired in connection with a dividend reinvestment plan, both of which are covered securities if acquired beginning in 2012. A noncovered security is any security that is not a covered security.

To enable brokers to meet the requirements of section 6045(g) for securities transferred between accounts, section 6045A provides that, beginning in 2011, a broker and any other person specified in Treasury Regulations that transfers custody of a covered security to a receiving broker must furnish to the receiving broker a written statement that allows the receiving broker to satisfy the basis re- porting requirements of section 6045(g). Except as provided by the Secretary, the statement must be furnished to the receiving broker within fifteen days after the date of the transfer. A covered security remains a covered security if transferred, but only if the receiving broker receives a transfer statement for the transfer.

To enable brokers to meet the requirements of section 6045(g) after an issuer of stock takes an organizational action such as a stock split, merger, or acquisition that affects basis, section 6045B provides that, beginning in 2011, an issuer must report to the Service and to each stockholder or nominee a description of any such action and the quantitative effect of that action on basis. This require- ment does not apply until 2012 to regulated investment companies.

On December 17, 2009, the Treasury Department and the Service published a notice of proposed rulemaking and notice of public hearing (REG-101896-09), 2010-5 I.R.B. 347 (74 FR 67010), on the information reporting requirements under sections 6045(g), 6045A, and 6045B. Many commenters on the proposed regulations stated that brokers and other custodians may have insufficient time to make programming changes necessary to comply in 2011 with final regulations. Commenters requested relief in 2011 from the transfer statement requirement under section 6045A in order to allow industry to focus initially on building the core systems for reporting the sale of covered securities under section 6045(g) beginning in 2011. However, commenters stated that existing systems could accommodate reporting for any transfer of stock that is incidental to the stock's purchase or sale using a cash-on-delivery ac- count or multiple broker arrangement. See Treas. Reg. §1.6045-1(c)(3)(iii)-(iv).

TRANSITIONAL RELIEF FOR CERTAIN 2011 TRANSFERS

Section 6722 imposes a penalty on any transferor that fails to timely furnish a correct transfer statement under section 6045A to the receiving broker. In order to promote industry readiness to comply with the reporting requirements for the sale of covered securities under section 6045(g) beginning in 2011, the Service will not assert penalties under section 6722 for a failure to furnish a transfer statement under section 6045A for any transfer of stock in 2011 that is not incidental to the stock's purchase or sale as described in Treas. Reg. §1.6045A-1(a)(1)(ii). Further, a receiving broker may treat this stock as a noncovered security.

DRAFTING INFORMATION

The principal author of this notice is Stephen Schaeffer of the Office of Associate Chief Counsel (Procedure & Administration). For further information regarding this notice, please contact Stephen Schaeffer at (202) 622-4910 (not a toll-free call).

©2010 Wolters Kluwer. All rights reserved.

16.) Federal Tax Day - Current,J.2Amounts Received for Transfer of Patent Interest were Ordinary Income (Farris, TCM), (Oct. 13, 2010)

33 Payments received by an individual from a pharmaceutical manufacturing and packaging business for his interest in a method and apparatus for transferring fluid from a vial into a syringe without using a needle constituted ordinary income and not long-term capi- tal gain. Services provided for in a representative agreement were not incidental and subsidiary to the sale and transfer of the needless syringe patents. The agreement provided that he would devote approximately forty hours per week for two years performing services as an independent contractor for the company. Also, the individual agreed to use his "best efforts" to perform sales and training; simi- lar best efforts provisions have been held to be ordinary income.

B.L. Farris, TC Memo. 2010-222, Dec. 58,356(M)

Other References:

• Code Sec. 1235 • CCH Reference - 2010FED ¶30,653.83 • Tax Research Consultant

o CCH Reference – TRC SALES: 24,106.05

Tax Court Memoranda (Current), Barry Lee Farris v. Commissioner., U.S. Tax Court, CCH Dec. 58,356(M), T.C. Memo. 2010-222, T.C.M. , (Oct. 12, 2010)

Barry Lee Farris v. Commissioner.

U.S. Tax Court, Dkt. No. 6314-09, TC Memo. 2010-222, October 12, 2010.

[Appealable, barring stipulation to the contrary, to CA-9.—CCH.]

[Code Sec. 1235]

Gains from exchanges of patents: Compensation v. sale of patent: Services.–

Payments received by an individual from a pharmaceutical manufacturing and packaging business for his interest in a method and apparatus for transferring fluid from a vial into a syringe without using a needle constituted ordinary income and not long-term capi- tal gain. Services provided for in a representative agreement were not incidental and subsidiary to the sale and transfer of the needless syringe patents. The agreement provided that he would devote approximately forty hours per week for two years performing services as an independent contractor for the company. Also, the individual agreed to use his "best efforts" to perform sales and training; similar best efforts provisions have been held to be ordinary income.—CCH.

Craig E. Barrere, for petitioner; Kimberly A. Kazda, for respondent.

KROUPA, Judge: Respondent determined a $14,187 deficiency, a $2,837 addition to tax for failure to file a return timely under sec- tion 6651(a)(1) and a $2,837 accuracy-related penalty under section 6662(a) with respect to petitioner's Federal income tax for 2006. 1 After concessions, the sole issue before this Court is whether the payments petitioner received from Cardinal Health Technologies, LLC (Cardinal Health) in 2006 constituted ordinary income or long-term capital gain. 2 We hold the payments should be treated as ordinary income.

FINDINGS OF FACT

Some of the facts have been stipulated and are so found. The stipulation of facts and the stipulation of settled issues and their accom- panying exhibits are incorporated by this reference. Petitioner resided in Pollock Pines, California at the time he filed the petition.

Petitioner invented a method and apparatus for transferring fluid from a vial into a syringe without using a needle (needleless sy- ringe). The needleless syringe made it possible to fill a medical syringe without exposing the liquid contents to airborne contami- nants. Petitioner applied for and received four patents with the United States Patent and Trademark Office (PTO) for the needleless syringe (needleless syringe patents).

In March 2004 petitioner assigned his entire right, title and interest in and to all needleless syringe patents to Cardinal Health, a pharmaceutical manufacturing and packaging business, for “$1 and for other good and valuable consideration.” The assignment agreement did not define “other good and valuable consideration” or provide for any other compensation or payment. Instead, it 34 stated that petitioner's “receipt of * * * [the $1 and other good and valuable consideration] is hereby acknowledged.” 3 The parties recorded and filed the assignment agreement with the PTO in July 2005.

Three months after signing the assignment agreement, petitioner entered into a sales representative agreement (representative agree- ment) with Cardinal Health. The representative agreement stated that petitioner would devote approximately forty hours per week for two years performing services as an independent contractor for Cardinal Health. All petitioner's services related solely to Cardinal Health's Smart Amp Products. The representative agreement did not define “Smart Amp Products.” It stated, however, that petitioner had “extensive knowledge and experience” regarding such products. Petitioner agreed to use his “best efforts” to perform all normal, routine services of a sales representative and train Cardinal Health personnel on the use of Smart Amp Products. 4 The representative agreement enumerated several services petitioner would perform including developing a strategy for generating sales for Smart Amp Products and establishing business relationships with potential customers. Cardinal Health agreed to pay petitioner $7,500 per month, which represented “full consideration for the services * * * [petitioner] * * * rendered.” The representative agreement contained an “Entire Agreement” clause stating that “the [representative] [a]greement constitutes the entire agreement between the parties” relat- ing to petitioner's services and Cardinal Health's payments, and the parties have no other agreements relating to the representative agreement's subject matter. The representative agreement stated that petitioner would begin providing services to Cardinal Health in May 2004, even though the agreement was not signed until June 2004, and the parties treated June as the start of the 2-year contract.

Petitioner received the final five monthly checks from Cardinal Health totaling $37,500 in 2006. 5 Petitioner failed to report the payments and failed to file a timely Federal income tax return for 2006. 6 Respondent examined petitioner's Federal income tax re- turn for 2006 and issued petitioner the deficiency notice.

Petitioner timely filed a petition with this Court. The parties filed a stipulation of settled issues in which petitioner admitted that he received $37,500 from Cardinal Health in 2006. Petitioner challenges only the characterization of the unreported income.

OPINION

We are asked to decide whether the payments petitioner received from Cardinal Health constitute ordinary income or long-term capi- tal gain. Petitioner claims that the payments he received in 2006 were from the sale of the needleless syringe patents and should therefore be characterized as long-term capital gain. Respondent argues that the payments received constitute ordinary income from the performance of sales and training services described in the representative agreement. We shall consider the parties' arguments af- ter first addressing the burden of proof.

The Commissioner's determinations are generally presumed correct, and the taxpayer bears the burden of proving otherwise. Rule 142(a). Section 7491(a) shifts the burden of proof to the Commissioner in certain situations. Petitioner does not argue that the burden of proof shifts to respondent under section 7491(a) and has not shown that the threshold requirements of section 7491(a) were met. See Higbee v. Commissioner, 116 T.C. 438, 442-443 (2001). Accordingly, petitioner bears the burden of establishing that the pay- ments he received from Cardinal Health constitute long-term capital gain, not ordinary income.

Generally, income a patent holder receives from the transfer of substantially all rights to a patent shall be treated as long-term capital gain. Sec. 1235(a). The parties agree that petitioner transferred all of his rights in the needleless syringe patents to Cardinal Health and that any income petitioner received for the transfer of the patents constitutes long-term capital gain. The parties differ on whether the payments petitioner received in 2006 were for the needleless syringe patents or for tangential sales and training services.

A patent transferor may render ancillary and subsidiary services in connection with the sale and transfer of a patent without affecting the capital nature of the total sale proceeds.

See Ruge v. Commissioner, 26 T.C. 138 (1956); Gable v. Commissioner, T.C. Memo. 1974-312. Ancillary and subsidiary services include providing the transferee with technical knowledge and consulting services that are an integral part of the patent transfer. See Ruge v. Commissioner, supra; Gable v. Commissioner, supra. A patent transferor will be deemed to have received ordinary income, however, when the transferor receives compensation for services that are unrelated or tangential to the patent transfer. Gable v. Commissioner, supra. Petitioner contends that the services provided for in the representative agreement were incidental and subsidi- ary to the sale and transfer of the needleless syringe patents. We disagree.

We first must determine whether the services rendered were in connection with the transfer of the needleless syringe patents. Peti- tioner transferred the needleless syringe patents to Cardinal Health in the assignment agreement. Petitioner acknowledged in the as- signment agreement that he had received full consideration for the needleless syringe patents. The assignment agreement did not refer to any additional consideration or any future agreement that the parties would enter or any other agreement regarding the transfer of the patents.

35 Petitioner and Cardinal Health entered into the representative agreement more than three months later. The representative agreement did not refer to any transferred patents or previous agreements. Rather, the representative agreement dealt only with petitioner's ser- vices as a sales representative and employee trainer for Cardinal Health's Smart Amp Products. Cardinal Health paid petitioner under the representative agreement for “full consideration for services rendered.” Moreover, the “Entire Agreement” clause stated that the representative agreement constituted the entire agreement between the parties related to petitioner's performance of services and that the parties had no other agreements affecting petitioner's performance of services.

Petitioner argues that the Smart Amp Products are synonymous with the needleless syringe patents and that any services performed were connected to the sale of the patents. Neither agreement between petitioner and Cardinal Health makes this comparison, how- ever, and petitioner has failed to provide the Court with any documents or other evidence to support this contention. Moreover, peti- tioner failed to testify or present any other evidence that would show that he and Cardinal Health intended the service payments to be in exchange for the patents. Absent evidence to the contrary, we find that petitioner assigned his needleless syringe patents in the as- signment agreement and the services performed under the representative agreement were not in connection with the transfer of any patent.

Moreover, we find that services petitioner performed under the representative agreement were not ancillary and subsidiary to the sale of the patents. Petitioner agreed to work forty hours per week for two years as a sales representative for Cardinal Health's Smart Amp Products. Cf. Ruge v. Commissioner, supra (patent transferor agreed to provide consulting services affecting the operations of trans- feror's patented invention not to exceed 60 days per year). We recognize that Cardinal Health may have hired petitioner because of his extensive knowledge and experience. We note, however, that his job duties consisted primarily of generating sales as opposed to providing Cardinal Health with technical knowledge about Smart Amp Products. Cf. Gable v. Commissioner, supra (patent trans- feror's duties included developing and researching technical information on the patented invention). Moreover, petitioner agreed to use his “best efforts” to perform the enumerated sales and training duties. The Court has held that income received under similar “best efforts” provisions constitutes ordinary income. See Ruge v. Commissioner, supra; see also Kimble Glass Co. v. Commissioner, 9 T.C. 183 (1947).

We find that petitioner has not presented evidence to show that the services he performed were ancillary and subsidiary to the transfer of the patents. Petitioner has the burden of proof, and he has failed to meet his burden. We find that the payments petitioner received from Cardinal Health in 2006 were for services performed, as stated in the representative agreement, and not for the sale of the pat- ents. Accordingly, we hold that petitioner received the $37,500 as ordinary income from Cardinal Health in 2006.

We have considered all arguments made in reaching our decision, and, to the extent not mentioned, we conclude that they are moot, irrelevant, or without merit.

To reflect the foregoing,

Decision will be entered for respondent.

Footnotes

1 All section references are to the Internal Revenue Code in effect for 2006, and all Rule references are to the Tax Court Rules of Practice and Procedure, unless otherwise indicated.

2 Petitioner concedes liability for the deficiency, addition to tax for failure to file a return timely and accuracy-related penalty.

3 Petitioner's counsel stated at trial that Cardinal Health paid petitioner an up-front lump sum. The assignment agreement does not reference a lump sum payment, however, and petitioner failed to present evidence regarding any such payment.

4 Petitioner's counsel at trial stated that petitioner never performed the services described in the representative agreement. Petitioner presented no evidence, however, to suggest the parties failed to abide by the representative agreement, and this Court will not accept counsel's bald assertion as fact. See, e.g., Smith v. Commissioner, T.C. Memo. 2001-313.

5 Petitioner reported the payments he received from Cardinal Health in 2004 and 2005 on timely filed Federal income tax returns. Those years are not at issue nor are they binding. See Auto. Club of Mich. v. Commissioner, 353 U.S. 180, 183-184 (1957); Demir- jian v. Commissioner, 457 F.2d 1, 6-7 (3d Cir. 1972), affg. 54 T.C. 1691 (1970).

6 Petitioner filed his Federal income tax return for 2006 more than three months after the filing deadline.

©2010 Wolters Kluwer. All rights reserved. 36 17.) Social Security wage base remains at $106,800 for 2011 Social Security News Release, 10/15/2010

The Social Security Administration has announced that the wage base for computing the Social Security tax (OASDI) in 2011 re- mains unchanged for the third year in a row at $106,800.

RIA observation: Monthly Social Security and Supplemental Security Income (SSI) benefits for more than 58 million Ameri- cans will not automatically increase in 2011. The Social Security Act provides for an automatic increase in these benefits if there is an increase in the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) from the third quarter of the last year a cost-of-living adjustment (COLA) was determined to the third quarter of the current year. As determined by the Bureau of La- bor Statistics, there is no increase in the CPI-W from the third quarter of 2008, the last year a COLA was determined, to the third quarter of 2010, therefore, there can be no COLA in 2011. Since there is no COLA, the statute also prohibits a change in the maxi- mum amount of earnings subject to the Social Security tax as well as the retirement earnings test exempt amounts.

The Federal Insurance Contributions Act (FICA) imposes two taxes on employers, employees, and self-employed workers—one for Old Age, Survivors and Disability Insurance (OASDI; commonly known as the Social Security tax), and the other for Hospital Insur- ance (HI; commonly known as the Medicare tax).

The FICA tax rate for employees and employers is 7.65% each—6.2% for OASDI and 1.45% for HI. For self-employed workers, the FICA tax is 15.3%—12.4% for OASDI and 2.9% for HI. There is a maximum amount of compensation subject to the OASDI tax, but no maximum for HI.

RIA illustration: On a salary of $106,800 (or more), an employee and his employer each will pay $6,621.60 in Social Security tax in 2011, the same as in 2010 and 2009.

RIA illustration: A self-employed person with at least $106,800 in net self-employment earnings will pay $13,243.20 for the Social Security part of the self-employment tax in 2011, the same as in 2010 and 2009.

RIA observation: Self-employed workers deduct half of their self-employment tax above-the-line in arriving at adjusted gross income.

RIA observation: The FICA tax rates have remained unchanged since '90.

References: For FICA tax, see FTC 2d/FIN ¶ H-4545; United States Tax Reporter ¶ 31,114; TaxDesk ¶ 541,001; TG ¶ 9500.

Document Header Checkpoint Contents Federal Library Federal Editorial Materials Federal Taxes Weekly Alert Newsletter Pre- view Documents for the week of 10/21/2010 - Volume 56, No. 42 Articles Social Security wage base remains at $106,800 for 2011 (10/21/2010) © 2010 Thomson Reuters/RIA. All rights reserved.

18.) Optional methods for determining self-employment earnings unchanged for 2011 Fact Sheet Accompanying Social Security News Release, 10/15/2010

The Social Security Administration has announced various cost-of-living adjustments (COLAs) for 2011. Most figures remain at 2010 levels, including the quarter of coverage figure, which remains unchanged at $1,120. Because the quarter of coverage figure remains the same, there will be no increase to the lower and upper limits under optional methods for computing self-employment tax, as explained below.

RIA observation: The Social Security Fact Sheet notes that the quarter of coverage figure remains at $1,120 because there was a decrease in the national average wage index for 2009.

Lower and upper limits under optional methods. Optional methods of computing self-employment earnings refer to the “lower limit” or “upper limit.” The “lower limit” for any tax year is the sum of the amounts required under Sec. 213(d) of the Social Security Act for a quarter of coverage in effect with respect to each calendar quarter ending with or within that tax year. (Code Sec. 1402(l)(1)) Thus, for 2010 and 2011, it is $4,480 ($1,120 × 4). The “upper limit” is 150% of the lower limit. (Code Sec. 1402(l)(2))

Optional determination of nonfarm self-employment earnings. For 2010 and 2011, an individual may use the nonfarm optional method only if (a) his net nonfarm profits were less than $4,851 and also less than 72.189% of his gross nonfarm income and (b) he 37 had net earnings from self-employment of at least $400 in 2 of the prior 3 years. This optional method permits individuals to compute their self-employment earnings as the smaller of two-thirds of gross nonfarm income or $4,480 for 2010 and 2011). (Code Sec. 1402(a))

Farmer's optional computation method. For 2010 and 2011, an individual may use the farm optional method to compute his net self- employment earnings only if (a) his gross farm income was not more than $6,720 or (b) his net farm profits were less than $4,851. This method permits individuals to compute their farm self-employment earnings as the smaller of (1) 66 2/3% of gross farm income, or (2) $4,480 for 2010 and 2011. (Code Sec. 1402(a) , Code Sec. 1402(l))

Using both optional farm method and optional nonfarm method. A self-employed individual with both farm and nonfarm incomes is allowed to use both optional computation methods if the farm income qualifies for the farm optional method and the nonfarm income qualifies for the nonfarm optional method. If both the nonfarm optional method and the farm optional method are used to compute net earnings from self-employment, the maximum combined total net earnings from self-employment for any tax year can't be more than the lower limit amount ($4,480 for 2010 and 2011). (Code Sec. 1402(a))

References: For optional methods for computing self-employment earnings, see FTC 2d/FIN ¶ A-6117; United States Tax Reporter ¶ 14,024.20; TaxDesk ¶ 576,027; TG ¶ 1789.

Document Header Checkpoint Contents Federal Library Federal Editorial Materials Federal Taxes Weekly Alert Newsletter Pre- view Documents for the week of 10/21/2010 - Volume 56, No. 42 Articles Optional methods for determining self-employment earn- ings unchanged for 2011 (10/21/2010) © 2010 Thomson Reuters/RIA. All rights reserved.

19.) Nanny tax threshold remains at $1,700 for 2011 Social Security Online

On Social Security Online, the Social Security Administration has announced that for 2011, cash remuneration paid by an employer for domestic service in the employer's private home isn't FICA wages if the amount paid during the year is less than $1,700 (same as for 2010 and 2009).

RIA observation: The dollar threshold applies separately to each domestic employee.

References: For the nanny tax, see FTC 2d/FIN ¶ H-4653.1; TaxDesk ¶ 544,009; TG ¶ 9630.

Document Header Checkpoint Contents Federal Library Federal Editorial Materials Federal Taxes Weekly Alert Newsletter Pre- view Documents for the week of 10/21/2010 - Volume 56, No. 42 Articles Nanny tax threshold remains at $1,700 for 2011 (10/21/2010) © 2010 Thomson Reuters/RIA. All rights reserved.

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