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Monday, July 30, 2007


Under Code Section 165(g), when a security becomes worthless (other than a security in certain affiliated corporations), the taxpayer will be treated as having sold the security. The Code provides that this will usually result in a capital loss for the taxpayer to the extent of its adjusted basis in the security.

Taxpayers would prefer to receive an ordinary loss, since the Internal Revenue Code limits the use of long term capital losses. Some commentators have suggested that if a taxpayer "abandons" a security, it avoids the application of Code Section 165(g) and thus allows for ordinary loss treatment.

As you would expect, the IRS doesn't like that end-around the capital loss rules. After noting that Code Section 165(g) was enacted to foreclose taxpayers with worthless securities from deducting their losses as ordinary, in the Preamble to proposed regulations issued under Code Section 165(g) the IRS is asserting that the same policy is at issue with this type of "abandonment" planning. To avoid what it perceives as an incorrect result, in Proposed Regulation Sections 1.165-5(i) the IRS has indicated that an abandonment of a security will be treated the same as worthlessness, and capital loss treatment will result.

REG-101001-05, Abandonment of Stock and Other Securities., 07/27/2007

Saturday, July 28, 2007


Under the Internal Revenue Code, miscellaneous itemized deductions are allowed for individuals (which include trusts and estates) only to the extent that the aggregate deductions exceed 2 percent of adjusted gross income. However, certain expenses of an estate or trust are not subject to the 2 percent floor. These expenses are administration expenses which would not have been incurred if the property were not held in the estate or trust (Code Section 67(e)). There has been a significant amount of litigation about what expenses come within this exception – especially as to whether investment advisory fees come within it.

The IRS has now issued proposed regulations on what test should be used to determine whether a deduction comes within the exception. The test employed by the proposed regulations is whether an expense is "unique" to an estate or trust – if it is unique it is not subject to the 2 percent floor. For this purpose, a cost is "unique" if an individual could not have incurred that cost in connection with property not held in an estate or trust.

The proposed regulations indicate that the following expenses are "unique" and thus should not be subject to the 2 percent floor, namely expenses in connection with fiduciary accountings, judicial or quasi-judicial required filings, fiduciary income tax and estate tax returns, the division or distribution or income or corpus to or among beneficiaries, trust or will contests or constructions, fiduciary bond premiums, and communications with beneficiaries regarding estate or trust matters. It also provides a list of items that are NOT unique and thus not subject to the 2% floor, namely relating to the custody or management of property, advice on investing for total return, gift tax returns, defense of claims by creditors of the decedent or grantor, and the purchase, sale, maintenance, repair, insurance or management of non-trade or business property.

The IRS also indicates it will "unbundle" fees for various services, so that each service will need to be addressed on a separate basis.

Of course, these are only proposed regulations, and are not currently applicable, but they are a clear indication of the course the IRS wants to take.

COMMENT: It is interesting that the Code uses the language which "would not have" been incurred if the property was not held in the trust or estate, and the IRS converts this to which "could not have" been incurred in the proposed regulations. It is difficult to determine if this is a meaningful difference, but it seems like it could (or should we say "would") be in some circumstances.

Proposed Regulations Section 1.67-4.

Tuesday, July 24, 2007


The IRS issued a mixed ruling to a taxpayer involved in a contingent payout sale under the installment sale method. In the ruling, a Subchapter S corporation sold assets. Part of the sales price included future payments contingent on earnings of the buyer.

The installment sale rules provide for deferral of income tax on gains from the sale of property when payments will be made in future years. In calculating gains each year, the seller's basis in the sold asset(s) are allocated to each payment as it is received. However, when, due to contingent payment provisions, the total price cannot be determined but the payment period is fixed, the taxpayer's basis (including selling expenses) is allocated to the tax years in which payments are to be received in equal annual increments. Treas.Regs. §15a.453-1(c)(3)(i).

In the ruling, the taxpayer applied for a special basis allocation that would allow it to apply its basis earlier than provided under the above contingent payment rule. The IRS allowed the revised method.

However, the IRS also indicated that Code Section 453A interest on the contingent payment amount would be imposed. Code Section 453A generally provides that interest is chargeable on tax deferred on the installment method to the extent that the deferred payments exceed $5 million. By charging interest on the contingent payment, the IRS is effectively saying that interest could be payable on payments that may never be received. This seems unfair, and clearly is an unfavorable application of the provision. Further, it is not clear how a taxpayer could even apply this in situations where the amount of the future contingent payment is unknown.

PLR 200728039

Saturday, July 21, 2007


The IRS does not have forever to pursue taxpayers for errors or omissions on their income tax returns. For income tax purposes, the IRS must assess additional income taxes within 3 years after the later of the date the tax return was filed or the due date of the tax return.

There are some exceptions to the 3 year limit. One major exception is found in Code Sec. 6501(e)(1)(A) ,which provides for a 6 year period of limitations if the taxpayer omits from gross income an amount that's greater than 25% of the amount of gross income stated in the return. For example, if a taxpayer reports $100,000 of income, but the IRS find that the taxpayer did not report a $35,000 gain on the sale of property, the taxpayer has omitted more than 25% of his or her gross income and the IRS can assess additional tax for up to 6 years.

What if the taxpayer overstated his or her tax basis of an asset, and this resulted in income of more than 25% of the reported income not being reported on the income tax return? Is this an "omission," or some type of error that does not allow the use of the 6 year statute of limitations? Tax basis is the "adjusted cost" of an item of property, and is used to compute net gain or loss on sale for income tax purposes. It may also affect other items, such as depreciation deductions.

This was the issue in a recent Tax Court case – the IRS was arguing that when a taxpayer overstated his basis in an asset, which resulted in a more than 25% omission in gross income, that the IRS had a 6 year period of limitations to assess more income tax. The Tax Court ruled with the taxpayer on this one. The Tax Court noted that the Supreme Court held that "omits" means something "left out" and not something put in and overstated (such as additional basis), and thus the 6 year statute does not apply. Bakersfield Energy Partners, LP, Robert Shore, Steven Fisher, Gregory Miles and Scott McMillan, Partners other than the Tax Matters Partner, 128 TC No. 17 (2007.

Coincidentally, the Claims Court also recently interpreted Code Section 6229(c) in a similar manner. Code Section 6229(c) has a similar 6 year extended statute of limitations for 25% omissions, but applies in the partnership audit area. Grapevine Imports Ltd. v. U.S., 100 AFTR 2d ¶2007-5065 (Ct Fed Cl 7/17/2007)

Thursday, July 19, 2007


August 2007 Applicable Federal Rates Summary:

-Short Term AFR - Semi-annual Compounding - 4.94% (4.91%/July -- 4.78%/June -- 4.79%/May)

-Mid Term AFR - Semi-annual Compounding - 5.03% (4.89%/July -- 4.59%/June -- 4.57%/May)

-Long Term AFR - Semi-annual Compounding - 5.24% (5.09%/July -- 4.85%/June -- 4.84%/May)


Tuesday, July 17, 2007


Both churches and qualified religious organizations are exempt from income tax under Code Section 501(c)(3). However, there are advantages to being a "church" as compared to a "religious organization." These include reduced reporting requirements, enhanced charitable deductions for contributors, and the ability to obtain Section 501(c)(3) status without filing a Form 1023 with the IRS. Therefore, many organizations that would qualify as exempt religious organizations like to go the extra mile if possible and be qualified as a "church." In deciding whether an organization is a church, the IRS examines 14 criteria – the more that are present, the more likely a "church" exists. These criteria are:

1) a distinct legal existence;

2) a recognized creed and form of worship;

3) a definite and distinct ecclesiastical government;

4) a formal code of doctrine and discipline;

5) a distinct religious history;

6) a membership not associated with any other church or denomination;

7) an organization of ordained ministers;

8) ordained ministers selected after completing prescribed studies;

9) a literature of its own;

10) established places of worship;

11) regular congregations;

12) regular religious services;

13) Sunday schools for religious instruction of the young; and

14) schools for the preparation of its ministers.

What happens if an organization is involved in creating and establishing churches – is that enough to qualify that organization as a church? In a recent private letter ruling, despite having many of the above factors present, the organization was denied status as a church. The principal reasons for the denial were that the organization did not have a regular, established congregation of members of its own who meet together, as a church, for regular worship services and instruction of the young, and further did not ordain ministers, operate Sunday schools for religious instruction of the young, and did not have a code of discipline, a distinct ecclesiastical government, an established place of worship, or a membership not associated with other local churches or denominations.

While the churches established by the organization had these criteria, these churches were deemed to be independent of the founding organization, and thus those criteria could not be claimed by the founding organization itself. Perhaps if the founded churches were affiliated and/or controlled by the founding organization, a favorable finding as a church might have been issued.

PLR 200727021

Saturday, July 14, 2007


Exempt organizations are generally required to file a Form 990 or 990-EZ each year. However, the Form 990 requirement is not applicable to organizations with less than $25,000 in annual receipts.

The IRS recently published a news release, reminding such small exempt organizations that while they do not need to file the Form 990 or 990-EZ, there is a new requirement to file Form 990-N, "Electronic Notice (e-Postcard) for Tax-Exempt Organizations Not Required to File Form 990 or 990-EZ." This filing requirement commences in 2008.

The filing is simple enough, and will include providing a legal name and mailing address, any other names used, a Web address if one exists, the name and address of a principal officer and a statement confirming the organization's annual gross receipts are normally $25,000 or less. While not fully developed yet, the IRS will provide a free, electronic means of filing the form.

While the filing does not include much information, this should not lull small exempt organizations into believing that they can ignore the filing or that penalties for nonfiling are de minimis. If the filing is not made for three years, the organization will automatically lose its exempt status.

For more information on these filing requirements, see Code Section 6033(i) & (j).

News Release 2007-129, 07/12/2007

Thursday, July 12, 2007


In 1969, Congress changed the rules for obtaining the charitable estate tax deduction for interests that pass into trusts that benefit both charitable and noncharitable beneficiaries. In particular, Congress was concerned that taxpayers were establishing charitable remainder trusts that were shortchanging charities. In those trusts, individuals would be the income beneficiaries, and the remaindermen would be charities. Taxpayers would take a charitable deduction for the actuarial valuation of the charitable remainder interest. However, in operation, they would invest the trust to maximize income to the income beneficiaries (and thus effectively reduce the value of the remainder interests), so that the charities would often never receive anything near to the projected actuarial values for which a deduction was allowed. Under the split-interest rules under Code Section 2055(e), a charitable deduction is now allowed only if the trusts qualify as an annuity trust, unitrust, or pooled income trust – these types of trusts protect the values that will be passing to the charitable remaindermen.

In a recent case, the decedent established a trust that provided for benefits to both charitable and noncharitable beneficiaries. However, the trust did not provide for an income interest to noncharities with a remainder interest in charities, so the abuse behind the split-interest rules was not present. More particularly, the trust provided that property was to be retained in trust for a fixed number of years, and then the trust would terminate, with specified shares then being distributed to certain charities and other shares to noncharitable beneficiaries. Since income could not be distributed before termination to just noncharitable beneficiaries, there really was no way to cheat the charities out of their actuarial shares.

The estate took a charitable deduction for the actuarial shares of the charities under the trust. The IRS audited, and said that since Code Section 2055(e) applies when there are both charitable and noncharitable beneficiaries in a single trust, no charitable deduction is allowed.

The estate took the IRS to court, claiming that Code Section 2055(e) was not intended to apply to its type of trust, and thus (based on the legislative history of the split-interest rules) the charitable deduction should not be allowed. The trial court held that Code Section 2055(e) did apply. The Third Circuit Court of Appeals has now upheld the trial court, finding that a split-interest trust exists which is not an annuity trust, unitrust or pooled income trust, and thus no charitable deduction is available. The fact that the trust did not have noncharitable income beneficiaries with charitable remaindermen was not determinative – the only issue was whether charitable and noncharitable beneficiaries existed in the same trust. The Court declined to rely on the legislative history of Code Section 2055(e), finding that there was no ambiguity in the statute allowing for it to look at or rely upon legislative history.

The lesson for taxpayers and their advisors is clear – be careful not to mix together charitable and noncharitable beneficiaries, in any manner, in a trust that is not structured to be an annuity trust, unitrust, or pooled income trust if a charitable deduction is desired.

GALLOWAY v. U.S., 99 AFTR 2d 2007-XXXX, (CA3), 06/21/2007)

Monday, July 09, 2007


The IRS has released final and proposed regulations dealing with the application of Code Section 4965 and the reporting requirements relating to that Section. Section 4965 imposes entity-level and manager-level excise taxes for prohibited tax shelter transactions to which tax-exempt entities are parties. Section 6033(a)(2) imposes disclosure requirements on tax-exempt entities that are parties to prohibited tax shelter transactions.

The following summarizes the application of these provisions.

In General

---Section 4945 imposes entity-level and manager-level excise taxes for prohibited tax shelter transactions to which tax-exempt entities are parties

---Section 6033(a)(2) imposes disclosure requirements on tax-exempt entities that are parties to prohibited tax shelter transactions

Entities Covered

---Plan and Non-plan Entities

-------Include entities described in Section 501(c), religious or apostolic associations or corporations described in Section 501(d) , entities described in Section 170(c) , including states, U.S. possessions, the District of Columbia, state political subdivisions and U.S. possession political subdivisions (but not including the U.S.), and Indian tribal governments.

-------Plan entities include Section 401(a) qualified pension, profit-sharing and stock bonus plans, Section 403(a) annuity plans, Section 403(b) annuity contracts, Section 529 qualified tuition programs, Section 457(b) retirement plans maintained by a governmental employer, IRAs under Section 408(a) , Archer MSAs under Section 220(d) , individual retirement annuities under Section 408(b) , Section 530 Coverdell education savings accounts, and health savings accounts under Section 223(d) .

---Only non-plan entities are subject to the entity level tax.

Transactions Covered That Can Give Rise to the Imposition of the Excise Taxes

---Prohibited Tax Shelter Transactions

-------Those identified by IRS as potentially abusive "listed" tax avoidance transactions and reportable transactions that are confidential transactions or transactions with contractual protection

---A Subsequently Listed Transaction

-------One that is identified as a listed transaction after the tax-exempt entity has become a party to the transaction and that was not a prohibited reportable transaction at the time the tax-exempt entity became a party to the transaction

-------Penalties relating to subsequently listed transactions incur excise tax generally only after the IRS identifies them as a listed transaction


---Every tax-exempt entity identified above that is a party to a prohibited tax shelter transaction must disclose to IRS: (a) that the entity is a party to the prohibited tax shelter transaction; and (b) the identity of any other party to the transaction which is known to such tax-exempt entity

---Any taxable party to a prohibited tax shelter transaction must disclose by statement to any tax-exempt entity that is a party to the transaction that it's a prohibited tax shelter transaction

---Form 4720, Return of Certain Excise Taxes Under Chapters 41 and 42 of the Code

-------Due on or before the date the non-plan entity's annual return under Section 6033(a)(1) (e.g., Form 990) is due, if the non-plan entity is required to file a return

---Form 5330, Return of Excise Taxes Related to Employee Benefit Plans

-------For entity managers of plan entities who are liable for Section 4965 taxes as entity managers

Expanded Definition of "Party" to a Prohibited Tax Shelter Transaction

---The proposed regulations would incorporate the definition of "party" in Notice 2007-18: a tax-exempt entity that facilitates a prohibited tax shelter transaction by reason of its tax-exempt, tax indifferent or tax-favored status

---Proposed regulations would broaden the term "party" to include a tax-exempt entity that enters into a listed transaction and reflects on its return a reduction or elimination of its liability for applicable federal employment, excise or unrelated business income taxes that is derived directly or indirectly from tax consequences or tax strategy described in the published guidance that lists the transaction

-------A tax-exempt entity doesn't become a party to a prohibited tax shelter transaction solely because it invests in an entity that in turn becomes involved in a prohibited tax shelter transaction

TD 9334, 07/05/2007 ; Reg. § 53.6011-1 , Reg. § 53.6011-1T , Reg. § 53.6071-1 , Reg. § 53.6071-1T , TD 9335, 07/05/2007 ; Reg. § 1.6033-5T , Reg. § 301.6033-5T , Preamble to Prop Reg 07/05/2007 ; Preamble to Prop Reg 07/05/2007 Prop Reg § 1.6033-5 , Reg. § 53.4965-1 through Reg. § 53.4965-9

Saturday, July 07, 2007


About a year ago, we wrote about a very interesting D.C. Court of Appeals case. In that case, the Court had declared that treating damages arising from emotional distress as taxable was unconstitutional since it was not an "accession to wealth." This was exciting stuff – for a Federal appeals court to declare that the Constitution prohibited some aspect of the U.S. income tax is a very rare and unusual event.

Alas, the excitement is gone. The D.C. Court of Appeals is now saying oops, we made a mistake because the government didn't raise the proper arguments, and that such damages are subject to income tax since they are not physical injuries within the exclusion allowed under Code Section 104. In terms of the Constitution, the Court found that even if not authorized by the Sixteenth Amendment to the Constitution (authorizing the income tax), this tax was an authorized excise tax that Congress has the power to impose since it was uniformly imposed.

There is speculation that the Court changed its position in fear that it would be opening the floodgates to constitutional challenges to various taxes.

Murphy v. IRS (CA DC 07/03/07), No. 05-5139, 100 AFTR 2d ¶2007-5019

Tuesday, July 03, 2007


Florida real property owners have recently suffered through the double whammy of rising ad valorem real estate taxes that coincided with rising real property values, and increased insurance costs due to hurricanes. Recently enacted tax relief aims to reduce the tax portion of the increased costs of home ownership.

The legislation is in two parts. The first part provides for immediate relief. The second part puts a proposed constitutional amendment before the voters in January 2008 which will allow for further reductions.

In regard to the immediate relief, all property owners will have their 2007 taxes reduced to 2006 levels, with further cuts being mandated in those localities that have had higher rates of tax growth in recent years. Further, future growth in taxes (excluding school taxes) will be limited to the rate of growth in personal income.

The proposed constitutional amendment provides for various relief, including:

  1. Replacing the current $25,000 homestead exemption, and the Save Our Homes tax-cap, with an exemption equal to 75% of the first $200,000 of a home's value, and 15% of the next $300,000 of the home's value. Homeowners will have a one-time choice of continuing with their current homestead exemption and a 3% Save Our Homes tax cap or the new exemption.
  2. A minimum $100,000 homestead exemption for low-income seniors.
  3. Taxing affordable housing based on the landlord's income from the property (instead of the highest and best use of the property).
  4. Taxing of working waterfronts based on the income from the property (instead of the highest and best use of the property.
  5. An exemption for the first$25,000 of tangible personal property.