Tax Court Voids Portion of Code Section 482 Cost Sharing Regulations

There are tax advantages for U.S. taxpayers to jointly develop intangible personal property with related non-U.S. entities. For an overview, see my prior post here.

Treasury Regulations provide detailed guidance on what costs must be shared between the co-developers if they want the IRS to respect the cost sharing arrangement. Under those regulations, stock-based compensation of one of the parties, such as restricted stock, nonstatutory stock options, statutory stock options (ISOs and ESPPs), stock appreciation rights, and phantom stock, must be shared.

The Tax Court has stricken as invalid Reg. § 1.482-7(d)(2) which requires such sharing of stock-based compensation costs. The Court found the rules to be arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law, because such cost-sharing does not generally occur in the real world between unrelated parties. The IRS was required to show some real world use of sharing of these costs because of the general arms-length standards of the Section 482 regulations (citing Xilinx v. Commissioner, which case also held that Congress never intended for the commensurate-with-income standard relating to intangible property to supplant the arm's-length standard). The Tax Court found that the regulations had not abandoned the arm’s length standard, and left for another day the question whether the IRS could do so in future regulations.

Altera Corporation and Subsidiaries, (2015) 145 TC No. 3

No Need to File §83(b) Election with Tax Return

Not a big item, but a helpful one – under proposed regulations a taxpayer need no longer file a copy of their Code §83(b) election with their income tax return for the year of the election.

Normally under Code §83, a taxpayer who receives property in connection with performing services does not include that property in income until the property is transferable or not subject to a substantial risk of forfeiture. Since it may be advantageous to bring that property into income when received (when it may have a lower value than later), taxpayers can nonetheless elect to include it when received under §83(b). To make the election, the taxpayer must file the election within 30 days of the property transfer and file a copy of the election with their income tax return for that year. Since the filing of a copy with the return may inhibit taxpayers from filing their returns electronically, this second requirement is now removed. However, the filing of the election within 30 days is still required.

The proposed regulations are proposed to apply on January 1, 2016. Nonetheless, taxpayers may rely on them for transfers occurring on or after January 1, 2015.

Preamble to Prop Reg 07/16/2015, Prop Reg § 1.83-2

Applicable Federal Rates - August 2015

Article Abstract: CPA Contingency Fees

TITLE	CIRCULAR 230 UNDER ATTACK: COURT STRIKES DOWN RESTRICTION ON CPA CONTINGENT FEES
AUTHOR(S)	ROGER W. DORSEY
PUBLICATION	Practical Tax Strategies, Jul 2015
PUBLISHER	WG&L
ABSTRACT	In Ridgely v. Lew (2014), the court found the IRS exceeded its statutory authority when it prohibited tax practitioners (including CPAs) from charging contingent fees for preparing and filing "ordinary refund claims."   The IRS sought to regulate such refund claims under Circular 230 regulations and under 31 USC 330 which gives the IRS authority to regulate what that statute terms "representatives" of taxpayers who "practice before" the Treasury Department (which includes the IRS).   The same court had previously blocked the IRS' scheme for regulating unenrolled tax return preparers (Loving (2013)).   The court's theory was that simply preparing and filing ordinary refund claims similarly does not constitute acting as the "representative" of a taxpayer or "practicing before" the IRS. The court defined an "ordinary refund claim" as one "that practitioners file after a taxpayer has filed his original tax return but before the IRS has initiated an audit of the return."   Since the plaintiff was a CPA (unlike in Loving), a profession long-regulated under Circular 230, the Loving principles are now extended to the regulation of all manner of tax professionals, licensed and unlicensed, enrolled and unenrolled.
RESEARCH TAGS	Circular 230; Contingency Fees; Professional Regulation

 

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Living at the Casino Does Not Make You a Professional Gambler

Professional gamblers can offset their losses from gambling against their gambling winnings. They can also deduct their other gambling expenses. Non-professionals (those not engaged in the trade or business of gambling) are limited in deducting their losses against gains as miscellaneous itemized deductions.

In a recent Tax Court decision, the taxpayer was employed full time by the Port Authorities of New York and New Jersey. He did not have a permanent home – instead he kept his belongings in a storage locker. After work, he would drive 125 miles to Atlantic City and stay overnight at casino hotels and gamble. He also gambled elsewhere.

Even though he did this all the time, the Tax Court did not find him to be a professional gambler In making its determination, it reviewed various factors under Code Section 183 that determines whether there is a true profit objective (a requirement for trade or business status) and found that objective lacking. These factors included:

     a. He did not carry on the activity in a businesslike manner, including maintaining complete and accurate books and records;

     b. He did not adjust his system or attempt to improve profitability by modifying his gambling methods;

     c. He did not have, nor develop, any material level of expertise;

     d. He had no history of success in any business activities (other than his unrelated day job);

     e. He had substantial income from sources other than his gambling;

     f. The taxpayer testified that he enjoyed gambling – elements of personal pleasure or recreation is a factor against trade or business status.

Boneparte, TC Memo 2015-128

State Legal Marijuana Dispensaries Lose Out on Business Deductions

Federal income tax is a tax on “net” income – gross income less allowable deductions. Unless, however, you are a drug dealer – Code Section 280E does not allow sellers of federally controlled substances to deduct their business expenses.

Since the time of enactment of Code Section 280E, numerous states have legalized the sale of marijuana products for medical and recreational purposes. Since such sales are legal under state law, should they punished for federal tax purposes via the disallowance of deductions? After all, Code Section 280E was aimed at illegal drug dealers, and these marijuana sellers are duly licensed under local law.

The 9th Circuit Court of Appeals has ruled that Code Section 280E applies to such state legal marijuana dispensaries. The court noted that Code Section 280E is based on legality under federal law, not state law. So as long as marijuana is illegal under federal law, absent a change in the Internal Revenue Code, marijuana dispensaries lose out on their business deductions. This effectively raises the rate of tax imposed on such businesses. In years when business expenses are high enough, the taxes may approach the net cash flow of the business and thus approach confiscatory rates of tax.

The only thing that will allow these dispensaries to remain in business is that cost of goods sold (i.e., the cost to purchase inventory) is not a deduction that is lost under Code Section 280E. Otherwise, if the cost of goods sold could not be deducted, it is likely that the taxes imposed on such businesses would equal or exceed their actual net profit.

So if you think federal law is irrelevant to marijuana sales in states that have legalized its sale – it still matters for federal income taxes!

Olive v. CIR, Tax Court Case No.l 13-70510 (July 9, 2015)

First Time Abate

Taxpayers who file a return late, make a late payment, or make a late tax deposit are subject to penalties. What is not known by most taxpayers, and a lot of tax practitioners, is that the IRS has a program to abate these penalties for those that have not been subject to them recently. The program for abatement is known as First Time Abate.

First time abatement is an administrative waiver and not statutorily mandated. The program has been underutilized largely because the IRS has not publicized the program and fails to provide taxpayers with guidance when clearly applicable.

To participate, a taxpayer must be otherwise compliant, must have not been previously required to file the return, and must have had no penalties imposed for the prior three years. As showing reasonable cause can be difficult in some situations, this program may provide relief to taxpayers who would otherwise be forced to pay penalties.

Details of the program are in IRM 20.1.1.3.6.1.

Partnership Rules Not Applicable to Determining Recourse vs Nonrecourse Status of Debt Outside of Subchapter K

Code Section 752 and its regulations provide extensive rules as to determining whether partnership debt is recourse or nonrecourse. Such determinations are relevant for basis determination purposes under Subchapter K (the Subchapter applicable to partnership taxation) and other Subchapter K purposes.

In Chief Counsel Advice, the IRS concluded that, for purposes of determining whether a limited liability company taxed as a partnership has either cancellation of debt (COD) income under Code Sec. 61(a)(12) or gains from dealings in property under Code Sec. 61(a)(3) upon foreclosure of its property, the Code Section 752 rules do not govern whether the debt at issue was recourse or nonrecourse. Instead, the Section 752 rules apply only for Subchapter K purposes.

Why was recourse vs. nonrecourse status relevant? This is because when a taxpayer disposes of encumbered property, and the encumbrance exceeds the value of the property, different tax results apply depending on whether the debt is recourse or nonrecourse. If it is a recourse debt, the amount realized on the sale attributable to the debt is limited so as to bring the amount realized only up to the fair market value of the property. The excess of the recourse debt over the fair market value of the property is treated as COD income. The bad news is that COD income is taxed at ordinary income rates. The good news, sometimes, is that COD income may be avoidable if one of the exceptions under Section 108 apply (relating to when cancellation of indebtedness income need not be recognized).

If the debt is nonrecourse, then the entire amount of the nonrecourse debt is included in the amount realized, and there is no COD income. Here the good news and bad news is flipped – all of the income is eligible for long term capital gains rates (if otherwise applicable based on holding period and character of the asset), but no opportunity for avoidance of COD income under Section 108 applies.

Chief Counsel Advice 201525010