Category Archives: Federal

Second Circuit: Co-Op Owner Is Entitled to Casualty Loss

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circseal2The Second Circuit Court of Appeals has reversed the Tax Court’s decision that a New York City co-op owner, Ms. Alphonso, could not deduct casualty losses that occurred on grounds owned in common with other cooperative shareholders.

The Tax Court held that Ms. Alphonso could not take a deduction for a casualty loss because she did not hold a property interest in the damaged property. The damage in question occurred when a retaining wall along the common property of the cooperative apartment building collapsed. The co-op shareholders contributed to the necessary repairs and clean-up. Ms. Alphonso took a deduction of about $23,000 for her share of the repairs, claiming that it qualified as a casualty loss under under IRC §165(c)(3).

The Tax Court did not address the merits of the casualty loss claim. Rather, the Court ruled as a matter of law that Ms. Alphonso did not hold a “sufficient” property interest in the common area of the apartment building to qualify for the deduction.

The Second Circuit vacated the Tax Court holding that although Ms. Alphonso’s interest in the damaged common area was not exclusive with respect to her fellow tenant shareholders it was still a property right. Thus, the “property” element of section 165(c)(3) was satisfied. The Second Circuit remanded the case to the Tax Court for further proceedings on whether the claimed damages qualified as a casualty loss.

Read the Second Circuit’s opinion here:
Alphonso v. Commissioner, No. 11-2364 (2d Cir. Feb. 6, 2013)

Read the Tax Court opinion here.

IRS Releases Schedule UTP Statistics for 2011

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The IRS recently released Schedule UTP filing statistics for the 2011 tax year. The statistics are not complete as returns from some late fiscal year filers and others still have not been processed.

As of December 2012, the IRS was able to report the following:

  • 1,783 taxpayers filed Schedule UTP with their 2011 returns
  • 83% of all returns with Schedule UTP were filed by taxpayers classified as Industry Case (IC) taxpayers by the Large Business & International (LB&I) Division of the IRS.
  • 4,120 uncertain tax positions had been disclosed
  • Coordinated Industry Case (CIC) taxpayers disclosed an average of 3.8 uncertain tax  positions per Schedule
  • IC taxpayers averaged 2.0 uncertain tax positions per Schedule
  • 47% of Schedule UTP returns included only one uncertain tax position

2011 also was the first tax year that prior year positions were required to be reported on the Schedule.  The IRS has not yet gathered the data to share any statistics to break out the total number of positions reported in the current year and prior years.

No information was released regarding the most frequently reported code sections underlying the uncertain tax positions.  

Read more about Schedule UTP here.

Conservation Easement Deduction Denied as Quid Pro Quo for Subdivision Approval

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The Tax Court denied the taxpayers’ deduction for the donation of a conservation easement where the taxpayer granted the easement pursuant to negotiations with a local zoning authority for approval of a subdivision exemption.

The deductibility of conservation easement donations is drawn from the general rule allowing the deduction of charitable contributions under IRC §170. Charitable contributions must be freely given, i.e., a gift, to qualify for the deduction. If the contribution is made in exchange for a specific benefit, i.e., a quid pro quo, then it does not qualify for the deduction.

The Tax Court found that the taxpayer’s donation of the easement was not a gift because it was “part of a quid pro quo exchange for Boulder County’s approving his subdivision exemption request.” The court also approved the application of the 20% substantial understatement penalty under IRC §6662(b)(2) against the taxpayer. The court denied the taxpayer’s reasonable cause argument to avoid the penalty, specifically noting the lack of testimony from the CPA who prepared the returns and invoking the “Wichita Terminal rule” to find for the government. The Wichita Terminal rule is drawn from a 67 year-old Tax Court case and generally provides that when a litigant fails to produce the testimony of a person that might be expected to testify, that failure gives rise to a presumption that the testimony would be unfavorable to the litigant’s case.

While the taxpayer lost on the 20% penalty, the court did reject the government’s argument for the 40% gross valuation penalty under IRC §6662(h)(2). In support of its position the commissioner alleged that the appraisal:

(1) was made more than 60 days before the grant of the second conservation easement; (2) does not describe the property; (3) does not contain the expected date of contribution; (4) does not contain the terms of the second conservation easement; (5) does not include the appraised fair market value of the second conservation easement on the expected date of contribution; and (6) does not provide the method of valuation Mr. Roberts used in that the report does not adequately identify the highest and best use of the property.

The taxpayer urged that the penalty did not apply under the exception provided in IRC §6664(c)(2) because the taxpayer obtained a “qualified appraisal” from a “qualified appraiser” and made a good faith investigation of the value of the property before making the donation. The court sided with the taxpayer and rejected the government’s arguments. The court voiced its particular concern with the government’s claim that the appraisal was not qualified because did not provide a method of valuation. The court noted that the appraisal specifically identified the well-established “before and after” valuation method and repeated, though without citation, the same concerns expressed by the Second Circuit Court of Appeals in Scheidleman v. Commissioner, that is, that the government’s claim really was directed at the reliability of the report and not its validity or “qualification”.

Read the entire opinion here:
Pollard v. Commissioner, T.C. Memo 2013-38

Tax Court Denies Conservation Easement that Allowed Substitution of Property

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us_tax_courtAs the IRS continues to challenge charitable deductions for the contribution of conservation and facade easements, the Tax Court is considering the details of these arrangements with greater scrutiny. In doing so, the Court is refining the law governing these transactions. In its most recent opinion on this issue, the Court clarified yet another requirement for taxpayers who wish to claim this charitable deduction.

In Belk v. Commissioner, the taxpayers donated a conservation easement over a 184 acre golf course and claimed a $10.5 million deduction on their 2004 tax return. The conservation easement agreement executed by the parties included a provision which allowed the owner of the property (i.e., the taxpayers) to substitute the property subject to the easement with “an area of land owned by Owner which is contiguous to the Conservation Area for an equal or lesser area of land comprising a portion of the Conservation Area.”

The IRS challenged the validity of the entire donation on the grounds that the real property interest (i.e., the golf course) was not donated in perpetuity because the substitution provision allowed it to be replaced by another property. The IRS argued that the substitution provision violated the requirement that the contribution be an interest in real property that is subject to a use restriction granted in perpetuity under IRC §170(h)(2)(C).

The IRS previously had argued that certain facade easements violated the “in perpetuity” requirement. See, Kaufman v. Commissioner, 134 T.C. 182 (2010) (Kaufman I) and Kaufman v. Commissioner, 136 T.C. 294 (2011) (Kaufman II). The Kaufman argument, however, was based on the language of IRC §170(h)(5) which requires that the conservation purpose of the easement be protected in perpetuity. Though the IRS prevailed in the Tax Court, Kaufman and the §170(h)(5) argument was overturned by the First Circuit Court of Appeals. Kaufman v. Shulman, 687 F.3d 21 (1st Cir. 2012).

In Belk, the IRS, and apparently the taxpayers (see footnote 17), combined the two provisions of §170 while making the perpetuity argument. Judge Vasquez, writing for the Court, parsed the issue more carefully. He noted that §170(h)(2)(C) requires that the property must be subject to a perpetual restriction on use as distinguished from § 170(h)(5) which requires that the conservation purpose be protected in perpetuity. The Court made it clear that the two provisions were separate and distinct and based its decision on the former.

The Court held that the donation made by the Belk’s did not constitute a “qualified real property interest” under §170(h)(2)(C) because the conservation easement agreement allowed for substitution of the contributed property. The court found that the contributed property was not subject to a use restriction in perpetuity but in fact subject to the restriction only so long as the substitution provision in the agreement was not exercised. Accordingly, the charitable donation did not meet the requirements of §170(h) and the deduction was denied in full. The Court did not reach the question of conservation purpose or valuation.

Read the entire opinion here:
Belk v. Commissioner, 140 T.C. No. 1 (2013)

District Court Decision Prevents IRS from Regulating Certain Tax Return Preparers

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Income-Tax-Preparation_Rialto-CA-92376_13253.11185131
UPDATE: On February 20, 2013, the Department of Justice Tax Division filed a notice of appeal with the U.S. Court of Appeals for the District of Columbia Circuit appealing the District Court’s ruling.

In a surprising decision, the U.S. District Court for the District of Columbia found in favor of three plaintiffs who challenged the Internal Revenue Service’s ability to govern tax return preparers pursuant to regulations issued in 2011. The 2011 regulations required, among other things, registration with the IRS and use of a registration number when preparing returns known as the PTIN (Preparer Tax Identification Number). The 2011 rules were based on 31 U.S.C. § 330 – a statute which the court noted was originally promulgated in 1884.

That statute gives the Department of Treasury the authority to regulate people who “practice” before it. As an agency of the Department of Treasury, the IRS is within the purview of the statute. The question that captured the District Court was whether tax return preparers were “practicing” before the IRS, and thus the Department, when they prepare and sign tax returns on behalf of others. It found that they were not and thus the IRS could not regulate them under the authority granted by the statute.

The District Court granted the plaintiff’s motion on summary judgment and also entered a permanent injunction preventing the IRS from enforcing the 2011 tax return preparer rules. The IRS responded to the court’s ruling on January 22, 2013 with an announcement on its website acknowledging that those tax return preparers specifically covered by the registration and reporting rules were no longer required to comply.

The case and the injunction does not apply to enrolled agents, CPAs, or attorneys. These individuals are still subject to the rules for practice before the IRS. Though the injunction is permanent, expect to see more action on this issue from the Department of Treasury and/or the IRS.

Read the entire opinion here:
Loving v. Internal Revenue Service, No. 12-385 (January 18, 2013, DC D.C.)

Tax Question May Determine Supreme Court’s Position on Same-Sex Marriage

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Last week, the U.S. Supreme Court granted certiorari in two cases that may decide the constitutionality of same-sex marriage. One of the two cases, U.S. v. Windsor, came to the Court by way of the tax code. In Windsor the high court will consider whether the decedant’s same-sex spouse qualified for the unlimited marital deduction under IRC Section 2056(a). Whether, and how, the court ultimately rules remains to be seen but the tax code may once again be the basis for a far-reaching decision out of the Supreme Court.

Tax Court: No Penalties for Son of Boss Participants

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In a memorandum opinion related to a division opinion we reported earlier this year, the Tax Court has found that underpayment and accuracy-related penalties asserted against investors in a “Son of Boss” tax shelter, did not apply to the participant taxpayers because they established reasonable cause under IRC § 6664(c)(1). However, the Court did sustain the government’s determination, which apparently was uncontested by the taxpayers, that they had underreported tax because of their involvement with the Son of Boss transactions.

The opinion offers a thorough discussion of the taxpayers’ conduct and the applicable standards for reasonable cause. The language and findings may provide useful guidance for taxpayers, and their counsel, seeking to avoid penalties by establishing reliance upon their advisors.

Read the entire opinion here:
Rawls v. Commissioner, T.C. Memo. 2012-340

IRS Releases Proposed Regs and FAQs on 3.8% Net Investment Income Tax

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With tax provisions set to expire on payroll taxes, capital gains rates, income tax rates, AMT exemptions, estate taxes, and nearly everything else, the tax picture for 2013 is anything but clear.

One thing that we can expect with certainty on January 1, 2013, is the introduction of the 3.8% investment tax under new Internal Revenue Code Section 1411. The new provision adds a 3.8% tax on the “net investment income” of individuals, estates, and trusts with modified adjusted gross income in excess of the threshold amounts of:

  1. $250,000 for joint returns and surviving spouses;
  2. $125,000 for married taxpayers filing separately; and
  3. $200,000 for everyone else.

Until now, there was little guidance on the details of this provision from the Patient Protection and Affordable Care Act (Obamacare). The Internal Revenue Service has now provided guidance in the form of proposed regulations and Frequently Asked Questions (FAQs).

Ambitious practitioners have until March 5, 2013, to submit comments on the proposed rulemaking.