Yesterday the 5th circuit reversed the Tax Court and held in Pilgrim’s Pride that a taxpayer could receive an ordinary loss on the abandonment of a stock interest. In 2004 the taxpayer affirmatively abandoned their stock interest and declined an offer to sell the underlying stock because a $98.6M ordinary loss on abandonment was worth greater than the $20M offer it had to sell the stock. However, the IRS and Tax Court disagreed, citing Section 1234A for the proposition that an abandonment of a capital asset was treated as a capital loss. Noting this was a novel issue, the 5th circuit court disagreed with the IRS and Tax Court reading of Section 1234A to indirectly cover abandonments, concluding that Section 1234A(1) only applies to the termination of contractual or derivative rights, and not to the abandonment of capital assets. This case is quite significant and is the latest and most determinative authority on whether abandonment of an asset results in a capital versus an ordinary loss.
In new Rev. Proc. 2015-20, the IRS permits a “small business taxpayer” to use a simplified procedure to change its method of accounting under the final tangible property regulations for tax years beginning on or after January 1, 2014. This rule allows these small taxpayers to change to certain accounting methods without the burden of filing Form 3115. The guidance also modifies Rev. Procs. 2015-14 and 2015-13.
Who is a Small Business Taxpayer?
A small business taxpayer is a taxpayer with one or more separate and distinct trades or businesses that has either (1) total assets of less than $10 million as of the first day of the taxable year in which the change of accounting method is made under the tangible property regulations or (2) average annual gross receipts of $10 million or less for the prior three tax years.
What are the alternate procedures?
Certain accounting changes can be made on the taxpayer’s federal tax return without including any separate statement. To qualify the change must be to an accounting method listed in the Rev. Proc. and must include an adjustment under section 481(a) that takes into account only amounts paid or incurred, and dispositions, by the trade or business in taxable years beginning after January 1, 2014.
No Audit Protection
Most voluntary accounting method changes are granted by the IRS with “audit protection,” which means that the IRS will not require the taxpayer to change its method of accounting for the same item if impermissibly used for a taxable year prior to the year of change. Rev. Proc. 2015-20 specifies, however, that a small business taxpayer changing accounting methods under the simplified procedure will not receive any audit protection for taxable years beginning before January 1, 2014.
Today was an important step in moving forward US tax reforms to encourage international investment in U.S. real estate. The Senate Finance Committee passed 17 different tax bills for consideration by the entire Senate. This package includes a FIRPTA reform bill sponsored by Senators Robert Menendez (D-NJ) and Michael Enzi (R-WY) to reduce the burden of the Foreign Investment in Real Property Tax Act (FIRPTA) for shareholders of public traded REITs. The proposal would increase the amount of public REIT stock an investor could hold from five percent to 10 percent without running afoul of FIRPTA. Although this concept is only a subset of past FIRPTA reform proposals such as S. 1181 and H.R. 2870 (from the last Congress), the associated oral testimony suggested a strong push to further expand the relief for international investors in real estate. Specifically, testimony noted the goal of exempting international pension funds from FIRPTA, similar to that proposed in the President’s budget proposals in recent years (see page 91 of the FY 2016 Greenbook).
The proposed legislation also contains related technical provisions. These include a specific definition of “domestically controlled” that clarifies when a REIT is domestically controlled for purposes of the exception applicable to the sale of stock in domestically controlled REITs. This definition limits the cases where an upper-tier REIT or RIC is treated as a domestic entity for purposes of determining whether a lower-tier REIT is domestically controlled and would be effective upon enactment (no grandfathering). To achieve revenue neutrality, the following new provisions are also included: (1) increasing FIRPTA withholding on gross proceeds from 10 percent to 15 percent; (2) requiring tax return and shareholder disclosure of US Real Property Holding Company status, (3) requiring FIRPTA withholding by brokers; (4) disallowing the “cleansing rule” for RICs or REITs (this rule allows corporate blockers to “cleanse” their FIRPTA taint by selling the real estate in a taxable sale prior to liquidation); and (5) providing that dividends derived from RICs and REITs would be ineligible for the rule that allows dividends from certain foreign corporations to be eligible for the dividends received deduction.
As tax filing has evolved from the days of paper and ledgers to electronic filing, it was only a matter of time before the tax community would also embrace the use of mobile technology. While tax season is not eagerly anticipated by many, individuals and businesses alike now welcome many new technologies that make the preparation and filing process easier, even mobile apps.
Today there’s a mobile app for almost everything to help busy people simplify and organize life. Consumers can organize and safeguard online passwords and manage benefits gained through various retail loyalty programs. They can confidentially track health records and save grocery shopping lists and menus for ease of future shopping.
The tax preparation community has responded in kind, with developers creating mobile apps from receipt-scanning service Shoeboxed to charitable deduction tracker and calculator ItsDeductible, an offshoot of TurboTax.
The Internal Revenue Service (IRS) has had a mobile presence since 2011. Recently, the agency announced the update of the app, called IRS2Go, version 5.0. The newest version of the app allows filers to keep track of their returns, stay on top of deadlines and also read the two IRS Twitter feeds. IRS2Go 5.0 allows users to view instructional YouTube videos explaining commonly asked filing questions. Each update to the app also includes improved error reporting.
Last month, technology bloggers on mobile technology website GottaBeMobile previewed updates of popular apps noted for easing the burden of tax filing for consumers. The IRS2Go app was noted one of the top five apps for making tax time easier.
The app is available on both GooglePlay and the App Store. The IRS recommends consumers who already have version 4.2 should install 5.0 to ensure continued updates and enhancements. Interested new users can access customer reviews of the IRS2Go app on CNET and apptweak.com. While customer reviews by laypeople can be useful to help the user experience, if consumers have questions about their individual returns they should consult a qualified professional or reach the IRS directly through its call center, website, or via social channels.
April 15 will be here before we know it. IRS2Go is sure to remind us!
In Si Boo LLC, the Tax Court denied capital gain treatment and assessed self-employment taxes on three taxpayers who regularly sold real properties acquired by tax deed. The court held that, although the taxpayers bought the tax liens primary to profit from redemptions of the liens, the repeated sales of properties forfeited to them as lien holders constituted ordinary income as a dealer in real estate.
The court found that the taxpayers’ intent was not to hold onto the properties for appreciation in value but rather to sell the properties quickly to recover their investment costs and/or to make a profit. Although the sales of real estate may not have been the primary source of taxpayer income (with the main goal that the tax liens be repaid), the court found the sales of these real properties were integral components in their respective trades or businesses, permitting them to profit from both the acquisition of the certificates of purchase of tax lien and the sales of properties if those certificates were not redeemed. The court also supported its dealer determination based on the the regular sales as well as the fact that the taxpayers had employees act for and on behalf of their businesses in acquiring tax deeds, preparing the properties for sale, and maintaining accounting and other records in the course of their trades or businesses.
In a new Action on Decision (AOD 2015-10), the IRS stated that it will not follow the Tax Court’s 2004 Martinez decision, which had allowed a general partner to exclude cancellation of debt (COD) income from a partnership in bankruptcy. Mr. Martinez was a general partner who guaranteed the partnership’s debt, and the bankruptcy court entered a court order approving a contribution by Mr. Martinez to partially fund the partnership’s liabilities. The Tax Court Memorandum decision relied on the Section 108 bankruptcy exclusion for not imposing tax on the partner’s COD income. Although the statute applies the bankruptcy exclusion at the partner level, and the partner was not in personal bankruptcy, the court noted that the statutory text looked to whether the taxpayer was under the jurisdiction of the court that made the bankruptcy discharge. The court then held that Mr. Martinez was under such bankruptcy court jurisdiction since the bankruptcy court explicitly asserted its jurisdiction over Mr. Martinez through his status as a general partner and a guarantor on the partnership debt.
In its AOD, the IRS stated its litigation position that it will not follow the Tax Court Memorandum decision in this case as well as the related cases of Gracia, Mirarchi, and Price. The IRS’s position is that a partner must be under the jurisdiction of the bankruptcy court “as a debtor”, citing the structure of Section 108 as well as stating that the statutory intent is to give relief only to partners who are debtors in bankruptcy in their individual capacities and need a “fresh start.”
In CCA 201501013, the IRS found that an offshore fund making loans to U.S. borrowers was engaged in a U.S. trade or business where multiple loans owned by the fund were originated by an agent of the fund. This conclusion is consistent with an earlier 2009 memorandum that similarly found that the activities of agents were attributed to the lending company.
The discussion in the CCA puts foreign investors in loan funds on notice that the IRS intends to apply heightened scrutiny to these funds, where agents of the fund are involved in loan origination activities. If those activities are sufficiently extensive, the IRS is expected to contend that the portfolio interest exception (eliminating withholding taxes) and treaty rate reductions will not be available and the interest income will be subject to taxation in the U.S. at graduated income tax rates (i.e., effectively connected income, or “ECI”).
- Increased Risk of IRS Audit. In the CCA, the IRS has encouraged its agents to pursue on audit the issue of whether the lending activities of an offshore fund constitute a U.S. trade or business taxable as ECI and to obtain guidance from the IRS National Office to assist in case development. Although the facts in the CCA did not appear to include common “seasoning” of loans by another party, this is likely to be an area of focus for U.S. tax auditors.
- Protective Tax Return Filing. An offshore fund that raises capital from foreign persons to acquire interests in loans to U.S. borrowers typically tries to operate so as to avoid U.S. trade or business treatment and, as a result, does not file U.S. income tax returns. This means that the statute of limitations for assessment does not run. Further, where the foreign fund or its partners are treated as corporations under U.S. tax law, the IRS can disallow any deductions related to the fund’s income, unless an IRS Form 1120-F is filed within 18 months of the due date of the normal annual corporate return. See Treasury Regulation 1.882-4(a)(3). To protect against the loss of all deductions where there is an ECI risk, foreign entities taxed in the U.S. as corporations should consider filing protective U.S. corporate income tax returns, which also starts the running of the statute of limitations.
The CCA also offers a detailed analysis to support the IRS conclusion that the lending and underwriting activities of the foreign fund did not qualify under the exception for “trading in stocks or securities” under Code Section 864(b).
In the annual ritual of last minute legislative action, the Senate has passed the renewal of nearly all of the so-called Extenders legislation by a vote of 76 to 16, which will make the tax incentives applicable to calendar year 2014 if signed by the President. As is all too common, the Tax Increase Prevention Act of 2014 (H.R. 5771), merely resurrects provisions that expired January 1, 2014, but which will again expire on January 1, 2015. The bill includes popular incentives in areas such as affordable housing, conservation contributions, charitable contributions using IRA funds, “new markets” tax credit, “bonus” depreciation , faster leasehold improvement depreciation, small business stock, and various renewable energy incentives. This one-year extension is costly, at $41.6 billion over 10 years according to the JCT. Excerpts from the CRS summary are below.
Subtitle B: Business Tax Extenders – Extends through 2014:
- the tax credit for increasing research activities;
- the low-income housing tax credit rate for newly constructed non-federally subsidized buildings;
- the Indian employment tax credit;
- the new markets tax credit; the tax credit for qualified railroad track maintenance expenditures;
- the tax credit for mine rescue team training expenses;
- the tax credit for differential wage payments to employees who are active duty members of the Uniformed Services;
- the work opportunity tax credit;
- authority for issuance of qualified zone academy bonds;
- the classification of race horses as three-year property for depreciation purposes;
- accelerated depreciation of qualified leasehold improvement, restaurant, and retail improvement property, of motorsports entertainment complexes, and of business property on Indian reservations;
- accelerated depreciation of certain business property (bonus depreciation);
- the special rule allowing a tax deduction for charitable contributions of food inventory by taxpayers other than C corporations;
- the increased expensing allowance for business assets, computer software, and qualified real property (i.e., leasehold improvement, restaurant, and retail improvement property);
- the election to expense advanced mine safety equipment expenditures;
- the expensing allowance for film and television production costs and costs of live theatrical productions;
- the tax deduction for income attributable to domestic production activities in Puerto Rico;
- tax rules relating to payments between related foreign corporations and dividends of regulated investment companies;
- the treatment of regulated investment companies as qualified investment entities for purposes of the Foreign Investment in Real Property Tax Act (FIRPTA);
- the subpart F income exemption for income derived in the active conduct of a banking, financing, or insurance business;
- the tax rule exempting dividends, interest, rents, and royalties received or accrued from certain controlled foreign corporations by a related entity from treatment as foreign holding company income;
- the 100% exclusion from gross income of gain from the sale of small business stock;
- the basis adjustment rule for stock of an S corporation making charitable contributions of property;
- the reduction of the recognition period for the built-in gains of S corporations;
- tax incentives for investment in empowerment zones;
- the increased level of distilled spirit excise tax payments into the treasuries of Puerto Rico and the Virgin Islands; and
- the tax credit for American Samoa economic development expenditures.
Amends the Housing Assistance Tax Act of 2008 to extend through 2014 the exemption of the basic military housing allowance from the income test for programs financed by tax-exempt housing bonds.
Subtitle C: Energy Tax Extenders – Extends through 2014:
- the tax credit for residential energy efficiency improvements;
- the tax credit for second generation biofuel production;
- the income and excise tax credits for biodiesel and renewable diesel fuel mixtures;
- the tax credit for producing electricity using Indian coal facilities placed in service before 2009;
- the tax credit for producing electricity using wind, biomass, geothermal, landfill gas, trash, hydropower, and marine and hydrokinetic renewable energy facilities;
- the tax credit for energy efficient new homes;
- the special depreciation allowance for second generation biofuel plant property;
- the tax deduction for energy efficient commercial buildings;
- tax deferral rules for sales or dispositions of qualified electric utilities; and
- the excise tax credit for alternative fuels and fuels involving liquefied hydrogen.
Subtitle D: Extenders Relating to Multiemployer Defined Benefit Pension Plans – Extends through 2015 the automatic extensions of amortization periods for multiemployer defined benefit pension plans and for multiemployer funding rules under the Pension Protection Act of 2006.
In Mingo v. Comm’r the 5th Circuit upheld a Tax Court decision and denied installment sale treatment to the extent the partnership interest sold related to underlying unrealized receivables. The taxpayer sold its interest in a service partnership for an installment note. The court denied installment sale treatment to the extent that the purchase price related to customer receivables inside the partnership. The 5th Circuit court concluded that if the underlying receivables had been sold directly, they would not have qualified for installment sale treatment. The court then applied an aggregate treatment to the partnership based on the notion that since the unrealized receivables were so-called “hot assets” under Section 751, the court could then extend Section 751 look-through principles to the installment sale area. The IRS has made such arguments before, but now the Tax Court and 5th Circuit agree. Although there has been some disagreement in the bar with the IRS’s extrapolation of Section 751 principles in this way, the Mingo case gives the IRS something to point to beyond its own rulings. The case further gave the IRS a win by using the concept of a Section 481 adjustment to push the adjustment through even though the underlying tax year was closed.
In reversing the Tax Court, the 11th Circuit in Long v. Comm’r allowed a real estate developer favorable capital gain treatment upon the sale of its rights to a land purchase contract for a condominium development, even though sale of the condo units themselves would have been ordinary income.
The taxpayer originally had a contract to buy land that it was going to use to develop luxury condominiums. When the seller backed out, the taxpayer sued for specific performance and won. While the seller was appealing the decision, the taxpayer sold its position in the litigation and reported capital gain on the sale. The IRS disagreed and said the income should be ordinary income under the “substitution for ordinary income doctrine” (since the taxpayer would have recognized ordinary income had it actually developed the condominium and sold individual condo units). The taxpayer disagreed.
The Tax Court concluded that the income should be ordinary because the taxpayer would have ultimately recognized ordinary income had it been able to complete its original plan to sell condos. In reversing the Tax Court, the 11th Circuit Court of Appeals concluded that the Tax Court erred in not recognizing that the taxpayer never owned the land, but merely had a contract to acquire land. The court observed that the taxpayer never entered into the land purchase contract with an intent to sell that contract right in the ordinary course of business. Rather, the taxpayer had always intended to fulfill the terms of the contract and develop the project itself. Further the court found that the “substitute for ordinary income doctrine” did not apply since receipt of the lump sum payment for the taxpayer’s lawsuit rights was not a substitute for ordinary income that was already earned. Instead the taxpayer was selling a right to develop the condo.