Teaching Team Roger A. McEowen CALT Director mceowen@iastate.edu - - PDF document

8/4/2015 1

CALT SUMMER SEMINAR OLYMPIC VALLEY, CA JULY 30-31, 2015

Center for Agricultural Law and Taxation

Teaching Team

• Roger A. McEowen

– CALT Director – mceowen@iastate.edu – www.it.iastate.edu – @CALT_IowaState

• Christopher Hesse

– Principal in Agribusiness Group, CliftonLarsonAllen, CPAs

• chris.hesse@claconnect.com
• Kristy S. Maitre

– CALT Tax Specialist and formerly with IRS

• Stephanie A. Hathaway

– International Tax Partner, Moss Adams LLP

• Michelle Van Dellen

– Senior Manager, Moss Adams LLP

8/4/2015 2

Tax Increase Prevention Act of 2014

• Contained the ABLE Act of 2014

– Created I.R.C. §529A

• Accounts can be established for a person receiving (or is

eligible to receive) SSI and Medicaid based on a disability that began before age 26.

– Maximum $14,000 annual contribution – Grows tax‐deferred – If distributions used for qualified expenses, not included in income – Amounts in an ABLE account don’t count as eligible resources up to $100,000 » The excess is a “resource” for SSI purposes, but no Medicaid

Other Tax “Happenings”

• Efforts to amend or eliminate I.R.C. §1031

– Will it happen?

• Tax Increase Prevention Act of 2014

– Signed into law on 12/19/14

• Provisions only effective until the end of 2014
• Contained the provision allowing taxpayers over age 70.5 to

have up to $100,000 of their IRA paid directly to charity without the amount included in income (but no charitable deduction allowed for it)

– Important tool because charitable deduction may not offset RMDs included in income due to limitations on charitable deductions and Pease phase‐out of itemized deductions

Tax Legislation

• When will it happen?

– Probably an extender bill late in 2015. – But, on July 21, the SFC passed a tax extenders bill that would extend currently expired provisions for 2 years (through 2016)

• First‐year 50% bonus depreciation
• $500,000 for Sec. 179 (and $2 mill. limit on qualifying property)
• WOTC and inclusion of long‐term unemployed (40% on first $6,000 of

wages paid

• School teacher deduction
• Exclusion of income for qualified charitable contributions from IRA for

those over 70.5

• 15‐yr depr. for qualified leasehold improvements, qualified restaurant

buildings and improvements and qualified retail improvements

• 5‐year period for built‐in gains in a C corp. that has converted to an S

corp.

– When will full Senate vote? – What will the House do? They have wanted to make some provisions “permanent”

8/4/2015 3

New Legislation

• Trade Preferences Extension Act (signed into law on June

29, 2015)

– Increase in penalties for incorrect information returns, including those required by Obamacare

• Penalty for filing incorrect return (was $100, now $250)
• Penalty for incorrect returns if corrected within 30 days (was $30, now

$50)

• Penalty for incorrect returns if corrected by Aug. 1 (was $60, now

$100)

• Penalty for intentionally disregarding to file timely and correct returns

(was $250, now $500)

• Maximum penalty per calendar year (was $1.5 mill., now $3 mill.)
• Max. penalty per calendar year if corrected within 30 days (was

$250,000, now $500,000)

• Max. penalty per calendar year if corrected by Aug. 1 (was $500,000,

now $1.5 mill.)

Increased Penalties

• Obamacare

– Penalties not imposed on entities that show they made a good faith effort to comply with the reporting requirements for 2015

• An untimely filed return won’t meet the good faith

requirement

• Could still get penalty waived if failure due to

reasonable cause

Increased Penalties

• The increased penalties for incorrect forms are

applied with respect to each incorrect form

– Try to take advantage of the combined form reporting when possible

• Ex: employer may use one Form 1094‐C to transmit all

Forms 1095‐C rather than multiple Forms 1094‐C

– Remember, the larger penalties now exist for failures in reporting and the penalties apply to each incomplete or incorrect form.

• Ex: Intentionally incorrect information with respect to one

employee could trigger a $500 penalty for both the Form 1095‐C filed with IRS and the Form 1095‐C provided to the employee

8/4/2015 4

Tax Legislation

• What are the big issues?

– Depreciation

• Sec. 179
• Bonus

– Cash method of accounting

• Pending Tax Court case involving pre‐paid expenses

– Other issues???

When is Accrual Method Required? Background

• Cash method of accounting is allowed for all

farmers except:

– C corporations with more than $1 million of sales – Farm Family C corporations with more than $25 million in sales – Farm Syndicates – Farm Tax Shelter

8/4/2015 5

Farm Family Corporation

• If at least 50% of voting and value is owned by
• ne family
• Member of 2 families own at least 65%
• Members of 3 families own at least 50% and

rest is owned by pension plan (does not happen often)

Gross Receipts Test

• Once the corporation hits gross receipts of

$25 million, then it is required to convert to the accrual method of accounting

• Gross receipts is determinative

– Purchase items that are sold are valued at gross sales amount, not net margin

• Related party rules apply
• Section 481(a) spread over 10 years

Farm Syndicate & Tax Shelters

• Mandatory Accrual Accounting
• Applies is more than 35% of owners are limited entrepreneurs
• Five key exceptions

– Individual participated in farming for five years – Individual principal residence is on the farm – Individual actively participates in any farming business – Individual principal business is farming – Interest is held by member of family that is related to one

• f the previous four exceptions

8/4/2015 6

Farming Syndicate – “Active Participation”

• IRS view – the exception for active management
• nly applies to an “individual”

– CCA 200840042 (partnership interest held by S corporation with only one shareholder (individual) was to be treated as held by a limited partner for purposes of the farming syndicate rule)

• Burnett Ranches, Limited v. United States (5th Cir.

May 22, 2014)

– Ranch qualified for active participation exception even though majority owner actively participated in managing the cattle operation through the owner’s wholly‐owned S corporation

Partnership Rules Inapplicable to Determining Recourse/Non‐Recourse Status of Debt Outside

• f Subchapter K – CCM201525010
• When determining whether an LLC taxed as a

partnership has either CODI or gain from foreclosure of its property, Sec. 752 does not apply in determining the nature of the debt

– When taxpayer disposes of property that has more against it than what it is worth…

• If recourse debt, income up to FMV with excess being

CODI (which can likely be excluded under Sec. 108)

• If non‐recourse, full amount of non‐recourse debt is

eligible for l.t. capital gain, but no CODI

1‐2

Debt Discharge

• Johnston v. Comr., T.C. Memo. 2015‐91

– Although the creditor waited ten years to enforce collection of an outstanding loan, the taxpayer‐debtor did not receive cancellation of debt (COD) income. – Additionally, cancellation of debt income from a forgiven loan was excludable under the Code Sec. 108 insolvency exception. – Expiration of S.O.L. was not an identifiable event as to when debt has been discharged – Determine whether client insolvent – insolvency exemption

2‐3

8/4/2015 7

Character of Gain

• Fargo v. Comr., T.C. Memo. 2015‐96.

– Partnership acquired a leasehold interest in a property with the intent to develop an apartment complex and retail space. The lease originally ran for 20 years, but was extended for another 34 years. The property generated only rental income and no substantial effort to sell the property was made for 13 years. – The property was sold for $14.5 million plus a share of the profits from the homes that would ultimately be developed on the property. The partnership reported $628,222 of capital gain, but IRS took the position that the transaction triggered $7.5 million or ordinary income. The court agreed with the IRS. – The court determined that :

• Property initially acquired for developmental purposes
• Efforts to obtain financing and continue that development were made
• Sale was to an unrelated party with the plan for the petitioner to develop the

property

• Efforts continued to develop the property up until the purchase date.
• While there were some factors that favored the petitioner (only minor

improvements made; no prior sales; no advertising or marketing performed), the court held that the factors weighed in the favor of the IRS and the sale was in the

• rdinary course of business under I.R.C. Sec. 1221(a)(1).

6

Character of Gain

• SI Boo, LLC v. Comr., T.C. Memo. 2015‐19

– Ordinary income and s.e. tax triggered on sale of properties acquired by tax deeds

• Taxpayers regularly did this
• Although the taxpayers bought the tax liens primary to

profit from redemptions of the liens, the repeated sales

• f properties forfeited to them as lien holders

constituted ordinary income as a dealer in real estate.

– Persons employed to act on taxpayer’s behalf in acquiring tax deeds and preparing tracts for sale and maintaining business records

• Not reportable on installment method

6‐7

Character of Gain

• Allen v. United States (N.D. Cal. May 28, 2014)

– Sale of 2.63 acres of undeveloped land triggered

• rdinary income
• Taxpayers admitted they acquired the property for the

purpose of development

– Held by taxpayer primarily for sale to customers in the

• rdinary course of business

– Didn’t matter that the property was the only one bought for development – Taxpayers active in getting property developed

8

8/4/2015 8

Character of Bonus Payments

• Dudek v. Comr., T.C. Memo. 2013‐272

– Facts:

• Petitioner received $883,250 as up‐front bonus payment to allow oil

and gas company to lock‐up property for eventual lease. The payment was not dependent on any extraction or production of oil or gas

• Petitioner treated amount as long‐term capital gain and argued that

sale rather than lease involved.

• IRS claimed amount was ordinary income and assessed additional tax
• f $147,397 and imposed accuracy‐related penalty of $29,479
• Petitioner said that if IRS was right, he was entitled to a depletion

deduction.

– Holding:

• Court agreed with IRS and also disallowed a percentage depletion

deduction because no production had occurred ‐ no well drilled on property at time payment received; permanent easement not involved

• Accuracy‐related penalty upheld

– Affirmed on appeal.

7

The Dudek Case – Bonus Payment

• Tax Court

– Noted that U.S. Supremes had long ago ruled that the receipt of a bonus payment by a lessor is ordinary income

• Burnett v. Hamel, 287 U.S. 103 (1932)

– Lease vs. sale analysis

• The key is whether the lessor retains an economic interest in

the deposit. If so, it’s a lease and the proceeds are ordinary income

– Here, the petitioner was entitled to a royalty of 16 percent of the net profits of any oil or gas extracted. That gave the petitioner an economic interest in the minerals in place

The Dudek Case – Lease Bonus

• The depletion issue

– I.R.C. §613A(d)(5)

• A percentage depletion deduction for income from oil and gas wells

does not apply to “any lease bonus, advance royalty, or other amount payable without regard to production from the property”

– Petitioner’s bonus payment was paid to induce him to enter into the lease agreement and was not related to any extraction or production of oil and gas – Court noted, however, that bonus payments are eligible for cost depletion via Treas. Reg. §1.612‐3(a)(1), with the amount being dependent on the taxpayer’s basis for depletion, the amount of the bonus payment and the future royalties the taxpayer expects to receive.

• Here, petitioner didn’t have any evidence as to the amount of

royalties he expected to receive. Thus, cost depletion couldn’t be computed.

8/4/2015 9

Questions from Dudek

• How does a lessor establish a separate “basis”

for mineral rights when the land and minerals are purchased together in a single transaction?

– Many buyers don’t allocate cost basis to mineral rights when they are acquired in the same transaction with the land – This could create a big problem!

To Exclude Gain On Sale of Home…Try Living in It

• Villegas v. Comr., T.C. Memo. 2015‐33

– Home used as a group home for disabled persons and taxpayers lived elsewhere – Group home sold for $600,000 and taxpayers used

• Sec. 121 exclusion
• Not available because house not used as a principal

residence

9

Parsonage Exclusion Survives

• Freedom From Religion Foundation, Inc. v.

Lew (7th Cir. Nov. 13, 2014)

– Exclusion of Sec. 107(2) is constitutional

• Excludes from gross income a minister’s rental

allowance paid to the minister as part of compensation for a home that the minister owns

– Sec. 107(1) not implicated

• Church can provide a minister with a parsonage and

exclude from the minister’s income the rental value of the parsonage provided as part of the minister’s compensation

9

8/4/2015 10

Reporting of Installment Gain

• Debough v. Comr., 142 T.C. No. 17 (2014)

– Facts:

• Taxpayer bought personal residence in 1966 along with 80

acres of mixed use land for $25,000. He agreed to sell it in 2006 for $1.4 million with the amount to be paid in installments through 2014.

• Gain of $657,796 reported
• $505,000 in payments reported on installment method

consisting of $56,920 of gain

• Buyers defaulted and property reacquired in 2009.
• Taxpayer treated reacquisition under I.R.C. §1038 such that

he wouldn’t have to report the portion of the gain that was previously excluded under I.R.C. §121

• IRS claimed that taxpayer should recognize long‐term capital

gain in 2009 when property reacquired

10

I.R.C. §1038

• If the sale of real property triggers indebtedness

to the seller with the debt being secured by the property that is sold and the seller reacquires the property in partial or full satisfaction of the debt, generally the reacquisition does not result in gain

• r loss to the seller and the debt does not

become worthless (even partially).

– The rule bars a taxpayer from claiming any loss on

• reacquisition. But, an exception exists where a

principal residence is repossessed and resold within one year.

Major Exception to I.R.C. §1038

• If the seller has received cash payment, I.R.C.

§1038 taxes the seller on the gain attributable to those payments to the extent these amounts have not previously been reported as income. I.R.C. §1038(b)(1).

• I.R.C. §1038(e)

– With respect to Sec. 121, taxpayers that reacquire the property and sell it within one year can treat the subsequent sale as the original sale for I.R.C. §121 purposes

• No application in this case

8/4/2015 11

Debough

• Court held that transaction fit squarely under

I.R.C. §1038 and that taxpayer must report the gain

– I.R.C. §1038 does not contain any provision to allow taxpayers to exclude I.R.C. §121 gain resulting from a sale and subsequent reacquisition

• f a principal residence because they didn’t re‐sell

it within one year.

Note on Debough

• Upon reacquisition of the residence, the taxpayer

would still be required to meet the two‐out‐of‐ five year ownership and use test.

– That could be difficult to satisfy in many reacquisition settings, unless the taxpayer moves back into the

• residence. If the test isn’t met, the taxpayer might be

able to satisfy the requirements for a reduced exclusion. – Also, the reacquisition would cause an increase the basis of the residence to the extent of the gain recognized on repossession which, in turn, would result in less gain on resale.

Your Son, the Lawyer, Should Not Be Your Exchange Facilitator

• Blangiardo v. Comr., T.C. Memo. 2014‐10

– Taxpayer bought property for $488,000 and then dumped wife. She gives up all rights for $500,000. – Taxpayer remarries and dumps her. She gives up all rights for $80,000 – Property sold for $2.25 million in a purported Sec. 1031 exchange using his son as the Q.I. in a transaction where he bought a $1.43 million property – Taxpayer gets a $1.512 taxable gain

• Amount paid to dumpees did not impact taxpayer’s basis

11

8/4/2015 12

IRS Wins the Down, But Loses the Game

• Starke v. Comr., T.C. Sum. Op. 2015‐40

– “Head Hog” offensive lineman co‐founded business and later took over fund‐raising

• Received base salary and business credit card for expenses

which were treated as advances for future wages or business expenses

• Co. started withholding from salary for purpose of paying

back advances

• He resigned when balance due on credit card was $83k

– IRS said this was a taxable advance in the year of retirement and not a loan – Court agreed » But, it was taxable in years received – which were out of statute unless a substantial understatement of tax was involved (IRS gets 6 years for that as well as if fraud involved). See T.D. 9466 (9/25/09)

• Left off 25% or more of gross income

12

Too Much Control Over Trusts

• Webber v. Comr., 144 T.C. No. 171 (2015)

– Insurer set up two variable life policies on relatives where there was no fixed premium and no fixed benefit

• Taxpayer puts up $700,000 to buy the policies via a

grantor trust

• Cash invested in hedge funds and privately owned

companies (of the taxpayer!)

– Not income to taxpayer if he doesn’t direct the investments » He did

12

Charitable Contributions – Do it Right!

• Kunkel v. Comr., T.C. Memo. 2015‐71

– Clothing and household items donated to charities with an attempt to keep the individual gifts at a value under $250 because taxpayer thought he didn’t need a contemporaneous acknowledgement for those – For contributions over $500, no records maintained – No appraisal for gifts over $5,000 – Deduction fully denied and 20 percent penalty imposed

16

8/4/2015 13

Sure Way to Blow A Conservation Easement Deduction

• Balsam Mountain Investments (T.C. Memo.

2015‐43)

– Retained right to change property boundary means it’s not a “qualified real property interest”

• Belk (4th Cir. Dec. 16, 2014) [page 18]

– Right to swap land subject to the easement

• Violates perpetuity requirement

16

No Deductions (except COGS) For “Pot” Facility

• Olive v. Comr., 9th Cir. Jul. 9, 2015

– Sec. 280E says no deduction for expenses incurred by medical marijuana facility even if operating in a state where such activity is legal

• Medicinal marijuana legal in 15 states

– Can deduct COGS – Here the only business activity was selling marijuana

• Other activities were not conducted with profit intent

22

No Deductions If No Profit Intent

• Shah v . Comr., T.C. Memo. 2015‐31

– Computer consulting services provided to family members without charged

• Not engaged in with profit intent, so no deduction for

associated expenses

23

8/4/2015 14

Must Be “Away From Home” To Deduct Traveling Expenses

• Jacobs v. Comr., T.C. Sum. Op. 2015‐3

– Long‐haul truck driver paid on a per‐mile basis and claimed deductions for meals and lodging while traveling

• Nope – never paid any household expenses or used the

“home” address for voter registration purposes

• Any use of “home” was for taxpayer’s convenience only

24‐25

Counting Travel Days

• Van Malssen v. Comr., T.C. Memo. 2014‐236

– Tax loss on vacation home rental limited because of excess personal use days – Under §280A(c)(5), when a taxpayer rents a dwelling unit to others but also uses it a residence during the same year, the deductions attributable to the rental use cannot exceed gross rental

• income. Under §280A(d)(1), a dwelling unit is considered a residence if the taxpayer uses it for

personal purposes for a number of days exceeding the greater of:

• (1) 14 days; or
• (2) 10% of the number of days during the year for which the unit is rented at a fair rental value.

– Under Code Sec. 280A(d)(2), if a taxpayer uses a dwelling unit for personal purposes for any part of a day, that day is counted as a personal use day. But if the taxpayer is engaged in repair and maintenance of the residence on a substantially full‐time basis for any day, that day is not considered a personal use day. Any personal use by a qualifying relative is imputed to the taxpayer. – Even if a taxpayer avoids having a dwelling classified as a residence, Code Sec. 280A(e) requires a taxpayer who uses the dwelling unit for personal purposes for even a single day during the tax year to limit his or her deduction for any rental activity by allocating expenses between personal uses days and rental use days. Days spent performing repairs and maintenance are disregarded when making the allocation.

• Issue is what any particular trip was for

– If repair and maintenance, first and last day of trip are business days – If combination of business and personal, then what predominates – Relative’s days counted as personal use days – Some of IRS assertions successfully countered.

27

Alleged Business Deductions – Down

• n the Farm
• Meinhardt v. Comr., T.C. Memo. 2013‐90

– Petitioners occasionally stayed at their Minnesota farmhouse, and let family and friends stay in the place rent‐free (or maybe in exchange for services like repairs, but never reported income nor kept records). – They rented out the 140 acres of farmland for cash, and tried to deduct the farmhouse expenses.

28

8/4/2015 15

Meinhardt

• No deductions allowed

– The rental of the land is separate from the farmhouse – Petitioners did no farming, and reported the rental income

• n Schedule E rather than Schedule F

– Petitioners couldn’t show any affirmative act whereby they discontinued personal use (including family use) and devoted the farmhouse to use in a trade or business, or for production of income. Thus, no deduction under I.R.C.

• Sec. 212
• Even if there was never any use of the property as a residence

there still must be some affirmative act appropriating the property for the production of income.

– No rental real estate business.

• No deduction under IRC §162

– On appeal, 8th Cir. affirmed

Zeroing‐Out C Corp. Income Via Bonus Didn’t Work

• Vanney Associates, Inc. v. Comr., T.C. Memo. 2014‐184

– Often, the strategy is to have C Corps avoid paying corporation income tax by “zeroing out” the C Corp’s taxable income by issuing a W‐2 bonus to its corporate shareholders who are also employees.

• It is not uncommon for the C Corporation to then “book” a loan

back to the C Corporation for these shareholders – so that no actual cash changes hands in what is typically structured as a year‐ end transaction.

– Be careful of reasonable comp issues and dividend issues – …and, make sure that year‐end bonus check can be honored if presented for payment at a bank » Must have sufficient funds at time bonus paid » Court disallowed entire amount of check as officer compensation even though a large part of it could have been paid. 28‐29

Building Can Be “Placed in Service” Before Store in Building Open For Business

• Stine, LLC v. United States (W.D. La. Jan. 27,

2015)

– “The building is placed in service when it is substantially complete, meaning in a condition of readiness and availability to perform the function for which it was built.”

• “Even though the government adamantly suggests that

the buildings were placed in service when they opened their doors for business, the government has failed to cite any authority whatsoever to show that ‘placed in service’ equates to ‘open for business”

33

8/4/2015 16

IRS Tells Veteran To Work Faster; Court Tells IRS, “Not So Fast”

• Lewis v. Comr., T.C. Sum. Op. 2014‐112

– Taxpayer was a disabled vet who owned a rental property adjoining his home

• Losses sustained on rental property that were

deducted

• IRS denied deduction on basis that taxpayer was not a

real estate professional – didn’t meet the 750 hour test

– Claimed the only way he got over the 750 hour threshold was because he worked too slow

• Court allowed the deduction

37‐38

Self‐Rental Rule Can Work To Avoid Sec. 1411, But It Can Also Work Against the Taxpayer

• Schumann v. Comr., T.C. Memo. 2014‐138

– Taxpayer was the president and majority shareholder

• f a number of businesses
• Did not qualify as a real estate professional for either of two

years at issue.

– The Court determined that:

• The rental income that he received for the use of two

properties that he owned by two of his businesses was subject to the self‐rental rules (because the taxpayer was materially participating in the business) and therefore considered non‐passive income that could not be offset by passive losses stemming from other properties

38‐39

No Deduction For Rental Expense or Loss on Sale

• Redisch v. Comr., T.C. Memo. 2015‐95

– Taxpayers bought land with intent of building seasonal residence. They later converted it to a rental property, but it was never rented. – Property sold at a loss – No deduction for loss because it wasn’t converted to a rental before the sale

• Multi‐factors

45

8/4/2015 17

Losses on Abandonment of Securities

• Pilgrim’s Pride Corp. v. Comr., (5th Cir. Feb. 25,

2015)

– Case arose before regulations issued that now treat losses from abandoned securities as worthless securities losses under Sec. 165(g) which makes them capital losses – Importance of court’s decision today?

• Partnership interests

– Like stock, contain inherent rights in management, profits, and assets and are generally capital assets – Sec. 1234 may not apply (based on the 5th Circuit’s opinion) » Can still claim ordinary loss for abandonment of partnership interests in certain situations, provided there is no relief from partnership liabilities 48

First Time Homebuyer Credit Cases

• Pittman – must actually own the home or at least

have some equity in it

• Wodack – home purchased in 1993 under installment

contract and had equitable interest at that time.

• Sullivan – no credit if interest in home acquired as

incident to divorce and got a carry‐over basis

• Oxford – trailer not a principal residence
• Leslie – date of purchase is key for existing homes; it’s

when occupancy is established for constructed homes

• Douglas – spouse still had interest in old home

(benefits and burdens)

50‐52

AOTC – Pay Tuition in the Correct Year

• Ferm v. Comr., T.C. Sum. Op. 2014‐115

– Student enrolled in college in fall of 2010 and was billed $2,113.16 for spring semester of 2011. Taxpayer paid the amount on Dec. 28, 2010 – Taxpayer filed 2011 return claiming the AOTC and IRS disallowed the credit for the amounts paid in 2010

• Court agreed – statute says the credit can only be

claimed for payments made in same year the academic period begins

• Pre‐payment statute inapplicable (applied for 2010, but

taxpayer claimed AOTC on 2011 return)

52

8/4/2015 18

Small Partnerships – Don’t Be Fooled

• If a partnership has 10 or fewer partners, it’s

not a partnership for TEFRA purposes

– Can possibly escape the penalty for not filing a partnership return – The exception doesn’t mean that the entity is not a partnership for tax purposes. IT IS!

• Brumbaugh, et al. v. Comr., T.C. Memo. 2015‐65
• CCA 201510046

54

Bank Immediately Liable Upon Notice

• f IRS Levy
• United States v. JPMorgan Chase Bank, NA

(C.D. Cal. Aug. 15, 2014)

– IRS interest in delinquent taxpayer’s account vests immediately on issuance of levy and property subject to levy must be surrendered.

• If not surrendered, bank is personally liable for debtor’s

tax bill

58‐59

Form 1099 and Freight Services

• Form 1099 is not required for freight services

– Applies to farmers that make payments in connection with trucking or hauling of livestock, grain or other farm products

• CCM 20151002F

64

8/4/2015 19

No Alimony Deduction for Garnished Wages

• Iglicki v. Comr., T.C. Memo. 2015‐80

– Taxpayer had amounts garnished from paycheck to satisfy separation agreement with ex‐wife to pay child support he had defaulted on

• Payments not terminated on death of either payor or

payee

• No alimony deduction

67

Medical Issues Not Enough To Avoid Penalty Tax on IRA Rollover

• U.I.L. 201523025 (Mar. 13, 2015)

– Distribution from IRA, then a work‐related injury which put taxpayer on medical leave

• Leave period expired after 60‐day IRA rollover period
• Taxpayer also caring for disabled wife

– No relief from 60‐day rule – No return of funds for more than 6 months after 60‐day period expired

• It was basically a short‐term, interest‐free loan used to

pay personal expenses

70

Investment in Oil and Gas Activity Triggered S.E. Tax

• Methvin v. Comr., T.C. Memo. 2015‐81

– Taxpayer invested in oil and gas interests – Normally, investment income would not be s.e. taxable, but court said that the operating agreement created a partnership and generated partnership income

• S.E. tax applied even though the taxpayer took no part

in management or operation of the ventures

74

8/4/2015 20

2014 Farm Bill

Chris Hesse

2014 Farm Bill

• AGI Limits
• Payment Limits
• Additional spousal limits
• Additional limits from Crop Sharing
• Entity Planning

– CRP – Farm Programs

AGI Limits

• Old Farm Bill had three AGI limits

– $500,000 non‐farm income – $750,000 farm income – $1 million for conservation programs

• New Farm Bill replaces with one overall $900,000

limit for all programs

• Based on trailing three year average (2014 based
• n 2010‐2012 average).
• S corporations and LLCs taxed as partnerships do

not include Sch. K deductions (179)

4

8/4/2015 21

AGI Limits (continued)

• Short‐year calculations

– According to FSA, need to recalculate years based

• n new “year‐end”
• Example – Assume C corporation changes

from October 31 to December 31. In the year that December 31 takes hold, then prior three year average must be on December 31 year‐end (even if no tax return of FS was prepared)

Worksheet for AGI Limitations

Client Name Determination year: 2014 2010 2011 2012 Average AGI Limitations Worksheet Per Tax Per Tax Per Tax Return Return Return Form 1040; AGI equals Form 1040, Line 37 Wages Interest income Dividend income Schedule C Schedule D Other gains, Form 4797 Pensions, annuities Schedule E, page 1 Schedule F K‐1 ordinary Social security Other income NOL HSA 1/2 SE tax Retirement plans SE health insurance IRA DPAD Other adjustments Form 1040, Line 37 ‐ ‐ ‐ Client Name Average AGI Limitations Worksheet 2014 Calculations Section Average Adjusted Gross Income ‐ CCC‐941 Questions If the result of Step A is greater than $900,000, the participant is ineligible for 2014 program payments no

6

Payment Limits

• Farm programs now have one $125,000 limit

per entity/person

– Entity level first, then to owners to four levels – Partnerships and joint‐ventures have no limit

• CRP retains the old $50,000 limit
• EQIP and other conservation programs have

various annual/total limits

1

8/4/2015 22

Payment Limitation Illustration

1

Attribution Limitation Illustration

2

Additional Spousal Limits

• A spouse with ownership in farm ground, etc.

is automatically allowed an additional $125,000 limit

– Needs to be signed up with FSA – Has separate AGI calculations – Husband/Wife LL(E) has only one $125,000 limit

8/4/2015 23

Crop Sharing Options

• Crop‐share landlords are considered

producers and can share in payments

– Farmer Entity is Tenant Farmer – Farmer (land holdings entity) is landlord – Results in additional limits

Crop‐Share Limit Planning Illustration

Entity Planning

• CRP

– For married couples, need to maintain joint

• wnership to maximize $100,000 limit (2 $50,000

limits)

• Farm Programs

– If operation is fairly small, then about any entity will work – If medium or larger size operation, need to maintain partnership or joint venture structure

8/4/2015 24

Medium/Large Operation Example

• Partnership structure for farm operating entity

– Each partner may be single member LLC to preserve liability protection – To maximize SE tax savings may have two husband/wife LLCs as partners (creates two more tax returns)

• Utilize crop‐share arrangement to create

additional limit(s) if needed

• Be careful of attribution of limits

Time For A Break!

• Morning Break

– 9:45 – 10:05 a.m.

Obamacare Employer Requirements

Roger A. McEowen and Kristy S. Maitre

1

8/4/2015 25

Market Reforms

• The ACA introduced a number of “market

reforms” to the health insurance market.

• These reforms create federal minimum

requirements with respect to access to coverage, premiums, benefits, cost‐sharing, and consumer protections.

• The reforms do not apply uniformly to all private

insurance market segments: non‐group, small group, large group, grandfathered.

1

Market Reforms: Non‐Grandfathered

• All non‐grandfathered health plans are subject to

the following market reforms:

– Nondiscrimination based upon health status. – Dependent coverage through 26 – Prohibition on rescissions – No cost sharing for preventive health services – Coverage of pre‐existing health conditions – Cost sharing limits – Prohibition on annual and lifetime dollar limits on essential health benefits

1

Small Group Market Reforms

“Essential Health Benefits” must be offered only by:

• Small group market (not self insured)
• Individual market
• These benefits include:

– Ambulatory services – Emergency services – Hospitalization coverage – Maternity and newborn care

1‐2

8/4/2015 26

Cost‐Sharing Requirements

• All new insurance plans are subject to annual out‐of

pocket spending limits for in‐network coverage of essential health benefits. ($6,350‐self and $12,700‐ family).

• Small group (not self‐insured) and individual market

insurance must meet minimum actuarial value

• calculations. (defined at 60%)
• Large group policies provide “minimum value,” which is

also defined as 60 percent of actuarial value.

• AV Calculator and Minimum Value Calculators are

found at: www.cms.gov.

2

Communication Requirements

• All employers offering health plans must

provide a summary of benefits and coverage (not exceeding four pages in length):

– At application time – Prior to time of enrollment or reenrollment – When insurance policy is issued

• Notice of material changes
• Marketplace notice at time of hire
• Notice of choice of physician

Grandfathered Plans

• Plans in existence when ACA enacted (March

23, 2010) are exempt from certain requirements:

– Nondiscrimination based on health status – No cost sharing for preventive Health services – Cost sharing limits

3

8/4/2015 27

Grandfathered Plans

• Grandfathered Plans are still subject to:

– Prohibition on lifetime limits – Prohibition on annual limits (group market only) – Summary of benefits and coverage – Coverage of preexisting health conditions – Dependent coverage until 26 years – Prohibitions on arbitrary rescission

Grandfathered Plans

• Plans lose their status as grandfathered plans

is they are changed in ways that “substantially cut benefits or increase costs for consumers.”

• The majority of grandfathered plans are no

longer in existence (especially in large group market).

Transitional Policy (“If you like your plan…”)

• Market reforms were effective January 1,

2014.

• Centers for Medicare and Medicaid have

extended “transitional policy.”

– Non‐grandfathered policies that would otherwise be cancelled can continue until October 1, 2016. – State insurance commissioners choose whether to enforce compliance with reforms.

3

8/4/2015 28

Big Penalties

• Failure to comply with ACA requirements

subjects violators to an “excise tax”

• $100 per day per violation per person to

whom the failure related.

• Employers must “self report” on Form 8928.
• Violations corrected within 30 days that were

not due to “willful neglect” are exempt.

• May still be prudent to report corrected

violation.

3‐4

Form 8928

4

Employer Mandate

• Called “Pay or Play.”
• 1. “Applicable Large Employees”
• 2. Subject to “Shared Responsibility Payments”

unless they offer

• 3. “Adequate and affordable” insurance to their
• 4. Full‐time employees and their dependents.

4

8/4/2015 29

Applicable Large Employer

• Includes for‐profit, non‐profit, and government

entities

• Employed at least 50 full‐time equivalent

employees during the preceding calendar year.

– If 50‐99 FTEs, mandate starts in 2016 – If 100 or more FTEs, must offer coverage to at least 70% of full‐time employees in 2015 (95% in 2016)

• Related entities treated as single employer in

accordance with qualified retirement plan aggregation rules.

5

Full‐time Equivalent Employees

• Average at least 30 hours per week.
• Number of FTE employees for any month

determined by dividing the aggregate number of service hours of employees who are not full‐time for the month by 120.

• If employer had more than 50 employees for less

than 120 days per year because of “seasonal workers,” not Applicable Large Employer.

• Complex rules beyond scope of this presentation.

5

Enforcement Delayed

• Employers with 100 or more employees must
• ffer coverage to at least 70% of their eligible

employees by 2015 (increases to 95% by 2016).

• Enforcement of the mandate for employers

with 50‐99 eligible employees will begin in 2016.

5

8/4/2015 30

Penalty‐”Shared Responsibility Payment”

• Shared responsibility payments will be

assessed against applicable employers failing to provide coverage for full‐time employees when required. The penalty applies when:

– At least one employee receives a PTC because insurance is not offered OR – Insurance offered is “unaffordable or inadequate”

5

Penalty A

• A $2,000 per employee penalty will be

assessed for employers choosing to offer no coverage to their employees.

• The penalty is only assessed if one FT

employee receives a PTC through an exchange.

• For 2015, there is no penalty for the first 80

employees.

6

Example of Penalty A

• If Johnson, Inc. offered no coverage for its

employees, penalty in 2015 would be (100 employees – 80 employee exemption) = 20 x $2,000 = $40,000.

• In 2016, exemption drops to 30 and penalty

would be $2,000 x (100‐30) = $140,000.

8/4/2015 31

Penalty B

• If “unaffordable or inadequate” insurance is
• ffered, the penalty is $3,000 per employee,

but penalty many not exceed penalty that would have applied if no insurance had been

• ffered.

6‐7

Example of Penalty B

• Johnson, Inc. sponsors group plan for 100 FTE
• employees. Plan is not affordable to 40, who

receive PTC through state‐exchange.

• Shared Responsibility Payment = 40 x (1/12 x

3,000) = $120,000 (But remember that penalty cannot exceed penalty for not offering insurance at all).

Affordable

• Insurance is deemed to be affordable (safe

harbor) to any worker for whom the employee’s share of the premium does not exceed:

• 9.5 % of Box 1 wages
• 9.5% of lowest hourly wage x 130 hours /

month, or

• 9.5% of federal poverty level

6

8/4/2015 32

Adequate

• Insurance is adequate if it offers minimum value.
• Plan’s actuarial value (the share of total allowed

costs that the plan is expected to cover) is at least 60% (Bronze plan equivalent).

• An actuarial value calculator is available to

employers at hhs.gov.

• Calculations include employer contributions to

HSAs, HRAs offered in conjunction with a HDHP.

Reporting and Penalty Process

• In 2016, employers with 100 or more

employees will have to report their 2015 offer

• f minimum essential (minimum value)

coverage to both the IRS and their employees.

• Form 1095‐C must be filed by February 28,

2016, or March 31, 2016, if filed electronically.

• Details regarding that penalty assessment

process have not been finalized.

7

Single Employer Common Control Test

• Related entities may be treated as a single

employer for ACA purposes.

• A multiple entity farming structure whose

companies were established under separate tax IDs is treated as a single employer under the controlled group rules of IRC §414.

8

8/4/2015 33

Single Employer Common Control Test

• If two or more entities are owned by five or

fewer persons who own more than 50% of the total combine voting power or more than 50%

• f the stock value:

– An individual is deemed to own the stock of their spouse and minor children. – An individual who owns more than 50% of the voting power or stock value is considered to own the stock of their lineal descendants. – Ownership interests of siblings are not included.

Example

• Bob owns 65% of FarmCo and 50% or LandCo.

Bob’s daughter, Julia, owns 35% of FarmCo and 50% of LandCo.

• Because Bob owns more than 50% of FarmCo,

Julia’s ownership is attributed to him.

• As a result, Bob is deemed to own 100% of

FarmCo.

• However, because neither Bob nor Julia owns

more than 50% or LandCo, there is no attribution for that entity.

8

SMALL EMPLOYERS

8

8/4/2015 34

Small Employer Health Insurance

• Employers with < 50 employees are not

required to offer health insurance to their employees.

• If they do offer coverage, they must abide by

applicable market reforms.

8

Small Business Health Tax Credit

• Beginning in 2014, a small employer (< 25

employees) may claim up to a 50% credit for two consecutive years to offset the cost of providing insurance coverage to its employees.

• To be eligible, the employer must pay at least

50% of FTE’s premium costs.

• To receive the tax credit (as of 2014), the

employer must enroll in a plan through the Small Business Health Options Program (SHOP) marketplace (currently only available through a broker).

8‐9

Credit Phase‐outs

• Credit is subject to two separate Phase‐outs, one

based on number of employees and one based upon average wages of employees.

• Phase‐out one (number of FTEs):

– Full credit is only available if number of FTE employees does not exceed 10. – Credit is reduced if employer has between 11 and 24 FTEs. – Credit is unavailable once 25 FTEs is reached.

8/4/2015 35

Credit Phase‐out Two (Wages)

• The full amount of the credit is available if average

wages do not exceed $25,000.

• A reduced credit is available if average wages fall

between $25,000 and $50,000.

• The credit is unavailable if the average wages equal or

exceed $50,000. Because phase‐outs are applied separately to the gross amount of the credit, it is of limited assistance. (Employees can go to https://www.healthcare.gov/small‐ business‐tax‐credit‐calculator/ to estimate their SHOP tax credit.)

Form 8941

Uses a different calculation for FTE than that used for employee mandate. The following persons are not counted for credit purposes:

• Seasonal workers (<=120 days worked)
• Sole proprietors
• Partners
• Shareholders owning > 2% of S Corp.
• Owner of > 5 % of business
• Family members (includes in‐laws)

9

Form 8941

Average wages may be calculated under one of three different methods. A different method can be used for each employee (choose most advantageous):

• Actual paid hours of service worked (vacation,

holidays, etc.)

• Days‐worked equivalency (8 hours of service for

each workday, including vacations and holidays)

• Weeks‐worked Equivalency (credits 40 hours for

each week in which the employee is credited for at least one hour of service).

8/4/2015 36

Interplay Between Self‐Insured Deduction and PTC

• Self‐employed farmers can deduct the cost of

health insurance premiums when calculating AGI.

• Beginning in 2014, self‐employed persons may

also be eligible for PTC, based on AGI and family size.

• Because self‐employed health insurance

deduction is allowed in computing AGI and AGI is used in computing PTC, taxpayer must know the allowable self‐employed health insurance deduction to calculate PTC and know PTC to calculate deduction.

Interplay Between Self‐Insured Deduction and PTC, cont.

• IRS issued Rev. Proc. 2014‐41 to provide

calculation methods to resolve this circular relationship.

• The ruling provides two calculation methods:

an alternative and an iterative.

• Eligible self‐employed individuals can

recognize substantial savings from the addition of the PTC.

Example

• Bob and Sally are married with two children. They earn

$75,000 from their farming operation. They enrolled in a Marketplace plan with an annual premium of $14,000. In 2013, they were allowed to deduct the entire premium

• amount. In 2014, however, they can claim a lower deduction,

but also receive a PTC:

Year Calculation Tax Savings 2013 $14,000 × 25% $3,500 2014 ($6,000 × 25%) + $7,000 PTC 8,500

8/4/2015 37

Certification for Small Employers Section 4980H Transition Relief

• Check this box if either

– (1) 2015 Section 4980H Transition Relief for ALEs with Fewer Than 100 Full‐Time Employees, Including Full‐Time Equivalent Employees (50‐99 Transition Relief) or – (2) 2015 Transition Relief for Calculation of Assessable Payments Under Section 4980H(a) for ALEs with 100 or More Full‐Time Employees, Including Full‐Time Equivalent Employees (100 or More Transition Relief) apply

• If an employer checks this box, it must also complete

Form 1094‐C, Part III, column (e), Section 4980H Transition Relief Indicator, to indicate the type of section 4980H transition relief for which it is eligible.

Column (e) Section 4980H Transition Relief Indicator.

• If the employer certifies by selecting box D on

line 22, that it is eligible for Section 4980H Transition Relief and is eligible for the 50 to 99 Relief, enter code A.

• If the employer certifies by selecting box C on

line 22, that it is eligible for Section 4980H Transition Relief and is eligible for the 100 or More Relief, enter code B.

• An employer will not be eligible for both types of

relief.

2015 Section 4980H Transition Relief for ALEs with Fewer Than 100 Full‐Time Employees

• r Full Time Equivalent Employees
• The employer is an ALE or is part of an Aggregated ALE

Group that had 50 to 99 full‐time employees, including full‐time equivalent employees, on business days in 2014;

• During the period of February 9, 2014, through December

31, 2014, the ALE or the Aggregated ALE Group of which the employer is a member did not reduce the size of its workforce or reduce the overall hours of service of its employees in order to qualify for the transition relief; and

• During the period of February 9, 2014, through December

31, 2015, (or, if the employer has a non‐calendar‐year plan(s)), ending on the last day of the 2015 plan year) the ALE or Aggregated ALE Group of which the employer is a member does not eliminate or materially reduce the health coverage, if any, it offered as of February 9, 2014.

8/4/2015 38

Also Certification for 100 or more

• 2015 Transition Relief for Calculation of

Assessable Payments Under Section 4980H(a) for ALEs with 100 or More Full‐ Time Employees, Including Full‐Time Equivalent Employees (100 or More Transition Relief)

• Form 1095‐C check the instructions

Form 1094‐C

13 ‐ 17

HEALTH REIMBURSEMENT PLANS & THE ACA

8/4/2015 39

Employer Health Reimbursement Plans

Health Reimbursement Arrangements (HRAs): Authorized by §§105, 106, HRAs are employer‐ funded plans used to reimburse (tax‐free) employee medical expenses, including health insurance premiums. Medical Expense Reimbursement Plans (MERPS): Also allowed under §105, MERPs reimburse employee medical expenses, but unused amounts are not carried over to following years.

Other Employer Reimbursement Plans

• Healthcare Flexible Spending Accounts (FSAs)

(§125): Employers and employees (limited to $2,500) may contribute pre‐tax dollars to this plan through cafeteria plan, which will reimburse employee for medical expenses.

• Employer Payment Plans (§106): Employers

reimburse employees for substantiated premiums, and payments are excluded from income.

11

IRS Notice 2013‐54

• In this guidance, the IRS Treasury Department

and the Department of Labor clarified the significant impact the ACA has on healthcare reimbursement plans.

• These changes went into effect on January 1,

2014.

8/4/2015 40

IRS Notice 2013‐54

• Employer health reimbursement plans are

generally considered group health plans.

Group health plan is defined as “a plan of, or contributed to by, …an employer…to provide health care (directly or otherwise) to the employees or their families.” IRC §5000(b)(1)

• Group health plans (unless exempt) are subject to

ACA market reforms, in particular:

– No annual dollar limits on essential health benefits. – No cost‐sharing for preventive health services

12

Bottom Line: Because most standalone (not integrated with another group plan) employer health reimbursement plans impose limits on what they reimburse and because they do not ensure preventive services at no cost, they violate the market reforms (if not exempt). Offering such plans, beginning in 2014, subjects employers to stiff penalties (up to $100 per day per violation per employee ($36,500/year).

IRS Notice 2013‐54 IRS Q & A (May 2014)

8/4/2015 41

Excepted from Market Reforms

• The following types of reimbursement plans are

specifically excepted from ACA market reforms and are therefore still allowed:

– Plans with fewer than two persons who are current employees. – Plans that provide only excepted benefits, including:

• Accident‐only coverage
• Disability income
• Certain Long‐term care
• Certain limited scope dental and vision benefits
• Employee Assistance Program benefits

13

HRA Integration

Beginning January 1, 2014, an HRA must provide

• nly excepted benefits or be integrated with an

ACA‐compliant employer sponsored group health plan. HRA’s may not be integrated with a plan purchased on the Marketplace. They may, however, be integrated with an employer group plan purchased via SHOP.

13

New guidance on reimbursement arrangements

DOL ACA FAQ XXII, Q&A1 (Nov. 6, 2014)

• Employer reimbursement of premiums is not

allowed, “without regards to whether the employer treats the money as pre‐tax or after‐ tax to the employee.” A raise is allowed, but there can’t be any employer involvement with the insurance.

8/4/2015 42

New guidance on reimbursement arrangements

DOL ACA FAQ XXII, Q&A2

• Employers cannot offer “employees with high

claims risk” a cash option in lieu of enrollment in the employer group plan.

New guidance on reimbursement arrangements

DOL ACA FAQ XXII, Q&A3 “A vendor markets a product to employers claiming that employers can cancel their group policies, set up a Code section 105 reimbursement plan that works with health insurance brokers or agents to help employees select individual insurance policies, and allow eligible employees to access the premium tax credits for Marketplace coverage. Is this permissible? “No. The Departments have been informed that some vendors are marketing such products. However, these arrangements are problematic for several reasons.”

New guidance on reimbursement arrangements

DOL ACA FAQ XXII, Q&A3

• 1. The arrangements are considered group

plans, making participants ineligible for premium credits.

• 2. These arrangements are subject to the

Market Reforms, and cannot be integrated with individual policies to satisfy them.

8/4/2015 43

New guidance on reimbursement arrangements

DOL ACA FAQ XXII, Q&A3 (continued) “The mere fact that the employer does not get involved with an employee's individual selection or purchase of an individual health insurance policy does not prevent the arrangement from being a group health plan. DOL guidance indicates that the existence of a group health plan is based on many facts and circumstances, including the employer's involvement in the overall scheme and the absence

• f an unfettered right by the employee to receive

the employer contributions in cash.”

Acceptable Employer Health Reimbursement Plans

• Healthcare FSA coupled with an employer

group plan where maximum benefit does not exceed the greater of:

– 2 x employee’s salary reduction election for the year; or – $500 plus the amount of the participant’s salary reduction election

13

Acceptable Health Reimbursement Plans

• HRA integrated with employer group health

plan that is ACA‐compliant

– Two ways to do this…

8/4/2015 44

Integration Method One‐ No Minimum Value

An HRA will be considered integrated if the following conditions are met:

• Employer offers group health plan that does not consist of
• nly excepted benefits.
• Employee receiving HRA is enrolled in group plan that does

not consist of one offering only excepted benefits (could be another plan, such as spouse’s)

• HRA is available only to employees also enrolled in the non‐

HRA group coverage.

• HRA is limited to reimbursement of:

– Co‐payments, Co‐insurance – Deductibles, Premiums, Non‐essential health benefits

13

Integration Method Two – Minimum Value Required

An HRA may also be integrated with another group health plan if:

• Employer offers a group health plan that pays at

least 60% of the total cost of medical services.

• HRA‐covered employee is enrolled in group plan

providing minimum value (may be another provider).

• HRA is only available to employees enrolled in

minimum value group coverage.

• An employee may permanently opt out of and

waive reimbursements annually.

14

Health FSAs

• Under the Guidance, Health FSAs provide only

excepted benefits if:

– The employer offers other group health insurance coverage and the maximum benefit payable to an employee does not exceed the greater of two times the employee’s salary reduction election for the year, or $500, plus the amount of the participant’s salary reduction election.

8/4/2015 45

Health FSAs

• The guidance says that Health FSAs are group health
• plans. If the health FSA is not excepted, it is generally

subject to market reforms, including the preventive services without cost‐sharing requirements.

• If it is not integrated with another group health plan, it

will fail to meet this requirement, even if it only reimburses premiums.

• A §125 FSA is not subject to the annual dollar limit

prohibition because it is subject to a separate annual limitation under §125(i). FSA’s offered outside of §125 are subject to the annual dollar limit prohibition.

Impermissible Plans in 2014 Subject to $100/day Fine

• Standalone medical reimbursement plans or

HRAs.

• Employer payment plans under which

employee premiums for a non‐employer group plan are paid on a pre‐tax basis.

• Health FSAs and §125 health FSAs that are not

excepted.

Other Points

• An employer can contribute money to an

employee’s individual HSA

– However, unless the employer sets up the HDHP and an HSA to make the contribution payment, the contributions must be made on a post‐tax basis.

• Note:

– Parts of this limitation applied before the ACA to bar the plan from being subject to complex group rules (comparability, etc.)

8/4/2015 46

What About Sec. 125 Plans?

• To not be subject to the ACA “reforms,” a Sec.

125 plan must be offered in conjunction with employer‐sponsored group coverage.

– Notice 2013‐54 states:

• “Although a health FSA is a group health plan…it may be

considered to provide only excepted benefits if other group health plan coverage not limited to excepted benefits is made available for the year to employees by the employer, but only if the arrangement is structured so that the maximum benefit payable to any participant cannot exceed two times the participant’s salary reduction election for the arrangement for the year (or, if greater, cannot exceed $500 plus the amount of the participant’s salary reduction election)”

More on Health FSAs

• If an employer provides a health FSA that does

not qualify as excepted benefits, the health FSA generally is subject to the market reforms, including the preventative services requirements.

• Because a health FSA that is not excepted

benefits is not integrated with a group health plan, it will fail to meet the preventative services requirement

Present Controversy

• Some vendors have taken the position the

premium‐only plans that only allow the purchase

• f individual insurance NOT provided on the

marketplace or through a state exchange are

• kay.

– We do not feel comfortable with this approach. Our concern is that such reimbursement would be considered a group health plan subject to market reforms

• So, unless the Sec. 125 plan provides only excepted benefits

such as limited dental and vision, we do not believe Sec. 125 plans are a safe employer offering absent a group health plan

8/4/2015 47

Steps to Compliance

• As of late 2014 what were you supposed to do

about existing non‐compliant plans?

– Taxpayers are supposed to self‐report any penalties on Form 8928

• No tax due if failure not known on account of

reasonable diligence

• Reasonable cause and no willful neglect AND failure to

pay tax corrected during the 30‐day period beginning

• n the first date anyone liable for the tax knew or

exercising reasonable diligence would have known that failure existed

Steps to Compliance

• What a practitioner should do:

– Document efforts to notify clients of the problem – 30‐day window runs from time of notification – Have recommended solution for client

• Immediate termination of any non‐qualified plans and

notice to affected employees

• Any corrective plan must be completed in 30 days

Key Question

• Should you then report the violation on Form

8928?

– If you don’t report, it will be more difficult the claim the exemption if IRS discovers the problem

• n its own
• Will IRS be generous in allowing exemptions in

the first year of the problem?

– It’s never good to count on IRS generosity!

8/4/2015 48

DOL FAQ (11/6/2014)

• Q1: My employer offers employees cash to reimburse the

purchase of an individual market policy. Does this arrangement comply with the market reforms?

• No. If the employer uses an arrangement that provides cash

reimbursement for the purchase of an individual market policy, the employer's payment arrangement is part of a plan, fund, or other arrangement established or maintained for the purpose of providing medical care to employees, without regard to whether the employer treats the money as pre‐tax or post‐tax to the

• employee. Therefore, the arrangement is group health plan

coverage within the meaning of Code section 9832(a), Employee Retirement Income Security Act (ERISA) section 733(a) and PHS Act section 2791(a), and is subject to the market reform provisions of the Affordable Care Act applicable to group health plans. ..

What About 2% Shareholders?

• Can you reimburse S corp 2 percent

shareholder‐employees’ individual premiums

• r is that also subject to the market reforms?

– No excise tax through 2015 (so, no Form 8928)

• But, no application to reimbursement for non‐ 2%

shareholders

– Transitional relief through June 30, 2015 applies

– Rely on Notice 2008‐1 until further guidance issued

17

IRS Notice 2015‐17

• Guidance on the Sec. 4980 excise tax for violating

the market “reforms”

– Reimbursement of individual health care premiums to employees remains an improper employment plan

• But, transitional relief for small employers provided

– Don’t have to file Form 8928 and won’t have to pay excise tax through June 30, 2015 – Transitional relief applies to both Medicare Part B or Part D premiums and to reimbursements of individual health policy premiums – No transitional relief to small employers who offered stand‐alone HRAs or other medical reimbursement plans to their employees Article on p. 18

8/4/2015 49

Fewer Than 2 Participants Who Are Current Employees – S Corporation

• If HRA covers both the 2%

shareholder/employees and a non‐2% shareholder/employee, it’s a group plan

– Not under the “fewer than two participants who are current employees” exception – Thus, the reimbursement of the non‐ shareholder/employee is illegal

19

Fewer Than Two Participants Who Are Current Employees – Family Coverage

• If an employee is covered under an HRA with a

spouse or dependent (who are also employees), this arrangement will be considered to cover only one employee

– If the small business has only family members and no other employees, can continue to reimburse for a family plan

Integration of Medicare Premiums

• Such reimbursement does not constitute an

employer payment plan

– Method provided for integrating the reimbursement with an employer group plan

19

8/4/2015 50

Notice 2015‐17 – More Comments

• Increasing an employee’s compensation and

not conditioning that payment on the purchase of health coverage does not constitute an improper employer payment plan

• But, treating premiums paid as taxable

compensation is problematic

21

Grassley Bill

• S.1697

– Would allow Sec. 105 plans to be used as they were before Obamacare

• Introduced on June 25, 2015 and referred to the

Committee on Finance

22‐37

C Corporations

• Where a C corporation sole owner and spouse

are the only employees of the C corporation, no “group health plan” subject to ACA requirements is established

– CALT article of Dec. 31, 2014 – IRS position taken in Notice 2015‐17

8/4/2015 51

For Small Employers, What Are the Big Issues?

• Counting people

– Who is a “participant”? – Who is an “employee”? – Do we count partners? – What about S corporation shareholders? – What about sole proprietors? – Who is eligible? – Can I leave some employees out of the plan? – How do the nondiscrimination rules apply to the ACA?

Examples

• C corporation

– A C corporation has 4 qualifying employees and pays the employees’ individual health insurance premiums directly or by reimbursement. Is this still allowed?

• No. This reimbursement plan may not continue.

– Would an HRA work? – What about a Flexible Spending Account?

What is the Remedy?

• What do I do with clients in this situation now?

– Stop reimbursements and payments. – Pay back taxes on reimbursements/payments. – Under DOL FAQ, violation still occurred. – Consider self‐reporting violation on Form 8928 with a penalty of ‐0‐. – IRC Section 4980D(3) states:

• A failure of a group health plan shall be treated as corrected if—
• (A) such failure is retroactively undone to the extent possible, and
• (B) the person to whom the failure relates is placed in a financial

position which is as good as such person would have been in had such failure not occurred.

8/4/2015 52

C Corporation

• A Schedule C corporation has only employee

and pays the employee’s individual health insurance premiums directly or by

• reimbursement. Is this still allowed?

– Yes. This meets the “fewer than two participants who are current employees exception .”

C Corporation

– What if only two employees of C Corporation are the husband and wife and one or both own the business?

• They are deemed not to be “employees,” whether or

not they received a W‐2. Would fall under exception for “fewer than two participants who are current employees.”

29 CFR § 2510.3‐3 (1) An individual and his or her spouse shall not be deemed to be employees with respect to a trade or business, whether incorporated or unincorporated, which is wholly owned by the individual

• r by the individual and his or her spouse, and

S Corporation

• An S Corporation has one owner and no other employees.

The S Corporation has always reimbursed the owner for the cost of his individual health insurance premiums.

– The payment is treated as a guaranteed payment (wages). – Payment is reported on boxes 1 and 14 of W2 – The payment is excluded from FICA under Notice 2008‐1. – The shareholder can take the 162(l) deduction for the cost of his health insurance premiums.

• Can this practice continue?

– Yes, there is one participant.

8/4/2015 53

S Corporation

• An S Corporation has five more than 2% shareholders and no other
• employees. The Corporation has always reimbursed the

shareholders for the cost of their individual health insurance premiums and the payments were treated as described on the last

• slide. Can this practice continue?

– Most likely not. The only way the 162(l) deduction can be taken under 2008‐1 is if the plan is a health plan established by the employer. If the employer establishes such a plan, it will likely be subject to ACA market reforms. DOL FAQ specifies that it does not matter if these payments were on a post‐tax basis. Safest course: avoid reimbursement until further guidance. – Transitional relief through 2015

S Corporation

What if the S Corporation has always reimbursed the one more than 2 % shareholder for her premiums, but has never provided health benefits to the one non‐owner employee? ‐As long as the “plan” legally comprises

• nly one participant, it will not be subject

to the ACA market reforms. The discrimination testing rules under 105(h) have not changed for self‐insured plans.

Partnership

• A partnership with three partners has always reimbursed the partners for
• premiums. Reimbursement is guaranteed payment, treated as wages.

Partners take 162(l) deduction. Can this continue?

– Most likely not. The only way the 162(l) deduction can be taken is if the plan is a health plan established by the employer. If the employer establishes such a plan, it will likely be subject to market reforms. DOL FAQ specifies that it does not matter if that these payments were on a post‐tax basis. Safest course: avoid reimbursement until further guidance. – 26 CFR 54.9831‐1 (d) (2) states: In the case of a group health plan, the term employer also includes the partnership in relation to any bona fide partner. In addition, the term employee also includes any bona fide partner. Whether or not an individual is a bona fide partner is determined based on all the relevant facts and circumstances, including whether the individual performs services

• n behalf of the partnership.

8/4/2015 54

S Corp and Partnership Remedy

• What do I do with clients in this situation NOW?

– Stop reimbursements for health insurance. – Pay FICA for reimbursements (for S Corporations). Do not report

• n Box 14 of W‐2. Shareholders/partners cannot take 162(l)

deduction. – These are mere guaranteed payments that should not subject S Corporation/Partnership to penalties. – Remember, there is transitional relief through 2015 for S corporations

Sole Proprietor

A sole proprietor has established an HRA for his

• ne full‐time employee, but his part‐time

employee is not eligible for this benefit. Is this arrangement still valid? It should be. Because only the full‐time employee is eligible for participating in the HRA under a valid distinction, this plan falls within the “fewer than two participants who are current employees.”

Sole Proprietor

• Can the sole proprietor still take the 162(l)

deduction for cost of his health insurance premiums? Likely yes. Although a sole proprietor is considered a participant in a group health plan if he receives benefits, the sole proprietor is not deemed to be an employee, as is a partner.

8/4/2015 55

PCORI Fee

• Patient‐Centered Outcomes Research Institute (PCORI)

fee on employers that sponsor a self‐insured health plan.

– For plans ending Sept. 30, 2014 and before Oct. 1, 2015, the fee is $2.08 for each life covered.

• An exception exists for self‐insured HRAs. The employer may count
• nly the employee as covered.

– The PCORI fee is calculated and submitted on Form 720

• Fee must be paid by July 31, 2015
• Deductible on Schedule F

– For farmers with medical reimbursement plans utilizing a 3d party administrator, the administrator may complete Form 720; farmers that administer their own plan are responsible for filing the form

38

Transitional Reinsurance Fee

• Beginning in 2014 and through 2016, there is a reinsurance

fee that plans must pay for each employee enrollee in a group health plan. The fee is $63 in 2014, and it will decrease in the two years following.

– $44 per enrollee for 2015 – $27 per enrollee for 2016

• The fee is owed by self‐insured employers.
• Plans with fewer than two active employees are exempt.

(See CMS Q & A at https://www.regtap.info/faq_viewe.php?i=596&u=15307& a=9)

• Fees collected by HHS

– Must submit membership count to HHS and they calculate the fee and invoice you

Increased Wages as Alternative to Impermissible Plans

Frank operates a grain and cattle farm and employs Harry and several others. During 2013, Harry purchased an individual health insurance policy, and Frank reimbursed Harry for the $350 per month premium on a pre‐tax basis. What are Frank’s options in 2014? No continued pre‐tax reimbursement May increase wages (subject to FICA and income taxes) Increased income may lower PTC available on Marketplace. Later learned that the increase in wage can’t be tied to employee’s health costs

8/4/2015 56

Health Savings Accounts (HSAs)

Individuals and their employers may contribute pretax dollars to an HSA in which contributed amounts can grow tax free. To qualify, individual must:

• Be covered by a high deductible health plan (HDHP)

(equivalent to a Bronze plan – 60% AV)

• Have no disqualifying health coverage.
• Not be enrolled in Medicare.
• Not have VA medical benefits within prior three

months.

• Not be eligible to be claimed as a dependent on

another person’s tax return.

41

Health Savings Accounts Limits

42

Health Savings Account Withdrawals

• Withdrawals are tax‐free if used to pay for

qualified medical expenses incurred on or after the HSA is established.

• Qualified expenses include those of spouse and

dependents.

• Withdrawals not used for qualified medical

expenses are subject to penalty tax (20%!) and included in gross income (does not apply to those age 65 and older).

– Obamacare increased the penalty tax rate

42

8/4/2015 57

“Cadillac” Tax

• Beginning in 2018, the ACA will impose a 40

percent excise tax on annual premiums associated with Cadillac health care plans.

• These plans are employer‐sponsored plans

costing more than $10,200 per employee (or $27,500 per family), including employer and employee‐paid contributions.

Considerations for U.S. Agricultural Businesses (and Owners) with International Activities

Stephanie Hathaway, CPA, MS, MPA 2200 Rimland Drive, #300 Bellingham, WA 98226 Phone: 360‐676‐1920 Fax: 360‐671‐5411 E‐mail: stephanie.hathaway@mossadams.com

Topics we’ll cover

• Overview of the U.S. Foreign Disclosure

Rules

• Who is required to disclose?
• What is required to be disclosed?
• What happens if disclosures are missed?
• What corrective filing strategies are

available?

2

8/4/2015 58

Overview of the U.S. Foreign Disclosure Rules

• Intended to prevent U.S. taxpayers from hiding income
• r assets using offshore entities
• The U.S. government has extensive enforcement

powers to compel disclosure by U.S. taxpayers regarding offshore activities

• Integrates with the U.S. “anti‐deferral” provisions to

prevent U.S. taxpayers from using offshore structures for deferral of taxation on certain types of income

• IRS requires U.S. persons to submit annual disclosures

detailing:

– Ownership and/or control of foreign assets and/or entities – Activity of and transactions with certain foreign entities and individuals

Overview of the U.S. Foreign Disclosure Rules

• IRS has greatly increased the resources focused on this area. The risk of

exposure and criminal prosecution has increased dramatically for non‐ filers in recent years

• There are significant civil and criminal penalties for failure to accurately

and timely disclose

– Timely filing is critical – Penalties start at $10K for each incorrect or late disclosure…even when no tax due

• Annual compliance can be costly, even for fairly simple
• ffshore structures
• Many of these disclosures require extensive details

derived from foreign legal documents and financial statements

• To control costs and achieve tax efficiency, U.S. taxpayers

planning to invest or do business offshore must understand how the foreign disclosure rules and anti‐deferral provisions will apply to the proposed structure

3

Who is Required to Disclose?

• U.S. citizens
• U.S. greencard holders (U.S. permanent residents)
• Other individuals who are U.S. income tax residents

pursuant to

– the “substantial presence test” of §7701(b)(3) or – who have elected to be treated as U.S. residents (under §7701(b)(4), §6013(g) or §6013(h), etc.)

• Individuals who must use the residency article of a bilateral

income tax treaty to be treated as non‐residents of the U.S. for income tax purposes

• U.S. entities (corporations, trusts, estates, partnerships,

LLCs, etc.)

8/4/2015 59

What is Required To Be Disclosed?

• Acquisition, ownership (direct, indirect or

constructive), and/or disposition of an interest in a:

– Foreign Corporation (Form 5471, 8621) – Foreign Partnership (Form 8865) – Foreign Disregarded Entity (Form 8858) – Foreign Trust (as U.S. grantor, owner and/or beneficiary) (Forms 3520 and / or Form 3520‐A) – Other foreign entity for which the U.S. classification must first be analyzed in order to determine which disclosure is required

• Must evaluate characteristics of the arrangement

4

What is Required to be Disclosed? Determining characterization of a foreign entity (trust vs business entity) for U.S. tax disclosure purposes:

• Trust – Trustee holds title to property for investment

purpose and/or for protection or conservation of that property for beneficiaries (who are generally passive)

• Corporation or Partnership – Has business purpose,

associates, free transferability of interest, limited liability, continuity of life, and centralized management

• If it’s not a trust, is it a per se corporation (Treas. Reg.

§301.7701‐2) or is it eligible to be treated as a flow‐through entity (partnership or disregarded entity)?

What is Required to be Disclosed?

• Transactions with:

– Certain Foreign Corporations, Partnerships or Disregarded Entities in which the U.S. filer has

• wnership (Forms 5471, 8621, 8865, 8858, 926)
• Contributions, Distributions, Loans, Compensation, Dividends,

Rents, Royalties, Interest, etc.

– Foreign shareholders (and related parties), when the reporting U.S. corporation is owned 25% or more by foreign persons (Form 5472) – Foreign Trusts (Forms 3520, 3520‐A)

• Contributions, Distributions, Loans

– Foreign Estates

• Receipt of bequests >$100K during a calendar year (Form 3520)

– Foreign Individuals

• Receipt of gifts >100K during a calendar year (Form 3520)

5

8/4/2015 60

What is Required to be Disclosed?

• Foreign bank and financial accounts (Form 114)

– In which a U.S. person has a “financial interest” and/or – Over which a U.S. person has “signature authority” – For accounts owned directly and indirectly

• Other specified foreign financial assets ‐applicable
• nly to U.S. individuals (Form 8938)

– Financial contracts (employment agreements, rental agreements, etc.) with non‐U.S. individuals/entities – Foreign pension arrangements – Beneficial interests in a foreign trust or estate – Loans to non‐U.S. individuals or entities – Foreign life insurance policy

Foreign Disclosure Rules (misc. issues)

• Filing thresholds vary
• Many foreign disclosures are an integral part
• f the U.S. filer’s annual income tax return

and their filing date is automatically extended with the filer’s income tax extension.

– If the foreign disclosures are missing from the return, the return is considered incomplete and the statute of limitations doesn’t start

• Form 3520‐A (for a Foreign Trust with a U.S.

Owner) requires its own extension (Form 7004)

• Form 114 (FBAR) has no extension available

6

Let’s look at an example…..

• Form 114 (Report of Foreign Bank and Financial

Accounts) – a.k.a. the “FBAR”

– Required to be filed by U.S. individuals and entities that have a financial interest in or signature authority over any foreign financial accounts if the aggregate value of the accounts >$10K at any time during the calendar year – Once filing threshold is met, every non‐U.S. account is reportable, regardless of size – Individuals are treated as owning/controlling accounts held indirectly through other U.S. and foreign entities – Penalty of $10K per error or late filing

8/4/2015 61

FBAR example (cont.)

• FBAR must be submitted through the FinCEN

(“Financial Crimes Enforcement Network”) BSA (“Bank Secrecy Act”) e‐file

system

– Due June 30 (no extensions available) for prior calendar year – not part of U.S. income tax return – For each foreign financial account, disclose:

• Maximum balance during calendar year (in USD)
• Type of account (bank, securities, other)
• Name and Address of Financial Institution
• Account number
• Information regarding other account owners
• Whether filer has a “financial interest” or “signature authority only"

in the account 7

What Happens if Disclosures are Missed?

• Significant civil and possibly criminal penalty exposure
• Statute of limitation may not run on filed returns that

are “incomplete” so if the IRS discovers the omission, tax and penalties can be assessed for many prior years

• Penalty assessment ($10K per late disclosure per year)

has become automatic for corporate filers

• IRS is vigilant about amended returns being filed to add

previously missing or understated foreign income or foreign disclosures and will assess the statutory penalties

• Fiduciaries of estates can be held liable for penalties if

the decedent failed to file all required foreign disclosures

What Corrective Filing Strategies are Available?

• Offshore Voluntary Disclosure Programs
• Streamlined Filing Procedures
• Penalty‐Free Delinquent Disclosure

Procedures

8

8/4/2015 62

Offshore Voluntary Disclosure Programs – Pros AND Cons

Pros:

• Protection from criminal prosecution
• Penalty regime is clear; may result in lower penalty than

statutory regime

• Filer becomes compliant with U.S. tax filing responsibilities

Cons:

• Requires very extensive information disclosure
• Higher professional fees to prepare information for

submission

• Penalty regime is inflexible
• Filer must agree to extend statute of limitations on period
• f time to assess tax and penalties
• Not all non‐filers are eligible

Prior Offshore Voluntary Disclosure Programs

• 2009 OVDP (Mar 23, 2009‐Oct 15, 2009)

– 20% offshore penalty – 2003 ‐ 2008

• 2011 OVDI (Feb 8, 2011‐ Sep 9, 2011)

– 25% offshore penalty – 2003 ‐ 2010

• 2012 OVDP (Jun 26, 2012 to Jun 30, 2014)

– 27.5% offshore penalty (plus a reduced rate for certain filers) – Most recent 8 years for which due date has passed

9

OVDP ‐ Offshore Penalty Base

• The amount on which the “offshore penalty”

is assessed

• IRS selects the year when the aggregate

value in the combined non‐U.S. accounts was highest

• Penalties assessed on this “high‐water mark”

even if the value of the investments held in non‐U.S. financial accounts later decrease significantly

8/4/2015 63

Initial Streamlined Filing Procedure for Non‐Residents

• Sep 1, 2012 – Jun 30, 2014
• Available for non‐resident U.S. persons who were

“low risk.” Absent high risk factors, if the filed U.S. returns reflected <$1,500 in U.S. tax due, filer was considered low risk. High risk factors included:

– Taxpayer had material economic activity in the U.S. – Taxpayer was a non‐filer in his/her country of residence – Taxpayer had non‐U.S. financial accounts or other activities outside his/her country of residence – Taxpayer had significant and/or multiple non‐U.S. entities

10

Initial Streamlined Filing Procedure for Non‐Residents

• Intended for U.S. citizens or permanent

residents (green card holders) who had been residing outside the U.S. since January 1, 2009 and who had modest income and were “low risk”

• Not available for U.S. residents
• Streamlined filers were required to submit the

following package to the IRS:

– U.S. income tax returns for past three years – FBARs for past six years – Completed IRS questionnaire

Current Corrective Filing Options

• 1. 2014 OVDP
• 2. Expanded Streamlined Filing Compliance

Procedures

– Only penalty is miscellaneous offshore penalty for U.S. resident filers

• 3. Penalty Free Procedures

– Delinquent FBAR submission procedure – Delinquent international information return Submission procedures

• 4. “Quiet” Filing

– Not recommended – IRS is watching for these

11

8/4/2015 64

2014 OVDP

• Modification of 2012 OVDP, effective July 1, 2014
• Added 50% offshore penalty provision for filers with

accounts at specifically identified foreign financial institutions

• Replaced FAQ’s #17 and #18 from 2012 OVDP with separate

penalty‐free procedures for filers who had no unreported income but who had failed to file either the FBAR or one of the other foreign disclosure forms

• Accelerated due date for paying offshore penalty to the

date of the OVDP submission

• Eliminated “reduced penalty” filer category, in

consideration of expanded Streamlined Filing Compliance Procedures

Expanded Streamlined Filing Compliance Procedures

• No protection from criminal prosecution
• Not eligible if already under examination or already

contacted by the IRS about the late filings

• Filer may have failed to file FBARs and information

returns and report income from non‐U.S. accounts and assets

• Must have valid U.S. TIN
• Must be able to make reasonable cause argument and

certify that failure wasn’t willful, under penalty of perjury

12

Expanded Streamlined Filing Compliance Procedures (Cont.)

• What to file:

– 6 prior years’ FBARs (filed electronically) – 3 prior years’ amended or delinquent income tax returns – 3 prior years’ missing international information returns (a.k.a. “foreign disclosures”) – Reasonable cause statement – Certification that FBARs have been filed, that failure to file was non‐willful and that filer is eligible for streamlined offshore program – Calculation and payment of tax and interest – Calculation and payment of the miscellaneous offshore penalty (for U.S. resident filers)

8/4/2015 65

Expanded Streamlined Filing Compliance Procedures (Cont.)

• Streamlined Foreign Offshore Procedures

– For non‐U.S. residents – No offshore penalty – Use IRS Certification Form 14653

• Streamlined Domestic Offshore Procedures

– For U.S. residents – 5% offshore penalty on:

• additional tax shown on the 3 years of amended returns
• highest aggregate end‐of‐year value for unreported non‐

U.S. accounts from prior 6 years

– Use IRS Certification Form 14654

13

Delinquent FBAR and International Information Return Submission Procedures

• Taxpayers who timely filed their U.S. income tax returns

and properly reported all income related to non‐U.S. assets, but who did not file certain international information returns or FBARs, are eligible to correct the errors without penalties.

• Not eligible if already under examination or already

contacted by the IRS about the late filings.

• Must be able to establish reasonable cause for the failure

to file. Fact pattern is very important.

• Even without reasonable cause, the IRS may relieve the

penalty for one late‐filed year.

Delinquent FBAR Submission Procedures

• File all missing FBARs via FinCEN BSA e‐file

system.

• Include a statement explaining the reason for

late filing.

• On the cover page of the electronic form,

select a reason for filing late.

14

8/4/2015 66

Delinquent International Information Return Submission Procedures

• File all missing international information returns.
• Attach all international information returns (other

than Forms 3520 and 3520‐A) to amended income tax returns for the years in question.

• Attach a reasonable cause statement to each

delinquent form explaining, in detail, the reason for the late filing.

– Must certify that any entity for which the information returns are being filed was not engaged in tax evasion.

Selecting a Filing Strategy

• Current filing options are very favorable for most U.S.

filers who have made errors in their U.S. filings and disclosures

• Demonstration of reasonable cause and non‐

willfulness is critical when using any non‐OVDP filing strategy

• If there is any potential criminal exposure, OVDP

provides protection from criminal prosecution MOST IMPORTANTLY: Before deciding on a filing strategy, consult with U.S. international tax and legal advisors who have experience with international non‐ filer situations

15

Farm Income Averaging

Chris Hesse

8/4/2015 67

• Eligible: 1040 farm income, including from

pass through entities

– But not as beneficiary of Form 1041

• Electable farm income

– Excludes land (but not building) gains – Excludes wages (except S shareholder) – Written lease for crop share landlord

• Example 2: Reducing a non‐farm capital

gain rate Farm Income Averaging

1

• Averaging is not an adjustment to prior

year income

• Example 3: Successive use of averaging

Farm Income Averaging

1 2 3 Curr. $29K $29K $28K $117K

Example 3

189 (p. 5‐6)

8/4/2015 68

1 2 3 Curr. $29K $29K $28K $51K $22K $22K $22K $66K

Example 3

191 (p. 5‐6)

Top Bracket Averaging: 2013‐2015

• Increased rates in 2013 bring automatic Sch. J

savings to top rate taxpayers for ‘13‐’15

– 39.6% to 35% ordinary – 20% to 15% capital gain

• Example 4: Capital gain and ordinary income
• Example 5: Amending 2013 to improve 2014
• Example 6: Software not optimizing

Schedule J and AMT

• AMT calculated before farm income averaging
• Example 7:

Tentative minimum tax $ 30K Regular tax before averaging (27K) AMT $ 3K Regular tax with Schedule J 20K Total tax $23K Conclusion: Cross it over!

8/4/2015 69

Decreasing AMT through Income Averaging

• After phase‐out of AMT exemption, adding

income generally decreases AMT:

– Tentative Minimum Tax/AMT rate: 28% – Regular tax: 35%‐39.6%

• Result: AMT diminishes, while regular tax only

increases at income averaging rate

• Example 8: Add $80,000 income

– AMT drops ‐$ 8,600 (11%) – Sched. J tax + 26,800 34% Net $ 18,200 23%

• Change in filing status from base year
• Late or amended elections
• Using a negative base year

– But addback NOL carried to other years

Farm Income Averaging Opportunities:

• Retiring farmer with carryover grain
• Machinery auctions
• High grain prices
• Spike Schedule F to avoid SE tax

Farm Income Averaging

8/4/2015 70

• 0% rate opportunity

– Joint TI below $74,900 (2015) – Single TI below $37,450 (2015)

• Caution:

– Phase‐in of taxable Soc. Sec.

– State Income Tax

Pursuing the 0% Capital Gain Rate

Time For Lunch!

• Session resumes at 1:00 p.m.

Repair Capitalization Regulations

Chris Hesse and Roger McEowen

8/4/2015 71

Final Repair Regulations

• Final and proposed regulations were issued on Sept. 13, 2013.

– Generally finalize the temp. and proposed regs. issued on 12/23/11 – Regs. issued under I.R.C. §168 (GAA and dispositions) again issued as proposed

• Generally effective for tax years beginning on or after Jan. 1, 2014

– At the earliest, IRS can’t impose the changes established by the regulations until examining return for 2014 tax year – Taxpayers do have the option to early adopt the regulations for tax years beginning on or after Jan. 1, 2012. – Contain some taxpayer‐favorable changes

• De minimis safe harbor
• Routine maintenance safe harbor

New Repair Regulations

• What’s the issue?

– I.R.C. §162(a) allows deduction for ordinary and necessary expenses paid or incurred during tax year in carrying on trade or business, including amounts paid for incidental repairs – I.R.C. §263(a) denies a deduction for any amount paid for new property or for permanent improvements or betterments that increase value of any property, or amounts spent to restore property

Unit of Property

• Unit of property (UoP) is base on which to

determine whether an improvement exists

• All components of property that are functionally

interdependent comprise a single UOP – Functionally interdependent if the placing in service of one component is dependent on the placing in service of another

8/4/2015 72

Unit of Property Definition

• Each building system is a separate UOP:

– Building structure is one UOP (roof, walls, windows, floors, ceilings) – Each building system is a separate UOP (HVAC, Plumbing, Electrical, Escalators, Elevators, Fire‐protection and alarm, Security, and Gas distribution)

2

Materials and Supplies – Two Types

• Incidental

– Deduct when purchased – No record of consumption – Expensing does not distort income

• Non‐incidental

– Record of consumption maintained or year‐ end physical inventories maintained – Deduct when first used or consumed

2

Materials and Supplies

• Definition: TPP used/consumed in
• perations, but not inventory, that is a:

– Component to maintain, repair or improve a UOP that itself is not a UOP – Fuel, lubricants, water, similar items – UOP with economic life ≤ 12 months – UOP with cost ≤ $200, or – Other property identified by IRS as materials

• r supplies
• Example 1 on p. 3

8/4/2015 73

Another Example

• Alexco provides billing services to its customers. It purchases 50

scanners to be used by its employees. Each scanner costs $150. In the first year, Alexco’s employees begin using 35 of the scanners and stores the remaining scanners for use in a later year – The scanners are materials and supplies under 1.162‐3(c)(1)(iv)

• Alexco may deduct the cost of the 35 scanners used in the

first year (if they are non‐incidental)

• The remaining scanners are deductible in the year first used

in Alexco’s trade or business. 1.162‐3(h), Example 7

– Note: If Alexco had treated all 50 scanners as incidental, then all 50 scanners are deductible at time

• f purchase

De Minimis Safe Harbor

• Elect to deduct assets if have:

– An Applicable Financial Statement (AFS) – Written accounting procedures at beginning of year – Treated as expense on AFS, and – Amounts < $5,000 per invoice or per item are deducted, or – Amounts paid for property with economic useful life

• f 12 months or less
• AFS defined as:

– SEC statement – Certified audit by independent CPA, or – Required by federal or state agency

• Non‐audited financial statement for government‐backed

loans (SBA, Farmer‐Mac, etc.) are not AFS

3‐5

De Minimis Safe Harbor

• Taxpayers without AFS can also elect the

safe harbor

– Same requirements except $500 limit per invoice or item – Accounting policy to expense need not be written – IRS is considering increasing the $500 threshold (Rev. Proc. 2015‐20)

8/4/2015 74

Safe Harbor is Not Limiting

• Safe harbor not

intended to prevent taxpayers from reaching an agreement with IRS revenue agent to use larger amount

• Should elect $500

even if use larger amount

Applying the De Minimis Safe Harbor

• A taxpayer may attach a safe harbor election

statement annually to timely filed tax return

– No Form 3115

• Applies to all amounts within the threshold

– Amounts deducted under the de minimis rule are not capitalized and are not treated as a material

• r supply
• “Small equipment”
• Tracked separately on books and records
• Example 2 on page 6

Final Repair Regulations

• For improvements to tangible property…

– Capitalization is required if expenditure is a betterment, restoration or adaptation of the unit

• f property to a new or different use

6

8/4/2015 75

Repairs

• Taxpayer may deduct amounts paid for

repairs and maintenance to tangible property as long as the amounts aren’t required to be

• capitalized. 1.162‐4(a)

– Examine what needs to be capitalized as an amount paid to improve tangible property in order to determine what can be deducted as a repair

Repairs – Routine Maintenance Safe Harbor

• Regs. allow a deduction (safe harbor) for routine maintenance on

tangible property defined as recurring activities that keep a UofP in

• rdinary efficient operating condition (inspection, cleaning, testing

and replacing of parts (with comparable replacement parts) of a UofP)

– Taxpayer expects, at time property placed in service, to perform the activities more than once during property’s class life. Under Rev. Proc. 87‐56…

• Ag Equipment ‐ 10 years
• Single Purpose Ag Structure – 15 years

– For buildings, the taxpayer must reasonably expect at the time it places the building in service to perform the activities more than once during a 10‐year period beginning from the time the building is placed in service by the taxpayer

• “Reasonable Expectation” is the rule, not “actually happens”
• This is an accounting method and not an optional annual election

Building Safe Harbor for “Small Taxpayer”

• Covers certain amounts paid for improvements and repairs to

eligible buildings

– Taxpayer must have average gross receipts of less than $10 million for the three previous tax years – Eligible building has tax basis, before depreciation, of $1 million or less – Safe harbor allows annual deduction of the lesser of $10,000 or 2% of building’s unadjusted basis for any amounts paid for improvements, repairs, maintenance and similar activities per eligible building

• property. 1.263(a)‐3(h)(1)

– Note:

• Taxpayer can have multiple buildings that use the safe harbor, but if amounts

paid during tax year exceed the $10k or 2% limit for an eligible building, the safe harbor is not available for that building. 1.263(a)‐2(h)(8)

– Annual election by attaching statement to return (include description

• f building(s))
• No Form 3115 required

8/4/2015 76

“Small Building” Safe Harbor

• Example:

– Assume that Penny is a qualified taxpayer. She owns a shop and a machine shed. Each building has an unadjusted basis of $100,000. The shop’s overhead door needed replaced and it cost $2,500 to do so. The machine shed needed new lights and minor roof

• repairs. The lights and roof repairs cost $1,500.
• Safe harbor election not available for shop
• Safe harbor applies to machine shed expenses
• Limitation applied separately to each building

– However, if the overhead door was reasonably expected to be replaced within 10 years, then allowed as routine maintenance expense

Acquisitions and Improvements

• These expenditures must be capitalized (I.R.C.

§263(a))

– Any amount for new buildings or for permanent improvements or betterments made to increase the value of any property or real estate, or… – Any amount for restoring property or making good the exhaustion of it for which an allowance is or has been made. 1.263(a)‐1(a).

7

Improvements

• Always capitalize amounts paid to acquire or

produce tangible property unless…

– The property qualifies as materials and supplies

• r…

– The property qualifies under the de minimis safe harbor and the taxpayer makes the safe harbor election

8/4/2015 77

What’s An Improvement?

• “Improvements” must be capitalized

– Betterment to a UoP – Restoration of a UoP – Adaptation of a UoP to a new or different use

• See Worksheet beginning on p. 11

“Betterments”

• Expense that improves productivity, strength,

quality or output of UoP;

• Is a material addition to the asset (physical

enlargement or increase in capacity)

• Expense that corrects material condition or

defect existing before acquisition or that arose during production

When is an Expenditure a “Betterment”?

• Must compare the condition of the property

immediately after the expenditure with the property’s condition immediately before the circumstances necessitating the expenditure

– Treas. Reg. 1.263(a)‐3(j)(2)(iv)

8/4/2015 78

Betterment ‐ Example

• Bob acquires a new tractor rated at 250 hp.

He pays an additional $20,000 to turbo‐ charge the engine and increase the horsepower to 300.

– This is a betterment

Betterment ‐ Example

• Mike overhauls the diesel engine on his

tractor for $22,000.

– This is simply maintaining the tractor and keeping it in operating condition – Simply correcting for normal wear and tear – The $22,000 is expensed as a repair

Acquisitions

• Must capitalize amounts paid to acquire or

produce real or personal property

• Only exceptions to general rule are:

– Materials and supplies, and – De minimis safe harbor

7

8/4/2015 79

Betterments

• Corrects a material condition or defect existing

prior to acquisition or during production of UOP

• Is for a material addition to the UOP

(enlargement, expansion, etc.) or a material increase in capacity, or

• Is reasonably expected to materially increase

productivity, efficiency, strength, quality or

• utput of UOP
• Example 3

– Dollar amount of expenditures not determinative!

8

Restorations to UOP are Capitalized

• Replaces a component of a UOP and taxpayer

recognized gain or loss on old component (disposition) or a casualty loss on old

• Restores inoperable property
• Rebuilds UOP to like‐new condition after end
• f its class life
• Replaces a part or parts that comprise a major

component or substantial structural part of UOP

• Example 4
• “Substantial”: No bright line test; roughly

30%‐40%

8

IRS Guidance on Threshold for Capitalization or Current Deduction

• LB&I‐04‐0315‐002, impacting IRM 4.51.2 (Jul.

6, 2015)

– 80% threshold for steam or electric generation property

• If more than 80% of a component or UoP is replaced,

then the expense must be capitalized

• Current deduction if less than 80% replaced

8/4/2015 80

Unavailability of Replacement Part Is Not a Betterment ‐ Example

• Farmer Jones owns an older computer with a

200 MB hard drive which crashes. The minimum size replacement available now is 750 MB. The upgrade to 750 MB hard drive is not a betterment due to the unavailability of the same size replacement part

– Treas. Reg. 1.263(a)‐3(j)(2)(iii)

Regulatory Requirement Not A Betterment ‐ Example

• Levi owns a meat packing plant that has oil

seepage in floors. The USDA requires Levi to add concrete floors and lining on the walls. The floor was functional before the seepage.

– The regulatory requirement does not result in a betterment.

– Treas. Reg. 1.263(a)‐3(j)(3) Example 12

What is an “Adaptation”?

• An “adaptation” must be capitalized if…

– The amount paid is to adapt a UoP to new or different use if the adaptation is not consistent with the taxpayer’s ordinary use of the UoP at the time the taxpayer placed the property in service – So, the cost of adding a feature to an existing machine to adapt it for a new use is a capitalized cost

10

8/4/2015 81

Adaptation That is not a New or Different Use

• Jenn owns and leases out space in a building

consisting of 20 retail spaces. The spaces are designed to be reconfigured. One of the tenants expands its occupancy by leasing two adjoining retail spaces. To facilitate the new lease, Jenn pays to remove the walls between the three retain spaces. The walls between the spaces are part of the building and its structural components.

– What’s the outcome?

Adaptation Example (cont.)

• The amount paid to convert three retail

spaces into one larger space for an existing tenant does not adapt Jenn’s building structure to a new or different use because the combination of retail spaces is consistent with Jenn’s intended, ordinary use of the building structure. The removal of the walls is not an improvement to the building

– 1.263(a)‐3(l)3), Example 2

Adaptations to UOP

• Adapts property to a new or different use
• Example 5 vs. Example 6

Worksheet: Definitions of improvements

10

8/4/2015 82

Dispositions

• Occurs when ownership of an asset is

transferred or when an asset is permanently withdrawn from use

– Includes sale, retirement, or physical abandonment of asset

• An entire disposition requires recognition of

gain or loss

244

13

Partial Disposition Election

• Proposed regs. allow taxpayers to elect

disposition rule when it disposes of a portion

• f an asset

– Application was mandatory under 2011 regulations for disposals of structural components

• f a building

– Elective regime does away with need to make GAA election for all buildings – Annual election vs. accounting method change

245

Final Regs. for Dispositions

• Taxpayer may electively recognize gain or loss
• n partial disposition of an asset

– Mandatory if casualty loss, trade or sale – Any reasonable method to determine basis of disposed portion

13

8/4/2015 83

Disposition

• Example

– Angela owns an office building with four elevators. She replaces one of the elevators.

• Since the elevator is a structural component of the building, it is a separate

asset for disposition purposes.

• Angela does not make the partial disposition election
• The retirement of the replaced elevator is not a disposition.
• Angela continues to depreciate it as part of the cost of the building and does

not recognize a loss for the retired elevator

• 1.168(i)‐8(i), Example 1

– If Angela treated each structural component of the building as a separate asset within the fixed asset system, the office building, including its structural components, is the asset for disposition purposes

• Same result as above
• 1.168(i)‐8(i), Example 2

247

Removal Costs

• Costs of removing an asset or a portion

thereof follow the treatment of the asset

– If disposal is treated as a disposition, removal cost are part of the disposition – If disposal is not treated as a disposition, removal costs are deducted or capitalized based on whether removal costs directly benefit a capitalized improvement

248

Handling Removal Costs

• Example:

– Jacob owns a building in which he conducts his retail business. The shingle roof is leaking but the building continues to function in the

• business. A contractor recommends that Jacob should remove the
• riginal shingles and replace them with new shingles. Jacob does not

consider the removal of the old shingles as a disposition.

• Assuming that the replacement of the shingles is not an improvement to the

building structure or systems and does not adapt the building structure or systems to new or different uses, the re‐shingling is not an improvement and is incurred by reason of repair and maintenance

• 1.263(a)‐3(g)(2)(ii), Example 3

– If Jacob treated the shingle removal as a disposition, he would deduct the adjusted basis of the components as a loss. Thus, the amounts paid for replacement shingles must be capitalized as a restoration

• Note: The amounts paid to remove the old shingles are not required to be

capitalized as part of the cost of the improvement, regardless of their relation to the improvement

– 1.263(a)‐3(g)(2)(ii), Example 4

8/4/2015 84

Election to Capitalize Repairs

• Taxpayer may elect to capitalize repairs and

maintenance items if same “on books and records”

– Annual election, not a method – Another tax preparer tool if income too low

Accounting Method Changes

• No required mass production of Forms 3115

– Has the individual farmer established a method of accounting with respect to supplies, capitalization?

• Two consecutive years

– IRS Office of Chief Counsel confirmed last fall that IRS was not expecting mass Forms 3115 for materials and supplies

• Taxpayers with no Form 3115 filing not targeted
• No need to file Forms 3115 to “affirm”

compliance with repair regs

• When would Method Code 187 apply?

251

Method Code #187

• It is for changing to deducting incidental materials and

supplies.

• Can you think of a situation in which a taxpayer could

possibly be in a violation of the accounting method for incidental materials and supplies?

– An incidental material and supply is one in which the taxpayer doesn’t have a record of consumption or take a physical inventory. – Are there any taxpayers that don’t deduct incidental materials and supplies when paid (cash basis) or incurred (accrual)?

• If a farmer deducts ad hoc small tools in some cases and

capitalizes in others, there hasn’t been an adoption of an accounting method.

– Form 3115 not necessary to adopt an accounting method

8/4/2015 85

Additional Thought on Accounting Method Change

• The issue has been way overblown

– Why would a taxpayer, who has been following court opinions

• ver the last 20 years in determining capitalization policy, need

to file Form 3115 to place them in compliance with the Regs.? The Regs. appear to adopt the outcomes of various court cases. Those taxpayers who have been following the cases in adopting principles of compliance should already be in compliance.

• The major exception to this relates to taxpayers who followed the

2008 proposed regulations, which used the entire building as a unit of

• property. The concept of building systems had not been adopted. If

taxpayers have been using the 2008 Proposed Regs. on buildings being the unit of property, a Form 3115 is necessary. Otherwise, in most cases, a Form 3115 is not necessary.

– Taxpayers should review prior capitalization and determine compliance, but this doesn’t require a wholesale filing for virtually every business.

Accounting Method Changes: Repair Regs.

• Generally effective for tax yrs. beginning in

’14

• Prior transactions may require method

change with Sec. 481(a) adjustment

• Example 7
• Accounting method changes:

– 4 year spread if income – 1 year if deduction

• Rev. Proc. 2014‐16: 10 new automatic

consent changes

13‐15

Small Business Relief: Rev. Proc. 2015‐20

• Small businesses may use cut‐off approach to

apply repair regs. beginning in 2014 and after

– No IRS audit protection for pre‐2014 methods

• Eligible businesses: Under $10M total assets
• r average annual gross receipts < $10M
• No late partial disposition method change for

pre‐2014 transaction

16‐20

8/4/2015 86

Small Business Relief: Rev. Proc. 2015‐20

• Amended return permitted until Oct. 15, 2015

to revoke any Form 3115 that contradicts adoption of cut‐off approach

– Opportunity to remove 3115s with no Sec. 481(a) adj. – Removes 5 year wait rule caused by Form 3115

• Attach statement indicating not using Rev.
• Proc. 2015‐20 if:

– Filing a Form 3115 with 481(a) adjustment (e.g., partial disposition) – Pre‐2014 transactions/methods are compliant

Repair Regulations

• IRS website FAQs, Feb. 2015: Final repair regs.

“synthesize existing case law and prior administrative rules into a framework . . .”

21‐34

Time For A Quiz

• Concentrate on the picture on the next slide

and see if you can spot any differences between the two objects in the picture.

– You have two minutes to complete the quiz

8/4/2015 87

IRS Audit Issues, Compliance Target Issues and Other Practical Information

Kristy S. Maitre, Tax Specialist Center for Agricultural Law and Taxation

State of IRS Service and Enforcement

• Internal Statement to Employees

– IRS must absorb $346 million during the remaining nine months

• f the fiscal year, plus an additional $250 million accounting for

inflationary and mandated costs – Reduced staffing in enforcement will result in at least 46,000 fewer individual and business audit closures and more than 280,000 fewer Automated Collection System and Field Collection case closures – The reduced enforcement staffing for FY 2015 means the government will lose at least $2 billion in revenue – Taxpayer service diminished further over the phone and in

• person. IRS anticipates an even lower level of telephone service

than before, which raises the real possibility that fewer than half

• f taxpayers trying to call will actually reach an assistor. The

actual percentage is 43%.

Pages 1‐3

8/4/2015 88

National Taxpayer Advocate Key Issues Facing IRS

• Health Care Implementation
• Access to IRS
• Correspondence Examination

Page 4 ‐ 5

Requesting an Audit be Transferred

• In considering these requests, the Service will take into

account the following factors:

– (i) The location of the taxpayer’s current residence; – (ii) The location of the taxpayer’s current principal place of business; – (iii) The location at which the taxpayer’s books, records, and source documents are maintained; – (iv) The location at which the Service can perform the examination most efficiently; – (v) The Service resources available at the location to which the taxpayer has requested a transfer; and – (vi) Other factors that indicate that conducting the examination at a particular location could pose undue inconvenience to the taxpayer.

Page 6‐7

Circumstances in which the IRS normally will permit transfers

• Office examination
• Field examinations
• Transfer for convenience of taxpayer’s

representative

• Transfer within thirteen months of expiration
• f limitations period
• Treas. Reg. §301.7605‐1(e)

Page 7

8/4/2015 89

Does your client qualify for First Time Penalty Abatement?

• The relief is a one‐time abatement
• The relief applies only to certain penalties
• Conditions for relief
• FTA does not apply for these issues

– Form 706 U.S. Estate Tax Return late filed returns or unpaid tax – Form 709, U.S. Gift (and Generation Skipping Transfer) Tax Return – Form 1120, or Form 1120S if returns were filed and a penalty assessed within the past three years. – The Daily Delinquency Penalty (DDP) IRM 21.7.7.4.23.1 – Information returns that is dependent on another filing – Generally, any portion of a FTD penalty charged for EFTPS avoidance. – Additional situations could apply as the IRM states the list is not all inclusive

Page 8‐9

What to Consider Before Applying for FTA – Reasonable Cause

• IRS will consider whether the taxpayer has “reasonable cause” for

the late filing, late payment or late deposit

• IRS will first look at the client’s compliance history and then check

the “reasonable cause” penalty relief criteria

• In certain situations, it would be in the client’s best interest to apply

for abatement under “reasonable cause” before using the one time First Time Abate

• “Reasonable cause” abatements require proof but offer more

advantageous relief than FTA

• For FTA, you must have a clean record for three years, whereas

“reasonable cause” is not limited by the three‐year rule

• Your client can qualify for “reasonable cause” as often as they meet

the criteria, but caution if your client is an habitual non‐filer, generally that excuse will only work once.

Reasonable Cause

• A “Reasonable cause” criterion as stated in

the IRM gives IRS broad discretion in granting relief

• The issue is generally difficult and you must

clearly state the “reasonable cause” and in addition substantiate with documentation the situation

• A general letter requesting this relief without

specifics in most cases will not be considered.

8/4/2015 90

Superseded Returns vs. Amended Returns

• When would you file a Superseded Return vs. an Amended

Return for the MeF Series 1040?

• Example:

– Example: Your client brings in their tax documents including all Forms W‐2 and 1099. During the interview they state that the employer was the only source of income and no other tax records have been received. You file the Form 1040 electronically on February 3, 20XX, receiving an acknowledgement on February 4, 20XX confirming acceptance. Two weeks later, your client brings in an additional Form W‐2 for a short‐term job they forgot about and requests that a correct return be filed to claim the income and withholding. If the return if filed before the due date of April 15, you would file a Form 1040 and at the top note “Superseded Return” in red. The return must be filed on paper and include all required schedules and statements that would have been included with the original return.

Pages 9‐10

Business Returns Business Returns – Forms 1120, 1120‐S, or 1120‐F and Form 1065 Superseded or Amended

• The MeF system processes both superseding and

amended returns for Forms 1120, 1120S, 1120‐F and Form 1065

• If the taxpayer is required to e‐file an original return

and needs to file an amended or superseding return, they must e‐file that return

• Any taxpayer who has received an approved waiver

from IRS to file their particular return on paper is exempted from this requirement.

• Tax years which are no longer available to e‐file can be

paper filed

Page 10‐11

Business Returns Business Returns – Forms 1120, 1120‐S, or 1120‐F and Form 1065 Superseded or Amended

• Corporate amended returns with carryback claims may

be e‐filed as long as the carryback claim box is checked.

• A superseding return must be a complete XML filing of

the entire return, with all required forms, schedules and attachments (XML or PDF, if applicable)

• A taxpayer filing a superseding return must indicate the

return is such by selecting the Superseded Return checkbox (designation) in the software or the return will reject as a duplicate filing.

• You will not see a checkbox or selection entitled

“Superseding Return” available on the paper forms.

8/4/2015 91

Power of Attorney Subject to FBAR Reporting

• IRS has taken the position in their “FBAR

Reference Guide” that “signature authority” includes “the authority of an individual (alone or in conjunction with another individual) to control the disposition of assets held in a foreign financial account by direct communication (whether in writing or otherwise) to the bank or other financial institution that maintains the financial account.”

• In an example, IRS explains that this definition

includes agents acting under a power of attorney (POA)

Pages 11‐12

Power of Attorney Subject to FBAR Reporting

• It is immaterial if the power has ever been

exercised

• The agent (along with the principal) is subject

to the FBAR filing requirements if the POA gives the agent signature authority over a foreign account that exceeds the dollar threshold.

Power of Attorney Changes and Information

• IRS Form 2848, Power of Attorney and

Declaration of Representative has changed to add authorization for the Affordable Care Acts Shared Responsibility Payment

• FOIA Request for the CAF

Representative/Client Listing – Sample provided

8/4/2015 92

Audit Issues

• Alimony
• High Income
• Partnerships
• Employment Taxes
• Cash Business/1099‐K
• Quickbooks’ audits
• Education Credits
• Form 1099 Q
• Charitable Contributions

Pages 13‐17

Alimony

• In tax year 2010, a total of 567,887 taxpayers

claimed alimony deduction totaling more than $10 billion

• 47 % of returns claimed alimony deductions

for which income was not reported on a corresponding recipient’s tax return or

• The amount of the alimony did not agree with

the amount of the deduction taken

IRS Issue

• IRS has no way to match amounts with Social

Security numbers

8/4/2015 93

Charitable Contributions

• Exempt Organizations Select Check (Pub 78

database)

• Quid Pro Quo Contributions

Pages 14‐15

Charitable Contributions Amounts Under $250

• A donor cannot claim a tax deduction for any

contribution of cash, check or other monetary gift unless the donor maintains a record of the contribution in the form of either a bank record, such as a cancelled check, or a written communication from the charity such as a receipt or a letter showing the name of the charity, the date of the contribution and the amount of the contribution.

Charitable Contributions Amounts Over $250

• A donor claiming a deduction of $250 or more is

required to obtain and keep a contemporaneous written acknowledgment for a charitable contribution

• To be contemporaneous the donor must

generally obtain the written acknowledgment no later than the date the donor files the return for the year the contribution is made.

8/4/2015 94

Court Case Villareale v. Commissioner, T.C. Memo 2013‐74

• The court denied the charitable contribution

deduction because the charity failed to provide to the taxpayer a contemporaneous written acknowledgement as required by §170(f)(8)(A)

• In addition, the written acknowledgement

must state whether goods and services were exchanged for the contribution.

Page 16

Durden v. Comr., T.C. Memo. 2012‐140

• The petitioners' charitable contribution deduction was denied due

to failure to strictly comply with substantiation requirements of §170(f)(8)(A)

• The petitioners contributed $22,517 to their church and statement

provided by church acknowledged donated amount, but did not state whether petitioners had received any goods or services in return

• Upon notice by IRS of problem with church's acknowledgement,

petitioners received corrected acknowledgement from church stating that petitioners had not received any goods or services;

• Tax Court held that first acknowledgement failed due to lack of

required statement, and that second acknowledgement failed because it was not received by petitioners before they filed their tax return for year at issue and was, therefore, not contemporaneous as required by Treas. Reg. §1.170A‐13(f)(2)).

8/4/2015 95

Form 1023EZ

• A new streamlined process for the Form 1023‐

EZ will also allow the IRS to concentrate more

• n compliance for §501(c)(3) organizations
• 17% of organization are expected to use Form

1023‐EZ

• Certain organizations not eligible
• IRS will verify qualification for the 1023EZ via

compliance checks or examinations on an after‐the‐fact basis

Pages 18‐19

Affirmation Letter

• How do you get a new exemption letter if the
• riginal is lost
• If the organization has changed its name and

address how does the organization make that change?

Page 19

CP 2000/AUR

• AUR cases are created from two primary

sources

– The Individual Master File or IMF that contains the individual tax return information – The Information Returns Master File or IRMF that contains the payer information

Pages 20‐21

8/4/2015 96

CP 2000/AUR

• CP 2000 notices deal only with information

mismatches or math errors they do not constitute an examination (audit)

• Rev Procedure 2005‐32

– “Taxpayer contacts and other actions that are not examinations

• the matching process is defined as a matching information
• n a tax return with … other records or information items

that are already in the Service’s possession” and “considering any records the taxpayer voluntarily provides to the Service … to explain a discrepancy between … a filed tax return …and information from third parties that is or may be used for the matching.”

CP 2000 Hints

• Respond timely, usually within 30 days and to the most

recent notice received on each issue

• Include the IRS response page on top of your response. This

helps ensure that the response will get where it needs to go

• Please address EACH and every issue in the notice and

securely attach the documentation behind the response page

• Provide telephone numbers where the taxpayer or

representative can be reached – Day and Night

• Use the envelope provided with your response
• If you cannot use the return envelope, be sure to write the

complete address (Including P.O. Boxes and Mail Stops) on the envelope you use

CP 2000 Hints

• If you are filing an amended return, submit it to the office that sent you

the notice, not where you usually file amended returns and ensure that the amended return is placed behind the response page

• On each page of the response, write the name control (first four letters
• f the last name), the whole SSN, and the tax year. Reason: This makes

it easier for pages of a response that may become separated to be re‐ associated with the notice response case file

• If you agree to the notice, please sign and return. If you don’t agree,

please explain why in detail

• If you cannot respond timely you may call and ask for additional time.

Note that IRS cannot extend the 90‐day period for you to petition tax court

• Staple the entire notice response package together

– Reason: This prevents parts of the response from being separated while it is being processed.

8/4/2015 97

Tips to Avoid a CP2000

• Do not group income amounts
• Each Form 1099‐B Sales of Stock Transactions should

be listed individually on Schedule D (including any transactions with a zero gain or loss). This may not always be possible.

• Explain when payer data is incorrect
• Report income on correct line
• When reporting items on a line without a specific

income designation i.e., Form 1040, line 21 “Other Income”, clearly identify the source of the reported amount.

• Include all back‐up schedules

New Direct Pay

• IRS’s web based Direct Pay lets taxpayers pay

their bills or make estimated tax payments directly from checking or savings accounts without fees or pre‐registration

• Taxpayer’s receive instant confirmation of the

payment and can access the information later via the confirmation number

• Bank information and other personal

information is not retained in the system

Pages 21‐25

Filing Forms W‐2 and 1042‐S Without Payee TIN’S – 1099 included

• Treasury Regulation 301.6109‐1(C)
• If you are required to file electronically but fail to
• do so, and you do not have an approved waiver,

you may be subject to a penalty of up to $100 per return for failure to file electronically unless you establish reasonable cause

• However, you can file up to 250 returns on

paper; those returns will not be subject to a penalty for failure to file electronically

Pages 25‐26

8/4/2015 98

Filing Forms W‐2 and 1042‐S Without Payee TIN’S – 1099 included

• The amount of the penalty is based on when you

file the correct information return

• The penalty is:

– $30 per information return if you correctly file within 30 days (by March 30 if the due date is February 28); maximum penalty $250,000 per year ($75,000 for small businesses – $60 per information return if you correctly file more than 30 days after the due date but by August 1;maximum penalty $500,000 per year ($200,000 for small businesses)

Filing Forms W‐2 and 1042‐S Without Payee TIN’S – 1099 included

• $100 per information return if you file after

August 1 or you do not file required information returns; maximum penalty $1,500,000 per year ($500,000 for small businesses)

• If you do not file corrections and you do not

meet any of the exceptions the penalty is $100 per information return

Filing Forms W‐2 and 1042‐S Without Payee TIN’S – 1099 included

• Small businesses—lower maximum penalties
• You are a small business if your average

annual gross receipts for the 3 most recent tax years (or for the period you were in existence, if shorter) ending before the calendar year in

• which the information returns were due are

$5 million or less

8/4/2015 99

Form 8879 as A Signature Document 3.11.3.14.10 (01‐01‐2015)

• You can paper file the return with Form 8879 attached

with a valid original signature, and there is any indication of rejected electronic filing or prior year

• Note: If Form 8879 is not present and there is only a

letter or statement present on the return or an attachment or a 5‐digit PIN present in the signature area of the return, correspond for an original signature

• It is important to note that unless this procedure is

attached to the return, IRS will generally return the tax return for an original signature. Note the IRM section in the attachment.

Page 27

Offer in Compromise

• Doubt as to Collectability
• Doubt as to Liability
• In the Best Interest of tax administration

Pages 27‐37

Fee

• There are two exceptions to the $186 fee:
• Doubt as to Liability or
• The individual qualifies for a low‐income exemption which applies if the taxpayer’s monthly income

falls below the 250% of the federal poverty level as defined by Health and Human Services

• Guidelines. To qualify for this exemption, section four of the Form 656 must be filled out.
• Payment options available include:
• Lump Sum Cash
• Selection of this option requires a 20% “down payment” be included with the offer. The remaining

payments become due after the date the offer is accepted in five or fewer payments within five or fewer months.

• Periodic Payments
• An initial payment must accompany the offer and the remaining balance will be due between six

and twenty‐four months depending on the offer the taxpayer proposed.

• Note: When using this option, monthly payments need to be paid as IRS is considering the offer.

Failure to pay the monthly payments will result in the offer being refused. All payments will be credit to the year in question. Interest and penalty continued to accrue on the tax liability during the specific time frame.

8/4/2015 100

Payment Options

• Lump Sum Cash
• Selection of this option requires a 20% “down payment” be

included with the offer. The remaining payments become due after the date the offer is accepted in five or fewer payments within five

• r fewer months.
• Periodic Payments

– An initial payment must accompany the offer and the remaining balance will be due between six and twenty‐four months depending on the offer the taxpayer proposed. – Note: When using this option, monthly payments need to be paid as IRS is considering the offer – Failure to pay the monthly payments will result in the offer being refused. All payments will be credit to the year in question

Conditions and Consequences

• Staying in compliance with all federal tax

liabilities

• Making required estimated tax payments
• In addition, the taxpayer must stay “clean”

and fulfill the above obligation for the next five years or the Offer will be voided

Reasonable Collection Potential (RCP)

• Measure the taxpayer’s ability to pay the tax debt

– Evaluation of taxpayer's assets – Property – Bank accounts and – Other assets liquid or otherwise

• Projecting future income potential less amounts

allowed for living expenses often using the IRS “Collection Financial Standards” to determine “allowable living expenses”

8/4/2015 101

What to Consider First?

• Installment Agreement

– The Online Payment Agreement allows taxpayers who owe $25,000 or less to self‐qualify and receive immediate approval.

• Additional Time to Pay

– A short period of time (60‐120 days) can be granted by IRS to pay the tax in full, either by calling IRS or applying through the Online Payment Agreement.

• Payment By Credit or Debit Card

– Payment of the tax liability via credit or debit card, using American Express, Discover, MasterCard, or Visa – IRS uses third parties for these types of payments who generally charge a fee to process the payment.

Other Issues to Consider

• Other issues to consider

– Each tax return has a Collection Statute Expiration Date (CSED)

• n the account record. Once that time frame has passed the

amount is deemed NOT COLLECTIBLE. – Revenue Officers are trained to protect the statute and in the more serious high dollar tax liability cases the collection attempts can get more aggressive. – When considering applying for an Offer in Compromise make sure you have a firm handle on the CSED. – That date generally begins when the return has been filed and the tax has been assessed

• But the time frame can be suspended for various reasons, one being

the application of an Offer in Compromise. The statute is suspended during the review and processing process and even longer if the case ends up in court.

Completing the Application

• Review the Offer in Compromise application
• Gather your taxpayer records of personal assets,

employment information, if self‐employed information on income, expenses and assets, monthly basic living expenses, and other documents requested on the application

• Verify that you have a complete listing of all information

requested

• An OIC Application has a large reject rate

– Sometimes due to an unqualified individual but also due to lack

• f disclosure of assets or income. IRS has multiple resources to

track assets, including assets that are hidden or have been transferred to third parties.

• Utilize the OIC Pre‐Qualifier Application to determine if the

client is eligible.

8/4/2015 102

Conditions to Apply

• Certain conditions have to be present in order

to apply for an Offer of Compromise:

– The taxpayer must be current with all tax filing business and personal – The taxpayer cannot be current involved in an

• pen bankruptcy proceeding

– The taxpayer must also be current with all federal employment tax obligations as well as required estimated tax payments for the current year

OIC Pre‐Qualifier

• The Pre‐Qualifier tool is easy

– The application itself requires far more detailed information – Substantiation is important in addition to a complete interview of the taxpayer – Gather the substantiation at the beginning of the process – As the sections are completed they require documentation to be submitted with the application.

Offer in Compromise

• The application only calculates the offer

amount

• The application does not ask for the tax

liability or for what years.

• The offer amount is based on future earning

potential and asset equity

8/4/2015 103

Offer in Compromise Appeal Process

• If the offer is rejected, the taxpayer will receive a

letter that provides the reason the offer was rejected. There is a 30‐day window for the appeals process from the date of the letter.

• Don’t confuse the offer being return with a rejection
• f the offer

– Oftentimes the OIC offer is incomplete and will be returned requesting additional information. This delays the process and extends the statute

• Using the OIC Pre‐Qualifier and reviewing the final

OIC Form 656 can avoid this issue

Appealing the OIC Determination

• An appeal of an OIC reject is very similar to an examination

appeal

– You will compile a list of items that you are in disagreement with and provide a detailed explanation and often supporting documentation to support the position.

• Form 13711 is available for your use when preparing the appeal
• Review all aspects of the offer and the documents prepared to

present the offer

• The Form 433‐ A/B should be thoroughly reviewed along with

the Monthly Income/Expense sheets

• Make sure all required documents were provided to support the

position and the calculation of the offer amount.

• Publication 1854: How to Prepare a Collection Information

Statement may assist.

Other Filing Issues Where, IRS can delay a Refund

• Federal Tax withheld that meets or exceeds 33% of the

stated income could be considered a frivolous filer and generally will be referred to review.

• A refund over $10,000 is another issue where the

return can be referred to review and delayed.

• Balance Due Returns and FAFSA access

– Returns with a balance due, even though electronically filed, are not generally processed until mid to late May or later, depending on the return volume of Refund Returns. This creates issues with your client and accessing a copy of the return via the “2015‐2016 IRS Data Retrieval Tool” – You will be unable to retrieve an amended return.

Pages 37‐39

8/4/2015 104

Form 1099 PATR/1099‐G and Line 3a and line 4a of Schedule F

• If you received distributions from a cooperative in 2015,

your client should receive a Form 1099‐PATR

– On line 3a, show your total distributions from cooperatives. This includes patronage dividends, non‐patronage distributions, per‐unit retains allocations, and redemptions

• f nonqualified written notices of

allocation and per‐ unit retain certificates – Line 4a includes amounts of government payments your clients received and are usually reported to you on Form 1099‐G.

• CP2000 issue: Use the two lines above for these kinds of

payments

– Bulking these payments on line 1a or 2 will result in an issuance

• f Notice CP2000.

Other Issues

• Storing Records Electronically
• Information reporting with respect to

payments made to veterinary corporations

• Where is My Amended Return?
• Get a Transcript ‐ Hacked

Page 39

Identity Theft

• Get a Transcript – IRS Hacked – SYSTEM SHUT DOWN

– They may ask the client to voluntarily create an IP Pin through the IRS system. – NO e‐mails will be issued; IRS currently has no secured e‐mail system in

• peration.

– IRS will not make phone calls to the individuals. – Have client change passwords on critical accounts, especially if the passwords are a birthdate or numbers in the SSN. – Be cautious using your social media accounts. Information there could provide clues to your passwords, like the name of your dog, or the year you graduated. – Watch for anything odd when checking your credit report, you might want to check it more than once a year or subscribe to a credit monitoring service. – Purchase of identity protection may be something your client should

• consider. Clients whose information was hacked will be offered FREE credit

monitoring service.

Page 40

8/4/2015 105

Identity Theft Letters

• 5071C Letter
• 4883C Letter
• 12 C Letter
• Other Identity Theft Notices/Letters

Pages 41‐49

Form 14039

• When to send and where
• File a paper return with the required documents

(more is better)

• Staple Form 14039 to the front of the return
• In addition, you must attach Form 8948 Preparer

Explanation for Not Filing Electronically and notate the reject code

• Expect a six to twelve month processing time

frame.

• Affordable Care Act
• There are no special or specific due diligence requirements

related to Affordable Care Act (ACA) issues

• Best practices
• Change of Circumstance issues
• Key Issues

– Exemptions – Penalties – Reconciling – Time – Education of Your Clients – Job Security and Possible Growth – Repeal Looms in the Background

Pages 50‐51

8/4/2015 106

Changes in Circumstance

• Changes in household income
• Divorce
• Marriage
• Birth or adoption of a child
• Increases or decreases in the number of dependents
• Eligibility for government sponsored or employee

sponsored health care coverage

• Moving to another address
• Gaining or losing non‐Marketplace health care

coverage

• Changes in filing status

Penalty Relief Related to Incorrect or Delayed Forms 1095A

• Notice 2015‐30 provides relief from the penalty

under:

• §6651(a)(2) late payment of a balance due
• §6651(a)(3) for failure to pay an amount due

upon notice and demand

• §6654(a) for underpayment of estimated tax
• a§6662 accuracy‐ related penalty
• This relief applies only for the 2014 taxable

year.

Election procedures and Information Reporting with Respect to Interests in Certain Canadian Retirement Plans

• Eligible individual:

– Is or was at any time a U.S. citizen or resident while a beneficiary of the plan; – Has satisfied any requirement for filing a U.S. federal income tax return for each taxable year during which the individual was a U.S. citizen or resident; – Has not previously reported as gross income on a U.S. federal income tax return the earnings accrued in, but not distributed by, the plan during any taxable year in which the individual was a U.S. citizen or resident; and – Has reported any distributions from the plan as if the individual had made an election under Article XVIII(7) for all years during which the individual was a U.S. citizen or resident.

8/4/2015 107

Election procedures and Information Reporting with Respect to Interests in Certain Canadian Retirement Plans

• Beneficiaries who have reported on their U.S. Federal

income tax return undistributed income that has accrued in a Canadian retirement plan during a taxable year are not “eligible individuals” within the meaning of section 4.01 of the revenue procedure

• Consequently, such beneficiaries are not eligible to apply

section 4.02 of this revenue procedure to make an election under Article XVIII(7) of the Convention and will remain currently taxable on the undistributed income

• If such a beneficiary desires to make an Article XVIII(7)

election with respect to a Canadian retirement plan, the beneficiary must seek the consent of the Commissioner.

You Snooze You Lose Hot Issues

• Karen Hawkins retirement
• 2015 Allowed Living Expense Standards have

been released – OIC

• Cal Pure Pistachios, Inc v. United States
• Education Credits – audits

– 3.6 million received more than 5.6 million in erroneous education credits for tax year 2012

• No form 1098‐T was issued
• Attending ineligible institutions
• Claimed credit for more than four years
• Attended school less than half‐time

8/4/2015 108

More Hot Issues

• Omitting information from the form 1040 can

extend the statue of limitations

• Electronic Confirmation Notices to Employer
• Employer Notices of Address Changes
• Filing deadline for 2016 = April 18, 2016
• Medicare Premium Hikes could effect your

clients in 2018

– Premiums are based on 2016 data, so deferring income could have an impact on 2018 premiums

• CALT RESOURCES

8/4/2015 109

Remaining Scoop Dates for Post‐Filing Season

• August 5, 2015
• September 23, 2015
• October 21, 2015
• October 28, 2015

Upcoming Tax Webinars June 2015

• Confronting a Tax Lien – June 23, Noon to

1:00 ‐ Your client has a tax lien against their

• property. This class will review the lien

procedures and provide guidance on who to call and the circumstances where a lien withdrawal is an option.

Upcoming Tax Law Webinars June 2015

• Payment Options for Your Client – June 24, Noon to 1:00 ‐ The

return has been filed but your client owes. What options does your client have in paying an IRS balance due? We will explore the various payment options available to your client.

• Business Use of Home – Historical vs the New Safe Harbor

Method – June 25, Noon to 1:00 ‐ The Business Use of Home deduction will be reviewed and the differences between the two methods available will be explored. This will help you determine what method works best for your client and the advantages and disadvantages of each method will be explored.

• Disaster – Assisting Your Client with Recovery – June 30, Noon to

1:00 ‐ When disaster hits depending on the circumstances, your client can file for a disaster loss on an amended return in some cases or for the loss on a current years return. How is the loss determined and what procedures will your client need to be aware

• f to determine the loss incurred will be discussed.

8/4/2015 110

CALT Website

http://www.calt.iastate.edu/

Tour of the CALT Website

CALT Staff

Roger A. McEowen CALT Director and is a Leonard Dolezal Professor in Agricultural Law Email: mceowen@iastate.edu Phone: (515) 294‐4076 Fax: (515) 294‐0700

Kristine A. Tidgren Staff Attorney E‐mail: ktidgren@iastate.edu Phone: (515) 294‐6365 Fax: (515) 294‐0700

8/4/2015 111

CALT Staff

Kristy S. Maitre Tax Specialist E‐mail: ksmaitre@iastate.edu Phone: (515) 296‐3810 Fax: (515) 294‐0700 Tiffany Kayser Program Administrator Email: tlkayser@iastate.edu Phone: (515) 294‐5217 Fax: (515) 294‐0700

Time For A Break!

• Afternoon Break

– 2:30 – 2:45 pm.

Potpourri of Agricultural Tax Issues

• 2:45 – 4:45 p.m.

8/4/2015 112

Depreciation

Chris Hesse

• Publ. 225 Table
• Vineyard assets: 7 year vs. 15 year
• Buildings and structures

– 1.5 DB method permitted for 15 year/20 year property – Single purpose vs. general use

• 1.5 DB restriction for assets used in

farming [page 5]

• Accounting method changes

Depreciable Recovery Periods

1‐2

Farm Real Property

• Land improvements = 15 year

– Not buildings

• Single purpose ag or hort structures = 10 year

– Livestock (includes poultry) feeding facility – Greenhouses

• Section 1245 real property = 7 year

– Look like buildings, but are integral part of manufacturing or production

• Farm buildings = 20 year

– Shops, machine sheds, houses for farm employees

3

8/4/2015 113

Bonus Depreciation

Acquired & Placed in Service Bonus % 1/1/08 – 9/8/10 50% 9/9/10 – 12/31/11 100% 1/1/12 – 12/31/14 50% 2015 and after ?

8

• 20 year property: Shops, machine sheds,

residence

• Trade basis counts for bonus
• Bonus depreciation on Sec. 1250 property:

Ordinary to extent > SL

• Conversion to personal use: Recapture

prior Sec. 179 > regular depreciation

– Bonus depreciation = regular depreciation – Example 2 on page 10

Bonus Depreciation: Planning Section 179 Bonus Depr.

New vs. used Both New only Trades Boot only Entire basis Effective for Tax years beg. 50%: 2012‐2014 in ’10‐’14 Eligible assets

• Sec. 1245

Recovery period property

• f 20 years or less

Phaseout? > $2M No

Depreciation Summary

8/4/2015 114

Section 179 Amounts

• Sec. 179 Asset Addn.

Tax yr. beginning in Limit Phase‐out Range 2007 $125,000 $500K ‐ $625K 2008‐2009 $250,000 $800K ‐ $1.05M 2010‐2014 $500,000 $2M ‐ $2.5M 2015 ?? Example 1: Phase‐out [page 13]

12

• Revocation in law thru 2014

– Example 2

• Late or amended election thru 2014

Section 179 Election & Revocation

• Late appearing income
• IRS audit: Capitalized repairs
• Adjust base for Schedule J averaging
• Improper designation
• Shift to another asset if unexpected sale

– Example 4 [page 15]

• Sec. 179 Late Election Opportunities

8/4/2015 115

• $25,000 Sec. 179 limit on > 6,000# veh.
• Exceptions that allow full Sec. 179:

– Seating > 9 persons behind driver (large van) – Pickup with ≥ 6 foot box (not 5.5!) – Vans with driver‐only seating

• Examples 5 and 6

Section 179 on Vehicles

• Noncorporate lessor ineligible unless:

– Short‐term lease – Overhead over 15% of first 12 mos. rent income – Example 7

• Active business income limit

– Example 8

Section 179 Issues

• Partnership vs. co‐ownership of

equipment

• Estates and trusts

– No Sec. 179 deduction for estate or trust purchases – No K‐1 allocations to a trust or estate – Example 10 [page 20]

• Vineyard eligible when placed in service
• Eligibility checklist

Section 179 Issues

8/4/2015 116

1 2 3 4 Depreciation: (xx) (xx) (xx) (xx) Gain: 4797: Ord. inc. ++ ++ – Basis ‐0‐ ‐0‐

• Elective annual grouping of assets in same

class, method, recovery period

• Example 1

GAA Depreciation

24‐27

• Electing GAA depreciation

– Form 4562, Line 18

– Binding only for current year additions

• “Qualifying dispositions” allow use of

basis against gain

– Cessation of business, casualty, charitable donation, Sec. 1031 or 1033, etc.

GAA Depreciation

Meals and Lodging

Roger A. McEowen

28‐34

8/4/2015 117

General Rules

• Furnished in‐kind to employee (including

spouse and children) for employer’s convenience on employer’s business premises…

– Excluded from employee’s gross income – Deductible by employer – ordinary and necessary business expense – Lodging must be as a condition of employment – Not wages for FICA and FUTA purposes

Exclusion of the Value of Meals

• On the business premises

– Place of employment where employee performs significant portion of duties or employer conducts a significant portion of business

For the Convenience of Employer

• Cannot be intended as compensation

– Employment contract that fixes terms of employment is not controlling. – Based on facts and circumstances

• Need a reasonable connection between providing

employees with meals and lodging and business interests of employer

– Note about leased premises

• Use a written lease that details amount of rent

corporation is paying and the corporation’s access right to the residence.

28‐29

8/4/2015 118

Other Points

• Include in income if it constitutes

compensation

• Meal allowances or reimbursements provided
• n routine basis for overtime work are not

“occasional meal money” under the de minimis rules

• Groceries can count as “meals” if employee

required to live on premises as condition of employment

Meals as a Fringe Benefit

• If more than 50% of the employees to whom

meals are provided on the business premises are provided for the employer’s convenience, then all meals are treated as furnished for the employer’s convenience

Caution

• Do employees have option of not purchasing

meals provided by employer at cost, IRS says the excess of FMV over price of meals is income to employees

8/4/2015 119

Employer‐Provided Lodging

• Employee must accept lodging on the

premises as a condition of employment and for employer’s convenience

• Must be provided “in‐kind”

– No cash allowances

What Is Lodging?

• Heat
• Electricity
• Gas
• Water
• Sewer service
• Household furnishings

– No Sec. 179

• Telephone services

30

“As a Condition of Employment”

• Must be necessary for the employee to

properly perform their job duties

– Objective standard – Corporate documents immaterial

8/4/2015 120

For “Convenience of Employer”

• Same thing as “condition of employment”

“On the Business Premises”

• Place of employment
• Immaterial whether meals and lodging are

provided on premises that the corporation leases rather than owns

– The real question is whether the lodging and meals are provided on the business premises

30‐33

Morehouse v. Comr. 140 T.C. No. 16 (2013)

• Facts:

– Taxpayer lived in TX and worked for Univ. of TX. He inherited farmland in SD and bought out farmland of other heirs. He cash rented the land to a SD farmer and later enrolled the majority of the land in the CRP. He eventually moved to MN.

• Arranged for farmer to perform CRP contract

requirements

• Received cost‐share for required maintenance
• Occasionally visited properties
• Did not pay self‐employment tax

Pages 35‐41 of potpourri session

8/4/2015 121

Morehouse

• IRS asserted self‐employment tax should be

paid on CRP rents

– Announcement 83‐43

• But this involved an active farmer

– 6th Circuit decision in Wuebker

• But this involved an active farmer

– CCA 200325002 – Notice 2006‐108

Morehouse

• Tax Court faced with two issues:

– Was Morehouse engaged in a trade or business under I.R.C. §1402(a)? – Were the CRP payments rents from real estate under I.R.C. §1402(a)(1)?

Morehouse

• Trade or business issue

– Court never defined what “trade or business” means in the ag context – There are three factors based on the I.R.C.

• Is the taxpayer bearing risks of production?

– CRP rents are fixed and are not tied to current yields

• Is the taxpayer bearing price risks?

– Commodity prices have no impact on CRP rents

• Is the taxpayer providing management?

– Must be regular, continuous and substantial

8/4/2015 122

The Morehouse Tax Court Debacle

• In a full T.C. opinion, the Court agreed with

the IRS

– Note: To her credit, Judge Paris did not join the

• pinion

Morehouse

• Tax Court agreed with IRS

– Taxpayer was in the trade or business of participating in the CRP with profit intent

• Was in trade or business of creating an “environmentally

friendly farm”

– Material participation requirement entirely skipped

• M.P., by statute, must be satisfied by the taxpayer
• personally. The conduct of the tenant doesn’t count
• The court said that the contract requirements were enough

– 6th Circuit’s opinion controlled

• But Wuebker involved an active farmer and there was a

“nexus” to his farming operation (Ray)

Morehouse Appeal

• Oral argument before the 8th Circuit was June 11 at St. Paul, MN

before Judges Loken, Beam and Gruender

– Beam

• “The IRS appears to have fashioned this rule out of whole cloth”
• The IRS change of position was “just a figment of the Commissioner’s

imagination”

• While IRS maintained that CRP payments aren’t rental payments because

there is no use and occupancy of the land, Judge Beam said that the CRP involved a situation where the “government comes on your land with rules and regulations”

– Loken

• “There still has to be a trade or business and the IRS has flipped‐flopped”
• On the S.E. taxability of value‐added payments in Bot, “the value added

payment was based on the amount of corn delivered”

8/4/2015 123

8th Cir. Reversal

• Morehouse v. Comr., No. 13‐3110, 2014 U.S. App.

LEXIS 19331 (8th Cir. Oct. 10, 2014)

– CRP is the modern day version of the Soil Bank Program

• IRS had said in Rev. Rul. 60‐32, the Soil Bank payments in the

hands of a non‐farmer were not s.e. taxable

– Position reiterated in Rev. Rul. 65‐149

• Court said the rulings were binding on the IRS in light of the

fact that IRS never published the Rev. Rul. that was announced in Notice 2006‐108

– Notice 2006‐108 not entitled to deference

8th Cir. Reversal

• Court distinguished Wuebker

– Morehouse involved a non‐farmer

• “The Sixth Circuit neither recognized nor rejected the IRS’s

position in Rev. Rul. 60‐32 that similar payments to non‐farmers were not self‐employment income”

– Court also said that CRP payments were received for the government’s use and occupancy of the taxpayer’s land

• CRP contract reserved the government’s right of entry
• Government could fulfill the contract requirements if taxpayer did

not

• Government is using the property for the government’s own

purpose or removing sensitive cropland from production and

• ther environmental purposes for the public’s benefit

8th Cir. Reversal

• Key point by the dissent

– “Whether CRP payments that the government made after December 31, 2007 or currently makes to a non‐farmer qualify as rentals from real estate under amended §1402(a)(1) is a question that the court’s decision does not resolve.”

8/4/2015 124

CRP Rents – Where Are We Now?

• In the 8th Cir., non‐farmers do not owe s.e. tax on CRP rents

for payments made before 2008.

– For post‐2007 payments, the case stands for the proposition that a non‐farmer is not engaged in the trade or business of farming and would also not owe s.e. tax on CRP rents

• IRS may issue a non‐acquiescence
• Tax Court opinion in Wuebker controls outside the 6th Cir.
• Sixth Circuit opinion in Wuebker controls within the 6th Cir.
• In other Circuits, the 8th Circuit’s decision is persuasive

authority.

– No penalties for taxpayers or preparers

• If taxpayer receiving Soc. Sec. payments, CRP rents are not

s.e. taxable (whether a farmer or not)

– Report on Sched. F, but back out on line 1b of Sched. SE

S.E. Taxability of Negative Easement Payments

• CCM 20152102F (Feb. 25, 2015)

– Taxpayer is a C corp that entered into agreements with a related corp to put development restrictions on taxpayer’s property in return for payments. The issue was whether the payments were “rents” or gain from the sale of capital assets, or gain from sale of Sec. 1231(b) property such that it will cause taxpayer’s personal holding company income to exceed 60% of adjusted ordinary gross income for the tax year

• PHC tax is an additional 20% tax on undistributed PHC

income (I.R.C. Sec. 541)

74‐75

S.E. Taxability of Negative Easement Payments

• IRS defined rent as “amounts received for the use
• f, or right to use, property of the corporation.”

– IRS cited Morehouse for the proposition that CRP payments are “rents” that are paid to the landowner for the government’s use of the property

• Here, the payments were made to prevent the recipient

from using their property in a way that would diminish the value of the payor’s property.

– This is a “use” of the property

– Morehouse supported IRS position because Morehouse was a non‐farmer

• Judge Beam, in Morehouse, believed that CRP payments

were the same as easement payments – rents

– The government was “using” the property for it’s own purposes

8/4/2015 125

Deferred Payment Contracts

Roger A. McEowen

42

Two Provisions for Livestock

• 451(e)

– One‐year deferral

• 1033(e)

– Involuntary conversion rule

42

451(e)

• Conditions for eligibility

– Principal business is farming – Cash method – Normal business practice is to defer – Area is eligible for assistance by federal government – Applies to excess livestock

8/4/2015 126

One‐year Deferral

• Calculating gain

– Example 1

• Successive elections
• Statement attached to return
• Principal business must be farming

43‐44

Involuntary Conversion

• Replacement period

– 2 years – 3 years – 4 years

• The election
• Destroyed by disease
• Drought or weather‐related condition

45

Deferred Payment Contracts

• It is often desirable to transfer title or sell crops in

the current tax year, but defer payment until the following year. To properly defer the income, you must have some form of a “deferred payment contract” in place.

• A “deferred payment contract” is taxed under the

installment sales rules. Sec. 453(b)(2) disallows the installment method for sales of inventory.

• However, sale of farm products are specifically

excluded from this taxation and thus allowed to use “deferred payment contracts” [Sec. 453(I)(2)(A)]

8/4/2015 127

Deferred Payment Rules

• Seller should obtain a written contract under local law binding buyer and seller.
• The contract should state the seller is not entitled to any proceeds until a certain

future date.

• The contract should be signed before the seller has any right to any proceeds.
• The buyer should not credit the seller’s account for any goods the seller wants to
• purchase. For example, when corn is sold to local co‐op and purchases fertilizer

from the same co‐op, the purchase of the fertilizer should not be applied against the amount owed to the farmer. The fertilizer should be separately billed and paid for.

• The contract should state the farmer has no right to assign or transfer the contract.
• The contract should also state the taxpayer has no right to use the contract as

collateral for a loan.

• The buyer should avoid sales through an agent where the agent holds the funds.
• Price‐later contracts should state that in no event could payment be received prior

to the desired date, even if the price is established earlier.

Election to Report in Year of Sale

• It is common to have multiple deferred payment contracts at

year‐end.

• If income is too low, farmer can elect to report the income on

any contract in the current year.

• The election is made on a contract by contract basis.
• The election is made simply by reporting the income on the

tax return.

• Care must be taken to not report the sale in the subsequent

year.

Deferred Payment Example

• Farmer Brown raised 100,000 bushels of grain in 2013. He sells 50,000 bushels at

harvest and enters into five 10,000 bushel deferred payment contracts at $7.50 per bushel.

• Example 1 ‐ When CPA Smith prepares the return, she determines that instead of

having desired farm income of $75,000, the actual income is zero. Farmer Brown thus elects to accelerate one of the contracts worth $75,000 into 2013 increasing his income to desired $75,000 level.

• Example 2 – Instead of entering into five contracts, assume Farmer Brown enters

into one contract. When CPA Sue informs him that his income is zero, Farmer Brown has lost any flexibility to increase his income. He can either show farm income of zero or accelerate $375,000 of the deferred payment income into 2013. Neither is what he wants.

8/4/2015 128

Substantiating Deductions

Roger A. McEowen

53

Substantiating Deductions

• Legislative grace
• Permanent books of account or records
• Cohan Rule:

– If expenses incurred, can estimate amount – Some evidence required – Disallowed if no basis

Lost Records/Reconstruction

• Records can be reconstructed

– Casualty or non‐casualty – Stolen – Lost access

• Cohan Rule inapplicable if caused by TP or lost

through carelessness

8/4/2015 129

Medical Expenses

• 10% threshold
• 65 and over exception
• No maximum limit
• Year actually paid

– Exception for insurance premiums

54‐58

Medical Expenses

• Expenditures were:

– Essential element of treatment, and – Not incurred for non‐medical reasons

• Property improvements

– Allowed to extent exceeds increase in property value

• List in materials

Medical Expenses

• Lodging and transportation

– Lodging ≤ $50 /night per person – Gas, oil, fees, tolls – Can use standard mileage rate

• Reimbursements

– Included in income to extent deducted

8/4/2015 130

Medical Expenses

• Eligible persons for inclusion

– TP, Spouse and dependents

• Substantiation:

– Name/address of provider – Amount and date of payment – Specific purpose

Casualties, Disasters & Thefts

• Sudden, unforeseeable and unusual event
• No Code definition of casualty
• Loss for personal property = lesser of:

– Decline in FMV, or – Adjusted basis

• Limited by:

– Loss exceeds $500, and – Loss exceeds 10% of AGI

• Timing: Claimed in

– Year loss incurred or – Year immediately preceding

58‐59

Section 212 Expenses

• All ordinary and necessary expenses for

– Production or collection of income – Management and maintenance of property – Determination or refund of any tax

• See lists in materials – not exclusive and with

many exceptions

59‐60

8/4/2015 131

Employee Expenses‐Form 2106

• Common and accepted in trade or business
• Vehicle
• Transportation
• Travel overnight
• Other business Expense
• Meals and entertainment

61

IRC §274

• Satisfy § 162 plus:

– Amount each expenditure – Dates of travel and business days – Destination – Business reason or expected benefit

• Disallowed in full unless every element

present

61‐68

IRC §274

• Contemporaneous log not required BUT
• Reconstructed records must be equal
• Travel expenses generally require overnight

stay

• Related to TP trade or business

8/4/2015 132

IRC §274

• Tax home as principal place of employment
• Factors include:

– Length of employment – Business justification of duplicate living expenses – Where spends more time or business activity – Where greater proportion of income

IRC §274

• No deduction for:

– Commuting expense – Spouse travel unless employee/business purpose – Travel for personal benefit – Meeting outside of North America with exceptions

• Entertainment subject to 50% with exceptions

Charitable Deductions

• Voluntary transfer of property without

adequate consideration

• Exceed FMV of any benefit received
• Long list of qualifying organizations

68‐71

8/4/2015 133

Charitable Deductions

• Non‐deductible expenses

– Fraternal society, order or association unless… – Raffle tickets – Services – Travel expenses – Trusts/Remainder interests except CRT/CRAT etc.

Charitable Deductions

• Substantiation

– Money

• Cancelled check
• Receipt showing

– Name of donee – Date, and – Amount

• Contemporaneous nature
• Earlier of date return filed or due date

Charitable Deductions

• Non Cash Contributions

– Generally FMV – Same receipt as money plus property description – If exceeds $500

• Date and manner of acquisition
• Adjusted cost or other basis

8/4/2015 134

Charitable Deductions

• Contribution over $5000

– Qualified appraisal

• Description of property
• FMV
• Statement appraisal made form income tax purposes
• Appraiser qualifications
• Signature and TIN of appraiser
• Attached to tax return

Charitable Deductions

• Patel v. Commissioner
• Minnick v. Commissioner
• Estate of Evenchik v. Commissioner
• Longino v. Commissioner
• Noz v. Commissioner
• Curcio v. Commissioner
• Robinson v. Commissioner

Selected Income Tax Issues Associated With Oil and Gas

Roger A. McEowen

76

8/4/2015 135

Overview

• Various types of payments
• Two new taxes effective 1/1/13

– The I.R.C. §1411 passive tax

Royalty Income

• Landowner royalty

– The right to the oil and gas or minerals in place that entitles the owner of a percentage of gross production free of expense of development and

• perations
• A continuing non‐operating interest
• The royalty payment is a payment for oil and gas

81

Royalty Payments

• Tax consequences

– Lessor

• Reports gross amount received

– No reduction by any part of cost of rights under which royalties received or by any amount allowable as a deduction when computing gross income – Reported to lessor in Box 2 of Form 1099‐Misc – May be subject to cost depletion – Include in NII

8/4/2015 136

Royalty Payments

• Tax consequences to lessee

– Deductible – Payment of ad valorem taxes on mineral property by lessee is an additional royalty to lessor

• To extent income from production covers the tax

payment

– Otherwise, it’s additional rent not subject to depletion

Advanced Royalties

• Paid before production of minerals occurs

– Lessee must pay royalties on a specified number

• f units of minerals annually (extraction

immaterial) – Lessee can apply amounts paid on account of units not extracted within the year against royalty

• n minerals extracted later; and

– Payment is avoidable

Advanced Royalties

• Tax treatment

– Lessee

• Deduct in year in which production is sold

– Lessor

• Ordinary income
• No percentage depletion
• Cost depletion in year payments are made

8/4/2015 137

Advanced Minimum Royalties

• In addition to conditions for advanced

royalties, the contract requires a substantially uniform amount of royalties be paid at least annually over the life of the lease or for a period of at least 20 years.

82

Advanced Minimum Royalties

• Tax treatment

– Lessor

• Same as advanced royalties

– Lessee

• Has option to deduct payments in year paid or accrued
• r when oil or gas is sold or recovered.

Shut‐In Royalty

• “Shut‐in” means a well is turned off due to

lack of market or marketing facilities

– Well remains capable of producing in commercial quantities – Lessee can deduct payment – Lessor has royalty income

8/4/2015 138

Lease Bonus

• An amount paid (usually per acre) to acquire

an economic interest in minerals.

• Must be payable in all events with no

conditions precedent or subsequent to subvert the payments.

77

Tax Consequences of Bonus Payments

• Lessee: Must be capitalized as leasehold

acquisition costs.

– May be subject to cost depletion

• Lessor: Must report ordinary income.

– Treated as an advanced royalty – Not subject to % depletion – However, the lease bonus may be subject to cost

• depletion. See Reg. § 1.612‐3(a).

Bonus Payment

• What if lessee deducts percentage depletion?

– Lessee’s depletable gross income from the property must be reduced by a proportionate part

• f the bonus paid
• The reduction is part of the bonus payment paid in the

tax year or prior years allocable to the product sold during the tax year.

• Lessee reduces gross income from the property by

amount of bonus payments paid for the lease

8/4/2015 139

Bonus Payment Paid in Installments

• Paid annually for fixed number of years

regardless of production and are not avoidable by lease termination

– Also consideration for granting lease – Lessee capitalizes the payments – Lessor has ordinary income equal to FMV of contract in year lease was executed (if right to income transferable)

• If not transferable, cash basis lessor can defer

recognizing payments until receipt.

79

Character of Bonus Payments

• Dudek v. Comr., T.C. Memo. 2013‐272

– Facts:

• Petitioner received $883,250 as up‐front bonus payment to allow oil

and gas company to lock‐up property for eventual lease. The payment was not dependent on any extraction or production of oil or gas

• Petitioner treated amount as long‐term capital gain and argued that

sale rather than lease involved.

• IRS claimed amount was ordinary income and assessed additional tax
• f $147,397 and imposed accuracy‐related penalty of $29,479
• Petitioner said that if IRS was right, he was entitled to a depletion

deduction.

– Holding:

• Court agreed with IRS and also disallowed a percentage depletion

deduction because no production had occurred ‐ no well drilled on property at time payment received; permanent easement not involved

• Accuracy‐related penalty upheld

– Affirmed on appeal.

77‐78

The Dudek Case – Bonus Payment

• Tax Court

– Noted that U.S. Supremes had long ago ruled that the receipt of a bonus payment by a lessor is ordinary income

• Burnett v. Hamel, 287 U.S. 103 (1932)

– Lease vs. sale analysis

• The key is whether the lessor retains an economic interest in

the deposit. If so, it’s a lease and the proceeds are ordinary income

– Here, the petitioner was entitled to a royalty of 16 percent of the net profits of any oil or gas extracted. That gave the petitioner an economic interest in the minerals in place

8/4/2015 140

The Dudek Case – Lease Bonus

• The depletion issue

– I.R.C. §613A(d)(5)

• A percentage depletion deduction for income from oil and gas wells

does not apply to “any lease bonus, advance royalty, or other amount payable without regard to production from the property”

– Petitioner’s bonus payment was paid to induce him to enter into the lease agreement and was not related to any extraction or production of oil and gas – Court noted, however, that bonus payments are eligible for cost depletion via Treas. Reg. §1.612‐3(a)(1), with the amount being dependent on the taxpayer’s basis for depletion, the amount of the bonus payment and the future royalties the taxpayer expects to receive.

• Here, petitioner didn’t have any evidence as to the amount of

royalties he expected to receive. Thus, cost depletion couldn’t be computed.

Questions from Dudek

• How does a lessor establish a separate “basis”

for mineral rights when the land and minerals are purchased together in a single transaction?

– Many buyers don’t allocate cost basis to mineral rights when they are acquired in the same transaction with the land – This could create a big problem!

Separate Cost Basis in Minerals?

• Internal Revenue Manual (4.41.1.2.1.2) (Dec. 3,

2013)

– There is no separate cost basis in the minerals unless:

• The seller’s cost included a stipulated amount for mineral

rights;

• The seller’s basis was the result of an estate tax valuation in

which minerals and the surface were valued separately; or

• The seller’s cost basis can be properly allocated between

surface and minerals because of substantive evidence of value attributable to the minerals at the date of acquisition

8/4/2015 141

Estimated Future Royalties on Wildcat Acreage

• Issue not addressed by Dudek:

– Can you claim a 100% cost depletion deduction in situations where a zero estimate of future royalties to be received in the future is reasonable?

• Yes. Collums v. United States, 480 F. Supp.864 (D. Wyo.

1979)

– A zero estimate of future royalties was reasonable where the lease was in a wildcat area and where there was no evidence to indicate there would be future production during the lease term. Court applied the formula in the Treas. Regs. to allow cost depletion deduction in year of receipt of lease bonus equal to the entire basis in the lease. But…

Service Position on 100% Cost Depletion

MSSP page 3‐44

Cost Depletion on Wildcat Acreage

If a taxpayer (landowner) receives a lease bonus on wildcat acreage and claims cost depletion equal to 100 percent of it cost, this has the effect of claiming that the minerals are worthless as they supposedly will produce no future income (i.e., no mineral deposit exists). Worthlessness must be proven by an identifiable event, and in this case, no such event has occurred. Further, it is assumed that the lease itself has value

• r the lessee would not have paid the bonus. Therefore, cost depletion should

not be allowed unless it is possible to make a reasonable estimate of future income and that estimated income is not zero. See also, TAM 8532011 (May 7, 1985)

86

Any Way Around the Problem Presented by the IRS?

• Consider the following:

– Before entering into negotiations with oil company, separate out an overriding royalty interest from the working interest and transfer the overriding royalty interest to a separate related party for a business reason. – Then negotiate similar deal with oil company and transfer entire working interest to the oil company – Bottom line:

• Oil company gets the working interest “subject to” the pre‐existing
• verriding royalty interest that the related party holds
• Stronger case for “sale” rather than “lease” – no retained economic

interest in the oil and gas deposit by retaining a royalty. Instead, the taxpayer has disposed of the taxpayer’s entire interest in the minerals.

– Step transaction??? Substance over form???

• See FSA 1999‐819

8/4/2015 142

Delay Rental Payment

• An amount paid for the privilege of deferring

development.

– Is “pure rent” and is not a payment for oil

• Must be avoidable

– This characteristic distinguishes a delay rental from a lease bonus payable in installments.

• Abandonment
• Commencement of development of operations

80

Tax Consequences of Delay Rental Payments

• Lessor

– Must report ordinary income – NII – Report on Schedule E, flowing to line 17 of 1040

• Lessee

– The IRS position is that they must be capitalized as leasehold costs under I.R.C. §263A up to depletable basis – To extent not required to be capitalized, may deduct

• currently. Treas. Reg. §1.612‐3
• May be allowed to capitalize or deduct on an annual basis. I.R.C.

§266

Service Position on Delay Rentals

• Reg. § 1.263A‐2(a)(3). Treat delay rentals as

preproduction costs and capitalize them to leasehold costs on the property. (1986)

• PLR 9602002. At least some delay rentals must

be capitalized. (1994)

• Coordinated Issue Paper. (1997)
• Appeals Settlement Guideline. (2002)

8/4/2015 143

Settlement Guidelines for Capitalization of Delay Rentals

• 1. Capitalize those delay rentals paid for leases that are

part of an area for which there was a comprehensive plan to explore and produce wells.

• 2. Capitalize those delay rentals paid for leases that are

part of an area in which there has been G&G activity since acquisition, or for which there has been a purchase of G&G information.

• 3. Use taxpayer information to develop an historical

production and pre‐production rate for leases.

Settlement Guidelines for Capitalization of Delay Rentals

4. Take a “look‐back” at what actually occurred. That is, deduction of delay rentals would be allowable in the year in which there was no further pursuit of production or pre‐production activities for the particular lease area. This would be feasible since Appeals consideration would be well after the fact. 5. Historical lease abandonment rates of the taxpayer involved could be used to determine an appropriate write‐

• ff period for delay rentals, without regard to the

particular lease involved. 6. Use of any other facts or factors, perhaps unique to the situation, which might indicate intent to develop or a lack thereof.

Bottom Line on Delay Rentals

• Capitalize if:

– A taxpayer performs geological and geophysical surveys (G&G) on acquired leasehold, or – Files a plan of development with an appropriate governmental agency, or – Authorizes funding for the development of the lease

8/4/2015 144

Production Payments

• Owner of oil and gas interest sells a specific

volume of production from an identifiable property until a specified amount of money or minerals has been received

– Payable only out of working interests’ share of production

83‐84

Production Payments

• Types

– Retained production payments – Carved‐out production payments

Production Payments

• Tax treatment

– Carved‐out payment generally treated as a nonrecourse mortgage on the property

• Lessee treats payment as repayment of principal and

interest expense

• Lessor treats payment as repayment of principal and

interest income

– No income at time transaction entered into

8/4/2015 145

Production Payments

• If payment is for development of the property,
• r the payment is retained when the property

is leased, payment is not an economic interest

– Ordinary income to lessor subject to cost or percentage depletion – Lessee capitalizes the payments

Basics of Depletion Deduction

Depletion = Greater of Percentage Depletion = Lesser of

Cost Percentage

100% of taxable income (N/A for Marginal Production) 15% of gross income

85

Depreciation

• Oil and gas property

– Normal MACRS rules – Typically 7‐year property – 200% declining balance method – Eligible for I.R.C. §179 – Eligible for “bonus” depreciation – DPAD (6% of DPRG)

88

8/4/2015 146

Natural Gas Gathering Lines

• New Statutory 7 Year Recovery Period
• Section 168(e)(3)(C)(iv) original use begins

with the taxpayer

• Placed in service after April 11, 2005

Natural Gas Gathering Lines: Current Law

Natural gas gathering lines are treated as:

7 year property under MACRS by Taxpayers

• Rev. Proc. 87‐56, Asset Class 13.2

Duke Energy Natural Gas Corp., 10th Cir. 1999 Saginaw Bay Pipeline Co., 6th Cir. 2003 Clajon Gas Co. LP, 8th Cir. 2004 and 15 year property under MACRS by the IRS

• Rev. Proc. 87‐56, Asset Class 46.0

Duke Energy Natural Gas Corp., 109 T.C. 416 Saginaw Bay Pipeline Co., D. Mich. Clajon Gas Co. LP, 119 T.C. 197

Natural Gas Gathering Lines: New Law

New § 168(e)(3)(C)(iv) provides that any natural gas gathering line the original use of which commences with the taxpayer after April 11, 2005 is depreciable as MACRS 7 year property. No AMT depreciation adjustment shall apply to property described in § 168(e)(3)(C)(iv), [§ 56 (a)(1)(B)]

8/4/2015 147

Natural Gas Gathering Lines: New Definition

A natural gas gathering line is defined in §168(i)(17) as: (1) The pipe, equipment, and appurtenances determined to be a gathering line by the Federal Energy Regulatory Commission, and

Natural Gas Gathering Lines: New Definition (Con’t)

(2) The pipe, equipment, and appurtenances used to deliver natural gas from the wellhead or a common point to the point at which the gas first reaches either:

a) A gas processing plant, b) An interconnection with a transmission pipeline for which a certificate as an interstate transmission pipeline has been issued by the Federal Energy Regulatory Commission, c) An interconnection with an intrastate transmission pipeline, or d) A direct interconnection with a local distribution company, a gas storage facility, or an industrial consumer (Code Sec. 168(i)(17), as added by the Energy Act).

Natural Gas Gathering Lines

• New Change in the Alternative Depreciation

System Class Life

– Former law: 22 year class life. (Asset Class 46.0) – New law: 14 year class life. § 168(g)(3)(B)

• No tax preference item for MACRS

depreciation on natural gas gathering lines. §56(a)(1)(B)

8/4/2015 148

Uncertainty May Continue

• The new law will not apply to:

– Natural gas gathering lines placed in service prior to the effective date, or – Used gathering lines acquired after the effective date.

Taxpayer’s Argument

• Taxpayers have taken the position that oil and gas

gathering lines are included in Asset Class 13.2 of

• Rev. Proc. 87‐56, and therefore have a recovery

period of seven years.

• Asset Class 13.2 “includes assets used by

petroleum and natural gas producers for drilling wills and production of petroleum and natural gas, including gathering pipelines and related storage facilities.”

Taxpayer’s Position

• The controversy occurs in situations in which the

gathering system is not owned by a producer, but instead is owned by an unrelated pipeline company.

• In these situations the pipeline company [the owner of

the gathering pipeline] argues that as long as the gathering pipelines are used by petroleum and natural gas producers [non‐owners] for the production of oil and gas from the underground formation, the gathering pipelines belong in Asset Class 13.2 with respect to the pipeline company.

8/4/2015 149

Service’s Position

• The government consistently takes the position that

the gathering lines of pipeline companies belong in Asset Class 46.0 of Rev. Proc. 87‐56, and have a recovery period of fifteen years.

• Asset Class 46.0 “includes assets used in the private,

commercial, and contract carrying of petroleum, gas and other products by means of pipes and conveyors.

• The government argues that the gathering line must be
• wned by a producer in order to qualify for Asset Class

13.2.

Plain Language Argument

• Thus, the specific language in Asset Class 13.2 was

materially and substantively modified, even though Section 1.04 of the Rev. Proc. 77‐10 states that no change to the asset class was intended by the drafters.

• It is also plain to see that that language requiring the

producer to own the gathering lines was omitted in this description in Rev. Proc. 77‐10.

• Here the seekers of intent must make a decision: Does

it mean what it was? Or Does it mean what it says?

It Means What it Says

• Three Circuit Courts of Appeal have held it

means what it says!

• Taxpayers have successfully taken MACRS

deductions based on a 7 year recovery period.

8/4/2015 150

Natural Gas Distribution Lines

• New 15 year Statutory Recovery Period

Natural Gas Distribution Lines

• Former Law:

– Natural gas distribution lines were treated as 20 year property under MACRS

[Rev. Proc. 87‐56, Asset Class 49.21]

– New law:

• § 168(e)(3)(E)(viii) provides that any natural gas

distribution line the original use of which commences with the taxpayer after April 11, 2005 and before January 1, 2011, is depreciable as MACRS 15 year property.

Natural Gas Distribution Lines

• Provision not to apply to used gas distribution

lines

– Used gas distribution lines purchased as an asset from an existing business or – Received as an asset in connection with a taxable acquisition of an existing business

• Binding contract exception is applicable

8/4/2015 151

Natural Gas Distribution Lines

• No Change in the Alternative Depreciation

System Class Life

– Former law: 35 year class life. – New law: 35 year class life. § 168(g)(3)(B)

• No tax preference item for MACRS

depreciation on natural gas distribution lines. § 56 (a)(1)

Uniform Capitalization Rules

• Rev. Rul. 68‐226

– An oil and gas leasehold is an interest in real property – Mineral interest is real property

• This means that a taxpayer who acquires and

develops oil or gas properties is engaged in a developmental activity as defined by I.R.C. §263A

89

UNICAP Rules

• Predevelopment expenses

– Can’t distinguish from intangible drilling costs

• IDCs are not subject to the UNICAP rules

– Exploration is a separate activity from development and production

8/4/2015 152

Damage Payments

• Crop damage payments are ordinary income

– Treat as a sale of the crop – If, however, a portion represents damages to business goodwill, payment is non‐taxable up to basis in the affected property, then taxable as §1231 gain.

• Payment for anticipated damages (but where

there are none), are ordinary income

174

USDA Grants – Income Taxation

• r Exclusion

Chris Hesse

92

• Definition

– Must conform to NRCS plan or local, state or county plan

• 25% deduction limit
• Ineligible expenditures

– Land clearing – Cash rent landlords ineligible for Sec. 175

• Recapture: Only if dispose within 10 years
• f land acquisition

Soil & Water Conservation Exp.

8/4/2015 153

Cooperatives and Farmers

Chris Hesse and Roger McEowen

94

Patronage Dividends

• What is included in patron’s gross income?
• What about “qualified written notice of

allocation”?

• What about non‐qualified patronage

dividends?

94

The Qualified Domestic Production Deduction

• General rules
• Detail with respect to agricultural producers

and ag businesses

96

8/4/2015 154

DPAD – Other Points

• Deduction equals 9 percent of the lesser of

QPAI or taxable income (AGI for an individual)

– Allowed for both regular tax and AMT – Not allowed when computing S.E. tax – Available for pass‐through entities, but is applied at shareholder, partner or beneficiary level – Co‐ops can claim the deduction

W‐2 Wage Limitation

• 50% of W‐2 wage limitation
• Note the definition of “W‐2 wages”

– In‐kind wages don’t count – Must be allocable to DPGR

• Example 2
• Example 2A – consider whether it’s worth it to pay the

spouse a W‐2 wage amount

– Various methods for computing W‐2 wages

97‐98

QPAI

• To compute QPAI, you must know DPGR, CGS

and other allocable expenses

• QPAI could be equal to overall taxable income

(AGI for individuals)

• Must be determined on an item‐by‐item basis

99

8/4/2015 155

FORM 8903

• Individuals – line 35 of 1040
• C corporations – line 25 of Form 1120
• Estates and trusts
• Farm landlords

– Depends on type of lease and whether landlord has W‐2 wages

DPGR

• What is DPGR

– Gross receipts received from qualified activities

• Trade or business

– No definition in regulations

• No support or service activities
• Crop insurance/FSA subsidies count
• Sale of productive livestock

– Raised livestock count – Sales of purchased breeding and dairy stock acquired as a mature animal probably don’t generate DPGR (and, in any event, only one taxpayer can claim a DPAD with respect to an item of tangible personal property)

DPGR and Hedging Transactions

• Gains and losses from hedges count as DPGR if

the hedge involves the purchase of supplies that are used in the taxpayer’s business

• Storage, processing and handling activities

– Example 3

100‐101

8/4/2015 156

Other Points on DPGR

• Gross receipts from operating mineral

interests count, but not gross receipts from mineral royalties and net profits interests

• Safe harbor can come into play

101‐102

Pass‐Through Entities

• Trusts/Estates
• Partnerships/S corporations
• Handling qualifying wages

– Example 8 on page 65

• Cooperatives

107‐108

Interest Charge Domestic International Sales Corporations (IC‐DISCS)

Michelle VanDellen, CPA, MS

8/4/2015 157

How an IC‐DISC Works ‐ Pass‐Through Entity Structure

Pass‐through entity structure:

• Sales commission is paid from the

Exporting Entity to the IC‐DISC, resulting in a tax deduction against individual ordinary income tax rates of up to 39.6% (43.4% for passive owners subject to NIIT*)

• The IC‐DISC isn’t subject to federal tax
• The IC‐DISC pays a dividend to its parent

(the Exporting Entity), which is taxed at the qualified dividend tax rate for individuals (20%) plus NIIT (3.8%)

* Net Investment Income Tax Commission Dividend

112

How An IC DISC Works – C Corporation Structure

C Corporation Structure

• Sales commission is paid from

the Exporting Entity to the IC‐ DISC, resulting in a tax deduction against corporate income tax rates of up to 35%.

• The IC‐DISC is not subject to

federal tax

• The IC‐DISC pays a dividend to

its shareholders, which is taxed at the qualified dividend rate for individuals (20%) plus NIIT of 3.8%.

Commission Dividend

113

Example: Hops Grower

8/4/2015 158

EXAMPLE: HOPS GROWER (CONT)

Questions?

Michelle VanDellen, CPA, MS Phone: 360‐685‐2205 E‐mail: michelle.vandellen@mossadams.com

Domestic Production Activities Deduction (DPAD)

Michelle VanDellen, CPA, MS

8/4/2015 159

Introduction

• Section 199 allows a tax deduction for

domestic production activities.

• Its goal is to give domestic manufacturers a

tax incentive for certain domestic production activities.

• It applies to many entities not engaged in

activities traditionally viewed as manufacturing.

How is the deduction calculated?

• The deduction is equal to 9% of the lesser of:

– Qualified Production Activity Income (QPAI); or – Taxable Income

• The deduction is also limited to 50% of wages

allocable to domestic production gross receipts (DPGR).

qualifying activities

• Growing operations
• Food Processing
• Manufacturing operations
• Agricultural and horticultural cooperatives

8/4/2015 160

Qualified Production Activities Income (QPAI)

Domestic Production Gross Receipts (“DPGR”) Less: COGS apportionable to such receipts Other deductions which are allocable to such receipts Equals: QPAI Questions? Michelle VanDellen, CPA, MS Phone: 360‐685‐2205 E‐mail: michelle.vandellen@mossadams.com

Hedging vs. Speculation

Roger A. McEowen

118

8/4/2015 161

Hedge or Speculation – What Difference Does It Make?

• Tax treatment:

– Hedging gains and losses

• Ordinary
• Not subject to loss deferral rules
• Not subject to mark‐to‐market rules
• Subject to S.E. tax
• Report on Sch. C or F

Hedge or Speculation – What Difference Does It Make?

– Speculation

• Gains and losses are capital in nature
• Are subject to loss deferral rules
• Are subject to mark‐to‐market rules
• Are not subject to S.E. tax
• Reported on Sch. D

So, What Is A Hedge?

• A transaction entered into in the normal course
• f business to manage risk of price change or

currency fluctuations

– Can be used to reduce risk of price change or interest rate change – Can be used to lock‐in position in commodity

• Once locked in, if the physical commodity increases in

value, the taxpayer’s value of the futures position should go down (i.e., there should be an offset)

8/4/2015 162

Hedging Example

Jack plans to plants 200 acres of beans and expects a yield of 10,000 bushels

 Before planting Jack buys 2 put options for $.15 totaling $1,500  The price of beans increase and the put options expire worthless  Jack sells the beans for $55,000

Reporting:

 $55,000 for sale of beans  $1,500 as hedge loss

119

Speculation Example

Farmer harvests crop, sells the crop and buys futures on the belief that prices will rise (instead of storing the crop)

 Subject to mark‐market rules

○ Additional reporting requirements – Form 6781 ○ Transaction closed out as of Dec. 31 ○ Treated as if sold for FMV on last business day of tax year (e.g., profit or loss must be reported on taxpayer’s return) ○ Net gain or loss allocated 40% to short‐term capital gain (or loss) and 60% to long‐term capital gain (or loss)

Example of how to report speculation

Jack sells his beans and buys 10,000 bushels

• n the CBOT, and buys 2 put options. The

price of beans increase, he lifts the futures position for a net gain of $15,000

 Reporting:

○ Report gain on Form 6781 and carry to Schedule D ○ 40 percent short‐term capital gain ○ 60 percent long‐term capital gain

120

8/4/2015 163

Method of Accounting

• Must clearly reflect income and reasonably

match the timing of the transactions with the timing of the item or items being hedged

– Under the regulations:

• Taxpayers must maintain books and records containing

a description of accounting method used for each type

• f hedging transaction in sufficient detail that shows

how the clear reflection standard is met

Commodity Transactions

• Identification rule

– Hedge must be identified as a hedge before close

• f day on which hedge created
• Item being hedged must be identified no more than 35

days after the transaction

121

How to Make The Identification

Statement on books and records identifying transaction as a hedge Can designate ledger account as containing

• nly hedge transactions

Inadvertent failure to disclose may qualify for relief Failure to identify may also trigger straddle rules (when taxpayer takes offsetting positions with respect to personal property)

8/4/2015 164

Timing Issues

• Match income, deduction, gain or loss from

hedging transaction with income, deduction, gain or loss on item being hedged

– Take care when multiple transactions for single crops involved

122

Commodity Futures Transactions and Entities

Pine Creek Farms (Tax Court 2001)

 Entity that engaged in hog futures transactions was not engaged in hog production – losses were capital

Welter (Tax Court 2003)

 Personal brokerage accounts used for transactions related to farming business – speculation treatment

IRS Examination Techniques

 What auditors look for:

 Hedging losses should be entered as negative amounts as “other income” on Schedule F  Whenever gross profit “appears” low or expenses appear high in relation to sales, auditors are to scrutinize commodity futures transactions  Broker statements  Taxpayer worksheets  Daily transaction sheets  Monthly summary statements  What commodities are involved? Some don’t reduce risk, per se

123

8/4/2015 165

Paying Ag Wages In Kind

Roger A. McEowen

127

In General

• Wages paid in kind (grain, milk, lodging,

clothing, etc.) are:

– Not subject to FICA, FUTA and FWT – Usually best for owner/employees or long‐term employees – FMV of in‐kind payment is income to recipient – Should be supplemented with some cash wages to maximize Tier SS benefits

Rules – 1994 P.I.K. Guidelines

• Employer recognizes income on amount of transfers
• Employer receives wage deduction equal to income amount
• Must issue W2 to employee and include these wages in Box 1

– Reported as 0 for FICA and Medicare wages

• FMV is based on the date of transfer
• Title must pass to employee
• Employee must have control of commodity, sell the commodity and

incur the costs of holding the commodity

• Any gain or loss on later sale is reported as capital gain or loss on

employee’s Form 8949 (flowing to Schedule D)

• Carrying costs associated with commodity (e.g., storage or

marketing costs) are miscellaneous itemized deductions subject to 2% of AGI limitation, reportable on employee’s Schedule A

8/4/2015 166

Rules (cont.)

• Sale by employee results in short/long term

capital gains/loss

• Should have written employment agreement

specifying the commodity terms

• Should be raised by the employer
• Do not need to allocate costs for current year

crop

Other Points

• Potential s.e. tax treatment to employee if

employee uses the commodity to produce other grain or to conduct a business

– Exposure limited to appreciation of commodity after receipt

• Have written employment contract detail

relationship and quantity or percentage of commodity paid in exchange for labor

• The longer the employee holds the commodity

the better

• Tougher to accomplish with livestock

8/4/2015 167

Recharacterization of Rental Real Estate Income As Non‐Passive

Chris Hesse

130

Bare Land Leases

• Net income from a rental activity is considered

not from a passive activity if less than 30% of the unadjusted basis of the property is depreciable:

– This regulation converts both net rental income and any gain on disposition from passive income into portfolio income. – This conversion rule only applies if there is net income from the activity; if there is a loss, the loss remains in passive status.

Self‐rented Property

• A similar rule applies if the rent income is

derived from a business in which the taxpayer materially participates [Reg. 1.469‐2(f)(6)].

• This can also be applied where the spouse is

the material participant.

8/4/2015 168

Grouping Issues

• Aggregation of self‐rentals prohibited:

– If one rental produces income and one rental produces a loss, grouping the two rentals will not

• vercome the self‐rental rule. The one with a loss

will still be passive and the one with income will be portfolio. You cannot combine the two into

• ne net number.

133

Grouping Issues (cont.)

• Strategies:

– Minimize loss activities – Use §469 authority to group if

• Same proportionate ownership interest
• Material participation
• Rental activity insubstantial

Grouping Issues (cont.)

• However, if the taxpayers can elect to group

the two rentals with the material participation entity, the combined income will be material and not subject to the passive loss rules.

8/4/2015 169

SE Tax on Farm Rental Income

Chris Hesse

134

Mizell Fact Pattern

LABOR LAND I FARMING ENTITY W-2/ K-1 $ RENT $ OWNER IRS POSITION EMPLOYEE

LANDLORD

FARMING ENTITY $ $

8/4/2015 170

• McNamara, CA‐8: Strong taxpayer victory
• Johnson, TC: Rents independent from

salary

• Solvie, TC: Per head hog barn rent = SE
• Solutions on self‐rental leases:

– Lease language: No landlord participation – Rent does not exceed market rate

Court Opinions: Self‐rental SE Issue

136

General Rules for Material Participation Roger A. McEowen

140

• 1. Section 469 says “a taxpayer shall be treated as

materially participating in an activity only if the taxpayer is involved in the operations of the activity on a basis which is (A) regular, (B) continuous, and (C) substantial.” (Sec.469(h)(1)).

General rules for material participation.

8/4/2015 171

It also says that “Except as provided in regulations, no interest in a limited partnership as a limited partner shall be treated as an interest with respect to which a taxpayer materially participates.” (Sec.469(h)(1))

General rules for material participation.

• 2. Spouse participation counts as your participation.

(Sec. 469(h)(5)

• 3. The passive loss rules apply in a limited way to

closely‐held C corporations and personal service

• corporations. They materially participate if

shareholders owning at least 50% of the assets materially participate, or (for C corporations only) if certain employee participation rules are met (Sec. 469(h)(4) and Sec. 465(c)(7)(C)).

General rules for material participation. General rules for material participation.

• 4. The real definitions of material participation are in

the regulations. For the most part, they are based

• n how much time a taxpayer spends on an activity.

8/4/2015 172

General rules for material participation.

You materially participate if (Reg. Sec. 1.469‐5T(a)):

• You participate over 500 hours;
• You participate at least 100 hours and up to 500 hours

in an activity and participation in that and other “100‐ 500 hour” activities (“significant participation activities”);

• You participate at least 100 hours and more than

anybody else;

• You are the only participant; or
• You materially participated in five of the past ten years

(or in any three years for a service activity).

General rules for material participation.

There is one other way to get there. Under Reg.

• Sec. 1.469‐5T(a)(7), you achieve material

participation if:

• “Based on all of the facts and circumstances

(taking into account the rules in paragraph (b) of this section), the individual participates in the activity on a regular, continuous, and substantial basis during such year.” Under Reg. Sec. 1.469‐ 5T(b)(2)(iii), that requires 100 hours of participation.

General rules for material participation. Issue: Does this 100‐hour rule prevent material participation for many activities started at the end of a taxable year? Is that overreach? The case law is inconclusive, but I find no case where a taxpayer has prevailed under the “facts and circumstances” test.

8/4/2015 173

Special rules for real estate professionals.

• Sec. 469(c)(7) allows some people in “real estate trades
• r businesses” to avoid the “per‐se passive” treatment

that otherwise applies to real estate. It applies the regular material participation rules to activities if :

140‐141

Special rules for real estate professionals.

• more than one‐half of the personal services performed in

trades or businesses by the taxpayer during the taxable year are performed in real property trades or businesses in which the taxpayer materially participates, and

• such taxpayer performs more than 750 hours of services

during the taxable year in real property trades or businesses in which the taxpayer materially participates.

• the “one‐half” test is often fatal for people with day jobs.

Special rules for farmers.

From the enactment of Sec. 469, there were efforts to make things different for farmers. From the Senate Committee reports on the 1986 Tax Reform Act:

With respect to material participation in an agricultural activity, clarification is provided regarding the decision‐making that, if bona fide and undertaken

• n a regular, continuous, and substantial basis, may be relevant to material
• participation. The types of decision‐making that may be relevant in this regard

include, without being limited to, decision‐making regarding (1) crop rotation, selection, and pricing, (2) the incursion of embryo transplant or breeding expenses, (3) the purchase, sale, and leasing of capital items, such as cropland, animals, machinery, and equipment, (4) breeding and mating decisions, and (5) the selection of herd or crop managers who then act at the behest of the taxpayer, rather than as paid advisors directing the conduct of the taxpayer.

141‐142

8/4/2015 174

Special rules for farmers.

That’s a looser standard than for other activities, which generally require participation in “operations.” Also in the committee reports:

In the case of farming, the committee anticipates that an individual who does not perform physical work relating to a farm, but who is treated as having self‐employment income with respect to the farm under section 1402, generally will be treated as materially participating.

That’s a standard that can be achieved short of 500 hours. The regulations don’t directly deal with these committee reports.

Special rules for farmers.

• Sec. 469(h)(3):

Treatment of certain retired individuals and surviving

• spouses. A taxpayer shall be treated as materially

participating in any farming activity for a taxable year if paragraph (4) or (5) of section 2032A(b) would cause the requirements of section 2032A(b)(1)(C)(ii) to be met with respect to real property used in such activity if such taxpayer had died during the taxable year.

Special rules for farmers. Issue: Is this also a substantive rule for active farmers? Or can participation fall short before you retire but be counted as participation afterwards? The regulations say (emphasis added):

8/4/2015 175

Special rules for farmers.

Except as provided in section 469(h)(3) and paragraph (h)(2) of this section (relating to certain retired individuals and surviving spouses in the case of farming activities), the fact that an individual satisfies the requirements of any participation standard (whether or not referred to as “material participation”) under any provision (including sections 1402 and 2032A and the regulations thereunder) other than section 469 and the regulations thereunder shall not be taken into account in determining whether such individual materially participates in any activity for any taxable year for purposes of section 469 and the regulations thereunder.

Land Rent.

• Reg. Sec. 1.469‐2T(f)(3):

Rental of nondepreciable property. If less than 30 percent of the unadjusted basis of the property used or held for use by customers in a rental activity (within the meaning of §1.469‐1T(e)(3)) during the taxable year is subject to the allowance for depreciation under section 167, an amount of the taxpayer's gross income from the activity equal to the taxpayer's net passive income from the activity shall be treated as not from a passive activity. For purposes of this paragraph (f)(3), the term “unadjusted basis” means adjusted basis determined without regard to any adjustment described in section 1016 that decreases basis.

143

Land Rent.

In short: Land rent income is non‐passive, but losses are passive.

8/4/2015 176

Grouping.

• 1. General rules:

“One or more trade or business activities or rental activities may be treated as a single activity if the activities constitute an appropriate economic unit for the measurement of gain or loss for purposes

• f section 469… Except as otherwise provided in

this section, whether activities constitute an appropriate economic unit and, therefore, may be treated as a single activity depends upon all the relevant facts and circumstances. A taxpayer may use any reasonable method of applying the relevant facts and circumstances in grouping activities.” (Regs. 1.469‐ 4(c).

142‐143

Grouping.

• 2. BUT!

a) Rental and non‐rental activities may not be grouped unless

• ne is “insubstantial.” There is an exception for rentals

between activities with identical ownership. b) No grouping real property rental and non‐real property rentals. c) If you own an farm activity (or other activities listed in Sec. 465(b)(2) “as a limited partner or a limited entrepreneur,” you may not group that with another activity. The regulation gives an example:

• Sec. 465(b)(2) Example.

Taxpayer A, an individual, owns and operates a farm. A is also a member of M, a limited liability company that conducts a cattle‐feeding business. A does not actively participate in the management of M (within the meaning

• f section 464(e)(2)(B)). IN addition, A is a limited partner

in N, a limited partnership engaged in oil and gas production.

8/4/2015 177

• Sec. 465(b)(2) Example.

Because A does not actively participate in the management of M, A is a limited entrepreneur in M's activity. M's cattle‐feeding business is described in section 465(c)(1)(B) (relating to farming) and may not be grouped with any other activity that does not involve farming. Moreover, A's farm may not be grouped with the cattle‐feeding activity unless the grouping constitutes an appropriate economic unit for the measurement of gain or loss for purposes of section 469.

Grouping.

• 3. Once you group, you are stuck with the groupings

unless:

If it is determined that a taxpayer's original grouping was clearly inappropriate or a material change in the facts and circumstances has

• ccurred that makes the original grouping clearly

inappropriate, the taxpayer must regroup the activities and must comply with disclosure requirements that the Commissioner may prescribe.

Grouping.

• 4. Rev. Proc. 2010‐13 gives procedures for disclosing new
• r changed groupings.
• 5. Temporary regulations under the HCA give taxpayers a

free shot at regrouping activities for 2013. Proposed

• Reg. Sec. 1.469‐11(b)(3)(iv)

8/4/2015 178

Material Participation: what counts, what doesn’t.

469(h) says involvement has to be in the “operations of the activity.” But not just any work. Reg. Sec. 1.469‐ 5T(f)(2) says work “of a type not customarily done by an

• wner of such an activity” with one of its principal

purposes being “to avoid the disallowance under section 469 and the regulations thereunder.”

144

Material Participation: what counts, what doesn’t.

469(h) also says “work done in the individual’s capacity as an investor” doesn’t count, including:

• 1. Studying and reviewing financial statements or reports
• n operations of the activity;
• 2. Preparing or compiling summaries or analyses of the

finances or operations of the activity for the individual's

• wn use; and
• 3. Monitoring the finances or operations of the activity in

a non‐managerial capacity.

Material Participation: what counts, what doesn’t.

Board membership doesn’t rule out participation in

• perations, but most non‐employee board members will

have a tough time winning the argument. See Scheiner, TC Memo 1996‐554.

• Travel time doesn’t count.
• Documenting time spent.

8/4/2015 179

Foreign Account Tax Compliance Act (“FATCA”): Payments to Foreign Persons

Stephanie Hathaway, CPA, MS, MPA

145‐169

FATCA & PAYMENTS TO FOREIGN PERSONS

• Enacted in 2010, enforcement delayed until July 2014
• Designed to prevent and detect offshore tax evasion
• Targets U.S. individuals and businesses making

payments to foreign recipients

• Imposes registration requirement, due diligence

reviews, information reporting and/or tax withholding

• bligations on foreign financial institutions (FFIs) and on

many U.S. businesses

• Willful failure to comply can result in large civil and

even criminal penalties

• Some foreign banks are no longer accepting U.S.

persons as clients because of the reporting required by FATCA

Requirements Under FATCA

• U.S. businesses must have procedures

in place to correctly identify and categorize foreign payees for FATCA compliance and potential 30% withholding tax

• IRS Form W‐8 series – provided by foreign

payees to U.S. payers ‐ indicates FATCA classification, discloses substantial US owners, and claims withholding exemptions available under Chapter 3 of IRC

• U.S. payers must have a completed Form W‐8

for any foreign entity before payments are made to that entity

8/4/2015 180

FATCA – Those Confusing Forms W‐8

IRS Form W‐8 is critical in FATCA compliance

• Form W‐9 – Request for Taxpayer Identification Number

and Certification (used only for U.S. payees)

• Form W‐8BEN – Certificate of Foreign Status of

Beneficial Owner for United States Tax Withholding and Reporting (Foreign Individuals)

• Form W‐8BEN‐E – Certificate of Status of Beneficial

Owner for United States Tax Withholding and Reporting (Foreign Entities)

• Forms W‐8ECI – Certificate of Foreign Person’s Claim

That Income Is Effectively Connected With the Conduct

• f a Trade or Business in the United States

FATCA – Those Confusing Forms W‐8

• Form W‐8EXP – Certificate of Foreign Government or

Other Foreign Organization for United States Tax Withholding

• Form W‐8IMY – Certificate of Foreign Intermediary, Flow‐

Through Entity, or Certain U.S. Branches for United States Tax Withholding and Reporting U.S. payers who make payments to foreign entities may also be required to file:

• Form 1042 – Annual Withholding Tax Return for US Source

Income of Foreign Persons

• Form 1042‐S – Foreign Person’s US Source Income Subject to

Withholding

– Do not use Form 1099 to report payments to foreign persons

FATCA – Final Points

• FATCA creates significant financial exposure for U.S.

businesses

• FATCA is here now ‐ waiting to comply can be very costly
• U.S. payers must develop a strategy to assess current

exposure and ensure compliance with FATCA

• Develop a consistent process for gathering and

compiling Forms W‐8 or W‐9 for all payees

• Withholding exemptions do not exempt the U.S. payer

from reporting. Payers must know the status of each payee and the classification of every payment

8/4/2015 181

Roger A. McEowen

Tax Issues Associated With Easement Payments

170

Overview

• Rights acquired

– Right to lay pipeline – Aerogenerators and road access – Electric lines – Other access rights

Nature of the Transaction

• Perpetual easement

– If no retained beneficial rights, it’s treated as a sale of the underlying tract – If beneficial rights retained, it’s a sale of an easement

108

8/4/2015 182

Easement Payments

• Grant of limited easement is treated as a sale
• f a portion of the rights in the land impacted

by the easement

– Proceeds first applied to reduce basis in land affected

Easement Payments

• Only basis of the land allocable to the portion

subject to the easement is reduced with excess treated as capital gain

– Two step on allocating basis (p. 109)

• See note box on p. 109
• Examples on p. 110
• Does the easement impact the taxpayer’s

entire property?

– Example on p. 111 and cases

Severance Damage Payments

• Does the easement bisect the taxpayer’s

property?

– If so, is the rest of the property usable?

• If not, then apply easement proceeds against basis in

entire property

– Might be able to use Sec. 1033 rules

112

8/4/2015 183

Temporary Easement Payments

• For space

– Access, storage, etc.

• Separately designated

– Rental income for the allocated amount

• Suggestion:

– Include the temporary space in the perpetual easement which is then reduced after a stated amount of time

• May get some basis offset
• May be able to classify as damage payments

174

Damage Payments

• May be able to be offset by basis in the

affected property

– Environmental contamination – Soil compaction

• If payment is for damage to growing crops

– Treat as sale of the crop

• Payments for future damage are treated as

rental payments (release language)

174‐175

Lease Payments

• It’s a right of use that generates ordinary

income (rental income)

– NIIT implications, but no S.E. tax – No basis offset

• Are reversionary rights retained?

– If not contingent, no sale treatment – If contingent, it’s a sale of an easement – If reversion triggered, easement status maintained

175

8/4/2015 184

Negative Easement Payments

• It’s rental income in the recipient’s hands

– F.S.A. 20152102F (Feb. 25, 2015) – Could have application to situations involving the government’s use of a taxpayer’s property to enhance wildlife and conservation

175

Eminent Domain

• Condemnation award

– IRS views it as solely for the property taken and is treated as a sale for tax purposes

• If it exceeds the FMV of the property taken the

taxpayer might be able to allocate the award to various types of damages.

176‐177

Deferral Of Gain

• Sec. 1033

– Reinvest in like‐kind property

• 3 years

– Can include severance damages if used to restore the property – A sale of the remaining property can also qualify for 1033 treatment if the remaining use is not practical and the property is sold

177

8/4/2015 185

Expenses

• Treat as capital expenditures

– Add to basis in the property subject to the easement

• Reduces gain on condemnation
• If made to substantiate and recover severance

damages, capitalize as part of basis of property that is not condemned

178‐179

Estate Tax Implications

• Long‐term leases can have an impact on

estate tax value

– Estate of Mitchell v. Comr.

• When did death occur?

– Still during development phase?

179

Thank You!

• mceowen@iastate.edu

– @CALT_IowaState – www.calt.iastate.edu – Home of TaxPlace

• Kristy Maitre

– ksmaitre@iastate.edu

• Chris Hesse

– Principal in Agribusiness Group, CliftonLarsonAllen, CPAs

• chris.hesse@claconnect.com
• Stephanie A. Hathaway

– International Tax Partner, Moss Adams LLP

• Michelle Van Dellen

– Senior Manager, Moss Adams LLP