By Annette Nellen, Esq., CPA, CGMA | Tax Adviser
During tax season, the government continues to churn out many rulings, regulations, and statutory changes. Here is a roundup of some of the federal tax developments from the first few months of 2016.
The first four months of 2016 resulted in one public law with tax changes, about 140 Tax Court decisions, 28 sets of regulations, 30 IRS notices, 28 revenue procedures, 11 revenue rulings, a few hundred private IRS rulings, and several congressional hearings, as well as various tax reports from the Treasury Inspector General for Tax Administration (TIGTA) and the Joint Committee on Taxation (JCT).
Listed below are selected federal tax updates, in brief format, with a focus on individual and small business taxation. Links are provided to the source documents for more detail.
2015 law changes for 2016 and beyond: Over 150 statutory changes were made by 2015 legislation, including many significant changes for 2016 and beyond, such as new due dates for some returns. For a list of the changes, see Nellen, “Changes in Tax Legislation in 2015: Lots of Them!” Tax Insider, March 24, 2016. Also, the JCT issued a 384-page summary of 2015 tax legislation (JCS-1-16 (3/14/16)).
Identity protection services: Announcement 2016-2, broadens the guidance of Announcement 2015-22 to exclude from income the cost of providing identity protection services to employees or individuals before a breach occurs, when the services are received from an organization that has the individual’s personal information. Cash received in lieu of the protection services, though, is taxable.
Demutualization: An unpublished opinion from the Ninth Circuit (Reuben, No. 13-55240 (9th Cir. 1/5/16)) follows an earlier decision in Dorrance, No. 13-16548 (9th Cir. 12/30/15), that held that the taxpayers had no basis in their stock because they had received nothing for their membership rights. Thus, the total amount received is taxable (see IRS Topic 430).
Schedule C caution: A report from TIGTA, Opportunities Exist to Identify and Examine Individual Taxpayers Who Deduct Potential Hobby Losses to Offset Other Income (Rep’t No. 2016-30-031), suggests the IRS step up its review of Schedules C to find individuals treating hobby losses as business losses. Key indicators of a problem Schedule C are years of losses, zero or minimal gross receipts, and other sources of income sufficient for living.
Charitable contribution deductions denied: As in past years, several cases decided so far in 2016 resulted in individuals losing their charitable contribution deduction because they did not follow the requirements of Sec. 170 and its regulations. A sampling of the problems:
- Brown, T.C. Memo. 2016-39: deductions lost due to lack of proof required for any cash contribution per Sec. 170(f)(17), as well as the contemporaneous written acknowledgment (CWA) required by Sec. 170(f)(8) for any contribution of $250 or more.
- French, T.C. Memo. 2016-53: loss of a conservation easement deduction because taxpayers lacked a CWA sufficient to satisfy Sec. 170(f)(8)(B)(ii).
- Atkinson, T.C. Memo. 2015-236: loss of charitable contribution easement deductions for easements on an operating golf course because the taxpayers did not meet all of the requirements of Sec. 170(h).
- Garcia, T.C. Memo. 2016-21: loss of $390 of travel expense charitable deductions due to lack of “evidence that they performed distinct services for their church apart from attending regular worship services.” Deduction of about $3,500 for used clothing was denied for lack of documentation including a CWA and lack of evidence that the items were “in good used condition or better” as required by Sec. 170(f)(16). Deductions of about $5,300 were denied because the taxpayer could not show the donee was a valid Sec. 501(c)(3) organization. An accuracy related penalty was assessed. Per the court: “Given the receipts and acknowledgment letters that petitioners received and maintained from their church and from other charities, they were clearly aware of the documentation they should have sought and received.”
- Gemperle, T.C. Memo. 2016-1,:loss of a façade easement donation deduction for failure to include the qualified appraisal on their return as required by Sec. 170(h)(4)(B)(iii)(I).
Fine clothing is not a uniform: The clothing required of a Ralph Lauren salesperson is not deductible. Barnes, T.C. Memo. 2016-79, reminds taxpayers that for clothing to be considered an ordinary and necessary business expense (including in the business of being an employee), the following three criteria must be met:
- Required or essential in the taxpayer’s employment;
- Not suitable for general or personal wear; and
- The clothing is not so worn.
And the court upheld IRS assessment of the negligence penalty with respect to the disallowed deduction for the work clothing because the taxpayer made an insufficient effort to determine his tax liability. Similarly, see Garcia, T.C. Memo. 2016-21.
Monitor tuition payments to maximize the American opportunity tax credit: In McCarville, T.C. Summ. 2016-14, the student lost out on obtaining the maximum American opportunity tax credit because he paid his 2011 spring semester tuition due in January 2012, in December 2011. The student had already paid fall tuition in 2011, which caused him to reach his maximum $2,500 AOTC for that year. All the court allowed was a $247 credit for a textbook purchase in 2012.
The facts of this case highlight another issue beginning in 2016 when taxpayers are required to have a Form 1098-T, Tuition Statement, to claim the American opportunity tax credit. McCarville did not have a 1098-T for 2012 because he did not pay anything to the university that year. Yet, he is entitled to treat related expenses paid to others (such as books) as eligible for the American opportunity tax credit. As noted in IRS Publication 970, Tax Benefits for Education (page 12):
[E]xpenses for books, supplies, and equipment needed for a course of study are included in qualified education expenses whether or not the materials are purchased from the educational institution.
Hopefully the IRS will address this issue in guidance before the 2017 filing season.
“Fixed” confusion for accrual-method taxpayers: In Giant Eagle, Inc., No. 14-3961 (3d Cir. 5/6/16), the Third Circuit, in a divided opinion, reversed a 2014 Tax Court decision (T.C. Memo. 2014-146). The appeals court found that rewards points (with an expiration date) given to grocery store customers to obtain a discount at the taxpayer’s gas station represented a fixed liability prior to the purchase of the gasoline. The Tax Court held that using the rewards points to buy gasoline was a prerequisite to Giant Eagle’s having a fixed or definite liability. The appeals court noted that Giant Eagle tracked monthly redemption rates to help prove the “absolute liability and a near-certainty that the liability would soon be discharged by payment” (slip op. at 13, citations omitted).
This ruling raises issues regarding the application of the “fixed” part of the Sec. 461 all-events test in similar contexts. That is, when may an accrual-method taxpayer treat a liability as fixed even though a third party must still take an action (such as redeem a coupon or return a broken product sold under warranty) for the taxpayer to actually incur a cost?
Partnership approach for employee treatment nixed: In May 2016, the IRS issued regulations (T.D. 9766 and REG-114307-15) to address a situation where some partners are treated as employees. In the situation addressed, a partnership forms an LLC that is a disregarded entity treated as a corporation for employment tax purposes. The entities treated the partners as employees of the LLC and, thus, eligible to participate in employee benefit plans with more favorable tax treatment than available to partners. The IRS continues to follow Rev. Rul. 69-184, which states that partners are not employees. Basically, the regulations state that partners cannot be employees of the LLC owned by the partnership, but also request comments on a possible exception to that rule. The regulations apply on the later of (1) Aug. 1, 2016, or (2) the first day of the latest-starting plan year after May 4, 2016, of an affected plan sponsored by the disregarded entity.
PPACA amounts for 2017: Rev. Proc. 2016-24 provides some of the indexed amounts relevant for certain Patient Protection and Affordable Care Act provisions for 2017. Still missing though, is the national average bronze plan premium amount for 2016, relevant in knowing the maximum individual shared-responsibility penalty for 2016 (Sec. 5000A) (the 2015 figure was provided in Rev. Proc. 2015-15). With the Rev. Proc. 2016-24 information, relevant figures follow for these ACA provisions:
FTC and Cuba: Rev. Rul. 2016-8 removes certain restrictions that had previously denied a foreign tax credit for income earned in and taxes paid in Cuba.
Timely mailing is timely filing: Notice 2016-30 updates the list of “designated private delivery services” that meet the timely mailing is timely filing rule of Sec. 7502, effective April 11, 2016.
Data security: In March, the IRS shut down the identity protection personal identification number (IP PIN) online tool due to data security issues (IRS announcement (March 7, 2016)). Lost or misplaced IP PINs can be retrieved by calling a toll-free number. In March and, again, in April, TIGTA warned the public about scammers trying numerous techniques to obtain confidential information and money from taxpayers (TIGTA 3/17/16 release and 4/21/16 release). The AICPA has several resources to help reduce identity theft and help practitioners deal with it should it occur.
IRS looks to the future: In February, the IRS announced an initiative that is already underway—the Future State. Technology and service are focal points of this initiative that centers on interacting with taxpayers via online, secure accounts. The IRS released an overview of the plan and Commissioner John Koskinen explained it to the Senate Finance Committee in testimony on Feb. 10. A description of the future state of an individual dealing with the Small Business/Self-Employed division provides an example where a filer is notified that he is at risk of exam due to an increase in his business expenses. The exam is conducted virtually by an agent “from across the country” and everything is resolved online.
The IRS National Taxpayer Advocate’s (NTA’s) 2015 report to Congress released in January 2016, lists concerns with the initiative, labeling it as the No. 1 “most serious problem” for the year. Concerns include that the IRS had not shared its work with the public and that face-to-face contact and phone calls between taxpayers and the IRS would be reduced or eliminated. The NTA notes that many individuals do not have access to the internet. Also, allowing unregulated preparers access to taxpayer data can pose security problems.
Increase in failure-to-file penalty: The Trade Facilitation and Trade Enforcement Act, P.L. 114-125, increased the Sec. 6651(a) penalty for failure to file a return from $135 to $205, effective for returns required to be filed after 2015. This amount is also adjusted annually for inflation, under legislation enacted in late 2014.
Internet Tax Freedom Act (ITFA) made permanent: The only temporary tax item left open from 2015 was the ITFA, which was set to expire Oct. 1, 2016. Congress took quick action using the Trade Facilitation and Trade Enforcement Act, P.L. 114-125, to make the ITFA moratorium permanent. This moratorium, dating back to 1998, prohibits state and local governments from imposing taxes on internet access fees and multiple and discriminatory taxes on e-commerce. The 1998 legislation grandfathered states already imposing taxes on internet access fees. The 2016 legislation removes this grandfather provision, effective after June 30, 2020 (relevant to Hawaii, New Mexico, North Dakota, Ohio, South Dakota, Texas, and Wisconsin). For additional information on the ITFA, see Stupak, The Internet Tax Freedom Act: In Brief, Congressional Research Service, April 13, 2016.
Trying to get a remote sales tax case to the Supreme Court: On March 29, South Dakota enacted S.B. 106 to require remote sellers to collect sales tax if they sell tangible personal property into the state, electronically deliver products or services into the state, and meet one of the following criteria for the prior or current calendar year:
- Gross revenues in the state exceed $100,000.
- Separate transactions total 200 or more.
The new law also provides that the state may bring action against any vendor who appears to be subject to the collection requirement even prior to the initiation of an audit or collection procedure. The state took action in the state’s Sixth Judicial Circuit Court against four vendors in March 2016. Action has also been brought against the state. For example, the American Catalog Mailers Association and Netchoice filed suit in April 2016 challenging the state’s new law.
South Dakota and a few other states hope to get a case before the U.S. Supreme Court to revisit the 1992 Quill decision (Quill Corp. v. North Dakota, 504 U.S. 298 (1992), which held that a state may make a vendor collect sales tax only if it has a physical presence in the state.
Regulations: Click here for a list of federal tax regulations issued in 2016.
Practitioners will see many more cases and IRS regulations and rulings for the rest of 2016. Given that it is an election year, there might not be any more tax laws enacted, other than perhaps ones dealing with identity theft and minor IRS reforms. Congress will continue to spend time on tax reform, likely focusing on various approaches to reduce corporate taxes including corporate integration (eliminating double-taxation of corporate earnings) or some type of consumption tax.
Annette Nellen, Esq., CPA, CGMA, is a tax professor and director of the MST Program at San José State University. She is an active member of the tax sections of the AICPA, ABA, and California State Bar. She is a member of the AICPA Tax Executive Committee and Tax Reform Task Force. She has several reports on tax policy and reform and a blog.
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