Current developments in individual taxation

This article is a semiannual review of recent developments in the area of individual federal taxation. It covers cases, rulings, and guidance on a variety of topics. The items are arranged in Code section order.

Sec. 61: Gross income defined

To value noncommercial flights on employer-provided aircrafts, the IRS has released the standard industry fare level cents per mile and terminal charges for use in calculating the taxation of fringe benefits under Sec. 61.¹

Sec. 86: Social Security and Tier 1 Railroad Retirement Benefits

In Johnson,² the Tax Court determined that, when calculating modified adjusted gross income to determine eligibility for the Sec. 36B premium tax credit, all Social Security benefits must be included in the calculation based on the year received, regardless of the period they relate to.

In this instance, the taxpayer did not include all the Social Security benefits he received during the year, which included a nontaxable portion of a lump-sum payment related to a prior year for which he made a Sec. 86(e) election. The court held that the definition of “amount equal to the portion of the taxpayer’s social security benefits (as defined in section 86(d)) which is not included in gross income under Sec. 86 for the taxable year” was unambiguous and the determining factor was the year of receipt, not the year the payment was attributed to.

The Tax Court, following ­Johnson, came to the same conclusion in Monroe.³

Sec. 104: Compensation for injuries or sickness

In Doyle,⁴ the Tax Court ruled that the taxpayers had incorrectly excluded income under Sec. 104(a)(2) related to emotional distress. The husband received a settlement from his former employer for wrongful discharge. For the settlement money to be considered nontaxable under Sec. 104, it must be for personal physical injuries or sickness. The taxpayers argued that the husband’s former employer had intended to pay him to compensate him for the physical sickness that was caused by his wrongful termination. To qualify to exclude income under Sec. 104(a)(2), a taxpayer must show “a direct causal link between the damages and the personal injuries sustained.”

The settlement agreement stated “$250,000 as settlement for his alleged emotional distress damages (non-economic) alleged in his claim for wrongful discharge in violation of public policy.”After concluding the settlement was in fact for emotional distress, the court determined that it was not in connection with a personal physical injury or physical sickness because Sec 104(a) states “emotional distress shall not be treated as a physical injury or physical sickness.”

Sec. 107: Rental value of parsonages

In Gaylor,⁵ the Seventh Circuit reversed a district court decision that Sec. 107(2)’s income exclusion for housing allowances provided for a “minister of the gospel” violated the Establishment Clause of the U.S. Constitution. As the Gaylor court noted, since the Religion Clauses of the First Amendment were adopted, courts have struggled with the interplay between them, as was seen in Walz v. Tax ­Commission of the City of New York.⁶

Whether a statute violates the ­Establishment Clause is evaluated under the three-part test set out in Lemon v. Kurtzman, 403 U.S. 602 (1971). Under this test, (1) the statute must have a secular legislative purpose; (2) its principal or primary effect must be one that neither advances nor inhibits religion; and (3) the statute must not foster an excessive government entanglement with religion. The district court found that the Sec. 107(2) housing exemption did not meet the secular purpose prong of the Lemon test because its true purpose was to “provide aid to a group of religious persons,” and it therefore violated the Establishment Clause.

The Seventh Circuit, however, determined that the IRS had established three secular purposes for the statute, so it had a secular legislative purpose. The court also found that the statute met the other two requirements of the test. Therefore, it reversed the district court’s decision and held that Sec. 107(2) is constitutional.

Sec. 108: Income from discharge of indebtedness

On Feb. 22, 2019, the IRS released an updated Real Estate Property Foreclosure and Cancellation of Debt Audit Technique Guide.⁷ The updated audit technique guide discusses the tax consequences when real estate is disposed of through foreclosure, short sale, deed in lieu of foreclosure, and abandonments.

In Letter Ruling 201902024, the IRS granted extensions of time for a taxpayer to make a Sec. 108(c)(3)(C) election to exclude income from the discharge of qualified real property business indebtedness and to make an election under Regs. Sec. 1.108-5(b) to reduce the basis of depreciable real property. The taxpayer was a real estate development partnership (organized as a limited liability company) that was formed to develop residential condominiums. When the partnership failed to reach its development goals and converted the remaining condominiums into rental units, it had cancellation-of-debt income.

Sec. 111: Recovery of tax benefit items

Rev. Rul. 2019-11, released on March 29, 2019, provided four examples illustrating how the long-standing tax benefit rule interacts with the new $10,000 state and local tax (SALT) limit enacted by the law known as the Tax Cuts and Jobs Act (TCJA)⁸ to determine the portion of any state or local tax refund that must be included in the taxpayer’s federal income tax return. The announcement does not affect the treatment of state tax refunds received in 2018. The TCJA limited the itemized deduction for state and local taxes to $5,000 for a married person filing a separate return and $10,000 for all other tax filers. The limit applies to tax years 2018 to 2025.

The ruling contains four examples of the application of the tax benefit rule. In Situation 2, the taxpayer paid $12,000 in state and local taxes — state and local income taxes of $7,000 and real property taxes of $5,000. Under Sec. 164(b)(6), the taxpayer’s SALT deduction is limited to $10,000. The taxpayer claims total itemized deductions of $15,000. In 2019, the taxpayer receives a $750 refund of state income taxes paid in 2018, meaning the taxpayer’s actual 2018 state income tax liability was $6,250 ($7,000 paid minus the $750 refund). Accordingly, the taxpayer’s 2018 SALT deduction would still have been $10,000, even if it had been figured based on the actual $6,250 state and local income tax liability for 2018. The taxpayer did not receive a tax benefit on the taxpayer’s 2018 federal income tax return from the taxpayer’s overpayment of state income tax in 2018. Thus, the taxpayer is not required to include income from the taxpayer’s 2019 state income tax refund on the taxpayer’s 2019 return.

Sec. 119: Meals or lodging furnished for the convenience of the employer

In Technical Advice Memorandum (TAM) 201903017, the IRS evaluated whether meals and snacks that the taxpayer provided to employees at its headquarters were includible in the employees’ wages. The taxpayer provided (1) meals without charge to all employees, contractors, and visitors, without distinction as to the employee’s position, specific job duties, ongoing responsibilities, or other external circumstances; and (2) unlimited snacks and drinks in designated snack areas that were available to employees, contractors, and escorted guests.

The IRS ruled that generally the value of meals the taxpayer provided to its employees was includible in the employees’ wages because the taxpayer failed to show that the meals were provided for substantial noncompensatory business reasons or for the employer’s convenience. However, it ruled that meals provided to employees on call to handle emergency outages were for a substantial noncompensatory business reason and were therefore excludable from income under Sec. 119. The IRS also concluded that the snacks the taxpayer provided in its designated snack areas were outside of the scope of Sec. 119 because they were not meals prepared for consumption at a meal time, and because quantifying the value of snacks consumed by each employee was administratively impractical, they were excludable from employees’ gross income as a de minimis fringe benefit under Sec. 132(e)(1).

Sec. 131: Certain foster care payments

In Feigh,⁹ the taxpayers received a Medicaid waiver payment for the care of their adult disabled children. The taxpayers did not include the payment in gross income but claimed the earned income tax credit and the refundable portion of the child tax credit, based on their earned income. The Tax Court held that the Medicaid payment would be excludable from gross income under Notice 2014-7 but would be taken into account in computing earned income for purposes of determining tax credits under Sec. 32 and Sec. 24.

Sec. 162: Trade or business expenses

Chief Counsel Advice 201912001 provides that the Sec. 318 attribution rules apply in determining who is a 2% shareholder of an S corporation qualifying to deduct health insurance premiums per Sec. 162(l). In this Chief Counsel Advice, an individual wholly owns the S corporation and the S corporation employs a family member of the sole shareholder. The family member is considered to be a 2% shareholder under the attribution-of-ownership rules under Sec. 318. Therefore, given that the S corporation provided group health insurance for all the employees of the entity and the cost of the health insurance coverage for the sole shareholder’s family member is included in his or her Form W-2, Wage and Tax Statement, compensation, that individual is entitled to an above-the-line deduction under Sec. 162(l) for self-employed health insurance. Having health insurance premiums treated as an above-the-line deduction instead of an itemized deduction generally results in a more favorable tax result for taxpayers.

Sec. 165: Losses

In Langston,¹⁰ taxpayers were denied a loss deduction for the sale of a former residence. The taxpayers lived in the house from 1997 until 2005. They began renovations on the home in 2001, which they did not complete until 2010. To prevent loss of homeowner’s insurance, the house was rented to a friend at a rate substantially below fair market value beginning in 2012. In 2013, the house was sold, and the taxpayers claimed a loss of $436,633. The court held that the property had not been converted from a personal asset to an income-producing asset, so the taxpayer could not take a loss on its sale. The court found that the taxpayers’ intent in moving out of the house was unclear, and the length of time between vacating the property and selling the property was not an indication of income-producing purposes. It should be noted that both petitioners have advanced degrees and the wife’s undergraduate degree is in accounting.

Sec. 172: Net operating loss deduction

In Bea,¹¹ the Eleventh Circuit, affirming the Tax Court, held that the taxpayers’ election to waive the carryback of a net operating loss was irrevocable. In this case, a professional return preparer included an unambiguous election to forgo the carryback in the taxpayers’ return and the taxpayers signed it. According to the court, the fact that the taxpayers did not know or understand the implications of the election was not relevant since they signed the return affirming that they had examined it. Thus, they could not revoke or disavow their election even though it was an error by the return preparer and created a negative tax position.

Sec. 183: Activities not engaged in for profit

Historical aircraft: In 1994, the taxpayer, a former U.S. Navy aviator, purchased a rare British long-range reconnaissance fighter plane, a Firefly, that was used during World War II.¹² The plane was 60% restored when he purchased it for $200,000 from an individual in Australia. The shipping cost from Australia to Colorado was an additional $60,000. After many years of restoration work, which the taxpayer had to complete mainly by himself due to the lack of available parts, the Firefly and the taxpayer were licensed to fly by the Federal Aviation Administration in 2002. To this day, the taxpayer “is the only person with such a license.” The taxpayer flew the plane in various airshows from 2004 until 2012, when the Firefly was damaged during a landing because a part had failed. During this time frame, the plane was featured on “20 or 30 different magazine covers.”

During 2007 to 2010, the taxpayer filed a Schedule C, Profit or Loss From Business, associated with the activity of the Firefly, reporting an average net loss of $122,000. This loss was mainly due to the depreciation reported for the Firefly, an average of $84,500 per year. Average income for the four years was only $9,500, with no income at all in 2010.

In applying the nine factors provided by Regs. Sec. 1.183-2(b), the court found that the taxpayer’s Schedule C business activity was not engaged in for profit.

Factors weighing against the taxpayer included:

• Lack of a formal business plan and separate financial books and records.
• Public filings for exemption status of property tax for the plane that indicated the taxpayer “was neither using the Firefly for commercial purposes nor holding it for sale.”
• Even though the taxpayer was an experienced pilot and had the knowledge to restore the plane, the court stated that “he failed to conduct research or seek advice on its business aspects and profitability.”
• Lack of success in carrying on similar activities that have displayed a profit motive, along with a consistent history of losses associated with the Firefly activity. His overall average income of the Schedule C activity “never exceeded even his insurance costs.”
• Personal pleasure was determined to be another reason for engaging in this activity because the plane brought the taxpayer “a good deal of fame and became closely linked to his social life. He got a tremendous amount of satisfaction from flying the Firefly, showing off its restoration, and being the only person in the country qualified to fly it.”

Yachting: In Steiner,¹³ the taxpayer failed to prove that his yachting activity was engaged in for a profit. The taxpayer was the CEO of an electrical supply business and a CPA. In 2001, the taxpayer purchased a 155-foot yacht for $4,650,000 and made improvements of $10,839,000 that were completed in 2009. The yacht required a full-time staff for upkeep and maintenance, with a monthly payroll of $25,000. The yacht was primarily used for personal use up until 2009, at which time the taxpayer decided to list it for sale and make it available for charter activity. Between 2010 and 2012, the yacht secured only one weeklong charter, resulting in $150,000 of revenue. The yacht was sold in 2012 for $4,455,000 despite having an asking price of $15,950,000. In filing a Schedule C for 2010, the taxpayer “claimed only $30 of charter activity deductions.” However, in 2011 and 2012, the Schedules C for the yacht activity reported losses of $705,406 and $122,420, respectively. The taxpayer did not claim a depreciation deduction in these respective tax years, even though his accountant determined that he was entitled to a deduction of $635,363.

In applying the nine factors provided by Regs. Sec. 1.183-2(b), the court found that even though the taxpayer had experience owning a yacht, there was a lack of expertise of the taxpayer associated with the activity because the taxpayer “did not have expertise in the charter business.” Also, the court found that the activity was not conducted in a businesslike manner because the taxpayer did not have a formal business plan in place and most of the expenses associated with the yacht were paid for from personal bank accounts. The court also stated that the taxpayer’s “tax reporting was not businesslike” because the taxpayer’s CPA determined he was entitled to a depreciation deduction, but the taxpayer refused to report the deduction “because there would be recapture upon sale.” Lastly, the fact that the taxpayer had a substantial income from other sources did not support the for-profit position of the activity. The taxpayer had net taxable income of $5,478,220 and $10,946,561, respectively, for 2011 and 2012.

Sec. 212: Expenses for production of income

Recovery of lost revenue: The Tax Court held in Garcia¹⁴ that the taxpayers were not entitled to deduct under Sec. 162 the legal expenses from the litigation stemming from a fraudulent scheme involving stock in a South African gold mining and investment company. The taxpayers claimed $64,180 in legal fees were deductible business expenses incurred by their wholly owned S corporation that were passed through to them. The IRS determined that the taxpayers could not deduct the fees as business expenses under Sec. 162(a) but could deduct them as nonbusiness income-producing expenses under Sec. 212. The court ruled that the petitioners failed to show any of the legal fees were ordinary and necessary in carrying on the trade and business of the S corporation and therefore were not deductible as business expenses under Sec 162.

Damages and losses: The Tax Court held in Ray¹⁵ that the taxpayer, Ames Ray, was not entitled to deduct the legal expenses from lawsuits against his ex-wife under Sec. 162. Ames had divorced his ex-wife Christina Ray a number of years ago; however, they continued to live together and share expenses. In 1993, the couple entered into an agreement to engage in an investment scheme using trading ­theories developed by Christina. ­Starting in 1998, Ames filed several lawsuits against Christina, seeking damages for funds trading losses from the investment scheme and her avoidance of payment of various debts she owed Ames under a confession of judgment.

Ames claimed the legal expenses were deductible as business expenses because he was engaged in the computer programming business and the legal expenses originated from his conduct of that business. The court held that the legal fees incurred with respect to the claims related to the confession of judgment were not deductible because they did not bear a sufficient relation directly to the taxpayer’s purported computer programming business. Additionally, the court held that Ames did not directly engage in a computer programming trade or business related to the investment scheme and, accordingly, the funds management losses were not deductible under Sec. 162. However, the court further held that 39.5% of the legal expenses related to the funds management losses qualified as a deduction under Sec. 212(1) because he engaged in the investment scheme with an intent to profit.

Sec. 217: Moving expenses

The Tax Court ruled in Schaekar¹⁶ that the taxpayer was not entitled to moving expense deductions for tax years 2013 and 2014. The taxpayer claimed $13,520 in 2013 as moving expenses because he moved his residence from Portland, Ore., to Wilsonville, Ore., while continuing work for Tyco in Wilsonville. Additionally, he claimed $14,697 in 2014 as moving expenses because he moved from Wilsonville to Sausalito, Calif., to begin work at Genentech in San Mateo, Calif. Genentech paid him $22,010 for his moving expenses, including incidental items, meals, storage and shipment expenses, and temporary lodging expenses for approximately four weeks. The court held that the taxpayer could not deduct his 2013 expenses because he did not move for employment in a new location. Additionally, the court held the taxpayer could not take a deduction for his 2014 moving expenses because he failed to produce any objective evidence that he paid any moving expenses in excess of the amount covered by Genentech.

Sec. 263: Capital expenditures

In legal advice issued by field attorneys, the IRS concluded that quarterly commitment fees paid to secure a revolving line of credit do not have to be capitalized and can be deducted.¹⁷

Sec. 267: Losses, expenses, and interest with respect to transactions between related taxpayers

The Tax Court held in Petersen¹⁸ that an accrual-method S corporation’s accrued but unpaid payroll expenses for employees who participated in an employee stock ownership plan (ESOP) were deferred until the year in which the payments were included in the employees’ income. The court found that the ESOP qualified as a trust and the related-party rules of Sec. 267 applied.

Sec. 280A: Disallowance of certain expenses in connection with business use of home, rental of vacation homes, etc.

In Perry,¹⁹ the Tax Court held that married taxpayers were not entitled to deduct miscellaneous expenses relating to a second home that they allegedly rented to family members. The court found that the taxpayers failed to prove they rented the home to their relatives, or if they had rented the home to relatives as they claimed, they had failed to charge fair market rent. Furthermore, the taxpayers did not document that they had paid property taxes, so the court denied them an itemized deduction for these amounts.

Sec. 280E: Expenditures in connection with the illegal sale of drugs

In Alternative Health Care Advocates,²⁰ the taxpayers were denied a business deduction for medical marijuana expenses due to the Sec. 280E provision barring business deductions when an entity is trafficking in controlled substances. They were also prohibited from deducting cost of goods sold above the amounts the IRS allowed.

In the consolidated case, a medical marijuana dispensary business was divided into a C corporation that owned the medical marijuana dispensary business and an S corporation that handled the daily operations for the C corporation, including paying employee wages and salaries. The taxpayers argued that while the C corporation was engaged in trafficking in controlled substances, the S corporation was not, so Sec. 280E did not preclude a deduction for its expenses. The Tax Court found that although the S corporation did not have title to the marijuana that the business sold, Sec. 280E’s application is not limited to sales on one’s own behalf and also applies to sales on behalf of another. Thus, the S corporation was engaged in trafficking in a controlled substance, and, like the C corporation, its expenses were not deductible under Sec. 280E.

Sec. 280F: Limitation on depreciation of luxury automobiles

In Rev. Proc. 2019-13 the IRS issued a safe harbor for determining depreciation deductions for passenger automobiles that qualify for the 100% additional first-year deprecation deduction under Sec. 168(k) and that are subject to the depreciation limits under Sec. 280F(a).

For a passenger automobile (acquired after Sept. 27, 2017, and placed in service in 2018) that qualifies for the 100% additional first-year depreciation deduction, the TCJA increased the first-year depreciation limitation amount by $8,000 to $18,000. Earlier, in Rev. Proc. 2018-25, the IRS provided tables of first-year limitations on depreciation of autos placed in service in calendar year 2018 and amounts includible in income by lessees of autos first leased during calendar year 2018. Under Sec. 280F(a)(1)(B)(ii), if the depreciable basis of a passenger automobile for which the 100% additional first-year depreciation deduction is allowed exceeds the first-year limitation in Rev. Proc. 2018-25, the excess amount is deductible in the first tax year after the end of the recovery period.

To mitigate the anomalous result that occurs in the tax years subsequent to the placed-in-service year and before the first tax year succeeding the end of the recovery period for a passenger automobile within the scope of the revenue procedure, the IRS has provided a safe harbor in Rev. Proc. 2019-13 that allows depreciation deductions for the excess amount during the recovery period, subject to the depreciation limitations that apply to passenger automobiles. To implement the safe-harbor method, the taxpayer must use the depreciation table in Appendix A of IRS Publication 946, How to Depreciate Property. The safe-harbor method does not apply to a passenger automobile placed in service after 2022, one for which the taxpayer elected out of the 100% bonus depreciation, or one for which the taxpayer elected under Sec. 179 to expense all or part of the automobile’s cost.

For passenger automobiles within Rev. Proc. 2019-13’s scope, Section 4.03 of the revenue procedure provides the details of how the deductible depreciation is calculated under the safe harbor, and Section 4.04 includes three examples illustrating the calculations.

Sec. 469: Passive activity losses and credits limited

In Barbara,²¹ the Tax Court held that a taxpayer materially participated in his business in the years 2009-2012, so contrary to the determination by the IRS, the losses for those years were not passive and the taxpayer could deduct them against other nonpassive income. The taxpayer owned a money-lending business, which had an office in Chicago with two full-time employees, and he managed it from his Florida residence when he was not in Chicago. The taxpayer represented that he worked 460 hours or more per year while in Chicago and 240 hours or more per year while in Florida, for all years. While this total of 700 or more hours exceeds the material participation requirement of 500 hours under Temp. Regs. Sec. 1.469-5T(a)(1), the court relied instead upon “facts and circumstances” — the seventh test (Temp. Regs. Sec. 1.469-5T(a)(7)), which applies if the taxpayer participated in the activity more than 100 hours and had regular, continuous, and substantial participation. There was no discussion in the opinion of any substantiation of the taxpayer’s participation through logs or records; instead the court noted, “we need not determine which party has the burden of proof because a preponderance of the evidence supports our findings of fact.”

Sec. 1001: Determination of amount of and recognition of gain or loss

In Totten,²² the Tax Court, for purposes of determining a taxpayer’s basis in certain mutual fund shares, accepted a broker statement as a reasonable evidentiary basis for an estimate of the basis of the shares under the Cohan rule. The broker statement provided a summary of values for various mutual funds that changed names between the acquisition and sale dates reported on the taxpayer’s return.

Sec. 1016: Adjustments to basis

The Tax Court in the Estate of Arthur S. Andersen²³ held that a taxpayer could not use the straight-line method of depreciation to determine the basis of a motel and RV park he had sold. Citing Sec. 1016(a)(2), which states that the straight-line method will be used where no method had been adopted, the taxpayer claimed that because the IRS did not specify the method that he should have used to calculate depreciation during its examination, the court was required to use the straight-line method. The Tax Court disagreed with the taxpayer, as it believed he undoubtedly adopted some depreciation method for depreciation expense that was claimed on previous years’ tax returns but had failed to substantiate what method he used by producing any of the returns. Thus, it accepted the IRS’s position in its notice of deficiency to the taxpayer as correct.

Sec. 1041: Transfers of property between spouses or incident to divorce

The IRS issued a private letter ruling in which it ruled that a payment and a transfer of interest by one former spouse to another constituted transfers between former spouses that are incident to divorce under Sec. 1041,²⁴ although the transfers occurred more than six years after the date when the marriage ceased. The payment and transfer were made pursuant to a stipulation and order of the divorce court, which was a modification and amendment to an earlier stipulation and order for the division of the property that was issued by the court within seven months of the entry of the final decree in the couple’s divorce. The IRS ruled that because the second stipulation and order were a modification and amendment of the first, the transfers were made to effect the division of property owned by former spouses as of the time their marriage ended.

Sec. 1221: Capital asset defined

A U.S. district court in Barnes²⁵ ruled against the taxpayers’ claim that a qui tam (whistleblower) award, which was a $3.6 million relator award, was not taxable income under the claim-of-origin doctrine. The court ruled that a qui tam award is taxable income under Sec. 61(a), as the qui tam award is a bounty or reward that a relator receives for uncovering a fraud and therefore is not precluded from taxation under the origin-of-the-claim doctrine.

The taxpayers further argued that if the award was subject to taxation, then it should be treated as a capital gain and not ordinary income. The court disagreed, finding that two circuit courts have held that the award constitutes ordinary income and not capital gain. The taxpayers also claimed the relator fee was an “exclusive interest in the action” that made it “property.” The court determined that it was not property because the taxpayers made no initial investment in an asset and any interest the taxpayers had in a portion of the recovery did not vest until the government received its recovery.

Secs. 1400Z-1 and 1400Z-2: Special rules for capital gains invested in opportunity zones

On April 17, 2019, the IRS issued a second set of proposed regulations on the qualified opportunity zone (QOZ) tax incentives enacted as part of the TCJA (Sec. 1400Z).²⁶ The new guidance clarifies a number of points not addressed in the first set of proposed regulations,²⁷ issued in October 2018, including: (1) Eligible investments include a direct investment into a qualified opportunity fund (QOF) or a purchase from another investor, but interests in a QOF property acquired in exchange for services, such as carried interests, are not eligible; (2) a taxpayer does not have to sell all of its interests in the QOF properties to qualify for the tax incentive as indicated in the original proposed regulations; (3) “substantially all” is defined as 90% when used in the context of a holding period and as 70% when used in any other context, such as a percentage of property; and (4) the transfer of a QOF investment via gift triggers gain recognition (as an “inclusion event”), except in the case of a transfer to a grantor trust.

Sec. 6015: Relief from joint and several liability on joint return

Spousal embezzlement: In Francel,²⁸ the taxpayer was denied innocent spouse relief despite his wife’s conviction for embezzlement from his medical practice. Thomas Francel is the sole shareholder of his S corporation medical practice where his wife and the office manager diverted cash payments. These payments were not reported as income by the medical practice. Secs. 6015(b) and (c) contain various requirements that need to be met for innocent spouse or separate liability relief to be granted. Most of the items were not in dispute, but the court denied relief based on Sec. 6015(b)(1)(B) — the requirement that the understatement of tax be attributable to an erroneous item of the nonrequesting spouse.

The IRS argued that the unreported cash fees were the income of the medical practice and should have been included in the taxpayer’s income as passthrough income. The court agreed, citing Secs. 165(a) and (e) and Regs. Secs. 1.165-8(a)(1) and (d). The income should have been included, and the business is entitled to a deduction in the year of discovery of the theft or fraud. Accordingly, the taxpayer failed the tests outlined in Secs. 6015(b) and (c) because the income was attributable to him. The court also determined that the taxpayer did not qualify for equitable relief under Sec. 6015(f) and Rev. Proc. 2013-34 because it would not be inequitable to hold him accountable for the liabilities. Therefore, the court denied him relief.

Knowledge of income: In Henry,²⁹ the taxpayer was granted equitable innocent spouse relief under Sec. 6015(f) despite her knowledge of unreported income. The taxpayer’s now ex-husband had a second job as a church musician during the period in question. This income was not reported for tax purposes, but the taxpayer made it a part of the court record during divorce proceedings. The court applied the factors outlined in Rev. Proc. 2013-34, including the knowledge or reason to know factor. The court determined the taxpayer was aware that her ex-husband received income from the church; she had alleged during divorce proceedings that he had omitted the income from his disclosures to the court. However, when weighed against the other factors, her knowledge of the omitted income was not enough to prevent relief. Her income and health status, along with her compliance with tax laws after the divorce, weighed in her favor.  

Footnotes

¹Rev. Rul. 2019-10.

²Johnson, 152 T.C. No. 6 (2019).

³Monroe, T.C. Memo. 2019-41.

⁴Doyle, T.C. Memo. 2019-8.

⁵Gaylor v. Mnuchin, 919 F.3d 420 (7th Cir. 2019), rev’g 278 F. Supp. 3d 1081 (W.D. Wis. 2017).

⁶Walz v. Tax Comm’n of the City of New York, 397 U.S. 664 (1970).

⁷IRS, Real Estate Property Foreclosure and Cancellation of Debt Audit Technique Guide (Feb. 22, 2019), available at www.irs.gov.

⁸Sec. 164(b)(6), as amended by Section 11042(a) of P.L. 115-97.

⁹Feigh, 152 T.C. No. 15 (2019).

¹⁰Langston, T.C. Memo. 2019-19.

¹¹Bea, No. 18-10511 (11th Cir. 1/31/19).

¹²Kurdziel,T.C. Memo. 2019-20.

¹³Steiner, T.C. Memo. 2019-25.

¹⁴Garcia, T.C. Summ. 2018-38.

¹⁵Ray, T.C. Memo. 2019-36.

¹⁶Schaekar, T.C. Summ. 2018-35.

¹⁷Legal Advice by Field Attorneys 20182502F.

¹⁸Petersen, 148 T.C. 463 (2017).

¹⁹Perry, T.C. Memo. 2018-90.

²⁰Alternative Health Care Advocates, 151 T.C. No. 13 (2018).

²¹Barbara,T.C. Memo. 2019-50.

²²Totten, T.C. Summ. 2019-1.

²³Estate of Arthur S. Andersen,T.C. Memo. 2019-2.

²⁴IRS Letter Ruling 201901003.

²⁵Barnes, 353 F. Supp. 3d 582 (N.D. Tex. 2019).

²⁶REG-120186-18.

²⁷REG-115420-18.

²⁸Francel, T.C. Memo. 2019-35.

²⁹Henry, T.C. Memo. 2019-24.