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As it does each year, the IRS issued updates to certain procedural matters, in Rev. Procs. 2022-1, 2022-2, and 2022-3. The first one is the revised procedures for issuing letter rulings; it was modified by Rev. Proc. 2022-10 and amplified by Rev. Proc. 2022-19. The significant changes from Rev. Proc. 2021-1 are:
- Taxpayer identification numbers (TINs) and contact information are required for all interested parties;
- Electronic signatures are allowed on Form 2848, Power of Attorney and Declaration of Representative.
- Income tax determination requests to the Small Business/Self-Employed Division can only be submitted electronically;
- The address for paper requests has been consolidated; and
- The fee for additional time to make an S election is the same as the fee for Sec. 9100 relief.
Revised procedures for furnishing technical advice (Rev. Proc 2022-2) were updated for the same electronic signature requirements as in Rev. Proc. 2022-1. Annually, the third revenue procedure issued updates the "no rule" listing. Rev. Proc. 2022-3 was amplified and modified by Rev. Proc. 2022-19, amplified by Rev. Proc. 2022-28 and Rev. Proc. 2022-32. The 2022 version indicates that whether a taxpayer is engaged in a "specified service trade or business" for purposes of Sec. 199A is an area for which rulings will not ordinarily be issued.1
Sec. 24: Child tax credit
Tiebreaker for credits tied to dependents: In Gopi,2 the Tax Court denied the additional child tax credit, earned income tax credit (EITC), head-of-household status, and dependency for two grandchildren of the taxpayer. The taxpayer's daughter moved in with the taxpayer and did not reveal that she was married. The taxpayer supplied all of the grandchildren's support except for some tax-free benefits provided to his daughter. He was unaware that his daughter was married and had filed a joint return with her husband for the tax year in question that also claimed the same children as dependents as the taxpayer did. Although the taxpayer qualified for all of the credits and dependency exemptions, the tiebreaker rule applies when more than one individual claims the same child or children as dependents, i.e., which individual is the parent of the qualifying child or children.3 Therefore, the Tax Court held, the grandfather did not qualify for the child-related tax benefits.
Noncustodial parent allowed credit: In Hicks,4 the taxpayer and his children's mother never married but had entered into a series of agreements about who could claim dependency exemptions. Each parent was to claim one of the two children each year. The mother had custody for more than half of each year but lived with her mother and did not file a tax return for 2014, the year in question. The taxpayer and the children's mother lived apart from one another. The grandmother (the mother's mother) claimed both children as dependents and claimed the child tax credit. The father provided more than half of both children's support. Although the father did not attach to his return Form 8332, Release/Revocation of Release of Claim to Exemption for Child by Custodial Parent, or other required documentation to show his entitlement to the credit, he did provide it upon examination and was granted the credit for one child.5
Sec. 32: Earned income tax credit
Nonfilers can claim the EITC and other credits: Rev. Proc. 2022-12 was issued Jan. 24, 2022. It allows nonfilers to claim the EITC, the child tax credit, and/or the recovery rebate credit for the 2021 tax year. A special procedure applies to certain individuals who (1) were not required to file a tax return for 2021; (2) had gross income for the year less than the applicable standard deduction; (3) had no adjusted gross income (AGI); and (4) had not already filed a 2021 return. These nonfilers can use a prescribed method to file a return electronically to claim the credits. The revenue procedure also allows nonfiling individuals to file a simplified return for 2021 on paper or electronically to claim the child tax credit and/or the rebate recovery credit.
EITC FAQs: On March 2, 2022, the IRS issued a fact sheet on the EITC for tax year 2021 that answered 17 frequently asked questions (FAQs).6 The EITC was expanded for 2021, and more taxpayers became eligible for it.
On May 25, 2022, the FAQs were updated. Q&A-15 explained that taxpayers could use their 2019 earned income to figure the 2021 EITC. Higher earned income in 2019 would allow a higher credit. Taxpayers who filed no returns for 2020 or 2021 previously or did not claim the EITC on the previously filed return were directed to file a late or amended return based on 2019 earned income.
Dependency is necessary for the EITC: In one Tax Court case, the taxpayerhad three children with his former spouse.7 The marital separation agreement awarded full custody of the children to the former spouse, although the children spent specified weekends and four weeks during the summer with the taxpayer. The taxpayer, who did not include with his return a Form 8332, was not allowed a dependency exemption for one of the three children, whom he claimed as a dependent and as a qualifying child for the EITC. His EITC claim was likewise disallowed for one tax year and partially disallowed for another.
Sec. 36B: Refundable credit for coverage under a qualified health plan
Final regulations: The IRS released final regulations8 under Sec. 36B regarding the affordability of employer-sponsored minimum essential coverage for purposes of the Sec. 36B premium tax credit. Some commentators had described the previous regulations as containing a "family glitch," in that only the employee's cost of coverage had been taken into consideration for the cost of covering the employee's family members and not the cost for the entire family. Proposed regulations issued in April 2022 were adopted with minor changes, effective Dec. 12, 2022. Treasury and the IRS stated in a preamble they believe these regulations represent a better reading of the relevant statutes. Over 3,000 comments had been received on the proposed regulations, most of them positive.
Cafeteria plan guidance: The IRS issued Notice 2022-41, which expands "change in status" elections for Sec. 125 cafeteria plans to allow employees to revoke a family coverage election to allow family members to enroll in a health care exchange plan. This notice was issued in conjunction with the final regulations under Sec. 36B described in the preceding paragraph. It is for elections effective on or after Jan. 1, 2023, and amplifies Notice 2014-55.
Calculating the premium tax credit: Rev. Proc. 2022-34 was issued to make indexing adjustments to calculate the premium tax credit for 2023. The required contribution percentage (now 9.12%) is updated by this revenue procedure, effective for plan years beginning in calendar 2023. Rev. Proc. 2014-37 is supplemented.
Advance premium tax credits: In Sek,9 married taxpayers and their children were covered by COBRA10 after the husband left his employment. When their COBRA coverage ended in August 2016, they purchased medical insurance through the New York state health exchange for the remainder of the year. The taxpayers claimed a Sec. 35 health coverage tax credit (HCTC) on their return for 2016. They also claimed a premium tax credit for all of 2016 on an amended return. The taxpayers stipulated before trial in the Tax Court that they were ineligible for the HCTC. The court, however, allowed a premium tax credit for months in 2016 after August, when they were enrolled in insurance through the exchange.
In another premium tax credit case, the taxpayers deducted a capital loss exceeding $123,000 on their tax return, received an advance premium tax credit, and claimed a premium tax credit for the year.11 In Tax Court, they unsuccessfully disputed the IRS's denial of a current loss in excess of $3,000. As a result, the court held, the taxpayers' recalculated income exceeded eligibility limits for any advance premium tax credit or premium tax credit.
Sec. 59(e): Optional 10-year write-off of certain tax preferences
Extension to make an election under Sec. 59(e): In several letter rulings, the IRS was asked to rule on requests for a 120-day extension to make an election under Sec. 59(e) to deduct ratably over a 10-year period Sec. 174 research or experimental (R&E) expenditures. In one letter ruling,12 the taxpayer inadvertently failed to attach a Sec. 59(e) election statement to its timely electronically filed income tax return, which was prepared as though the election statement had been properly attached.
In three other letter rulings,13 the taxpayers intended to make an election under Sec. 59(e) to deduct ratably over a 10-year period their R&E expenditures, but the statement required to make the election was not timely filed with the income tax return. In all cases, the IRS ruled favorably and granted a 120-day extension to make the election, noting that the taxpayers acted reasonably and in good faith and that granting relief would not prejudice the government's interests.
Revocation of original Sec. 59(e) election and extension to make new elections: In another letter ruling,14 the IRS was asked to rule on whether to (1) permit the taxpayer to revoke its original Sec. 59(e) elections to capitalize and amortize intangible drilling and development expenditures and mining exploration expenditures for the tax year, and (2) grant an extension of time for the taxpayer to make new elections under Sec. 59(e) to capitalize and amortize the expenditures.
At issue was the fact that, after filing its income tax return, the taxpayer discovered that it had failed to include certain expenditures in its timely filed elections due to a rare natural event that damaged one of its facilities and prevented the taxpayer from identifying all expenditures eligible for the Sec. 59(e) election. The taxpayer asserted that, but for the natural event, all eligible expenditures would have been included in its Sec. 59(e) elections to allow it to use available production tax credits. The IRS issued a favorable ruling, permitting the taxpayer to revoke its original Sec. 59(e) elections and granting an extension of time to make new elections.
Sec. 61: Gross income defined
Paycheck Protection Program — loan forgiveness:The IRS issued much-anticipated guidance15on the timing of tax-exempt income arising from the forgiveness of Paycheck Protection Program (PPP) loans. The Service advised that taxpayers may exclude expenses, paid or incurred, from gross income at the time the PPP loan forgiveness application is filed or when the PPP forgiveness is granted. The guidance is effective for any tax year in which the taxpayer paid or incurred expenses, PPP forgiveness was applied for, or PPP loan forgiveness was granted.
Treatment of improperly forgiven PPP loans: The PPP loans made available under the Coronavirus Aid, Relief, and Economic Security (CARES) Act of 202016 provided $800 billion in relief to qualifying taxpayers during the COVID-19 pandemic. If taxpayers satisfied specific forgiveness criteria, as outlined in 15 U.S.C. Sections 636m and 636(a)(37)(J), then the PPP loan would be forgiven in whole or in part. The size of the PPP loan determined the support necessary for lenders to forgive the loan. In some instances, the taxpayer may only be required to make representations on the forgiveness application. Loans qualifying for forgiveness are treated as exempt from gross income.
IRS Chief Counsel Advice (CCA) 202237010, released Sept. 16, 2022,determined that taxpayers who make one or more representations that they satisfy the conditions for the forgiveness of a PPP loan but do not factually satisfy the forgiveness conditions — and thus improperly receive loan forgiveness from their lender — must include the loan amount in gross income and are not eligible to exclude the amount of the forgiven loan from gross income under 15 U.S.C. Section 636m(i) or Section 276(b)(1) of the COVID-Related Tax Relief Act of 2020.17
In addition to the guidance mentioned above, the IRS also outlined in News Release 2022-162 on Sept. 21, 2022,three specific conditions required to exclude forgiven PPP loan amounts from income:
- The loan recipient was eligible to receive the PPP loan;
- The loan proceeds were used to pay eligible expenses, such as payroll costs, rent, interest on the recipient business's mortgage, and/or utilities; and
- The loan recipient applied for loan forgiveness.
Sec. 62: Adjusted gross income defined
Certain trade or business deductions of employees — eligible educators: In News Release 2022-70 issued March 29, 2022, the IRS reminded eligible educators that, due to an inflation adjustment,18 they could deduct as out-of-pocket eligible classroom expenses up to $300 in tax years 2022 and following, the first increase since the deduction was enacted in 2002.
Sec. 72: Annuities; certain proceeds of endowment and life insurance contracts
Sec. 72(t) and 72(q) exceptions expanded: Taxpayers have been allowed an exemption since 1989 from the 10% penalty for early distribution from a retirement plan by taking substantially equal periodic payments over their life expectancy. The 1989 notice allowing this exception was modified in 2002 by Rev. Rul. 2002-62. Notice 2004-15 allowed the same methods for early distributions from nonqualified annuities with respect to the Sec. 72(q) penalty.
The exemption was modified again in 2022 by Notice 2022-6 (modifying and superseding Rev. Rul. 2002-62 and Notice 2004-15). Three methods are allowed to calculate the payments that avoid these penalties. Two rely on a reasonable interest rate limited by 120% of the federal midterm rate under Sec. 1274 at the start of payments.19 The Sec. 1274 rates have been very low in recent years; the current notice allows a maximum interest rate of 5% if that exceeds the value calculated by the 120% rule.
Sec. 72(t) penalty: In Grajales,20 the taxpayer argued that the 10% "exaction" on her early pension withdrawal was not valid because a penalty requires supervisory approval under Sec. 6751(b)(1). The IRS contended that the amount was not a penalty, addition to tax, or additional amount but was in fact a tax. The Tax Court agreed, and the Second Circuit affirmed the decision.
In Salter,21 the taxpayer received a distribution from his retirement plan before age 59½ and owed the 10% additional tax. He reduced the amount subject to the 10% tax by $5,647, representing unreimbursed medical expenses he incurred that year. He knew that he did not need to itemize deductions to use that exception under Sec. 72(t)(2)(B). However, the Tax Court held, the exception applies to expenses allowable as an itemized deduction, i.e., in excess of the 10%-of-AGI limitation (applicable to that tax year). The medical expenses did not exceed that limitation, the Tax Court noted. The court also found that the taxpayer failed to provide documentation for the expenses.
Sec. 108: Income from discharge of indebtedness
Insolvency: In Kelly, married taxpayers argued that their insolvency allowed a Sec. 108(a)(1) exclusion of income with respect to their limited liability company's (LLC's) canceled debt.22 However, the bankruptcy court disagreed due to the taxpayers' lack of supporting documentation. While the taxpayers testified to their financial situation and provided statements for some checking and retirement accounts, the court explained that without supporting documentation of all assets and liabilities, insolvency could not be determined for the period in question. Additionally, the court disagreed with the taxpayers' argument that they were not in possession of their company after its repossession by their lender. The court explained that taxpayers retain ownership of repossessed property until it is sold. Therefore, the company's value would be considered in the taxpayers' insolvency determination before the sale.
Late elections: The IRS denied late election relief in Letter Ruling 202205023 to exclude from income the discharge of qualified real property debt under Sec. 108(c)(3)(C). Taxpayers may receive late election relief under Regs. Sec. 301.9100-1(c), provided they meet certain requirements including acting reasonably, in good faith, and not with hindsight. The IRS determined the request was unreasonable, having been made more than six years after a timely election was required. Relief is often denied when the period of limitation is closed for the initial election year and subsequent years, as no amended returns or IRS assessment would be allowed to determine whether government interests are prejudiced. Additionally, the IRS found the taxpayer to be acting with hindsight, as its only reason for requesting late election relief was to affect the outcome of a subsequent state tax proceeding.
Student loans: Notice 2022-1 provided that lenders should not file or furnish payee statements for student loan debt discharged and excluded from gross income for tax years 2021 through 2025 under Sec. 108(f)(5). Accordingly, no Form 1099-C, Cancellation of Debt, should be provided in these situations.
Sec. 121: Exclusion of gain from the sale of a principal residence
In Webert, the Tax Court ruled on whether a cancer patient's home sale qualified for Sec. 121 gain exclusion.23 In 2005, Mrs. Webert was diagnosed with cancer, the same year she and her husband purchased the home in question. The Weberts alleged they resided in the home from 2005 through 2009 and experienced financial hardship due to Mrs. Webert's extensive medical treatments and related reduced working capacity. In 2009, the Weberts attempted to sell the home due to their medically related financial condition but were unsuccessful and decided to rent it from 2009 through 2015 as a last resort. The home was ultimately sold in 2015, resulting in a long-term capital gain, which they excluded from gross income under Sec. 121.
Under examination, the IRS disallowed the entire exclusion, arguing the Weberts did not use the home as their principal residence for at least two of the five years immediately preceding the sale — the requisite period under Sec. 121(a). The Weberts argued that the sale was due to Mrs. Webert's health problems, therefore allowing a reduced exclusion under Sec. 121(c)(2)(B).24
The IRS moved for summary judgment on the exclusion issue. The court ruled that the Weberts had not met the principal residence use requirement during the required 2010 through 2015 period and granted summary judgment on that point. However, it found that a reduced exclusion was plausible, given Mrs. Webert's numerous health issues precipitating the sale. Nonetheless, the court explained, as the reduced exclusion is also based on periods within five years prior to the sale that the home is used as a principal residence, the result of this reduced exclusion also appeared to be zero in the Weberts' case. Because neither party had addressed whether, as a matter of law, Mrs. Webert's health was a material fact, the court did not grant the IRS summary judgment on this point.
Sec. 135: Income from U.S. savings bonds used to pay higher education tuition and fees
Section 3.18 of Rev. Proc. 2021-45 set modified AGI phaseout ranges for the Sec. 135 exclusion for tax years beginning in 2022 at $128,650 to $158,650 for joint returns and $85,800 to $100,800 for all others. The phaseout range is increased for 2023 to $137,800 to $167,800 for joint returns and $91,850 to $106,850 for all others in Rev. Proc. 2022-38.
Sec. 165: Losses
Patent infringement: The Ninth Circuit affirmed the Tax Court's denial of a net operating loss that a neurosurgeon claimed based on his allegation that a patent infringement reduced the value of his shares in a corporation holding the patent, which, he claimed, was an involuntary conversion.25 The Ninth Circuit found that this argument failed, as a "diminution in the value" of a capital asset is insufficient to declare a capital loss, and the shares had not been sold at a loss or otherwise shown to have been rendered worthless during the tax year. The court also found that the alternative argument that the alleged patent infringement constituted a Fifth Amendment taking by inverse condemnation failed. It noted that no court had ruled in the taxpayer's favor on patent infringement, and the Tax Court could not adjudicate the issue. The Ninth Circuit, however, did vacate accuracy-related penalties that had been imposed by the IRS and upheld by the Tax Court.
Property sold for criminal forfeiture: In Sestak,26 the taxpayer received $3.2 million in bribery proceeds in 2012 to provide U.S. visas to foreign nationals and sold real estate acquired with the proceeds at a loss in connection with criminal forfeiture. The Tax Court did not allow the 2013 loss as a deduction under Sec. 165 or 162. Several cases were distinguished in which deductions had been allowed in connection with an illegal business because in this case, the Tax Court held, public policy would be frustrated by allowing them.
Termination fees: The IRS Office of Chief Counsel determined that termination fees a taxpayer paid were dispositions of property within the meaning of Sec. 1001, resulting in losses under Sec. 165, rather than business expenses under Sec. 162.27 The taxpayer paid a termination fee to back out of a proposed acquisition. Concurrently, the taxpayer paid another termination fee to a corporation attempting to purchase the taxpayer entity. The taxpayer asserted that Regs. Sec. 1.263(a)-5(c)(8) would allow an ordinary deduction. The IRS stated that Sec. 263(a) provides that merger expenses are to be capitalized.
Sec. 170(c): Charitable contribution defined
Guidance on leave-based donation programs benefiting Ukraine: Employer leave-based donation programs permit employees to elect to forgo vacation, sick, or personal leave in exchange for their employers' making cash payments to charitable organizations described in Sec. 170(c).
Notice 2022-28 states that such employer leave-based donation payments made by an employer before Jan. 1, 2023, to Sec. 170(c) organizations to aid victims of the Russian invasion of Ukraine will not be treated as gross income, wages, or compensation of the employees. Similarly, employees electing or able to elect to forgo leave that funds the qualified employer leave-based donation payments will not be treated as having constructively received gross income, wages, or compensation. Electing employees may not claim a charitable contribution deduction under Sec. 170 for the value of the forgone leave.
An employer may deduct qualified employer leave-based donation payments under Sec. 170 or Sec. 162 if the employer otherwise meets the section's requirements.
Sec. 170(f): Disallowance of deduction in certain cases and special rules
In several cases, courts determined whether taxpayers claiming charitable contribution deductions met the substantiation requirements of Sec. 170.
In Keefer, the taxpayers were denied a deduction for a charitable contribution of a partial interest in a partnership, which held hotel property, to set up a donor-advised fund while the hotel's sale to a third party was pending.28 The district court disallowed the deduction for two reasons: First, the donation was ruled an anticipatory assignment of income because the taxpayers failed to give away the entire partnership interest. Under the terms of the donation, the charity's interest in the partnership was limited to sharing in the proceeds from the sale of one of the partnership's assets (the hotel), which the court deemed an assignment of income only, not a complete assignment. In other words, the taxpayers retained all interests in the partnership except the interest in the sale proceeds, which meant that they had not given the property away entirely.
Second, the taxpayers did not obtain a proper contemporaneous written acknowledgment of the contribution, and the initially written acknowledgment referred to an intended donation, not an actual one. A subsequent document properly acknowledged the donation but failed to state that the recipient organization had exclusive legal control of the donated asset, as required for contributions to donor-advised funds.
In Harrison, one of the issues centered on the taxpayer's reported $7,550 in charitable contributions on her 2015 income tax return.29 The IRS disallowed the entire amount. In Tax Court, the taxpayer presented limited testimony and receipts for noncash contributions, but her records lacked the donated items' acquisition dates, descriptions, and cost basis. Since the court had insufficient information to place a value on the property donated, it allowed the taxpayer $500 for noncash contributions. The taxpayer also produced one receipt for a $100 cash donation, for which the court allowed a deduction.
In Scholz, the issues included $5,290 cash charitable contributions and $4,441 noncash charitable contributions reported on the taxpayer's 2016 income tax return.30 The IRS allowed $2,645 of the cash gifts, but the taxpayer did not produce documentation to support the additional $2,645 deduction claimed; therefore, the Tax Court upheld the IRS's disallowance of that portion. The noncash charitable contributions included a $1,000 deduction for a vehicle donated to a charitable organization and $3,441 in food donated to homeless students. The vehicle donation was not supported by the documentation required for a donation of property valued over $500. Specifically, there was no written acknowledgment from the donee organization, no information on the manner and date of acquisition, and no cost basis for the vehicle. The IRS allowed a $500 deduction for the vehicle donation, and the Tax Court agreed. The deduction for food donated to homeless students was disallowed because cash and other items given directly to individuals for their personal benefit are not deductible charitable contributions under Sec. 170, since they are not given to or for the use of a charitable organization.
In Rau, the court considered the taxpayer's claimed $9,010 of noncash charitable contributions for household items donated to Goodwill Industries.31 The household items came from her residential rental property, which had been rented to college students for several years and, by her testimony, had fallen into significant disrepair. The taxpayer did not present convincing evidence that the items she donated were in "good used condition or better," as required by Sec. 170(f)(16)(a); consequently, the IRS limited her deduction to $500. The Tax Court sustained this treatment, noting that her testimony regarding the poor condition of the rental property weakened any idea that the donated items were in good used condition.
In Furrer, married taxpayers/farmers formed charitable remainder annuity trusts to which they donated agricultural crops.32 The IRS denied charitable contribution deductions for the donations because the taxpayers failed to meet the substantiation requirements. For gifts of property (other than publicly traded securities) valued in excess of $5,000, the taxpayer generally must obtain a qualified appraisal of the property and attach to the return on which the deduction is claimed a fully completed appraisal summary on Form 8283, Noncash Charitable Contributions.33 The taxpayer must also maintain records substantiating the deduction. The taxpayers did not secure an appraisal, attach completed Forms 8283 to their returns, or maintain written records supporting the deduction, and the Tax Court upheld the IRS's determination.
Sec. 170(f)(11): Qualified appraisal and other documentation for certain contributions
In Schweizer, the taxpayer was an art dealer/auction director who donated a sculpture to an art institute and claimed a $600,000 deduction for the gift on his 2011 income tax return.34 The IRS disallowed the deduction because the Form 8283 attached to the return was incomplete, and no qualified appraisal was obtained or provided. The Tax Court affirmed the IRS's position on the disallowance. The court also was asked to consider whether the taxpayer met the exception in Sec. 170(f)(11)(A)(ii)(II) despite the failure to meet substantiation requirements if "it is shown that the failure to meet such requirements is due to reasonable cause and not willful neglect."
Reasonable cause is determined based on the facts and circumstances of the situation. In this case, the taxpayer claimed that he relied on his tax preparer's advice that it was unnecessary to include either a fully completed Form 8283 or a qualified appraisal with his tax return. The court found no evidence to support this assertion. It noted that even if the tax preparer had supplied such advice, the taxpayer could not have reasonably relied on it in good faith since the taxpayer was an experienced art donor familiar with Form 8283 and its requirements. Consequently, the court determined that the taxpayer did not qualify for the reasonable-cause exception.
Sec. 170(f)(12): Contributions of used motor vehicles, boats, and airplanes
In Izen, the Fifth Circuit upheld the Tax Court's decision that the taxpayer was not entitled to a charitable contribution deduction for the donation of his 50% interest in an aircraft to an aeronautical heritage society because he did not provide a contemporaneous written acknowledgment that satisfied the requirements of Sec. 170(f)(12)(B).35 For a donation of a qualified vehicle, including an airplane, the value of which exceeds $500, the taxpayer must provide a contemporaneous written acknowledgment from the donee organization of the contribution, including the donor's name and TIN. An acknowledgment is contemporaneous if the charitable organization provides it within 30 days of the contribution. Additionally, the recipient organization must provide the IRS with the information contained in the acknowledgment.
With his 2010 Form 1040-X, Amended U.S. Individual Income Tax Return, the taxpayer, Joe Alfred Izen Jr., provided a letter from the donee organization, but it was addressed to Philippe Tanguy, not Izen. Also, the letter did not mention Izen or include his TIN. Izen also submitted a copy of a donation agreement between him, Tanguy, and the society, but it, too, lacked his TIN. Finally, although Izen attached Form 8283 to his Form 1040-X, the Form 8283 did not include his TIN and was not signed contemporaneously.
Izen argued that he substantially complied with the rules and that the documents he submitted should be read together with his tax return to support the claimed deduction. The court denied the substantial-compliance argument because the doctrine of substantial compliance applies to a failure to meet a regulatory requirement, not a statutory requirement. Thus, taxpayers must strictly follow the documentation requirements set out by Congress in the statute to qualify for the charitable contribution deduction.
Sec. 170(h): Qualified conservation contribution
Owners of real property sometimes agree to limit the use of their property for conservation purposes. Sec. 170(h) allows a charitable contribution for the fair market value (FMV) of a qualified conservation contribution, which is defined as a contribution "(A) of a qualified real property interest, (B) to a qualified organization, (C) exclusively for conservation purposes"36 The Code and accompanying Treasury regulations delineate the requirements to be met before a contribution is deductible. A variety of issues can arise.37
Validity of judicial extinguishment proceeds regulations: In recent decisions, two federal circuits split on whether the IRS violated the notice-and-comment rule-making requirements of the Administrative Procedure Act (APA) when it promulgated the judicial extinguishment proceeds regulation.38 This regulation, issued in 1986, addresses how a conservation easement donor and donee should divide the proceeds if the easement is subsequently judicially extinguished. Under the regulation, the donee must be entitled to at least a minimum proportionate share of post-extinguishment proceeds, including a proportionate value of post-donation improvements.
During the pre—rule-making public notice period, some comments on the proposed regulations had disagreed with this approach. In Hewitt, the Eleventh Circuit ruled that the IRS failed to respond to "significant comments" concerning the extinguishment proceeds calculation, violating the APA's procedural requirements.39 The court thus found the regulation's allocation method for post-extinguishment proceeds procedurally invalid. But in Oakbrook Land Holdings, the Sixth Circuit upheld the procedural and substantive validity of the extinguishment proceeds regulation.40 Oakbrook Land Holdings LLC petitioned the U.S. Supreme Court to review the Sixth Circuit's ruling, hoping the justices would step in to resolve the circuit split. However, on Jan. 9, 2023, the Court denied Oakbrook's petition.41
Conservation purpose must be protected in perpetuity: In Pickens Decorative Stone,42 Morgan Run Partners,43 Thompson,44 Sparta,45 and Corning Place Ohio,46 the issue arose whether the IRS properly disallowed charitable contribution deductions for conservation easement donations because the easement deeds did not satisfy the protected-in-perpetuity requirement under Sec. 170(h)(5). In all the cases, the Tax Court denied IRS motions for partial summary judgment on this issue.
In Pickens and Morgan Run, the court denied the IRS's motions because material fact issues were ill suited to summary judgment.
In Thompson and Sparta, the IRS contended that the easement deed failed to satisfy the protected-in-perpetuity requirements, in that carve-outs improperly reduced the donee's share of post-extinguishment proceeds for donor improvements. The Tax Court was obligated to follow the Eleventh Circuit precedent established in Hewitt invalidating the judicial extinguishment proceeds regulation as having been adopted without following proper notice-and-comment rule-making procedures47; therefore, the court ruled that summary judgment for the IRS was not appropriate.
In Pickens Decorative Stone, Morgan Run Partners, Thompson, and Sparta, the IRS assessed penalties in conjunction with the disallowance of charitable contribution deductions for the donation of conservation easements. The Tax Court granted IRS motions for partial summary judgment that it complied with the Sec. 6751(b) requirement for written supervisory approval for penalties. Therefore, the penalties will stand if the court eventually disallows the conservation easement contribution deductions.
In Corning Place Ohio,the IRS argued that the charitable contribution deduction for a conservation easement donation was properly disallowed because the easement deed violated the judicial extinguishment proceeds regulation and therefore did not satisfy the protected-in-perpetuity requirement under Sec. 170(h)(5). The court found that the apportionment formula in the deed was consistent with the regulation.
Also in Corning Place, the IRS disputed whether the taxpayer had complied with substantiation and qualified appraisal requirements under Secs. 170(h) and 170(f). The appraisal that the taxpayer had included as support for the deduction omitted the appraiser's qualifications, which were supplied to the IRS subsequently. The Tax Court noted that, while the taxpayer did not comply with the relevant requirements literally, there remained material facts regarding substantial compliance or reasonable cause that would benefit from further explanation at trial. The court denied the IRS's motion for partial summary judgment.
Finally, in Glade Creek Partners,the Tax Court ruled after a trial that the taxpayer improperly took a charitable contribution deduction for a conservation easement donation because the easement deed did not comply with the judicial extinguishment proceeds regulation and therefore did not satisfy the protected-in-perpetuity requirement under Sec. 170(h)(5).48 Glade Creek appealed to the Eleventh Circuit. After Glade Creek filed its appeal, the Eleventh Circuit issued its ruling in Hewitt, invalidating the proceeds regulation.49 Accordingly, the Eleventh Circuit vacated the Tax Court decision and remanded the case to the Tax Court for reconsideration.
Valuation of the conservation easement at the time of donation: In Champions Retreat Golf Founders,50 the Tax Court addressed a question about the proper valuation of a conservation easement donation. Previously in the case, the Tax Court had affirmed the IRS's determination that Champions Retreat Golf Founders LLC was not entitled to a deduction in tax year 2010 for a qualified conservation contribution because it did not satisfy the conservation purpose requirement of Sec. 170(h).51 In 2020, the Eleventh Circuit reversed this decision and remanded the case, directing the Tax Court to determine the proper amount of the deduction.52
The value of a charitable contribution deduction for a conservation easement is the FMV of the easement at the time of the contribution. The appraisal submitted by the taxpayer in support of the deduction relied on the "before and after" method to value the easement. If the "before and after" method is used, the valuation must consider the current use of the property as well as its potential "highest and best use."53 This is where the controversy arose. The taxpayer's appraisers thought that the property's pre-donation highest and best use was as an 18-hole golf course and residential subdivision. They valued the easement at $10,427,435. The appraiser for the IRS asserted that the pre-donation highest and best use was as a 27-hole golf course. He assigned a value of $20,000. All appraisers agreed that the highest and best use after the easement was as a 27-hole golf course. In the end, the court modified one of the taxpayer's appraiser's valuations and settled on a value of $7,834,091.54
Sec. 172: Net operating loss deduction
In Villanueva, the court considered whether the taxpayer was entitled to a net operating loss (NOL) deduction.55 The taxpayer initially reported a loss from the disposition of a condominium in California on Form 4797, Sales of Business Property, attached to his 2013 tax return. Upon examination, it was determined that a mortgage lender had foreclosed on the property in 2009, and the taxpayer lost possession of it then. The taxpayer then prepared amended returns for 2009 through 2013 during the audit. The 2009 amended return reported the disposition of the condo at a loss, but the amended return was not filed. The taxpayer contended that he was allowed an NOL for 2009, which would then carry forward to 2013. The court found that even if he had a loss on the foreclosure in 2009, he did not establish that the carryover amount was still available in 2013. Therefore, the court concluded that the taxpayer was not entitled to an NOL deduction for 2013.
Sec. 183: Activities not engaged in for profit
In Huff, a miniature donkey—breeding activity was deemed to have a profit motive despite losses from 2010 through 2017, including the tax years at issue, 2013 and 2014.56 In addition to the breeding activity, the taxpayer owned a successful investment management firm with a "research-driven investment philosophy." After purchasing farmland in New Jersey in 1987, the taxpayer researched the best use of the property through his investment management firm. From this research, the taxpayer determined that he would receive benefits under New Jersey agricultural law if he bred miniature donkeys.
Seeking to build a profit-making business for his daughter, he moved forward with such a plan in 2010. Despite the taxpayer's having AGI from his other business pursuits of $21 million and $29 million in 2013 and 2014, respectively, his miniature donkey—breeding activity produced losses of $87,236 and $47,039. The IRS denied these deductions upon audit on the grounds that the activity was not carried on as a trade or business but instead as a hobby. However, in applying the nine factors provided by Regs. Sec. 1.183-2, the Tax Court concluded that the taxpayer "entered into the breeding activity with the dominant hope and intent of making a profit."
Despite the taxpayer's not having a written business plan for the activity, the court determined that his overall actions presented evidence of his profit objective. This was further demonstrated by the changes the taxpayer implemented through the years in response to problems such as stillborn deaths of the animals. While the taxpayer himself expended limited time and effort in the activity, he engaged the services of various experts for help with the operation of this specialized breeding business (some for vision and others for execution).
Finally, regarding the elements of personal pleasure and recreation from the activity, the taxpayer testified that he derived "zero personal pleasure" and stated, "These are not pets. This is like livestock" and that the miniature donkeys were "quite ugly" and looked like a "gigantic hairball." The court concluded that he had a profit objective and that the loss deductions were allowable.
Sec. 212: Expenses for the production of income
In Olsen, the Tenth Circuit affirmed a Tax Court holding that investors in a solar power tax shelter scheme were not entitled to depreciation deductions or credits for the solar equipment, as no profit motive was established for the purchases.57
In Luna, the taxpayer made numerous miscellaneous itemized deductions for unreimbursed employee expenses.58 The IRS disallowed the full amounts claimed on the return, concluding that the deductions were not allowed due to lack of substantiation and that the taxpayer failed to establish that the expenses were ordinary and necessary in connection with a trade or business.
Sec. 213: Medical, dental, etc., expenses
In Salter59 (also discussed above under Sec. 72 and below under Sec. 274), the taxpayer made a distribution from a retirement plan. To avoid the 10% additional tax on the withdrawal, the taxpayer claimed an exception due to medical expenses. But the taxpayer did not show he incurred any medical expenses, and therefore the exception was rejected.
In Patitz,60 deductions were denied for medical expenses, as there was no substantiation or evidence about whether health insurance had covered them.
Sec. 215: Alimony, etc., payments (repealed)
In Rojas,61 deductions for pre-2019 alimony were not allowed since the payments were subject to a child-related contingency and therefore were considered child support rather than alimony. A state court had agreed there was no child support, but that was deemed irrelevant for federal tax purposes.
Sec. 262: Personal, living, and family expenses
In Sonnitag,62 the Tax Court disallowed expenditures that the petitioner (who was in the music entertainment business) deducted as research expenses. The petitioner claimed the cost of concert tickets, a portion of his cable TV bill, music subscriptions, and television streaming services as business expenses. The Tax Court held that the expenses were primarily for personal enjoyment instead of for a trade or business. Deductions are generally unavailable for personal expenses under Sec. 262(a).
In Sherwin Community Painters Inc.,63 the Tax Court held that a company could not take a business deduction for tuition expenses paid for the owner's daughter's boyfriend (and later husband) to take a coding course at a university. The court held that the tuition was a personal expense; under Sec. 262, a taxpayer cannot deduct personal or family expenses. The company contended it received website services in exchange for the tuition because, after completing the course, the boyfriend used his learned skills to update the company's website, spending considerable time on this task, and later performed additional computer-related work without compensation. But the boyfriend was not an employee of the company and did not have an agreement that he would perform any services in exchange for the tuition. The court concluded that the company paid the tuition without an expectation of a return and thus lacked a business purpose for the expense. Consequently, it was a personal expense of the owner.
Sec. 274: Disallowance of certain entertainment, etc., expenses
In Salter64 (also discussed above under Secs. 72 and 213), the Tax Court denied the taxpayer's itemized deductions for automobile expenses because he failed to substantiate them. The taxpayer worked for Home Depot from home but regularly traveled by car to the stores he supervised. Home Depot offered reimbursement for travel expenses based on a mileage rate; however, the taxpayer did not request reimbursement because he believed he would get a bigger refund if he claimed his automobile expenses on his tax return. Sec. 274(d)(4) sets forth substantiation requirements with respect to listed property. Passenger automobiles are listed property under Sec. 280F(d)(4)(A)(i). Because the taxpayer failed to produce evidence to substantiate his automobile expenses, such as mileage logs or odometer readings, his claim was denied.
Sec. 401(a)(9): Required distributions
SECURE Act proposed regulations: In February 2022, the IRS proposed regulations65 under the Setting Every Community Up for Retirement Enhancement (SECURE) Act, enacted in December 2019 and effective for 2020 and later years.66 The Service later delayed the effective date of the proposed regulations until 2023.67 The regulations relate to required minimum distributions (RMDs) from qualified plans, Sec. 403 arrangements, individual retirement accounts (IRAs), annuities, and Sec. 457 plans. At the same time, the IRS updated almost all distribution regulations and converted them from a series of questions and answers (Q&As) to the type of text familiar in IRS regulations. Comments were requested by May 25, 2022 (the AICPA submitted three comment letters68).
The proposed regulations clarify the definition of a "conduit trust," establish the "age of majority" as 21 years old, and forgive year-of-death RMDs for decedents if the beneficiary was in compliance by the due date of their tax return. Other provisions are more controversial. Under the SECURE Act, individual persons who are designated beneficiaries are subject to a 10-year rule if they do not meet the definition of an eligible designated beneficiary. But the proposed regulations introduce differing tax treatment depending upon whether the decedent died after the required beginning date of the RMDs.
Many commentators addressed the two versions of the 10-year rule introduced by the IRS proposals. Before the proposed regulations were issued, most practitioners had interpreted the 10-year rule to require only that the inherited account be paid out in full by the end of the year that includes the 10-year anniversary of the death. Requiring RMDs for each of the 10 years and the remaining balance in the 10th year — which applies if the decedent was receiving RMDs before death — surprised many.
Notice 2022-53 was welcome especially because deferring the effective date of the proposed regulations served to eliminate the specter of 50% penalties for beneficiaries who did not take RMDs in 2021 and 2022, being unaware they were subject to the year-by-year version of the 10-year rule. This change in the effective date, along with the provision of the proposed regulations that allows an IRA beneficiary to take the decedent's date-of-death RMD before the extended due date of the beneficiary's return for the year of the decedent's death, prevented many heirs from being subject to the 50% penalty imposed by Sec. 4974.69 The notice indicates that the final regulations will apply no earlier than the 2023 distribution year.
Sec. 402(c): Rules applicable to rollovers from exempt trusts
The IRS received so many ruling requests to waive the 60-day rollover requirement that it released Rev. Proc. 2016-47, which contains a procedure for eligible taxpayers to self-certify that they are eligible for a waiver. The procedure for self-certification was updated in 2020 by Rev. Proc. 2020-46. As a result, fewer requests for relief are seen. However, letter rulings were issued in 2022 for two requests that did not fit exactly into the revenue procedure's framework.
Medical condition and death of spouse: In IRS Letter Ruling 202218028, the taxpayer had a severe medical condition diagnosed before the tax year in question. She withdrew an amount from her 401(k) and her IRA in the same year and failed to roll over either distribution. Her spouse had previously managed her financial affairs, but he had died before the distributions were taken. After the 60-day rollover period had expired, the taxpayer had recovered enough from her health problems to ask for help with her finances and submit a ruling request for a waiver of the 60-day rollover requirement, which included medical and other documentation in support of her request. The IRS waived the requirement and allowed the taxpayer additional time to roll over both distributions.
Rollover allowed for fraud victim: In IRS Letter Ruling 202244029, the taxpayer failed to roll over funds in a timely manner because she was the victim of fraud. Under the highly complex scheme, a computer alert supposedly directed her to contact a financial institution. The alert told her that hackers had put illegal information on her computer and withdrawn funds. She was directed to contact another person who was purportedly with her bank's anti-fraud department. That person told the taxpayer she had to secure her funds and that illegal material on her computer was a federal crime. She was referred to a third person who claimed to be a federal officer who promised to write her a check to reimburse her for withdrawals made from her accounts. She was told she would be arrested if she contacted law enforcement. Ultimately, she contacted authorities to report the fraud. The IRS waived the 60-day rollover requirement and allowed the taxpayer additional time for the rollover.
Sec. 408(d)(3): Rollover contribution
In general, for a surviving spouse to roll over a retirement benefit into his or her retirement account, that spouse should be named as the primary beneficiary. In three recent letter rulings, however, the IRS allowed IRAs with estate or trust beneficiaries to be rolled over by the surviving spouse.
Estate named as beneficiary: In IRS Letter Ruling 202210016, the decedent named his estate as an IRA beneficiary. His surviving spouse was authorized by the probate court to administer the estate; she was the only estate beneficiary. The IRS concluded that since the taxpayer/spouse was both the sole administrator of the estate and the sole beneficiary of the decedent's IRA proceeds that passed through the estate, no third party could prevent the spouse from receiving the benefits and rolling them into an IRA. A tax-free rollover was allowed to her existing IRA.
Estate beneficiary by default: The decedent opened an IRA and named himself as the beneficiary, according to IRS Letter Ruling 202214008. At his death, the custodian transferred the IRA to a beneficiary account in the name of the decedent's estate. He had not reached age 72, so benefits ordinarily would have been subject to the five-year rule. However, he left a will that named his surviving spouse as the sole beneficiary of his estate and executor. In an analysis similar to the item above, the IRS allowed the spouse to have the beneficiary IRA transferred to a new IRA in her name, with no adverse tax consequences.
Sole beneficiary: In IRS Letter Ruling 202227005, the decedent's IRA was payable to a joint trust that provided that any retirement assets would be allocated to the survivor's trust portion after the first death. The decedent's two IRAs were transferred to a new inherited IRA at his death. With respect to the new IRA allocated to the survivor's trust, the taxpayer had the right to distribute the new IRA or any part of it to the taxpayer.
The taxpayer, as the surviving spouse, trustee, and sole beneficiary of the survivor's trust, wished to roll over the inherited IRA into one or more IRAs in the taxpayer's name. Because no third party could prevent the taxpayer from receiving the proceeds of the IRA and from rolling over the proceeds into the taxpayer's own IRA, the IRS allowed a tax-free rollover of the inherited IRA.
Sec. 461(l): Limitation on excess business losses of noncorporate taxpayers
The excess business loss limitation that originated as part of the law known as the Tax Cuts and Jobs Act70 limits the amount of trade or business losses that can offset nonbusiness income for noncorporate taxpayers such as individuals, trusts, and estates. An excess business loss equals aggregate trade or business deductions that exceed the sum of aggregate trade or business gross income or gain plus a threshold amount. This disallowed loss is carried forward to the next tax year as an NOL.
The limitation initially applied to tax years beginning after Dec. 31, 2017, and before Jan. 1, 2026. However, the CARES Act retroactively postponed its implementation to tax years beginning after Dec. 31, 2020. The American Rescue Plan Act of 202171 then extended the provision one year through 2026, and later, in 2022, the Inflation Reduction Act72 added two years through 2028. As a result, the excess business loss limitation's current period of applicability is 2021—2028.
The calculation's initial threshold in 2018 was set at $250,000 (or $500,000 for joint filers), with these amounts indexed for inflation annually. Rev. Proc. 2021-45 indexes the amount for 2022 to $540,000 for joint returns and $270,000 for all others. The threshold is increased in 2023 to $578,000 for joint returns and $289,000 for all others.73
Sec. 469: Passive activity losses and credits limited
In Rogerson,74 the Tax Court addressed the issue of material participation after a corporate reorganization. Before the reorganization, the businesses were all operated through one S corporation. The taxpayer materially participated in the S corporation (S1) for at least five of the 10 immediately preceding years. The reorganization divided the existing S corporation activities into three S corporations. The taxpayer filed his tax returns reporting material participation in S1 and S3 but reported S2 as a passive activity. The taxpayer argued that S2 should be considered a new activity; thus, the five-of-10-years test would not apply.
The Tax Court determined that Regs. Sec. 1.469-5(j)(1) does not require the precise activity to have existed in prior years to apply the five-of-10-years test. The regulation treats a taxpayer as materially participating in an activity under this test if the new activity includes significant Sec. 469 activities that were included in an activity in which the taxpayer materially participated in five of the 10 preceding years. Since the activity in S2 was part of the activities of S1 prior to the reorganization, the court ruled that the five-of-10-years test applied and that the taxpayer materially participated in S2 for the years in question.
Sec. 1041: Transfers of property between spouses or incident to divorce
In Redleaf,75 the Eighth Circuit concluded that $51 million in payments by Andrew Redleaf to his former wife, Elizabeth, pursuant to a marriage termination agreement, were made under Sec. 1041 rather than being deductible alimony payments under now-repealed Sec. 215. The court affirmed the Tax Court's decision.
Andrew and Elizabeth married in 1984, and Andrew initiated divorce proceedings in 2007. They owned substantial marital properties. On Feb. 4, 2008, after months of litigation, they sought to resolve the remaining financial issues by entering into a marital termination agreement (MTA). The final divorce judgment and decree dissolved the marriage under Minnesota law, approving the MTA and incorporating many of its provisions into the decree. The MTA provided that if it was approved and the marriage dissolved, all terms "shall be made by reference a part of any decree issued."
This dispute involved the tax consequences of deferred payments that Andrew made to Elizabeth in 2012 and 2013. Andrew took the position in his federal income tax returns that these were deductible "alimony and separate maintenance payments." Elizabeth's returns claimed, on the other hand, that the payments were nontaxable transfers of property incident to divorce.
The IRS issued separate deficiency notices to each of them. The notice to Andrew explained he had not shown that the payments "qualified as alimony," and the one to Elizabeth said that payments to her "are includable in taxable income as alimony income." Both individuals filed petitions with the Tax Court, where the IRS took the position that the payments were neither alimony payments deductible by Andrew nor taxable income to Elizabeth. The Service therefore acknowledged that Elizabeth was entitled to summary judgment, reversing the deficiency.
After consolidating the cases, the Tax Court granted summary judgment in favor of Elizabeth, agreeing with the IRS.
The Tax Court focused on two of the four criteria in former Sec. 71(b)(1)76 that define deductible alimony payments. First, Andrew's obligation to make payments would continue if Elizabeth had died before the final payment was due. Second, the MTA designated the payments as not includible in Elizabeth's gross income and not deductible by Andrew.
Based on this and the need for the two decisions to be consistent, the Tax Court granted summary judgment in the IRS's favor in Andrew's case. On appeal, the Eighth Circuit affirmed the decision.
The outcome might have been different if the MTA had been crafted differently. The Eighth Circuit commented, "Rather surprisingly, given the overall sophistication of the document" and the substantial state court litigation between the parties that followed, the MTA "contained no provision clarifying (designating) that the payments in question were not includable in Elizabeth's gross income and allowable as a deduction to Andrew." Further, the MTA did not unambiguously state that Andrew had no liability to make payments after Elizabeth's death.
Sec. 1400Z-2: Special rules for capital gains invested in opportunity zones
Several taxpayers recently requested letter rulings related to missing the deadline to file Form 8996, Qualified Opportunity Fund, and self-certify in the initial year of a qualified opportunity fund (QOF). In IRS Letter Ruling 202223012, the LLC manager engaged Firm 1 to prepare its tax return. Firm 1 was divided into two parts, the consulting team and the tax compliance team. The manager provided to the consulting team of Firm 1 the operating agreement that included the company's purpose, emphasizing the taxpayer's intent to qualify as a QOF. The tax compliance team of Firm 1 completed and timely filed the taxpayer's Form 1065, U.S. Return of Partnership Income, but did not include Form 8996 in the tax return. In year 2, the tax compliance team became aware of the omission. The IRS determined that the taxpayer had acted reasonably and in good faith and granted the relief to file an amended return to make the election under Sec. 1400Z-2 and file Form 8996.
In IRS Letter Ruling 202230001, the LLC manager, intending to be a QOF, used two firms to prepare various real estate partnership returns. The manager engaged and intended for Firm 1 to prepare Form 1065 of the LLC, which required Form 8996. Due to a miscommunication, Firm 1 thought that Firm 2 was preparing the return, and an extension for Form 1065 was not filed; thus, Form 1065 and Form 8996 were not filed by the due date, and the election to self-certify as a QOF on Form 8996 was not timely made. Form 1065, including Form 8996, was filed after the discovery. The Service again determined that the taxpayer had acted reasonably and in good faith and allowed the late-filed Form 1065 and Form 8996 to be considered timely filed.
Finally, in IRS Letter Ruling 202233011, the accounting firm and tax adviser knew that the client intended to invest an eligible gain in a QOF but did not realize that the client had created a partnership intended to be the QOF and intended for the firm to prepare the partnership tax return. This was discovered after the initial due date of the partnership tax return. The IRS again allowed the taxpayer to file a late Form 1065 and Form 8996 to self-certify as a QOF.
All of these taxpayers intended to self-certify as a QOF in the initial returns. The error was discovered relatively close to the original filing deadline, which fitted nicely into the requirements for the Service to determine that the taxpayer acted reasonably and in good faith and that the grant of the relief would not prejudice the government's interests. Different facts and circumstances may not receive the same determination.
Sec. 1402(a): Net earnings from self-employment
Over the last several years, the popularity of residential rental apps, such as Airbnb, has grown rapidly. Individual taxpayers can use these apps to earn income by renting a spare bedroom, a guest house, or even a second property. There has been plenty of debate regarding the characterization of these rental activities as passive or nonpassive under Sec. 469(c). However, whether the activity is passive or nonpassive does not affect whether the activity is included or excluded from net earnings from self-employment.
In a memorandum released Dec. 23, 2021, the IRS Office of Chief Counsel advised on issues related to whether income from these rental activities can be classified as earnings from self-employment.77 This advice was in response to a question asking for clarification about how services, such as maid services, rendered to occupants can affect the rental income's classification.
Some of the major questions answered in the published advice included:
- Is a"rental activity" under Sec. 469(c)(2) excluded from net earnings from self-employment under Sec. 1402(a)?
- Can a taxpayer's rental of living quarters be classified as "rentals from real estate" and thus be excluded from net earnings from self-employment, specifically, when the taxpayer is not a real estate dealer?
The advice memorandum indicates that an activity's classification as a rental activity does not, in and of itself, exclude the net earnings from self-employment tax.
In addition, if the taxpayer is not a real estate dealer and earns rental income from living quarters, the taxpayer must first determine whether services are rendered to the occupants of the space to determine whether it should be considered earnings from self-employment. If the taxpayer does not render services to the occupants, the income may be excluded from net earnings from self-employment.
If services are rendered to the occupants, the net rental income should be included in net earnings from self-employment if the following two facts are present: (1) the services rendered are not clearly required to maintain the space for occupancy, and (2) the services are substantial enough that compensation for them can be said to constitute a material portion of the rent.
Sec. 4973: Tax on excess contributions to certain tax-favored accounts and annuities
In Couturier,78 the taxpayer requested summary judgment that he was not liable for the 6% excise tax penalty for overfunding his IRA by $25 million. He reasoned that the IRS could not impose a penalty for the years 2004—2014 because it had not issued a deficiency notice for the 2004 rollover transaction that gave rise to the excess contribution; his 2004 income tax return was not examined. Denying his motion for summary judgment, the Tax Court found nothing in Sec. 4973, Treasury regulations, or other IRS authority "that makes the assertion of an income tax deficiency a precondition for determining an excise tax deficiency for the same year."
Footnotes
1Rev. Proc. 2022-3, §4.01(19).
2Gopi, T.C. Summ. 2021-41.
3Sec. 152(c)(4)(A)(i).
4Hicks, T.C. Memo. 2022-10.
5See Sec. 152(e)(2).
6Fact Sheet 2022-14, updated by Fact Sheet 2022-30.
7Ola-Buraimo, T.C.Summ.2022-2.
8T.D.9968.
9Sek, T.C.Memo.2022-87.
10Health care continuation coverage purchased through a former employer, as established by the Consolidated Omnibus Budget Reconciliation Act of 1985, P.L.99-272.
11Powell, T.C.Summ.2022-19.
12IRS Letter Ruling 202206011.
13IRS Letter Rulings 202209008, 202233009, and 202237009.
14IRS Letter Ruling 202224006.
15Rev.Proc.2021-48.
16Coronavirus Aid, Relief, and Economic Security Act, P.L.116-136.
17 Subtitle B, Title II, of Division N of the Consolidated Appropriations Act, 2021, P.L.116-260.
18Sec.62(d)(3).
19The fixed amortization and fixed annuitization methods.
20Grajales, 47 F.4th 58 (2d Cir.2022), aff’g 156 T.C.55 (2021).
21Salter, T.C.Memo.2022-29.
22In re Kelly, No.18-60514 (Bankr.N.D.N.Y.12/14/21).
23Webert, T.C.Memo.2022-32.
24If the sale is “by reason of a change in place of employment, health, or ... unforeseen circumstances.”
25Filler, No.21-71080 (9th Cir.7/13/22), aff’g in part T.C.Memo.2021-6.
26Sestak, T.C.Memo.2022-41.
27Chief Counsel Advice 202224010.
28Keefer, No.3:20-cv-0836-B (N.D.Tex.7/6/22).
29Harrison, T.C.Summ.2022-6.
30Scholz, T.C.Summ.2022-5.
31Rau, T.C.Summ.2022-4.
32Furrer, T.C.Memo.2022-100.
33See Sec.170(f)(11).
34Schweizer, T.C.Memo.2022-102.
35Izen, 38 F.4th 459 (5th Cir.2022).
36Sec.170(h)(1).
37Several provisions relating to qualified conservation contributions were included in the SECURE 2.0 Act, which was enacted in December 2022, after the period covered by this update. The legislation provides safe harbors to allow taxpayers to correct easement deed language regarding extinguishment clauses and boundary line adjustments; the IRS is directed to develop safe-harbor language for this purpose. In addition, certain limitations are placed on charitable deductions for conservation easements by passthrough entities. See Section 605 of the SECURE 2.0 Act of 2022 (Division T of the Consolidated Appropriations Act, 2023, P.L. 117-328).
38Regs.Sec.1.170A-14(g)(6)(ii).
39Hewitt, 21 F.4th 1336 (11th Cir.2021).
40Oakbrook Land Holdings, LLC, 28 F.4th 700 (6th Cir.2022).
41Oakbrook Land Holdings, LLC, No.22-323 (U.S.1/9/23) (cert.denied).
42Pickens Decorative Stone, T.C.Memo.2022-22.
43Morgan Run Partners, T.C.Memo.2022-61.
44Thompson, T.C.Memo.2022-80.
45Sparta, T.C.Memo.2022-88.
46Corning Place Ohio, T.C.Memo.2022-12.
47Regs.Sec.1.170A-14(g)(6)(ii).
48Glade Creek Partners, T.C.Memo.2020-148, vac’d in part, No.21-11251 (11th Cir.8/22/22).
49Hewitt, 21 F.4th 1336 (11th Cir.2021).
50Champions Retreat Golf Founders, LLC, T.C.Memo.2022-106.
51Champions Retreat Golf Founders, LLC, T.C.Memo.2018-146.
52Champions Retreat Golf Founders, LLC, 959 F.3d 1033 (11th Cir. 2020).
53Regs.Secs.1.170A-14(h)(3)(i) and 1.170A-14(h)(3)(ii).
54Champions Retreat Golf Founders, LLC, T.C.Memo.2022-106.
55Villanueva, T.C.Memo.2022-27.
56Huff, T.C.Memo.2021-140.
57Olsen, No.21-9005 (10th Cir.11/4/22), aff’g T.C.Memo.2021-41.
58Luna, T.C.Summ.2022-18.
59Salter, T.C.Memo.2022-29.
60Patitz, T.C.Memo.2022-99.
61Rojas, T.C.Memo.2022-77.
62Sonnitag, T.C.Summ.2022-3.
63Sherwin Community Painters, Inc., T.C.Memo.2022-19.
64Salter, T.C.Memo.2022-29.
65REG-105954-20.
66Division O of the Further Consolidated Appropriations Act, 2020, P.L. 116-94.
67Notice 2022-53.
68On June 14, 2022; July 1, 2022; and Dec.22, 2022.
69Prop.Regs.Sec.54.4974-1(g)(3).For tax years beginning after Dec.29, 2022, the penalty is reduced to 25% (10% if the failure is corrected timely), by the SECURE 2.0 Act (Division T of the Consolidated Appropriations Act, 2023, P.L.117-328).
70The law known as the Tax Cuts and Jobs Act (TCJA), P.L.115-97.
71American Rescue Plan Act of 2021, P.L.117-2.
72Inflation Reduction Act, P.L.117-169.
73Rev.Proc.2022-38.
74Rogerson, T.C.Memo.2022-49.
75Redleaf, 43 F.4th 825 (8th Cir.2022).
76Sec.71, which was repealed by the TCJA, generally does not apply to divorce or separation instruments signed after Dec.31, 2018.
77Chief Counsel Advice 202151005.
78Couturier, T.C.Memo.2022-69.
