Document summaries for the week of June 18, 2018

CORPORATIONS

Corporation was not a bona fide insurance company and was taxable under Sec. 881

The Tax Court held that a corporation’s transactions were not bona fide insurance contracts for federal income tax purposes; therefore, the taxpayer was not exempt from tax as an insurance company described in Sec. 501(c)(15) and was not entitled to make an election under Sec. 953(d) to be treated as a domestic insurance company. The court also sustained the IRS’s determination that the taxpayer had fixed or determinable annual or periodical income from sources within the United States and was subject to the 30% tax under Sec. 881. Reserve Mechanical Corp., T.C. Memo. 2018-86 (6/18/18).

EMPLOYEE BENEFITS

Employee stock options are not taxable under Railroad Retirement Act

The Supreme Court reversed a Seventh Circuit decision and held that employee stock options are not taxable compensation under the Railroad Retirement Tax Act of 1937. Wisconsin Central Ltd., No. 17-530 (U.S. 6/21/18).

ESTATES, TRUSTS & GIFTS

Tax Court rejects estate’s position on valuing an interest in split-dollar life insurance

The Tax Court denied an estate’s motion for partial summary judgment where the estate argued that, in valuing a decedent’s interests in three split-dollar life insurance arrangements, Regs. Sec. 1.61-22 applied and Secs. 2036, 2038, and 2703 did not apply. The court agreed with the IRS that Regs. Sec. 1.61-22 does not apply for purposes of the estate tax and therefore did not directly apply to the estate. Estate of Cahill, T.C. Memo. 2018-84 (6/18/18).

INDIVIDUALS

Ranching activity was engaged in for profit, but couple did not materially participate in it

The Tax Court held that, while a couple operated a ranch with the objective of making a profit, they did not establish that they spent a majority of their hours doing so in a capacity other than as investors. The court concluded that, after subtracting the investor hours, and because the ranch employed a full-time manager, the couple did not materially participate in the ranching activity, which was therefore passive, suspending its losses. Robison, T.C. Memo. 2018-88 (6/19/18).

Medical marijuana business is not entitled to deductions

The Tax Court held that, under Sec. 280E, a couple who were the sole shareholders in an S corporation that was licensed to grow and sell medical marijuana in Colorado could not deduct from the S corporation’s income business expenses of compensation of officers, wages, repairs and maintenance, rents, taxes and licenses, interest, depreciation, advertising, employee benefit programs, and miscellaneous other deductions. The taxpayers also argued that denying a deduction for their wages was discriminatory because S corporations are required to pay a reasonable salary to shareholders. The court also rejected this argument, noting that Sec. 280E applies regardless of whether taxpayers or a third party receives the wages. Loughman, T.C. Memo. 2018-85 (6/18/18).

Court upholds fraud penalties against taxpayer who admitted filing fraudulent returns

The Tax Court upheld fraud penalties the IRS assessed against a taxpayer who admitted to filing fraudulent returns. The court said that because the taxpayer admitted to filing fraudulent returns, agreed that from 2008 to 2011 he underpaid his taxes by over $100,000, and that the underpayment for each year was due to fraud, the fraud penalty applied to each of the fraudulent returns and the underpayment amount subject to the fraud penalty was the difference between the income reported on the original fraudulent returns and the amount of income in the IRS’s notices of deficiency. Gaskin, T.C. Memo. 2018-89 (6/20/18).

Couple cannot deduct expenses for home improvements; must include full amount of retirement account in income

The Tax Court held that a couple did not establish that they rented their second home to relatives and that, even if they had, that they had rented the home at a fair rental value. Thus, the court denied the couple’s miscellaneous expense deduction for improvements made to that home. The court also concluded that the wife had to include the full amount of a retirement distribution in income, including funds that she did not receive because they were offset to pay off an outstanding loan. Perry, T.C. Memo. 2018-90 (6/20/18).

IRS PROCEDURE

Individual providing services to LLC was an employee; no Section 530 relief available

The Tax Court held that (1) an individual who worked for a limited liability company (LLC) that owned and operated an apartment building that the individual provided services for was an employee of the business rather than an independent contractor; (2) the LLC was not entitled to relief under Section 530 of the Revenue Act of 1978 with respect to employment taxes owed; and (3) the LLC was liable for additions to tax under Secs. 6651(a)(1) and (2) and penalties under Sec. 6656(a) on the respective employment taxes and unemployment tax for the tax periods at issue. In denying Section 530 relief, the court noted that the LLC issued no Forms 1099-MISC to the individual. Hampton Software Development, LLC, T.C. Memo. 2018-87 (6/19/18).

IRS issues July 2018 applicable federal rates

The IRS issued a ruling that prescribes the applicable federal rates for July 2018, including the applicable federal interest rates, the adjusted applicable federal interest rates, the adjusted federal long-term rate, and the adjusted federal long-term tax-exempt rate. Rev. Rul. 2018-19 (6/18/18).

Rules for electronic filing of information returns amended

The IRS issued proposed regulations amending the rules for determining whether information returns must be filed using magnetic media (electronically). The proposed regulations would require that all information returns, regardless of type, be taken into account to determine whether a person meets the 250-return threshold. REG-102951-16 (6/18/18).

Tax withholding gets credited to a taxpayer’s account on the tax return due date

The Office of Chief Counsel advised that, under Sec. 6513(b), the IRS credits tax withholding to a taxpayer’s account on the date the tax return for that year is due, and the credits are applied as of the due date without regard to any extension of time to file and whether the return is filed timely or late. Therefore, the Chief Counsel’s Office said, an overpayment comprised of prepayment credits, such as withholding, is available to be used as an offset as of the date the return is due, even if the return is filed or processed after the original due date. CCA 201825031 (6/22/18).

IRS should follow Sec. 6335 and Sec. 6337 due to seizure from a taxpayer

The Office of Chief Counsel advised that, with respect to a seizure from a taxpayer, the IRS should follow Sec. 6335 (sale of seized property) and Sec. 6337 (redemption of property). CCA 201825030 (6/22/18).

IRS levy on government disbursement due to federal contractor does not have priority where IRS did not file an NFTL

The Office of Chief Counsel advised that, in a situation where a federal government contractor owes unpaid taxes and the IRS levied on a federal contract disbursement due to the contractor from the Department of Defense and did not file a Notice of Federal Tax Lien (NFTL), the levy is not a setoff in this context, and the normal priorities under Sec. 6323 (validity and priority against certain persons) apply. Thus, because the government never filed an NFTL, a third party’s perfected security interest has priority over the government’s claim. CCA 201825029 (6/22/18).

Chief Counsel’s Office advises IRS not to assess Sec. 6694 penalty on S corp. owner

The Office of Chief Counsel advised that, unless the co-owner of an S corporation acted similarly to the owner in Elsass, 978 F. Supp. 2d 901 (S.D. Ohio 2013), aff’d, 769 F.3d 390 (6th Cir. 2014), where the court found that the owner of an S corporation was a tax return preparer for the purposes of the penalties provided for under Sec. 6694 and Sec. 6695, an assessment of the Sec. 6694 penalty against an S corporation co-owner could present a legal hazard. Alternatively, the Chief Counsel’s Office said, an S corporation may be a tax return preparer within the definition of Sec. 7701(a)(36), and the proper person on which to assess the penalty under Sec. 6694(b), but only if the requirements set forth in Regs. Sec. 1.6694-3(a)(2) are met. CCA 201825028 (6/22/18).

Language in settlement agreement was not controlling for characterizing settlement payments

The Office of Chief Counsel advised that certain language in a settlement agreement was not controlling for purposes of characterizing the settlement payments as deductible under Sec. 162(a) (ordinary and necessary business expenses). The Chief Counsel’s Office said that additional factual information was necessary to determine whether certain disgorgement payments were deductible under Sec. 162(a) or nondeductible under Sec. 162(f) (fines or penalties). CCA 201825027 (6/22/18).

IRS exercised due diligence in pursuing penalty against couple

The Tax Court granted an IRS motion relating to the assessment of a Sec. 6651(a)(2) penalty on a couple after noting that nothing in the record supported a finding that the couple would suffer unfair surprise, disadvantage, or prejudice as a result. The court also found that any filing delay for the issues before the court was not due to the IRS’s failure to exercise reasonable diligence. Brown, T.C. Memo. 2018-91 (6/21/18).

Fifth Circuit vacates obstruction conviction

In a case remanded from the Supreme Court, the Fifth Circuit vacated a taxpayer’s obstruction conviction, in light of the Supreme Court’s holding in Marinello, 138 S. Ct. 1101 (2018), that an obstruction conviction requires proof that the obstructive conduct occurred during the pendency of a particular investigation of which the taxpayer was aware, but upheld her conviction for filing false tax returns and remanded the case for resentencing. Westbrooks, No. 16-20409 (5th Cir. 6/21/18).

Sec. 1400Z-2 opportunity zones listed

The IRS issued a list of designated qualified opportunity zones under new Sec. 1400Z-2. Notice 2018-48 (6/20/18).

PARTNERSHIPS

IRS withdraws disguised-sale regulations

The IRS announced that it is withdrawing the temporary regulations issued in T.D. 9788, which addressed the allocation of partnership liabilities for disguised-sale purposes. REG-131186-17 (6/18/18) (see related news story).

S CORPORATIONS

Eighth Circuit disallows passthrough losses

The Eighth Circuit affirmed a Tax Court decision that disallowed taxpayers’ claimed losses from their S corporations, which operated nursing homes, because the taxpayers had insufficient basis in the S corporations. Hargis, No. 17-1694 (8th Cir. 6/22/18).

STATE & LOCAL TAX

Supreme Court overturns Quill

The U.S. Supreme Court held that states can assert nexus for sales-and-use-tax purposes without requiring a seller’s physical presence in the state. South Dakota v. Wayfair Inc., No. 17-494 (U.S. 6/21/18) (see related news story).

TAX ACCOUNTING

IRS issues automatic procedure for changing methods for citrus replanting costs

The IRS issued a new automatic method change for certain taxpayers to not apply the uniform capitalization rules of Sec. 263A to citrus replanting costs, pursuant to Sec. 263A(d)(2)(C), added by P.L. 115-97, known as the Tax Cuts and Jobs Act. Under the new provision, Sec. 263A does not apply to certain costs of replanting citrus plants after their loss or damage. Rev. Proc. 2018-35 (6/19/18).