Document summaries for the week of May 10, 2021

CORPORATIONS

Cost of goods sold cannot be a standalone deduction

The Tax Court held that a corporation, which paid $180 million to acquire hundreds of thousands of acres of minerals and lease interests in several states, could not deduct as cost of goods sold estimated drilling costs for natural gas exploration and mining where it had no gross receipts or sales attributable to the sale of natural gas during the years at issue. The court rejected the corporation’s argument that it should be allowed an offset for cost of goods sold as a standalone deduction in advance of any gross receipts and found that cost of goods sold is allowed only as an offset against gross receipts from the sale of goods. BRC Operating Co. LLC, T.C. Memo. 2021-59 (5/12/21).

EMPLOYEE BENEFITS

IRS issues inflation-adjusted numbers for HSAs and excepted-benefit HRAs

The IRS issued a revenue procedure that provides the 2022 inflation-adjusted amounts for health savings accounts (HSAs) and the maximum amount that may be made newly available for excepted-benefit health reimbursement arrangements (HRAs). For calendar year 2022, (1) the annual limitation on deductions under Sec. 223(b)(2)(A) for an individual with self-only coverage under a high-deductible health plan is $3,650; (2) the annual limitation on deductions under Sec. 223(b)(2)(B) for an individual with family coverage under a high-deductible health plan is $7,300; (3) a “high deductible health plan” is defined under Sec. 223(c)(2)(A) as a health plan with an annual deductible that is not less than $1,400 for self-only coverage or $2,800 for family coverage, and the annual out-of-pocket expenses (deductibles, co-payments, and other amounts, but not premiums) do not exceed $7,050 for self-only coverage or $14,100 for family coverage; and for plan years beginning in 2022, the maximum amount that may be made newly available for the plan year for an excepted-benefit HRA under Regs. Sec. 54.9831-1(c)(3)(viii) is $1,800. Rev. Proc. 2021-25 (5/10/21) (see related news story).

ESTATES, GIFTS & TRUSTS

Estate subject to 40% penalty for intentionally undervaluing assets

With respect to a decedent’s rights to payments under split-dollar agreements includible in the decedent’s gross estate, the Tax Court held that the decedent’s sons knowingly hired an appraiser who would undervalue the split-dollar rights for estate tax purposes. The court thus concluded that the estate’s appraisal of the split-dollar rights was not reasonable and found the estate liable for a 40% penalty for the gross valuation misstatement of those rights. Estate of Morrissette, T.C. Memo. 2021-60 (5/13/21).

EXEMPT ORGANIZATIONS

Appeals court upholds ‘educational organization’ regulation

The Eighth Circuit held that the taxpayer is an educational organization under Sec. 170(b)(1)(A)(ii) and therefore exempt from paying unrelated business income tax on unrelated debt-financed income under Sec. 514(c)(9)(C)(i). The court upheld Regs. Sec. 1.170A-9(c)(1), which defines an educational organization as one whose “primary function is the presentation of formal instruction” and whose noneducational activities “are merely incidental to the educational activities,” which the district court had held to be invalid. Mayo Clinic, No. 19-3189 (8th Cir. 5/13/21).

INDIVIDUALS

IRS clarifies taxation of dependent care benefits in light of recent legislation

The IRS issued a notice addressing the taxation of dependent care benefits provided through a dependent care assistance program that are made available in tax years ending in 2021 and 2022 due to the application of either the carryover or the extension of a claims period made available under Section 214 of the Taxpayer Certainty and Disaster Tax Relief Act of 2020, enacted as Division EE of the Consolidated Appropriations Act, 2021, P.L. 116-260. The notice (1) clarifies that if these dependent care benefits would have been excluded from income if used during the tax year ending in 2020 (or 2021, if applicable), these benefits will remain excludable from gross income and are not wages of the taxpayer for the tax years ending in 2021 and 2022; and (2) clarifies that these amounts will not be taken into account for purposes of the application of the limits under Sec. 129 to the other dependent care benefits available for the tax years ending in 2021 and 2022. Notice 2021-26 (5/10/21) (see related news story).

Couple failed to prove that a late Tax Court petition had been timely mailed

The Tax Court granted an IRS motion to dismiss a case for lack of jurisdiction after finding that a married couple’s Tax Court petition was not timely filed and the couple did not carry their burden of proving that the petition was timely mailed. The court noted that the envelope that contained the Tax Court petition bore a postage meter stamp but no postmark or other marking affixed by the U.S. Postal Service, was not damaged, and there was no indication that it was misdelivered, misdirected, or misplaced. Spain, T.C. Memo. 2021-58 (5/11/21).

Consultant not entitled to unsubstantiated travel and contract labor expenses

The Tax Court held that a self-employed taxpayer, who filed a Schedule C, Profit or Loss From Business, describing his business as sales and consulting for the entertainment industry, was not entitled to deduct travel expenses because he failed to substantiate the expenses and one of his main clients testified that the taxpayer was reimbursed for travel taken on the client’s behalf. The court also concluded that the taxpayer was not entitled to unsubstantiated deductions for contract labor for work performed at a construction site after noting that the taxpayer’s Schedule C did not mention anything about construction and the taxpayer had not issued any Forms W-2, Wage and Tax Statement, to employees or Forms 1099-MISC, Miscellaneous Income, to contract laborers for payments made during 2016. Adler, T.C. Memo. 2021-56 (5/10/21).

Legal fees paid in unsuccessful malpractice suit are a nondeductible personal expense

The Tax Court held that a married couple could not deduct amounts for mortgage interest expense and vehicle-related expenses beyond what the IRS had allowed because the couple failed to substantiate the additional amounts. The court also concluded that the couple were not entitled to home office expenses beyond what the IRS had allowed and could not deduct legal fees related to an unsuccessful malpractice suit against an attorney because the origin and character of the claim related to the couple’s personal income tax and the expense was thus a nondeductible personal expense. Bailey, T.C. Memo. 2021-55 (5/10/21).

Taxpayers who ran securities fraud scheme are liable for additional taxes

The Tax Court held that a taxpayer, who owned a software company in the early 2000s and ran a pump-and-dump investment scheme that landed him in prison for money laundering, tax evasion, wire fraud, and other assorted crimes (1) could be prosecuted for civil tax liability after his criminal judgment and, in fact, owed tax on a large capital gain as a result of his use of certain corporations as alter egos, and (2) was taxable on income forfeited as a result of his criminal conviction. With respect to the taxpayer’s partner in crime, the court held that he was liable for tax on $500,000 paid to him in 2000 but never reported to the IRS. Jenkins, T.C. Memo. 2021-54 (5/10/21).

Repaid Social Security benefits are includible in income

The Tax Court held that a taxpayer who received Social Security disability benefits in 2016 and then was obliged to repay them in 2020 must include the benefits in income in 2016. Fletcher, T.C. Summ. 2021-9 (5/10/21).

Correctional officer fails to substantiate numerous expenses deducted on return

The Tax Court held that a taxpayer, who worked as a correctional officer and was required to pay for certain expenses relating to his employment, (1) could not deduct clothing expenses where the reimbursement he received from his employer exceeded the amount he spent on clothing that was not adaptable to general use as ordinary clothing; (2) could not deduct amounts spent for grooming and laundry because such expenses are inherently personal; (3) could not deduct auto expenses because his substantiation of those expenses failed to identify a beginning destination, business purpose, or miles driven and was inherently unreliable due to inconsistencies with other documentation; (4) could not deduct weaponry expenses beyond those already allowed by the IRS because the documentation for such expenses failed to satisfy the strict substantiation requirements of Sec. 274(d); (5) could not deduct the cost of meals eaten at work where there was no evidence to establish that the taxpayer, while on duty and as a condition of employment, was required to purchase his meals through contributions made to a common meal fund. Finally, the court held that the taxpayer could not deduct almost $9,000 of unreimbursed employee business expenses incurred for advanced skills training because he failed to establish that the expenses were ordinary and necessary expenses related to his employment, or if ordinary and necessary, that he was not entitled to reimbursement pursuant to an agreement with his employer. Post, T.C. Summ. 2021-10 (5/12/21).

INTERNATIONAL

New procedure addresses accounting for controlled foreign corporations

The IRS issued a procedure on accounting method changes made on behalf of certain foreign corporations. The procedure accomplishes the following: (1) expands, for a limited period, the availability of automatic consent for controlled foreign corporations (CFCs) to change their methods of accounting for depreciation to the alternative depreciation system under Sec. 168(g) in order to ease the burden on CFCs of conforming their income and earnings and profits computations with their qualified business asset investment computations; (2) prescribes terms and conditions for accounting method changes made on behalf of CFCs, to ensure that Sec. 481(a) adjustments resulting from CFCs’ method changes are properly included in computations of tested income and tested loss; (3) clarifies certain aspects of the “150 percent rule” that limits audit protection for CFCs and 10/50 corporations. Rev. Proc. 2021-26 (5/11/21).

IRS PROCEDURE

Failure to get supervisor approval before RAR is issued precludes penalty assessment

The Tax Court held that a Form 4549, Income Tax Examination Changes, also known as a revenue agent report (RAR), received by a married couple along with a Letter 4121, Agreed Examination Report Transmittal, was the “initial determination” by an “individual” to impose a penalty for purposes of Sec. 6751(b). The court concluded that, because no supervisor approval was provided before the RAR was issued, the penalty assessed on the couple did not meet the requirements of Sec. 6751(b). Battat, T.C. Memo. 2021-57 (5/11/21).

Sec. 45K reference price published for 2020

The IRS published the reference price under Sec. 45K(d)(2)(C) for calendar year 2020. The reference price applies in determining the amount of the enhanced oil recovery credit under Sec. 43, the marginal well production credit for qualified crude oil production under Sec. 45I, and the applicable percentage under Sec. 613A to be used in determining percentage depletion in the case of oil and natural gas produced from marginal properties. Notice 2021-29 (5/10/21).

2021 marginal depletion percentage is 15%

The IRS announced that the applicable percentage under Sec. 613A(c)(6)(C) for purposes of determining percentage depletion on marginal properties for calendar year 2021 is 15%. Notice 2021-30 (5/10/21).

IRS announces tax relief for Tennessee storm victims

The IRS announced that victims of severe storms, straight-line winds, tornadoes, and flooding that began March 25, 2021, in portions of Tennessee now have until Aug. 2, 2021, to file various individual and business tax returns and make tax payments. TN-2021-01 (5/13/21).

IRS confirms borders of designated qualified opportunity zones

The IRS announced that the boundaries of the designated qualified opportunity zones for purposes of Secs. 1400Z-1 and 1400Z-2 were established at the time they were designated and are not subject to change. The recent release of the 2020 census data by the U.S. Census Bureau does not affect the boundaries. Announcement 2021-10 (5/14/21).

Dyed diesel fuel penalty relief announced

In response to recent disruptions of the fuel supply chain, the IRS announced that it will not impose a penalty when dyed diesel fuel is sold for use or used on the highway in Alabama, Delaware, Georgia, Florida, Louisiana, Maryland, Mississippi, North Carolina, Pennsylvania, South Carolina, Tennessee, Virginia, and the District of Columbia. This relief is retroactive to May 7, 2021, and will remain in effect through May 21, 2021. IR-2021-108 (5/13/21).