2016 Year-End Tax Update

December, 2016

Okay, Now What?

Celebrating an Anniversary, Then a Look Forward, Before We Look Back

In last year’s materials,2 loosely styled “Make America Great Again!,” we ruminated upon (and also thought about) what role, if any, federal income taxes might play in helping to make America great again,3 once the interminable election campaign was finally concluded.

Well, now we know. It will be huge!

In an election stunner, at least to the chattering class and media geniuses, if not to millions of Americans who believed that their votes, rather than forecasts from CNN, MSNBC, Fox News, etc., would decide the outcome, Donald Trump, not Hillary Clinton, will be our next president and the Republican Party, with which the president-elect is somewhat familiar and loosely aligned, will control both houses of Congress.

President-elect Trump and the House Republicans have both proposed major tax legislation, which, if enacted in substantial part, would provide a garden of earthly delights to virtually all American taxpayers. Their proposals differ, but the highlight of each plan is a significant reduction in tax rates, as well as a modicum of simplification. Key aspects of the Trump tax proposals are described below.

It is noteworthy that Secretary Clinton’s tax proposals would have adversely affected two groups of taxpayers only, i.e., those who are living and those who are dead. The rest of you would have been safe for the time being.

Once again, my party, the None of the Above Party, was unsuccessful in the election, but we came much closer this time, and perhaps, for a good reason.

Before touching on possible future legislation, we note with nostalgia the anniversary of the enactment of the Tax Reform Act of 1986 (TRA ʼ86), the last great attempt at simplifying the federal income tax system. 2016 marks the 30th anniversary of TRA ʼ86. For those of you whose memories aren’t that good any more, or who may still have been in your formative years, TRA ʼ86, among other things, homogenized the rate structure among various income classes (ordinary income, dividends, capital gains), introduced the tax shelter-fighting passive activity loss limitation rules, did away with tax-free interest on industrial development bonds for commercial projects, greatly expanded the AMT, thereby helping it grow into the monster it is today, etc.

TRA ʼ86 reduced the number of tax rates from 15 to four (actually, to three if one excludes a “bubble” 33 percent rate), both increasing the lowest bracket and reducing the highest bracket, which, I am told, is the only time in our history in which that has been done at the same time. Taxpayers whose income exceeded a threshold essentially paid federal income taxes at a flat rate of 28 percent on all of their income.

Practitioners who were around in the autumn of 1986 will grimly recall those frantic days and nights from October 22, 1986, through New Year’s Eve desperately spent trying to finish all deals, make all elections, etc. in advance of 1987 effective dates. Some of my partners tell how, in their former law firms, they had to draft attorneys from the litigation department to staff tax projects. In my old firm, we somehow met production, but that’s what it felt like  a giant, auto-like assembly line in which we completed assignments and kept the big line moving.4

What practitioners often fail to recall is that TRA ’86 was intended to be revenue neutral, because President Reagan insisted that revenue neutrality accompany tax simplification. Thus, corporate and capital gains tax rates were increased and individual tax shelters and other loopholes were phased out to help balance the revenue lost by lowering individual rates. While the Trump tax proposals described below would achieve a fair degree of simplification, they are not  by their provisions anyway  intended to be revenue neutral.

The tax simplification initiative of TRA ’86 began to unravel a mere four years later when President Bush, who had asked us to “read his lips,” nevertheless increased taxes. (Guess we should have read his body language or crossed fingers instead.) But some residue of TRA ’86 lives on as a testament to the accomplishments that can be realized when legislators work together in good faith to achieve a common goal, after having taken care of special interests, neighbors, and friends. Happy 30th anniversary, TRA ’86.

I don’t plan to devote too much space in these materials to the president-elect’s tax proposals. More detail is on his website, and until the final legislation is written and enacted, there can be numerous changes, additions, and compromises along the way. If, and when, major tax legislation is enacted, we will be back to describe for you its provisions and planning implications. Rest assured, however, that in the tax version of Murphy’s Law, any changes that are enacted will not be as simple as they appear, will take longer than you think to get done, and will become effective at the worst possible moment. In the meantime, however, here are some of the most important aspects of Trump’s tax proposals:5

The number of individual tax brackets would be reduced to three, i.e., 12 percent, 25 percent, and 33 percent. The marginal rate would decrease from today’s 39.6 percent. The current capital gains rate structure (with a 20 percent maximum rate) would be maintained.

Itemized deductions would, in effect, be devalued by increasing the standard deduction to $30,000 for married taxpayers filing a joint return and $15,000 for single taxpayers. The deduction for personal exemptions would be eliminated, and the availability of itemized deductions in the aggregate would be capped at $200,000 for joint return filers and $100,000 for single taxpayers. In view of the foregoing, a number of practitioners have advised clients who made large pledges to charity that were to be paid over a number of years to consider accelerating the entire contribution into 2016, and others have advised clients to flee states like New York, California, Massachusetts, and New Jersey (each of which, purely coincidentally, went for Clinton in the election) for Florida, Texas, etc.

Both the AMT and the additional 3.8 percent Medicare tax on net investment income would be repealed, the latter as a corollary to the proposed repeal of the Affordable Care Act. A repeal of those taxes, coupled with the significant proposed increase in the standard deduction, would result in meaningful simplification and, perhaps, a decreased need for tax return preparers.

The estate tax, too, would be repealed, but capital gains held at death and valued at more than $10 million would be subject to tax. (It is very unclear what this last provision means and how it would work.) Contributions of appreciated assets to private foundations at death would be disallowed.

A friendly note of caution to our legislators. A limitation on the step-up in basis at death might be like introducing autonomous cars into a world of drivers on I-95, each of whom was exhibiting signs of extreme road rage. It has been tried before with woeful results and could again prove problematic, even in a world of nearly unlimited computing power, nor would the issue be confined to recordkeeping, if heirs and executors had to grapple with providing liquidity for a capital gains imposition.

Major business changes would be enacted, including a reduction in the marginal corporate tax rate from 35 percent to 15 percent and a one-time deemed repatriation of offshore profits to be taxed at 10 percent. Not clear is whether the 15 percent rate would also apply to income from pass-through entities such as S-corps and LLCs.

 Readers are again reminded that it can be a long strange trip from proposal to legislation, and the content of the tax law changes that ultimately get enacted, if any, as well as the timing and effective dates of such changes, are very much up in the air at this time.

The View from Bucks County, Thanksgiving, 2016

As I sat down to draft these materials, I was struck by the seeming dichotomy between the lack of legislation in 2016 and the enormous amount of regulatory and other pronouncements, important decisions, and the usual assortment of impaired taxpayers and other crazy stuff that seems to find its way easily into the tax arena.

As is our wont, we set forth below a sampling of those items that we found most significant, interesting, or just plain stupid. These materials are not intended to be exhaustive  your author, after all, as Jackson Browne would have it, remains fully engaged “in the struggle for the legal tender.”6 Rather, they are intended to highlight tax items from the past year that I deemed most noteworthy and which may be useful in your practice and, hopefully, entertaining.

This discussion is mine alone, and none of my colleagues in our Tax Department nor in my law firm is responsible, or to blame, for the content of these materials, editorial or otherwise (and, Lord knows, much of my work is “otherwise”). Nevertheless, I would be remiss not to acknowledge the valuable contributions of my friend and long-time partner, Tom Gallagher, who delights in reading tax cases on his front porch in the summer while sucking on expensive single malt scotches with names I can’t pronounce and who cheerfully called my attention to some of the more amusing cases described herein. I believe (and hope) that Tom has at last forgiven me for having helped recruit him on two different occasions and, as some of you know, one needs to forgive me of my sins to be considered a friend. Thanks, Tom.

So come along with me, fellow traveler, as we take a tour of 2016 tax developments. As always, I am honored by your time and attention.

Selected 2016 Development

Return Filing Matters, Accounting, and the Profession

Some Fun with Numbers:

The Social Security Wage Base for 2017 will increase more than 7 percent from $118,500 to $127,200, and the maximum FICA tax rises by $539.40, from $7,347 to $7,886.40. By contrast, Social Security beneficiaries get a lousy 0.3 percent benefit increase, or $5 per month for the average beneficiary. More financial oppression of working seniors!

Section 401(k) plan maximum salary deferral contributions remain at $18,000; the catch-up contribution amount remains $6,000.

The annual gift tax exclusion remains $14,000, provided we still have a gift tax. Absent repeal, the estate tax exclusion amount for 2017 goes up from $5,450,000 to $5,490,000.

The top ticket price at the box office to the Broadway show “Hamilton” is an incredible $849. Now, I’m sure it’s a splendid experience, even if the cast insists on addressing you personally after the show, but I wouldn’t pay $849 for a performance unless it was the Sermon on the Mount.

Employers are reminded that 2016 Forms W-2 must be filed with the SSA by January 31, 2017, rather than the end of February as was previously the case. Similarly, Forms 1099-MISC must now be filed with IRS by January 31, 2017.

Incomplete portions of certain of Donald Trump’s state tax returns for 1995, sent to the New York Times, reveal a reported loss of an incredible $975 million that, some pundits proclaimed, might have allowed the president-elect to avoid paying federal income taxes for 20 years. Separately, Mr. Trump’s foundation was ordered by the N.Y. State Attorney General’s Office to suspend fundraising in New York which, in view of the investment acumen that gave rise to the $975 million loss, seems like a good idea.

Governor Chris Christie announced in September that New Jersey would withdraw from a tax compact with Pennsylvania, which permits residents of each state who work in the other state to pay income tax on their wages only in their state of residence. The Reciprocal Personal Income Tax Agreement has been in effect for nearly 40 years, and as a result of the governor’s decision, thousands of taxpayers on both sides of the Delaware River would have to pay more taxes, beginning in 2017.

In late November, however, in an apparent fit of sanity, the governor changed his mind, because of anticipated savings from the reform of health care in New Jersey, and so the reciprocity agreement will thankfully remain in effect.

 Christie, whose term expires next year, is at the time of this writing rumored to be a leading candidate for the post of Secretary of Transportation, given the breadth of his knowledge of tunnels, roads, and bridges.

As reported in Bloomberg, the AICPA wrote to IRS and Treasury to complain about the burden imposed on U.S. taxpayers living abroad by duplicative and complicated Forms FINCEN Form114 (FBAR), Form 8938 (Statement of Specified Foreign Financial Assets), Form 3520 (Transactions with Foreign Trusts), and Form 3520-A (Foreign Trust with a U. S. Owner). The AICPA said that FATCA had made at least some of these required forms unnecessary.

Regulations eliminating the requirement that a taxpayer file a copy of his § 83(b) election with his tax return became final in July, effective for property transferred on or after January 1, 2016. TD 9779. This change is said to facilitate the electronic filing of tax returns.

The GAO reported in April that the largest profitable U.S. corporations had paid an average effective tax rate of 14 percent from 2008 to 2012. Senator Bernie Sanders had requested that this report be prepared. He’ll no doubt be delighted to learn of Trump’s proposal to “increase” the tax rate to 15 percent. Feel the Bern, baby!

As of March of this year, about $950 million in potential refunds remained unclaimed by taxpayers who had yet to file their tax returns for 2012, according to IRS.

In Vichich v. Commissioner, the Tax Court ruled that a deceased taxpayer’s second wife was not entitled in 2009 to an AMT credit with respect to the tax return that the decedent and his first wife had filed in 1998. A deceased taxpayer’s unused deductions said the court, must be used on his final return or they are lost forever, unlike the evil which men do.

The new partnership audit rules, which allow IRS to collect deficiencies from partnerships and which we covered in some detail at one of last year’s seminars, take effect in 2018 but permit partnerships to elect early opt-in. Now, IRS is concerned that insolvent or near-insolvent partnerships will take advantage of early opt-in, so that the Service would have to try to collect taxes from partnerships that cannot pay the bill. To deal with this concern, IRS has released guidance requiring partnerships electing early opt-in to represent that they are not insolvent, nor in danger of insolvency, and that they reasonably anticipate having sufficient assets to pay potential deficiencies.

In U.S. v. Tilford, the Fifth Circuit ruled that the “innocent spouse” defense does not provide relief against a restitution order in a criminal tax case, upholding a garnishment on the wages of a taxpayer whose ex-spouse pled guilty to a tax crime. Criminal restitution, even in a tax case, is not a tax to which the innocent spouse defense might apply, said the court.

And in U.S. v. Davis, the Sixth Circuit upheld the right of the federal government to sell a home owned by a married couple to enforce a tax lien against the husband only, rejecting Ms. Davis’ arguments that the government could only sell her husband’s interest in their vacation home.

So the moral of these cases, my friends, is to teach your daughters not to marry no-good, tax delinquent scoundrels. God bless the child who’s got her own.

It Was a Tough Year for IRS As Well

A TIGTA report in May concluded that IRS had misallocated “millions of dollars” of Affordable Care Act (ACA)credits. The Inspector General said that IRS correctly dealt with 93 percent of ACA credits.

And in an August report, TIGTA announced that between February 2011 and December 2015, a shocking 1,100,000 taxpayers were victimized by employment-related identity theft but were not notified of that fact by IRS. Employment-related theft refers to the use by a person of another person’s identity to get a job. Voters in Philadelphia and Chicago reportedly shrugged off the news as nothing unusual.

But, IRS did warn tax professionals of the use by identity thieves of remote technology to take over the computers of return preparers in order to e-file tax returns and direct the payment of refunds to accounts of the hackers. About two dozen such cases were discovered. Readers will recall that a cyber-attack on the IRS “Get Transcript” function had previously affected about 720,000 taxpayers (originally reported as 330,000 taxpayers). Those taxpayers said IRS, had been notified, albeit somewhat belatedly.

Cybersecurity problems continue to be a major issue with the tax filing system, just as they are in the non-tax world.

In a more helpful vein, IRS announced in April that taxpayers could pay their taxes with cash at more than 7,000 7-Eleven locations. Instructions for this payment option can be found on the IRS website. There is a $1,000 per day payment limit and a $3.99 per payment fee. There is no limit, however, on daily purchases of Slurpees. “Oh thank heaven for 7-Eleven.”

We previously reported on the Cosentino case, a Tax Court memorandum decision that held that the receipt by the taxpayers of a $375,000 payment to settle a malpractice claim against their accounting firm was a nontaxable recovery of capital. The negligent advice related to what IRS concluded was an abusive tax shelter involving a § 1031 exchange. Now, in AOD 2016-001, IRS announced its non-acquiescence with the decision.

In a case involving Giant Eagle, Inc., the Third Circuit, reversing the Tax Court, held that the supermarket chain could deduct discounts on the purchase of gas that shoppers earned through loyalty program purchases at the markets, even though the customers had not used up their discounts by the end of the years in issue. The court concluded that the liabilities were sufficiently fixed to satisfy the “all events test.” IRS announced in October that it did not acquiesce in the decision and would follow it only in cases appealable to the Third Circuit.

Employment Tax Matters

In CCA 201634023, IRS ruled that “short week benefit payments” paid to employees who worked fewer than 36 hours in a week or who could not work due to weather conditions did not constitute “supplemental unemployment benefits” (SUBs) and, as such, were wages for FICA purposes. Rev. Rul. 90-72 requires that SUBs must be linked to state unemployment compensation to be excluded from wages, and the payments here in issue were not so linked.

Readers will recall that in 2014, the Supreme Court decided in U.S. v. Quality Stores, Inc. that severance payments not tied to the receipt of unemployment insurance benefits were also wages for FICA purposes.

We live in litigious times. Thus, in a rather odd case, Liverett v. Torres Advanced Enterprise Solutions LLC, a worker claiming to be an employee and not an independent contractor unsuccessfully sued his service recipient for willfully misrepresenting his status and fraudulently issuing him a Form 1099-MISC, rather than a W-2.

Recently issued regulations amending § 301.7701-2 set forth the IRS position that members of a partnership that owns a single member tax-disregarded LLC (SMLLCs) are subject to self-employment tax on amounts purportedly paid to them as wages by the SMLLC. The confusion in this area apparently arises from the rule that SMLLCs are treated as corporations for employment tax purposes, but IRS said that the rule does not apply to the self-employment tax treatment of partners in the partnership that owns the SMLLC. Your author has seen numerous companies (often private equity firms) use this structure in an attempt to avoid self-employment taxes for owner-managers. Gotcha!

CCA 201622031 concludes that the cash payment by an employer of the cost of gym memberships for participation in a wellness program is not excludable from income under Sections 105 and 106, nor is a reimbursement of the employee’s cafeteria plan salary reduction amount applied to pay for the gym membership. Employee payments of gym membership fees are not medical care under § 213(d) nor an excludable fringe benefit under § 132, even though provided as part of a wellness program, said the Service. Whatever the technical merit may be of the issues described in the CCA, the result seems misguided.

Real Estate Matters

Gragg v. U.S., a Ninth Circuit case, provides a useful reminder that it is not enough to qualify as a real estate professional under § 469(c)(7) to avoid the passive activity loss limitation rules applicable to rental real estate. Real estate professionals must also demonstrate that they materially participate in real estate rental activities to avoid the PAL limitations. § 1.469-9(e)(1) and § 1.464-9(e)(3)(i). Mrs. Gragg was a full-time real estate agent. She and her husband owned two rental properties that produced losses. The taxpayers were unable to demonstrate material participation but argued that Mrs. Gragg’s status as a real estate professional “automatically” rendered the rental losses nonpassive. The court rejected that argument, finding instead that real estate professional status merely removes the per se bar of § 469(c)(2) on treating rental real estate losses as active.

The Tax Court arrived at the same result in Perez v. Commissioner, a 2010 Memorandum decision.

IRS ruled in Rev. Rul. 2016-15 that debt secured by real estate held by a taxpayer for sale to customers in the ordinary course of its trade or business is not qualified real property businesses indebtedness for purposes of the debt cancellation rules of § 108, citing the legislative history to the QRPBI rules and the provisions of § 1017. As such, a taxpayer cannot elect to exclude from income a cancellation with respect to a loan secured by inventory property on the theory that the loan is qualified real property businesses indebtedness.

In Exelon Corporation, a lengthy Tax Court decision, the court ruled that the requirements for a tax-free exchange of like-kind properties under § 1031 were not satisfied, finding that the properties that the taxpayer received in exchange for its power plants were not true leases of real property but, rather, were loans.

In August, IRS finalized its regulations defining “real property” for purposes of the REIT rules of the code. The rules, which are generally pro-taxpayer, expand the definition of acceptable passive functions to items such as pipelines, roads, railroad tracks, and electrical wires (i.e., “providing a conduit or a route”), and broaden the definition of “land” to include water and air space adjacent to land (e.g., air rights).

International Tax Matters

As noted earlier, the taxation of foreign operations of U.S. and U.S.-controlled entities seems almost certain to be an important subject of any proposed tax legislation. Some of the items described briefly below help explain why the international tax arena is in dire need of rethinking and reform. If you’ll permit me an editorial observation, too many very smart people have spent too many hours dreaming up too many techniques for the singular purpose of confounding tax authorities both here and abroad. I don’t know that when the president-elect spoke of the system being “rigged,” he was thinking of the taxation of international operations, but it is not beyond the realm of possibility. We’ll see what next year brings but, if history is any guide, a new tax regime that too many smart people will spend too many hours trying to manipulate awaits us.

In a July filing with the Securities and Exchange Commission, Facebook revealed that it could face an additional federal income tax liability (with interest and penalties) of between $3 billion and $5 billion resulting from transfer pricing adjustments with respect to licenses involving its Irish subsidiary. Facebook has petitioned the Tax Court for redress.

In August, the European Commission found that Apple had received illegal state aid from Ireland and ordered the company to pay Ireland $13 billion euros in back taxes and interest.

Even more extraordinary than that staggering sum was the response of the Irish government that angrily announced that it — Ireland — would appeal the order of the Commission awarding it $14.5 billion or so. This marks the first time in recorded history that a government voluntarily turned its back on tax revenue. The Minister for Finance, one Michael Noonan, explained that “there are some very important principles at stake in this case and that a robust legal challenge … is essential to defend Ireland’s interests … no state aid was provided.”

Now for those of you who think I either just plain got that wrong, or that they don’t understand what I wrote (or what Minister Noonan said), or that this is another tired, drunk Irishman joke, I’ll try it again as simply as I can. The European Commission determined that Ireland illegally aided Apple. As punishment for aiding and abetting this tax evasion, Ireland was ordered to accept about $14.5 billion, which it promptly and proudly refused, promising to go to court instead to protect its right not to have to accept this money. I’m biting my tongue as I write this, trying mightily to restrain myself from adding the hundreds of witty but cutting remarks that come to mind from a policy of such abject stupidity. Minister Noonan would not have lasted long in your author’s administration.

New rules curbing inversions, issued on April 4, effectively killed a planned merger between pharmaceutical giants, Pfizer and Allergan PLC, and drew angry comments from both the companies and the Obama administration. Allergan’s CEO said “we followed the rules Congress had set, but for the rules to be changed is un-American …” Bloomberg reported that White House Press Secretary Josh Earnest later replied that “it is difficult to have a lot of patience for an American CEO trying to execute a complicated financial transaction to avoid paying taxes in America talking about what it means to be a good citizen …”

The anti-inversion regulations for American companies are much like the Hotel California, i.e., “You can check out any time you like, but you can never leave.”

Also in April, IRS issued a voluminous and, quite frankly, shocking set of proposed debt-equity regulations under § 385 intended largely, but not exclusively, to attack earnings — stripping techniques involving “excessive” loans among U.S. corporations and their foreign affiliates.

The proposed § 385 regulations are exceedingly complex and ineffably boring. Those proposed regulations, and the games they were intended to address, represent about all that is wrong with federal income tax law,7 and make practitioners ashamed at times to reveal their true professions in polite company.

To paraphrase, the president-elect, I moved on those proposed regulations hard, but I failed.

To its credit, the Treasury Department carefully considered the numerous comments to the proposed regulations that it solicited and received. The final regulations, promulgated in October, did away with many of the provisions that most troubled practitioners and added numerous exceptions to deal with common or routine transactions that the proposed regulations would have attacked.

A detailed discussion of the § 385 regulations is beyond the scope of these materials, and they have been ably dealt with elsewhere, including at a recent lunch meeting of the Philadelphia Tax Supper Group. (A lunch meeting of the tax supper group, you ask? Why not?)

What will become of these regulations in future tax reform remains to be seen, so readers who have not yet studied these rules may want to move them further down the pile.

Online poker sites “Party Poker” and “Poker Stars” are not foreign financial accounts said the Ninth Circuit, reversing (in part) a district court decision that had upheld penalties on the taxpayer for failing to disclose the accounts. U.S. v. John Hom.

Estate and Gift Taxes

Assuming that this is not the last time that there are estate and gift taxes to describe in these scribblings, the following items may be of continuing interest to practitioners.

A hot, but difficult, issue in the world of estate taxes is the value of the right to use the image, earn royalties, sell records, etc. of deceased artists such as Michael Jackson and Whitney Houston. Both of their estates are currently litigating this issue and, in the case of Michael Jackson’s estate, the parties are a million miles apart, with the estate having valued the rights to the King of Pop’s posthumous image and likeness at an “off the wall” $2,105 (perhaps continuing the “smooth criminal” self-description of Mr. Jackson), and the IRS having valued them at $434 million. The case promises to be a “thriller.”8

The parties in Ms. Houston’s estate dispute are reportedly only about $22 million apart.

The Jackson estate case is docketed for February.

Any of you who, like your author, have thoroughly enjoyed a visit to Graceland but who have been involuntarily subjected there to the most pervasive and fierce retailing effort in the known world can testify to the enduring value of the images of our deceased heroes.

Important new regulations significantly restricting the use of valuation discounts with respect to interests in closely held business were issued in August. Among other things, a new, larger class of “disregarded restrictions” was added by the proposed regulations which, if adopted in their current form, would have the effect of increasing gift, estate and generation-skipping taxes on the transfer of business interests to family members by eliminating or reducing valuation discounts that have typically been claimed by taxpayers and not infrequently upheld by the courts. The proposed regulations have been criticized, comments submitted and a hearing on the regulations has been scheduled, so the final word on the subject may not yet have been written.

S-Corps and Partnerships

In PLR 201633017, IRS ruled that an S-corp did not have more than one class of stock where it made disproportionate distributions due to (i) an error in the stock ownership percentage information it used, (ii) distributions it made for composite state tax payments on behalf of its shareholders (which it originally treated as loans but later recharacterized as distributions), and (iii) correct those disproportionate distributions. IRS accepted the corporation’s representation that it did not have a principal purpose to circumvent the one class of stock rule.

We previously reported on Williams v. Commissioner, in which the Tax Court ruled that the passive activity loss limitation rules and, in particular, the self-rental rule, apply to S corporations, even though Code § 469 does not specifically refer to S-corps. (Reg. § 1.469-4(a), however, does state that a taxpayer’s activities include those conducted through S-corps.) In this case, the taxpayers’ S-corp leased real estate to their professional medical corporation. Now, the Fifth Circuit has upheld the Tax Court’s determination that the rental income was nonpassive.

In Squeri v. Commissioner, the taxpayer, a cash basis S-corp providing janitorial services, chose not to deposit (and report as income) checks received in the last quarter of each year until January of the following year. On audit, IRS included in income for each year the checks that were received during the year but not deposited until January and excluded the amounts deposited in January of that year that had been received in the prior year. For the first year under examination, however, IRS did not exclude the checks that had been received in the prior year, because that year was time-barred. The Tax Court upheld IRS’s determination under the “duty of consistency” doctrine and sustained the civil fraud penalty.

In October, important final regulations dealing with disguised sales, the allocation of partnership liabilities, and bottom guarantees were issued. These regulations are intended to eliminate or severely reduce the benefits of leveraged distribution transactions, which have troubled IRS for some time.

In an April legal advice memorandum (GLAM 2016-001), IRS concluded that “bad boy guarantees” of a partner would not cause an underlying partnership debt to fail to qualify as a nonrecourse liability unless and until the partner became liable for the debt on the happening of a carve-out event. This reversed the position that the Service had taken earlier this year in CCA 201606027 that had been roundly criticized by practitioners.

Certain State and Local Tax Developments

A group of plaintiffs, including the American Beverage Association, brought suit to challenge the city of Philadelphia’s 1.5 cent-per-ounce sweetened beverage tax, which is curiously imposed on diet soda as well. The tax, if upheld, is expected to raise approximately $90 million next year. Williams et al. v. City of Philadelphia et al.

In happier beverage news, Pennsylvania, in June, enacted legislation allowing supermarkets, gas stations, convenience stores, etc. to sell beer and wine. Another provision of the law allows for the direct shipment of wine in limited quantities from wineries that obtain a shipper license.

Purely as a courtesy to my readers, to ensure that the new law is working well, your author placed an order with our favorite Sonoma County vineyard. I am pleased to report that the delivery to our house went very smoothly.

Yahoo Finance cited a report in the Marijuana Business Daily (apparently, there is such a publication) that noted that Colorado pot establishments are increasingly being audited by IRS. The audits are said to be focused on the non-filing of Form 8300 that requires businesses to report cash payments of $10,000 or more.

Word to the Service: Chill out, baby.

Pennsylvania Act 84 authorizes a tax amnesty program to run from April 21, 2017, to June 19, 2017. All penalties and one-half of the interest due will be waived for eligible taxpayers. A bulletin describing the program in Q&A form was issued in September.

Airbnb agreed to collect and remit Pennsylvania’s hotel occupancy tax, beginning July 1 of this year. The local hotel tax in Philadelphia and Allegheny County will also be collected.

Some Princeton, N.J., residents sued to challenge Princeton University’s real estate tax exemption. Bloomberg News reports that the average annual real estate bill of Princeton residents is about $17,700, which would make me unhappy as well, and that one of the plaintiffs complained that the university operated “like a hedge fund that conducts classes.” Princeton University has since agreed to make meaningful payments to the town.

Yale University is also the subject of legislation that would tax its real estate and a portion of the earnings of its $25 billion endowment.

The city of Chicago will no longer tax feminine hygiene products, instead increasing the tax on cigarette alternatives.

Other Selected Tax Developments

IRS has ratcheted up its attacks on “micro-captive insurance companies,” which can elect under § 831(b) not to pay income tax on their premium income, so long as the premiums do not exceed $1.2 million per year ($2.2 million, beginning in 2017). Among the abuses that concern IRS are (i) that captives write coverage insuring risks of their affiliates that are so improbable that, in all likelihood, claims will never be paid, and (ii) that the captives invest in the stock or debt instruments of their parents. (Coverage for radiological and biological warfare and nuclear holocaust insurance are among my personal favorites.)

IRS has now issued a notice warning taxpayers that certain micro-captive “transactions of interest” have the potential for tax evasion. Micro-captives are also on IRS “dirty dozen” list of scams.

In CCA 201642035 and FAA 20163701F, IRS changed its position regarding the treatment to the payer of a breakup fee in a failed merger or acquisition. IRS now says that the fee gives rise to a capital loss under § 1234A, not an ordinary deduction as it had previously privately ruled.

And in CCA201624021, IRS stated that a target corporation that was acquired in a transaction in which a § 338(h)(10) election was made could not make the safe-harbor election of Rev. Proc. 2011-29 with respect to success-based fees. According to IRS, the “covered transaction” consisting of a taxable acquisition “by the taxpayer” of assets that constitute a trade or business applies only to the acquiring corporation. § 1.263(a) – 5(e)(3)(i). Thus, the target here had to capitalize its success-based fees.

Having tired of reviewing numerous ruling requests for relief from failure to have made a rollover from a qualified plan to an IRA, or from IRA to IRA within the required 60 days, IRS helpfully issued a revenue procedure that allows taxpayers to self-certify as to why more time was needed. If the cause was one or more of the 11 or so reasons described in the Rev. Proc., and if the rollover is accomplished within 30 days of when the impediment was overcome, plan trustees or custodians can rely on the taxpayer’s certification, absent knowledge that the excuse is false.

The taxpayer in CRI-Leslie LLC v. Commissioner entered into an agreement to sell its Florida hotel to RPS LLC for $39 million. The buyer made $9.7 million in nonrefundable deposits under the agreement of sale but failed to make closing, thereby forfeiting the deposits. IRS challenged the taxpayer’s treatment of the forfeited deposits as capital gains on the ground that § 1234A, by its terms, applies only to capital assets and not to terminated contracts for § 1231 property, and the Tax Court sustained IRS’s determination.

In PLR 201611007, IRS agreed that the transfer of all of the non-revenue-producing employees who performed a function for two of the taxpayer’s subsidiaries, together with the assets used by those employees, to another subsidiary satisfied the requirements of §3121(a)(1), thereby allowing the successor subsidiary to count the transferor subsidiaries’ payment of compensation in determining when the successor subsidiary met the Social Security wage base with respect to the transferred employees. The entire business of the transferors did not have to be transferred to the successor for § 3121(a)(1) to apply.

CCA 201605017 analyzes a purported like-kind exchange of airplanes, where the relinquished plane was used both for business and for personal purposes. The advice concludes that the relinquished aircraft could not be considered to be two assets; it was either held for business use or personal use. The examining agent was directed to obtain more information about the use of the plane in order to determine whether the plane was business or personal use property, and the CCA points out that there is no general 50 percent personal use threshold for this purpose.

A putative class action was filed against Costco by New Jersey residents who allege that Costco overcharged customers by collecting a 7 percent sales tax on purchases of Charmin toilet paper, even though toilet paper is exempt from the tax. Counsel for the plaintiffs said the problem is “widespread.” Folks, you can’t make this stuff up.

The Usual Cast of Oddballs

Soccer star Lionel Messi was sentenced to 21 months in prison for tax fraud, but the sentence will be served under probation so as not to impair the play of FC Barcelona, Messi’s team. (Lionel is number 10 in your program, but number 1 in your hearts.)

Former U. S. Tax Court Judge Diane Kroupa and her husband were indicted for tax evasion and obstruction and entered into plea agreements with the government.

When a taxpayer, Santander Holdings USA, filed a brief in the Court of Appeals in a tax case involving a “foreign tax credit generator,” which Santander won in the District Court, it argued that the case of Bank of New York Mellon v. Commissioner should not be followed because Judge Kroupa, who decided the case, was under audit when she rendered her decision and so had a “disabling conflict.” We’ll see if Kroupa’s misconduct taints other cases decided by her.

Former Philadelphia Traffic Court Judge Michael Sullivan was sentenced to 10 months in prison after pleading guilty to avoiding federal employment taxes by paying employees of a bar he owned in South Philadelphia under the table.

If, like your author, you have trouble sleeping in the morning, you have undoubtedly been bombarded by commercials for “my pillow.com.” You know the one — “For the best night’s sleep in the whole wide world, it’s my pillow.com.” Now, as an enhancement to the pillow’s attributes, it comes with a bonus to New York’s sleep-deprived residents, i.e., no sales tax, or so my pillow.com thought, before settling a whistleblower suit over its failure to collect sales tax and allegedly preparing false confirmations to achieve that result.

Don’t get mad, get even! In Wolosky v. Holenstein, a New Jersey resident brought suit to raise the property tax assessment on the home of Ms. Penny Holenstein, who happened to be the tax assessor for the town in which Mr. Wolosky lives, and the New Jersey Tax Court allowed the case to go forward despite the defendant’s assertions that the suit was simple harassment. Wolosky was said to be displeased by the way Holenstein handled his tax appeal of the assessment on a property he owned. A peculiar New Jersey statute permits a taxpayer to challenge a tax assessment on another property in the same county.


So now, my friends, as we count our blessings, look forward to celebrating with our loved ones during this season of miracles, and await the brave new world of 2017, may our enemies go to Hell, may our country remain great, and, as I have long believed, remember that “the best things in life aren’t things.”

And from our house to yours, we wish each of you season’s greetings and a healthy and prosperous new year.

1 Long-time readers will recall our rather inexplicable need to recite some verse or other from Wham!, a 1980’s pop duo, in each year’s Update. Don’t ask. It could be Culture Club instead.

2 Thanks to my loyal readers who, according to my family, made 2015’s update the most read publication of the year, other than the Bible, which, of course, contains much more good news than these materials. Given its popularity, an illustrated version of the update for young children is in the works for next year.

3 As we noted then, some of us think America is already pretty special but, who knows, maybe she can be greater still.

4 I borrow liberally here from the classic song by that great American poet and songwriter, Bob Seger, “Making Thunderbirds.”

5 The president-elect is not the only one with a dog in the fight. The House of Republicans have their own tax proposals, known as “A Better Way: Our Vision for a Confident America.”

6 Jackson Browne – “The Pretender.”

7 The proposed regulations and their preamble exceeded 500 pages and purported to interpret a code provision that was enacted 50 years ago and then virtually ignored ever since.

8 The value of Michael’s image and likeness is only one issue in the case. IRS adjusted the reported value of the estate from $7 million to more than $1.3 billion, determined a deficiency in excess of $700 million and is seeking nearly $200 million in penalties. 



Dennis L. Cohen

Of Counsel


(215) 665-4154

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    “Last Christmas, I gave you my heart
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    And for those of my fellow Americans who are concerned about our country, the direction it’s taking, and our place in the world we live in, take comfort my friends in these immortal lyrics from Charlie Daniels and the boys:

    “Well the eagle’s been flyin’ slow
    And the flag’s been flyin’ low
    And a lotta people sayin that America’s fixin to fall
    Well speakin’ just for me
    And some people from Tennessee
    We’ve got a thing or two to tell you all
    This lady may have stumbled
    But she ain’t never fell
    And if [our enemies] don’t believe that
    They can all go straight to hell….
    God bless America again.”

    “In America” – The Charlie Daniels Band