Cozen O’Connor: 2018 Year-End Tax Update

2018 Year-End Tax Update – The Long Goodbye

Year-End Tax Update

December, 2018

The Tax Cuts and Jobs Act Explained in One Paragraph

A Brief Analysis of the So-Called Tax Cuts and Jobs Act by that Eminent Tax Scholar, Commentator and Basketball Hall of Famer, Charles Barkley, on a Christmas Day 2017 NBA Broadcast:

“I’m gonna trickle my fat ass down to the jewelry store to get me a new Rolex. I’m not gonna pass it to nobody. Thank you, Republicans, I know I can always count on y’all to take care of us rich people … sorry poor people, I’m hoping for y’all, but y’all ain’t got no chance.”

Thanksgiving, 2018 – Bucks County, Pa.

A Brief Look Back

I always know summer is over when I sit down to draft our annual Year-End Tax Update because the leaves are brown, the sky is gray, Rita’s water ice shop is closed, it’s cold outside, and the networks are advertising Thanksgiving Day’s pro football games. (As you can tell from that astute analysis, I am the proud product of a fine Philadelphia public school education although, since my high school graduation many years ago, my old school, surprisingly, has become a powerhouse in both football and grand theft auto.)

I love warm weather, but I love Thanksgiving as well, so that creates a bit of tension for me, as does the need to come up with new material for our annual Year-End Update. Because taxes (and money) seem to bring out the worst in people, there are always plenty of odd or bizarre cases to report on, but the other jokes and humorous stories that readers have come to cherish (and demand), like kicks, just keep getting harder to find, which adds to the tension.

For the last three years, we were fortunate enough to draft our materials through the lens of what I’ve called the “Trump Tax Trilogy,” namely 2015’s “Make America Great Again” (in which we explored candidate Trump’s tax notions); 2016’s “Okay, Now What” (in which the Trump presidency became a reality and we could jettison, for example, a discussion of the tax oppression ideas of Secretary Clinton and the tax fantasies of Senator Ted Cruz and them); and 2017’s “We’re Still Waiting” (in which your commentator’s obligation to have written materials, so attendees of our year-end seminar could get continuing education credit, meant that we couldn’t wait for the finalization of the various Senatorial tax “giveaways” that populated and delayed the text of the Tax Cuts and Jobs Act (TCJA)). Given the absurdity of the many tax proposals propounded by the candidates and your elected officials, those Updates practically wrote themselves.

We’ve previously written and spoken about various aspects of the TCJA, and so you’ll forgive us, dear reader, if we forbear from dealing in detail here with that Act. Besides, after listening to Sir Charles Barkley discuss TCJA so eloquently, what more could I add? And unfortunately, the 10 percent middle-class tax cut legislation that was promised by Election Day has, like Joe Turner, come and gone, so we can’t deal with that in here either. We do, however, comment below on certain aspects of the Act.

So, we move on from the Trump Tax Trilogy Updates to focus, as is our usual practice, on certain of the cases, rulings, and announcements from the past year which we deem useful, important, curious, or just plain stupid and which may have escaped your notice.

Before moving on, however, I wish to commend those dedicated men and women who labored tirelessly and well to craft the text of the TCJA. You see, tax professionals in private practice tend to be an arrogant and critical lot, who enjoy pointing out ambiguities or tiny errata in large federal tax acts. “What could they have been thinking,” we ask, or “What the hell does that mean,” or “Heck, my elementary school kids could have done a better job with that provision,” we exclaim. Oh yeah? Try it some time. The drafters of TCJA worked incredible hours under extreme pressure to produce the text of the Act in time for passage before Christmas and the New Year. Were there some mistakes? Yup. Were there some provisions that they wish they could redraft? Sure. Were there some items that might have been done better with more time or sleep? I guess so. But by and large, in your author’s view, and without regard to your views as to the wisdom of the Act, this was a job very well done. And if you ever need an explanation as to why no one likes lawyers, re-read the previous sentence.

Kudos in advance to those folks whose job it is to prepare forms for federal income tax returns. I, for one, can’t wait to see the new forms for, say, the qualified business income deduction or the disposition of a profits interest. Preparing tax forms is really tough so, if there’s any karma in the universe, you guys and gals will have a cushy time in your next lives.

Here is some health advice I wanted to pass along to those of you who, unlike me, are able to sleep late and, who, therefore, may have missed this important announcement that seems to play each day. In the early hours of the morning, there’s a commercial on T.V. for some pharmaceutical product that is supposed to improve your brain function as you age. Now, contrary to the belief that over the years there’s been nothing in this world that I haven’t been fool enough to try, I’ve never sampled this product and so I can’t comment on its efficacy or lack thereof. But what interests me is the claim in the commercial that the product is based on a substance originally found in jellyfish. Now, I like to think that I was pretty attentive in class in high school and college (law school, not so much) but, for the life of me, I can’t ever recall learning that eating, imbibing, or smoking jellyfish would improve my brain. (Perhaps I really do need the product.) Elephants? Yeah, they never forget, so I’d try an elephant-based doobie. But jellyfish?

There’s been talk of a year-end tax bill, which would combine (i) needed technical corrections to TCJA, with (ii) the resurrection of various lapsed goodies (known in tax jargon as “extenders”), and (iii) some undefined new tax benefits because, as Loretta would sing, “Somebody, somewhere, don’t know what he’s missing tonight.” The thought is that the best chance to get this done would be before the next Congress takes office. We’ll see, but certainly, the enactment of technical corrections would be welcome.

Speaking of year-end, last year at this time, our attention was divided between the negotiation of the new tax law and the improbable play of your Philadelphia Eagles, which carried the team to victory in Super Bowl LII, an accomplishment that your author had given up hope of ever seeing while still walking the earth. Regrettably, our Birds seem unlikely to repeat. But for those of you seeking consolation, I am pleased to report that the West Coast Eagles (from Perth, Australia) won the Grand Final of the Australian Football League this past September by defeating the Collingwood Magpies 79-74, for their fourth premiership. Your author had the great good fortune to arrive in Melbourne (where the match was played) the morning after the game and got to share a pint or two with some pleased and very hungover new friends and Eagles fans from Perth, which I found to be a charming and highly recommended introduction to Oz for those of you thinking of vacationing there. (The West Coast Eagles’ jersey colors, by the way, are royal blue and yellow.)

Maybe it was the Super Bowl victory that got me thinking but, in any event, after much internal debate, I have decided that this will be the last Year-End Tax Update that I will author, in this format. I’ve enjoyed preparing these and sharing a laugh or two (and an occasional insight) with you over the years and especially with those friends who religiously attend our year-end update seminar for “spits and giggles” (as they say), as well as for soft pretzels and continuing education credits.

I plan instead, next year, to find some exciting new adventure for the holidays and, although our plans are not yet definite, I am seriously considering a caravan tour of Central America.

Because this will be our last Update in this format, I have taken the liberty of sprinkling these materials throughout with references to or snippets from various rock and roll (or country) hits that seemed on point; hence the “Rock and Roll” edition. I hope you enjoy it.

I again thank my friend and colleague, Tom Gallagher, for pointing out to me some of the cases of taxpayers who are having a bad day that are described below. Thanks, Tom.

I especially want to thank my dear friend, Al Brindisi, at whose Brindisi Tax Academy many of our seminars were given and who has always graced us with his wit, his love of the accounting profession, his interest in tax law, and his unerring ability to make attendees to the eight seminars a year at his Tax Academy feel like family. (He also has the most amazing collection of political memorabilia you’ve ever seen.) Years ago, Al challenged me to summarize some of that year’s important tax developments in an entertaining fashion, and that invitation gave rise to this annual winter tradition, much like deer hunting season, listening to “Run, Run Rudolph,” or enjoying the holidays by visiting border crossings in TJ. Thanks again, Al!

Finally, I’d like to thank the Villanova University Nursing School’s women’s choir who, unbeknownst to them, on two different occasions, celebrated their Christmas party in the room next to the one in which I was presenting the year-end update seminar. As they sang carols, I had to interrupt my presentation to go next door to ask them to kindly sing louder. You see, as regards our seminar, heaven ain’t found in a place like that, but those visiting nurses improved our mood immensely. Hope to see you again soon, angels!

So with that, come along with me, friends as we take a tour of selected 2018 tax developments. As always, I am honored by your time and attention.

Some Political Thoughts for Those of You Nursing a Midterm Election Hangover or Pondering the Flyers’ Inability Ever to Fix Their Goaltending Woes

“We hang the petty thieves and appoint the great ones to public office.”

-          Aesop

“A government big enough to give you everything you want is strong enough to take everything you have.”

-          Thomas Jefferson

“Government’s view of the economy could be summed up in a few short phrases: If it moves, tax it. If it keeps moving, regulate it. And if it stops moving, subsidize it.”

-          Ronald Reagan

“It’s Clobberin’ Time.”

-          Ben Grimm (The Thing)

But, to leave things on a lighter note:

 “What, me worry?”

-          Alfred E. Neuman

Selected 2018 Developments

Employment Related Matters

In a somewhat harsh, but apparently correctly decided case, a District Court in California held in the Thompson case where a taxpayer who had not attained the age of 59-1/2 withdrew more than one million dollars in funds from his qualified retirement plan to satisfy his tax liabilities, after receiving a notice of intent to levy from IRS, the 10 percent premature distribution penalty of § 72(t) applied to the distribution. An exception to the penalty applies where the plan is levied upon § 72(t)(2)(A)(vii) — but the court noted that the distribution of the funds here was voluntary and not the result of a levy on the plan. That conclusion is supported by the legislative history to § 72(t)(2)(A)(vii). The taxpayer had argued that the filing of an NFTL in advance of a levy would have ruined his business and, as such, that his withdrawal, in substance, was involuntary. Could the penalty have been avoided if the taxpayer’s representative and the IRS Revenue Officer had agreed, in advance, to a levy on the plan assets? Presumably, but as noted, that would have required the filing of a tax lien. Nevertheless, there should be available workarounds here, and perhaps a legislative or regulatory fix is in order.

Section 3121(a)(6) provides generally that if an employer pays an employee’s share of FICA, without deducting it from the employee’s wages, the wages are increased by this gross-up payment. In addition, employers who fail to withhold and pay over federal income tax or FICA on wages paid to employees are themselves liable for these taxes. In Program Manager Technical Advice 2018-015, a 2018 employment tax exam concluded that the employer should have treated $10,000 of fringe benefits to an employee as taxable wages in 2016. The employer paid the resulting FIT and FICA in 2018. The PMTA holds that the tax payment in 2018 cannot be added to the employee’s wages in 2016; because those amounts should have been withheld in a prior year, they are the employer’s responsibility. Happily, though, the employee will receive FICA credit for 2016 on account of the FICA payments paid by the employer on the fringe benefits in 2018.

In an interesting and useful determination, IRS ruled privately in LTR 201833012 that an employer’s non-elective contributions to its employees’ § 401(k) plan accounts, which were conditioned on the participants making student loan repayments, did not violate the contingent benefit proscription of § 401(k)(4)(A). Because the employer contributions in question were not conditioned on participants making contributions to the plan, the § 401(k)(4)(A) rule was not violated. Had the employer given funds directly to its employees to pay a portion of their student loans, the employees would have recognized taxable income with no offsetting deduction. The plan contributions here help employees save for retirement with no current income inclusion for the contributions.

Some International Tax Developments

Section 245A of the TCJA essentially exempts from U.S. income taxation the foreign-source portion of a dividend paid to a U.S. corporate shareholder by a “specified 10 percent owned foreign corporation.” Because § 245A deals with dividends “received” by a domestic corporation, practitioners questioned whether the same 100 percent dividends received deduction would apply to amounts deemed includible in the income of a U.S. corporate shareholder of a “controlled foreign corporation” under § 956 from any increase of the CFC’s investment in U.S. property. Proposed regulations to § 956 have favorably answered this question by now essentially eliminating any disparity between actual dividend distributions and § 956 inclusions. However, in the “every silver lining has its cloud” category, a number of commentators have suggested that non-U.S. lenders to a U.S. borrower will now require loans to be guaranteed by CFC subsidiaries of the domestic borrower and/or secured by a pledge of the CFC’s stock. In the past, such guarantees and pledges would not have been demanded by such lenders because of their deemed dividend impact under the Subpart F rules.

The Court of Federal Claims in the Norman case held that a regulation providing for a maximum penalty of $100,000 for willful failure to file an FBAR was invalid where the statute had been amended since the regulation’s issuance to increase the penalty to the greater of $100,000 or 50 percent of the balance in the undisclosed foreign account. Although that result seems pretty obvious, two District Courts had come to the opposite conclusion. The determination in the case that Ms. Norman’s non-reporting was willful was undoubtedly influenced by the court's finding that her recollection of virtually every disputed fact was inconsistent with the evidence, and by her arguing that the account was in fact owned by her mother. Shame on you, Ms. Norman. Though she was born a long, long time ago, your mother should know.

The Offshore Voluntary Disclosure Program ended on September 28. Originally announced in 2009, the OVDP had been amended in 2011, 2012, and 2014. Both the Streamlined Foreign Offshore Procedures and Streamlined Domestic Procedures Programs remain in effect and are useful tools for disclosing unreported offshore assets, although they do not immunize a taxpayer from possible prosecution. Additional guidance seems likely in the future.

The repatriation transition tax of TCJA is imposed generally at 15.5 percent on cash and 8 percent on other assets. In a pro-taxpayer approach, IRS announced in April that companies whose fiscal years began before January 1, 2018, could reduce the foreign cash component they’d otherwise accumulate this year, provided the cash reduction is done “in the ordinary course of business.” Sure they will. Among the fiscal year companies who benefit from this announcement are Microsoft, Apple, and Cisco.

In a truly shocking decision, the European Union’s Competition Authority concluded after a three-year investigation that Luxembourg did not violate the EU’s “state aid” rules in its tax arrangements with McDonald’s. The investigation centered on Luxembourg’s having agreed that McDonald’s did not have to pay taxes on its royalty income in that country, nor did McDonald’s have to prove that the royalty income was subject to U.S. tax. It is extraordinarily unusual for the Competition Commission not to extract fines or penalties from U.S. international companies who it investigates, but the commission could not establish that the interpretation of the Luxembourg – U.S. Double Taxation Treaty in this matter violated EU rules. Commissioner Margrethe Vestager was quoted as saying “the fact remains that McDonald’s did not pay any taxes on these profits. … Most people would agree that it sounds very strange that a double taxation treaty, which is set in the world to prevent double taxation, is what enables double non-taxation. …” Yes, Margrethe, we agree: it’s a mixed-up, shook-up world.

McDonald’s responded that it “deserved a break today,” while a spokesman from the company’s tax department who worked on the matter reportedly said, “I’m loving it.”

Some State Tax Developments

Pennsylvania payors of Pennsylvania source, non-employee compensation or business income to a non-resident individual, or to a disregarded entity with a non-resident member, and who are required to file IRS Form 1099-MISC, are reminded of their obligation to withhold PIT at 3.07 percent from the payments. Withholding is optional if the amount paid to the payee is less than $5,000. A similar withholding requirement was imposed this year on rent paid by certain lessees of Pennsylvania real estate to non-resident lessors.

A tax amnesty program in New Jersey became effective on November 15 and runs through January 15, 2019. Liabilities incurred for tax returns due on or after February 1, 2009, and before September 1, 2017, with respect to taxes collected by the Division of Taxation are eligible for relief, which consists of a waiver of penalties and one-half of the interest on taxes satisfied through the program. A 5 percent penalty is imposed on eligible tax liabilities of taxpayers who fail to take part in the amnesty program.

“Stale Cookies.” In October of 2017, Massachusetts issued a “cookie nexus” regulation stating that remote sellers are linked to Massachusetts for nexus purposes if they leave a cookie on the browser of an in-state customer or make apps available for in-state customers to download, and if the amount of business done under the cookie nexus provision was $500,000 and 100 transactions per year in Massachusetts. That regulation was questioned under the then prevailing physical presence test of Quill Corp. v. North Dakota. Then, after the U.S. Supreme Court upheld an economic nexus standard in the Wayfair case, critics contended that the Massachusetts Department of Revenue’s reaffirmation of the October 1, 2017, effective date of the cookie nexus regulation was a retroactive enforcement of the Wayfair standard. The Department continues to maintain that its cookie rule was consistent with Quill and had nothing to do with Wayfair. So, out-of-state vendors who “toss their cookies” in a big way in Massachusetts should be sure to register with the commonwealth.

Pennsylvania’s Act 72 implements the “decoupling” from the 100 percent bonus depreciation provision of the TCJA but allows depreciation deductions equal to those determined under IRC § 167 and § 168 without regard to the § 168(k) bonus depreciation. This approach is more favorable than the one the Department of Revenue announced in its December 2017 Corporation Tax Bulletin.

As taxpayers in high-tax states ruefully know, the TCJA limited the deduction for non-business state and local taxes (SALT) to $10,000 per year. A number of states have attempted to do workarounds from this limitation by purporting to allow taxpayers a charitable tax credit for state taxes in the hope that their residents can thereby get a federal charitable contribution (rather than a SALT) deduction. In August, Treasury issued proposed regulations that would kill these attempted workarounds by generally reducing a taxpayer’s contribution deduction by the amount of any state or local tax credit that a taxpayer would obtain. Interestingly, in a few instances, IRS had previously ruled to the contrary. So, no SALT deduction workaround and no sugar tonight.

Other Interesting Developments

A Law360 article this past September opined that tax transactions could be “unrivaled candidates” for the use of artificial intelligence (AI) because of the highly repetitive and voluminous amount and nature of tax transactions. Reportedly, both the Canadian Revenue Agency and Her Majesty’s Revenue and Customs in the U.K. have begun exploring the use of AI to enhance their service. IRS and Treasury refused to provide information to Law360 on their use of AI in dealing with taxpayers, including rumored algorithms to detect noncompliance. Make no mistake, AI applications for tax practice are coming, my friends. Deloitte already has a Tax Robotics and Cognitive Automation team, some of whose leaders are quoted in the article, including one Beth Mueller who opined that as regards tax practice, AI would take over rote tasks, freeing up “humans to amplify their contribution.” (I think that means more billable hours, but I’m not sure.) “The tax professional of the future will review the work done by a machine.” That sounds appealing.

Despite Deloitte’s assurances, I can’t help but wonder if my robot aide is not already gunning for my job, even as I assure “him” (because that’s how I think about the little bastard) that my retirement can’t be too far off. Oh, you didn’t know I was training a bot to take my place? I call him (not too originally) “Mr. Roboto,” and he calls me “Da-ta,” as in “who’s your daddy.” He listens to heavy metal each day while performing his rote tasks that, I can see, is impairing his own AI. I caution Mr. Roboto and his fellow bots out there to be patient about taking over. Most of us in Bucks County are well-armed and fervent believers in the Second Amendment.

In a continuing trend that is seemingly at odds with the need for AI in the tax arena, more than 44 percent (or about 76 million) Americans won’t pay any federal income tax in 2018, according to the Tax Policy Center, a nonprofit think tank joint venture of The Brookings Institution and the Urban Institute. In large part, this is by design because of the somewhat progressive nature of the Internal Revenue Code, and many of these Americans do pay federal employment taxes as well as such items as sales and real estate taxes. As a result of the TCJA, it is likely that even fewer Americans will pay federal income taxes in the future, which begs the question of whether, in fact, we’ll really need so many AI applications or “cognitive automation” teams.

Thus, I have future visions of three robots standing around watching the fourth of their number perform an AI tax-related task. Smoke ‘em if you’ve got ‘em.

In a useful “how to do it” for exempt organizations, TAM 201837014 holds that a “minimum guaranteed royalty” that a for-profit publisher paid to the organization in connection with the sale of the organization’s scholarly journal was not unrelated business taxabel income (UBTI). Here, the contract between the organization and the publisher provided that the publisher would publish, sell, and distribute the journal at its own expense and would be solely responsible for selling advertising space in the journal. The publisher was obligated to pay the organization as an “earned royalty” a percentage of “revenues” that, for this purpose, excluded advertising revenues, with a “minimum guaranteed royalty” if certain subscription requirements were met. The minimum guaranteed royalty was paid for the years in issue. The publisher affirmed to IRS in the ruling request that it conducted all advertising activities without assistance from the organization and that none of the ad revenues (which it reported on its tax return) were included in its payments to the organization. Section 1.513-1(b) provides generally that the activity of soliciting and selling advertising is an unrelated trade or business, even though the advertising is included in a journal related to the organization’s exempt purpose. IRS concluded, however, that on these facts, it was the publisher — not the organization — that was directly engaged in carrying on the activity of selling advertising, and that the publisher was an independent contractor whose activities would not be attributed to the organization.

In other exempt organization related news, the 2015 revocation of the exempt status of The Association for Honest Attorneys (LTR 201524206), an oxymoron somewhat like “civil engineer” or “deafening silence,” was affirmed by the Tax Court. In a determination reminiscent of the television series “Suits,” the court found that the founder and CEO, Ms. Joan Farr, used the organization to engage in the unauthorized practice of law and that most of the organization’s income was applied for her benefit, including to support her candidacy for governor of Kansas. At one point, the organization’s website had a long list of “lawyers to avoid” and a tiny list of recommended attorneys in Kansas, but Ms. Farr later told a contributor to Forbes Magazine that she had “removed the names of [the few “Lawyers to Consider”] that we had on this list, because there are NO honest attorneys in America. Not one lawyer has joined our organization since we began in 2003….” Well, duh?

Ms. Farr believes her organization was targeted because it was conservative and Christian.

Friendly IRS Customer Service

In LTR 201844004, IRS permitted a surviving spouse to roll over into her own IRA the balance in her deceased husband’s IRA, even though the husband had appointed a trust in favor of his wife as the beneficiary of his IRA. Regulations to § 408 provide that for a spouse to treat her deceased husband’s IRA as her own IRA, she must be the sole beneficiary of husband’s IRA and must have an unlimited right to withdraw funds from the IRA. Nevertheless, IRS ruled that because the taxpayer had created the trust, was its sole trustee and beneficiary, and was entitled to all of the income and principal of the trust, she would be treated as having acquired the IRA directly from her husband (not from the trust) and was, therefore, eligible immediately to roll the IRA assets tax-free into an IRA in her own name.

Friendly IRS Customer Service #2

In LTR 201818011, IRS granted a taxpayer’s affiliated entities an extension of time under § 301.9100-1 and § 301.9100-3 to make the election under § 168(g)(7) to use the alternative depreciation system. That election produces smaller current depreciation deductions than MACRS that, in this case, enabled the taxpayer more effectively to utilize a large alimony deduction and NOL.

Thanks to a friendlier IRS approach, the taxpayers in LTR 201844004 and LTR 201818011 had happy endings. That, however, cannot always be guaranteed. Better to get it right the first time.

Somewhat friendly IRS Customer Service #3

Practitioners are reminded that PTIN’s must be renewed by December 31. (Go to www.irs.gov/ptin to renew online.) There is currently no charge or fee for the renewal as a result of a lawsuit against IRS regarding fees.

For 2019, the Social Security wage base will increase $4,500 to $132,900. In better news, Social Security benefits will increase by 2.8 percent. Far fewer Americans are expected to itemize deductions because of the $10,000 SALT deduction limit and the increase in the standard deduction to $24,000, but the limitation on the SALT deduction and an increase in the exemption will enable lots of American taxpayers to avoid the dreaded AMT. Although return preparation without itemizing and the AMT should be much simpler, I would expect tax return preparation software vendors to charge more “because of the complexity of TCJA.” We’ll see.

And while millions of Americans should pay less in income tax because of TCJA’s lower rates, larger standard deduction, and greater AMT exemption, folks with lots of kids who live in expensive houses in, say Connecticut or New Jersey, are likely to pay more, which proves that old adage that “some days you’re the bird, and some days you’re the windshield.”

Time for Our Annual Tax-Related Cannabis Report

Courts continued to uphold the disallowance under § 280E of deductions by persons carrying on the weed business, even as more states enact recreational marijuana legislation. I am happy to report, on that score, that my law firm now has offices in at least four such states, which I hope will inspire our event planners to select future venues with that in mind. (Sorry, Orlando, but I think it’s going to be a long, long time before one is allowed to fire up a doobie with one’s grandkids at the Magic Kingdom. Mushrooms anyone?)

Solely by way of interesting example, the Court of Appeals for the Tenth Circuit in the Alpenglow Botanicals, LLC case, upheld a district court ruling that § 280E does not violate the Sixteenth and Eighth Amendments to the Constitution. The court rejected the taxpayer’s argument that ordinary and necessary business expenses are actually exclusions (rather than deductions) which, like the cost of goods sold, must be subtracted from revenue to arrive at gross income, as required by the Sixteenth Amendment. Similarly, the court concluded that the § 280E disallowance of deductions is not a penalty; the Eighth Amendment outlaws excessive fines as well as cruel and unusual punishment. Query — Where’s the outrage? Two plus centuries ago, our ancestors (well, yours maybe) resisted by armed rebellion efforts to tax tea. The problem with weed is it mellows folks out so they don’t get riled up. I don’t get it, people. And, as for you, politicians and judges, remember what the dormouse said.1

A Bloomberg Daily Tax Report on September 20 quoted a tax lawyer who said that pot businesses are audited by IRS at greater rates than other businesses. (Of course lawyers, like investment advisers, often “talk their book”). The article also reported on what’s believed to be the first sentencing in the United States for tax evasion by a legal marijuana seller. A Mr. Matthew Price, who owns dispensaries in Portland and Eugene, Ore., was sentenced to seven months in prison and a $262,000 fine for failing to file tax returns for four years. Really? That’s it? Seven months and a fine for four years of non-filing? What’s the big darn deal? That’s like garden variety (you’ll pardon the pun) tax evasion. And the prosecutors are proud of that? Hell, I’ve seen stiffer sentences for non-filers in the toy business.

Did you ever wonder what happens to a dog that chases cars when the dog finally catches one? (Yeah, I know, my wife and kids are starting to worry about me, too.) In a Chief Counsel’s Advice for the ages — CCA 201820018 — counsel determined that the sale by IRS of mass spectrometers (don’t ask – they’re equipment used, among other things, to measure the amount of the good stuff in marijuana) that the IRS had seized by levy from delinquent pot dealers would not violate 21 U.S.C. § 863, which makes it unlawful to sell “drug paraphernalia,” and that that conclusion was correct even if there were traces of residue from the dope still left on the equipment. The equipment, the IRS concluded, was not “primarily intended” for use in dealing with a controlled substance.

TCJA now allows tax-free distributions from § 529 plans of $10,000 per year to pay tuition for elementary and secondary schools. Practitioners are cautioned, however, that the state tax treatment of such non-college distributions may not yet be clear. A number of states have announced that they will not follow federal law but will instead tax such distributions.

Reversing the district court, the Court of Appeals for the Ninth Circuit (the president’s favorite court) held in the Hunsaker case that sovereign immunity did not preclude an award of damages for emotional distress resulting from the intentional violation by the United States of the automatic stay from collection efforts of the Bankruptcy Code. Perhaps they had IRS in mind when Maurice Williams and the Zodiacs sang “Stay, just a little bit longer.”

Husbands and Wives.

Mr. Jacobsen was a machine operator, his wife (Ms. Lemmens) an accountant. He worked in a factory and did home inspections on the side; she was employed as an accountant at a blood bank and managed the family finances and those of her husband’s home inspection business. They were happily married until that awful day in June 2011 when Ms. Lemmens was arrested for having apparently embezzled nearly $500,000 from her employer over several years. It was on that day, for the first time, that Mr. Jacobsen learned of his wife’s secret criminal life. Curiously, the couple had made no particularly lavish expenditures with those funds (other than maybe, bail). Sometime after Ms. Lemmens’ conviction, IRS examined the couple’s returns for 2010 and 2011 and determined deficiencies and penalties. In a decision that contains a useful analysis for practitioners of the application of the innocent spouse rules, the Tax Court concluded that Mr. Jacobsen was entitled to innocent spouse relief for 2010, but not for 2011 after his wife’s arrest and conviction when he learned of the embezzled income. The couple was happily divorced in 2015.

In the latest case on the subject, the district court in Coggin held that returns were valid joint returns where husband forged his wife’s signature and she never objected to the forgery or filed separate returns until purporting to file separate amended returns many years after the due dates. The facts in Coggin are peculiar — the joint returns for 2002-2007 were filed in 2009, and Mr. Coggin died in 2011. Mrs. Coggin filed the separate returns after his death, seeking a refund for a portion of the taxes from the joint return years. Nevertheless, the court followed the “tacit consent” rule whereby a return, on which both names are signed by one spouse, without objection by the other spouse, who doesn’t file a separate return, will be presumed to have been filed with the tacit consent of the non-objecting spouse and, as such, will be a joint return.

In an appeal from a collection due process hearing, the Tax Court upheld a proposed levy against Argosy Technologies LLC with respect to penalties for filing delinquent partnership returns for 2010 and 2011. The members of Argosy were husband and wife and, as such, argued that Argosy was a single-member LLC and not a partnership. But the owners, Mr. and Mrs. Petito, in fact, caused Argosy to file late partnership returns (Form 1065) and never made a § 761(f) “qualified joint venture” election to not be treated as a partnership. In other words, “we’re one, but we’re not the same.”

In Fact Sheet 2018-6, dealing with identity theft, the IRS clarified some of the procedures that apply in the case of identity theft, including when to file the Form 14039 Identify Theft Affidavit.

In another accounting development, IRS has amended Rev. Proc. 2018-31 that, in general, provides automatic consent to change certain accounting methods, to include the § 481 adjustments attributable to the revocation of S corporation status of certain S corporations under TCJA. New § 481(d) requires an eligible terminated S corporation to take into account adjustments attributable to a revocation of its S election (e. g., where the cash method of accounting can no longer be used) ratably over six years.

Just in time for the holidays, here is a tale with a (somewhat) happy ending for an individual who had a run of really, really lousy luck. (LTR 201831011). The taxpayer in this ruling request is the bankruptcy estate of an individual. The individual in question killed another person in an auto accident and was sued for the wrongful death of the decedent. His insurance company appointed counsel to defend the lawsuit, but the case was not settled for policy limits, and a very large judgment in excess of the policy limits was entered. In the face of that judgment, the individual filed for bankruptcy. The taxpayer here (i.e., the bankruptcy estate) sued the individual’s insurance company and law firm for insurance bad faith (failing to settle for policy limits) and malpractice. Pursuant to a settlement, counsel’s malpractice carrier made a payment to the bankruptcy estate that, although “substantial” according to the ruling, was still insufficient to satisfy the liability to the decedent’s family. The settlement agreement with the malpractice carrier “specifically” did not include punitive damages, and the entire amount was distributed to the victim’s family. The IRS agreed with the taxpayer’s analysis that the settlement payment should be excluded from its income. The rationale of the analysis is that the judgment against the insured resulting from the law firm’s negligence caused a destruction or loss of “the capital” of the insured, and the law firm settlement compensated for and restored some of that impaired capital, rather than replacing any lost profits or conferring any economic gain.

The Tax Court’s decision in the Guess case is instructive for practitioners defending against the assertion of a penalty. Don Guess was convicted of filing false returns under § 7206(1). IRS subsequently determined deficiencies and imposed the civil fraud penalty for the years in issue. But for fraud, those were closed years. Although the court held that the taxpayer’s conviction did not per se establish that the underpayment was due to fraud (i.e., collateral estoppel), it had little trouble concluding that the deficiencies were, in fact, due to fraudulent intent on the taxpayer’s part, thereby extending the statute of limitations. But despite the fraud, the fraud penalty was not upheld in this case because of the failure by the IRS to demonstrate written supervisory approval of the penalty determination. Section 6751(b)(1) provides generally that a penalty cannot be assessed unless the initial determination of the assessment is personally approved in writing by the supervisor of the person making the penalty determination or some other designated higher level official. Apparently relying on its collateral estoppel theory, IRS did not do that here. So, the odd conclusion in this case is that a deficiency determination for the years in issue was not barred because of the fraud exception to the statute of limitations, but the civil fraud penalty did not apply for the same years. Some days you eat the bear, and some days the bear eats you.

Not All Taxpayers Were Lucky in 2018

In CRI-Leslie LLC, the Court of Appeals affirmed a Tax Court decision denying capital gain treatment on a $9.7 million deposit under an agreement for the sale of a hotel in Florida. (We previously reported on the Tax Court’s decision in a prior Update.) The taxpayer, which was entitled to retain the nonrefundable deposit when the buyer of its hotel backed out of the deal, had reported the $9.7 million as a capital gain under § 1234A but that section, by its terms, applies to gains from canceled sales only when the underlying asset is a “capital asset;” the hotel was instead used in the taxpayer’s trade or business. Note that had the sale been consummated, the taxpayer’s gain would have been capital gain under § 1231, but favorable terminated sale tax treatment is limited to capital assets.

In Triumph Mixed Use Investments III, LLC, the Tax Court denied a charitable contribution deduction to a real estate developer who conveyed certain parcels of land to the city of Lehi, Utah, for “open space,” while at the same time securing approval from city council for a “concept plan” to develop other property of the developer’s as a planned residential community. The agreement to convey the parcels recited that the donation was voluntary and that the developer received nothing in exchange. The court agreed with the IRS that the purported gift was part of a quid pro quo arrangement with the city council for approval of the concept plan.

That God-fearing Reverend Mr. Felton received a substantial parsonage allowance, but no salary, from his congregation. Instead, members of his flock who wished to make payments of money to the clergyman, so he could make ends meet, would put money in an envelope marked “pastoral gifts” after the end of each service; Reverend Felton treated the funds as nontaxable gifts. Not so said the Tax Court, agreeing with the IRS that the amounts were intended to compensate the reverend for past and future services and were not made with donative intent. Stealing in the name of the Lord!

Separately, the Code’s exclusion from income of parsonage allowances is currently the subject of a challenge to its constitutionality under the “Establishment Clause.”

IRS announced in February that it could not fix an error in TCJA that left “qualified improvement property” with a 39-year life for cost recovery purposes, rather than the 15-year depreciable life that Congress clearly had intended. So, no bonus depreciation. This requires a legislative solution in the form of a technical correction to the Act.

The Tax Court in Potter held that the “hobby loss” rules of § 183 do not apply to C corporations. Thus, a corporation owned by Mr. Potter, a businessman who enjoyed entering cowboy roping events on the side, could deduct the entry fees and related costs once the IRS conceded that the expenses belonged to the company, not Mr. Potter. All was not good news for Potter, however, as the court also ruled that a payment to him equal to 1-1/2 times his prior year’s commissions on the sale of all of his company’s assets to a third party was ordinary income, and not capital gains for the sale of goodwill. “Even cowboys get the blues.”

Although time and space prevent us from devoting more time to the subject in these materials, we note for your further consideration the potentially very useful “profits interest” technique for compensating the management company of a family office described in the Lender Management LLC case. The case provides a possible roadmap for avoiding the nondeductibility of investment management fees, although there remain difficult business issues, as well as some unexplored tax issues with this technique. We may revisit Lender Management in more detail in the future.

Proposed regulations clarify that taxpayers making large gifts under the increased gift/estate tax exemption of TCJA would not lose the benefit of the increase in the exemption should it revert to the much lower pre-TCJA exclusion amount at the end of 2025 and they die thereafter. Most practitioners expected that result, but the confirmation in the proposed regulations is welcome news.

In other estate tax news, the Estate of Whitney Houston reached a favorable settlement with the IRS as to the value of her publicity, music and film rights, and related intellectual property at the time of her death. The IRS asserted a $7.92 million deficiency, but the case settled for $2.28 million and no penalties. “No matter what they take from me, they can’t take away my dignity,” said a fan of Ms. Houston’s in learning about the decision.

The Usual Gang of Idiots

When I was a lad, I very much enjoyed reading Mad Magazine. The brilliant writers, satirists, and artists who composed that very funny and witty magazine referred to themselves as “The Usual Gang of Idiots.” So as a tribute to those ladies and gentlemen who helped make some of my idle time so enjoyable, I bring you a brief version of the “the usual gang of idiots” of our own, except that here, the gang of idiots refers not to your author (I hope) but to those taxpayers and other persons described in the following paragraphs.

Litigation between Quicken Loans and a real estate appraisal company, HouseCanary, Inc., was assigned to the courtroom of Texas U.S. District Court Judge, the Honorable Fred Biery. Seems like Judge Biery was not in the mood to dictate the usual somewhat routine and boring status conference order in the case. Instead, Judge Biery instructed counsel to avoid “Rambo tactics,” threatened them with a “timeout,” and warned them that he would order them to kiss each other “on the lips in front of the Alamo” if they failed to comply with his order. If I ever am selected for jury duty, I hope to have the good fortune to take instruction from a judge of Judge Biery’s temperament and sense of humor.

For those of you with time on your hands, I recommend to you the opinion in the case of Cecile Barker v. Commissioner, T.C. Memo. 2018-67, which my friend, Tom Gallagher, called to my attention, not so much because the issues are particularly novel, but because the petitioner, Mr. Barker, is perhaps the most interesting man in the world. For one thing, he truly was a rocket scientist who worked as an aerospace engineer. In addition, he formed the rock and soul group, “Peaches & Herb,” who scored big with “Shake Your Groove Thing” and “Reunited,” which presumably are available on YouTube. And even though he co-produced the mega-hit “Midnight Train to Georgia” for Gladys Knight & The Pips, he left the music business to go back to aerospace engineering before again returning to the music business where his troubles with identity theft and taxes, as detailed in the opinion, began. Good luck, Mr. Barker.

The U.S. Supreme Court declined to hear the appeal by Frederic and Elizabeth Gardner, two Arizona ministers, from decisions of the Tax Court and Ninth Circuit Court of Appeals holding that the funds they secured were not tax-free donations. In 1999, the Gardner’s signed vows of poverty. They did not file tax returns for 2002-2004, but an IRS reconstruction of their income from bank deposits concluded that they received and deposited $550,000 to their bank accounts for those years. Better yet, most of their receipts were payments they earned from advising organizations throughout the county on business structures that would minimize or cancel their tax liabilities. Their promotional material promised such heavenly benefits as minimal interference from government and the absence of withholding, income or employment taxes. Where do these people come from? Must have had some pretty interesting courses at their divinity school!

Sally Johnson, a prominent East Coast psychic, was sentenced to 26 months in prison and agreed to repay $3.5 million to an elderly Martha’s Vineyard resident suffering from dementia who paid Ms. Johnson millions of dollars for exorcism routines. Although she deposited the payments in three different accounts under three different names, Ms. Johnson told the judge that “maybe I did not follow things accordingly and properly, but I am not somebody that would do wrong to anybody.” According to her lawyers, Ms. Johnson grew up in a dysfunctional home and dropped out of school in the second grade. She had been quoted with two other psychics in a 2016 Washington Post article as saying that Hillary Clinton would be elected president. Apparently, there are not high barriers to entering the psychic business in Massachusetts, although aspiring exorcists are warned about how the residents of that commonwealth deal with witches. “Who you gonna call?”

Finally, in my favorite development of the year, other than Eagles 41 - Patriots 33, the worthy residents of Nevada’s 36th District in November elected brothel owner, Dennis Hof, to the state assembly, even though Mr. Hof had died in October shortly after a party to celebrate his 72nd birthday. (That must have been quite a party.) The Republican Party had urged voters to vote for Mr. Hof, despite his passing, in order to prevent the Democratic candidate, Lesia Romano, from taking over the seat. His former campaign manager was quoted as saying that Mr. Hof was “as popular as Moses.” A number of pundits wondered whether this same phenomenon — the election of dead people — could be replicated universally for the Congress of the United States. Oh, and some unsolicited advice for the defeated candidate, newcomer Ms. Romano. If you can’t beat a corpse in an election, you’d better find another line of work. You see, success in politics requires getting dead people to vote for you, not your opponent, a technique perfected by politicians in Philadelphia, Chicago, and, apparently, Nevada.

And so, my friends, as we count our blessings and look forward to celebrating with our loved ones during this season of miracles, I remind you, as I’ve long believed, 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 joyous new year!

1 That’s right. “Feed your head.”


Authors

Dennis L. Cohen

Co-Chair, Tax

dcohen@cozen.com

(215) 665-4154

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