Transcript 2011 Business & Corporate Tax Update

By Dennis J. Gerschick,
Attorney, CPA, PFS, CFA
 Dennis worked as a CPA in the tax dept. of Ernst &
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Whinney before law school
Dennis worked in the tax dept. of a large Atlanta law
firm
Dennis started his own law firm in 1990
Dennis also manages a venture capital fund
Dennis speaks frequently about a variety of topics. See
www.RegalSeminars.com
 March 18 – Hiring Incentives to Restore Employment
Act (the “HIRE Act”)
 In March, the health care reform, which included
many tax provisions
 September 27, the Small Business Jobs Act
 December 17, the Tax Relief, Unemployment Insurance
Reauthorization, and Jobs Creation Act of 2010
 Between December 2007 and December 2008, there
were eight pieces of federal tax legislation
 The rules change fast!
 Look for applicable dates – starting and ending
On April 14, 2011, the Comprehensive 1099 Taxpayer
Protection and Repayment of Exchange Subsidy
Overpayments Act of 2011 (the 1099 Act) was signed into
law.
The 1099 Act repeals both the expanded Form 1099
information reporting requirements mandated by last
year’s health care legislation and also the 1099 reporting
requirements imposed on taxpayers who receive rental
income enacted as part of last year’s Small Business Jobs
Act.
The “Super Committee” selected by Congress need to
agree upon budget changes – budget cuts & “revenue
enhancements” OR automatic cuts will go into effect
Will they agree upon any changes????
Many agree that changes to the taxation of “C”
corporations will be made
Allow U.S. corporations to bring into the U.S. cash held
in foreign subsidiaries
Broaden the tax base but lower the corporate tax rate
 As a result of the repeal, the 1099 reporting rules
continue unchanged.
 The increased penalties were not repealed
 See Section 6041
 To reduce the federal budget deficit, Congress is
expected to amend the tax code before December 31,
2011.
 After the November, 2012 elections, in 2013, more tax
legislation is expected.
 See Section 168(k)
 The bonus depreciation rate is increased from
50% to 100% in the case of qualifying property
acquired after September 8, 2010 and before
January 1, 2012, and placed in service before
January 1, 2012 (or before January 1, 2013 in the case of
property with a longer production period and certain
noncommercial aircraft). See §168(k)(5).
 The new law does not contain a provision allowing a
taxpayer to elect the standard 50% rate for property
that qualifies for the 100% rate.
 A taxpayer may elect out of bonus depreciation with
respect to any class of property placed in service
during the tax year. See §168(k)(2)(D)(iii).
 See Rev. Proc. 2011-26 (issued 4-18-11); 28 page revenue
procedure focusing on the new bonus
depreciation rules.
 On page 28, there is contact information for IRS
personnel.
 For 2012, the §179 dollar limit is increased from
$25,000 to $125,000.
 The investment limit for 2012 is increased from
$200,000 to $500,000.
 The $125,000 and $500,000 amounts will be indexed
for inflation.
Without inflation, the taxpayer will not get a §179
deduction if the taxpayer places more than $625,000 of
qualifying property in service ($625,000 - $500,000 =
$125,000).
The new maximum expensing amount and phase-out
level for tax years beginning in 2012 is actually lower
than the levels in effect for tax years beginning in 2010 or
2011 (maximum expensing amount of $500,000, and a
phase-out level of $2,000,000). For tax years beginning
after 2012, the maximum expensing amount will drop to
$25,000, and the phase-out level will drop to $200,000.
 The entire cost of most new depreciable section 1245
property acquired after September 8, 2010 and placed
in service before January 1, 2012 can be claimed as a
100% bonus depreciation deduction under section
168(k)(5).
 A taxpayer will benefit by expensing property that
does not qualify for bonus depreciation (used
property) and property with a long MACRS
depreciation period.
Since 2005, there has been:
a. No tax legislation
b. Many pieces of tax legislation
c. No other significant developments
d. No IRS action of any kind
 For compensation received during 2011, the 2010 Act
reduces the employee portion of the Social Security
tax rate under the FICA tax by 2% to 4.2%.
 Similarly, for self-employment income in 2011, the
Social Security portion of the tax rate is reduced by 2%
to 10.4%
 President Obama has proposed more changes in this
area
In March 2010, new section 7701(o) was added to the
Internal Revenue Code. Section 7701(o)
(1) Provides that, in the case of any transaction to which
the economic substance doctrine is relevant, the
transaction shall be treated as having economic
substance only if :
(i) the transaction changes in a meaningful way (apart
from Federal income tax effects) the taxpayer’s
economic position
(ii) the taxpayer has a substantial purpose (apart from
Federal income tax effects) for entering into the
transaction.
 See Notice 2010-62
 This notice provides interim guidance regarding the
codification of the economic substance doctrine under
section 7701(o) and the related amendments to the
penalties under sections 6662, 6662A, 6664, and 6676
 The IRS will not issue a private letter ruling or
determination letter pursuant to section 3.02 (1) of
Rev. Proc. 2010-3, 2010-1 I.R.B. 110 (or subsequent
guidance), regarding whether the economic substance
doctrine is relevant to any transaction or whether any
transaction complies with the requirements of section
7701(o).
In July, 2011, the IRS Large Business and International (LB&I)
Division issued guidance to examiners on the newly codified
economic substance doctrine limiting the application of
penalties relating to the doctrine
LB&I-4-0711-015
The LB&I directive tells IRS examiners that, until further
guidance is issued, they should apply the penalties in
sections 6662(b)(6) and (i) and 6676 (governing erroneous
claims for refund or credit) only to the economic substance
doctrine and may not impose them due to the application of
any other “similar rule of law” or judicial doctrine, such as the
step-transaction, substance-over-form or sham-transaction
doctrines.
The LB&I directive also instructs IRS examiners how to determine when it
is appropriate to seek the approval of the director of field operations
(DFO) to raise the economic substance doctrine. This determination will
involve four steps:
1. *The examiner should evaluate whether the circumstances in the case
are those under which application of the economic substance doctrine to
a transaction is likely not appropriate;
2. *The examiner should evaluate whether the circumstances in the case
are those under which application of the economic substance doctrine to
a transaction may be appropriate
*For steps 1 and 2, the directive provides lists of specific circumstances
that tend to show that application of the economic substance doctrine is
likely not appropriate or may be appropriate, as the case may be.
3.* If the examiner determines that the application of the
doctrine may be appropriate, the examiner must make a
series of inquiries before seeking approval to apply the
doctrine; and
4. If an examiner and his or her manager and territory
manager determine that application of the economic
substance doctrine is merited, the directive provides how to
request DFO approval.
*For step 3, the directive provides specific inquiries the
examiner must answer.
The directive clarifies for examiners that, for
transactions involving a series of interconnected steps
with a common objective, the term “transaction” refers
to all of the steps taken together. Examiners can apply
the directive separately to one or more steps with a
common objective, but must seek guidance from their
manager and consult with local IRS counsel before doing
so.
Revenue Procedure 2011-14
The IRS released updated procedures under which
taxpayers can receive automatic consent to change their
accounting methods. The revenue procedure updates
prior guidance contained in Revenue Procedures 200852 and 2009-39 and gives additional accounting method
changes for which taxpayers can obtain automatic
consent. The revenue procedure also modifies the
procedures in Revenue Procedure 97-27 for requesting
and obtaining non-automatic advance consent for a
change in method of accounting.
The 325-page revenue procedure covers dozens of
accounting method changes. It also reiterates in detail
the rules applicable to accounting method changes and
the application process and specifies when audit
protection is available for tax years prior to the year of
the change.
Rev. Proc. 2011-29
This revenue procedure provides a safe harbor election
for allocating success-based fees paid in business
acquisitions or reorganizations described in § 1.263(a)5(e)(3) of the Income Tax Regulations. In lieu of maintaining
the documentation required by § 1.263(a)-5(f), this safe
harbor permits electing taxpayers to treat 70% of the
success-based fee as an amount that does not facilitate
the transaction. The remaining 30% of the fee must be
capitalized as an amount that facilitates the
transaction.
Ralph’s Grocery Co. V. Com’r, T.C. Memo 2011-25 (1-27-11)
100 page decision
Judicial doctrines are:
a. No longer used
b. Only used by taxpayers
c. Used in every case
d. Still relevant
Is every expenditure either deductible or capitalizable?
Hultquist v. Com’r, T.C. Memo 2011-17 (1-24-11)
Issue: Whether petitioners are entitled to reduce their
gross receipts reported on Schedule C by cost of goods
sold of $32,450 or, alternatively, deduct the amount as a
bad debt under section 166(a)?
Case Study of Franklin Duncan
Highlights:
Cost of goods sold includes the cost of items acquired
for resale and the costs of producing items for resale.
Reg. 1.162-1(a)
Though cost of goods sold is technically an
adjustment to gross income and not a deduction,
substantiation or the amounts claimed as cost of
goods sold is required.
See Rodriguez v. Commissioner, T.C. Memo 2009-22.
Where taxpayers do not have adequate records but the
record indicates that they clearly incurred an offset to
gross income, we may estimate the offset on the basis of
the evidence.
Cohan v. Commissioner, 39 F 2d 540, 543-544 (2d Cir.
1930)
Jackson v. Commissioner, T.C.Memo. 2008-70
Section 166(a) provides as a general rule that a
deduction shall be allowed for any debt which becomes
worthless within the taxable year. Only a “bona fide”
debt can be deducted, however.
Reg. 1.166-1(c).
A bona fide debt arises when a debtor-creditor
relationship is formed as a result of an unconditional,
valid, and enforceable obligation to pay a fixed or
determinable sum of money.
Boatner v. Commissioner, T.C. Memo. 1997-379, affd.
without published opinion 164 F.3d 629 (9th Cir. 1998);
Reg. 1.166-1(c).
 The objective indicia of a bona fide debt include a
note or other evidence of indebtedness and an interest
charge.
See Clark v. Commissioner, 18 T.C. 780, 783 (1952), affd.
205 F.2d 353 (2d Cir. 1953).
 Also considered are the existence of security or
collateral, the demand for repayment, records that
may reflect the transaction as a loan, and the
borrower’s solvency at the time of the loan.
See Schenk v. Commissioner, T.C. Memo. 1996-113.
The Results:
Petitioners have not established the existence of a
bona fide debt.
Petitioner and Mr. Duncan never agreed to a repayment
schedule setting forth how often payments were to be
made, nor did they specify a maturity date for the loans.
 Petitioner never made any demands for repayment
despite the fact that he was aware that Mr. Duncan
continued to sell the patented fishing accessories with
another company.
See Reg. 1.166-1(c).
We also believe that any repayment was conditional on
the future success of the business. We interpret
petitioner’s statement to mean that he expected to be
repaid only if the business became profitable, which
undermines the unconditional obligation requirement
specified in the regulations.
 Not every expenditure is either deductible or
capitalized
 Mr. Duncan did not have a written agreement
 He did not provide for various contingencies
 He did not understand his upside or downside
 He acted first, thought second
Every expenditure:
a. Must be capitalized
b. May be deductible if there is authority
c. Is a waste of money
d. Must be made to make money
Hellweg v. Com’r, T.C. Memo. 2011-58 (3-9-11)
Intro: Ps held ownership interests in and controlled an S
corporation. Ps’ Roth IRAs formed a DISC which entered into
a commission agreement with the S corporation.
For excise tax purposes only, R recharacterized commission
payments from the S corporation to the DISC as distributions to Ps
followed by Ps’ contribution of the proceeds to their Roth IRAs. R
determined that Ps were each liable for:
(1) Excise taxes on excess contributions to their Roth IRAs under
sec. 4973, I.R.C.
(2) An accuracy-related penalty under sec. 6662(a), I.R.C.;
(3) Additions to tax under sec. 6651(a)(1), I.R.C., for failing to file
the appropriate information returns.
Section 4973 imposes a 6-percent excise tax on excess
contributions to IRAs.
A DISC provides a mechanism for deferral of a portion of the
Federal income tax on income from exports.
The DISC itself is not taxed, but instead the DISC’s shareholders
are currently taxed on a portion of the DISC’s earnings in the form
of a deemed distribution.
Secs. 991, 995(b)(1)
This allows for deferral of taxation on the remainder of the DISC’s
earnings until those earnings are actually distributed, the
shareholders dispose of their DISC stock in a taxable transaction,
or the corporation ceases to qualify as a DISC.
Secs. 995(b)(2), (c), 996(a)(1)
A DISC sometimes does not generate the income it
reports on its returns and might otherwise not be
recognized as a corporate entity for tax purposes if it
were not a DISC.
Addison Intl., Inc. v. Commissioner, 90 T.C. 1207 (1988),
affd. 887 F.2d 660 (6th Cir. 1989)
Jet Research, Inc. v. Commissioner, T.C. Memo. 1990-463;
see also sec. 1.992-1(a), Income Tax Regs.
“The DISC may be no more than a shell corporation,
which performs no functions other than to receive
commissions on foreign sales made by its parent.”
Thomas Intl. Ltd. v. United States, 773 F.2d 300, 301 (Fed.
Cir. 1985)
Foley Mach. Co. v. Commissioner, 91 T.C. 434, 438 (1988)
see also Jet Research, Inc. v. Commissioner, supra.
The IRS argued the outcome was controlled by a prior Service
Notice. However, the Tax Court responded: Service notices
do not carry the force of law…
see Standley v. Commissioner, 99 T.C. 259, 267 n.8 (1992), affd.
without published opinion 24 F.3d 249 (9th Cir. 1994),
…. and are therefore not accorded deference under Chevron
U.S.A. Inc. v. Natural Res. Def. Council, Inc.
467 U.S. 837, 843-844 (1984); see United States v. Mead Corp., 533 U.S.
218 (2001).
Although they may be entitled to deference under
Skidmore v. Swift & Co., 323 U.S. 134 (1944), see United States v.
Mead Corp., supra, we need not decide whether Notice 2004-8,
supra, should be given Skidmore deference because the
Transaction does not fall within the scope of the notice.
The Transaction being valid for income tax
purposes, it must also be valid for purposes of
section 4973.
Since respondent has made no section 482 adjustment
which would result in distributions from ADF to
petitioners for income tax purposes, the ADF commission
payments cannot be treated as distributions to petitioners
for purposes of the section 4973 excise tax.
Therefore, the ADF commission payments do not
constitute excess contributions to petitioners’ Roth
IRAs.
Section 408(e)(2)(A) provides that an IRA loses its
exempt status if it engages in any transaction
prohibited by section 4975.
Section 4975(c)(1) prohibits a specific list of selfdealing transactions between a plan and a
disqualified person. We have previously held that a
similar transaction was not a prohibited transaction
under section 4975(c)(1)(A) or (E).
See Swanson v. Commissioner, 106 T.C. 76 (1996).
We also held that the DISC’s payment of dividends
to the IRA was not a prohibited transaction under
section 4975(c)(1)(E) because “there was no such direct
or indirect dealing with the income or assets of a plan, as
the dividends paid by Worldwide did not become
income of IRA #1 until unqualifiedly made subject to the
demand of IRA #1.” Id. at 89.
Reading tax cases:
a. Is a complete waste of time
b. Shows that the IRS wins every time
c. Is boring
d. Is a great way to learn tax law
Michael C. Hollen, DDS, P.C. v. Com’r, T.C. Memo 2011-2
(1-4-11)
Facts: Dr. Hollen, a dentist and officer of his P.C.,
represented his own P.C. He sought a declaratory
judgment that his P.C.’s ESOP and its related employee
stock ownership trust are qualified under §401 and §501,
respectively.
The IRS determined that the ESOP and ESOT did not qualify
for the 1987 tax year and every year thereafter because:
(1) The ESOP was not timely amended to include provisions
required by a number of different code sections
(2) (2) the ESOP failed to follow the vesting schedule required by
section 411(a)(2)(B)
(3) ESOP failed to use an independent appraiser to appraise
employer securities as required by section 401(a)(28)(C)
(4) The beneficiary account of Dr. Hollen exceeded the allowable
amount of annual additions for the 1989 plan year.
Note: this is a 2011 case!
To prevail, the taxpayer must prove that the IRS abused its
discretion. Under this standard, the taxpayer must persuade
the Court that the IRS’s determination was unreasonable,
arbitrary, or capricious.
See Buzzetta Constr. Corp. v. Com’r, 92 T.C. 641, 648 (1989).
The ESOP is not qualified because the required provisions
failed to be effective for the whole of the remedial
amendment period.
See Ronald R. Pawlak, P.C. v. Com’r, T.C. Memo 1995-7.
While the ESOP’s plan document reflects the vesting
schedule required by law, it did not follow that schedule
in operation.
Winger’s Dept. Store, Inc. v. Com’r, 82 T.C. 869, 876 (1984);
Quality Brands, Inc. v. Com’r, 67 T.C. 167, 174 (1976)
The taxpayer did not explain why its vesting schedules did not comply
with the required vesting schedule.
The taxpayer also declined the IRS’s offer to participate in a closing
agreement program (CAP) that would allow for retroactive compliance.
The taxpayer did not use an “independent appraiser” which is a “qualified
appraiser”
Reg. 1.170A-13(c)(5)(I). The ESOP failed at least two requirements of that
regulation.
Finally, §401(a)(16) provides a trust is not qualified if the plan provides for
benefits or contributions that exceed the limitations of §415.
Clendenen v. Com’r, T.C. Memo 2003-32, aff’d 345 F.3d 568 (8th Cir. 2003);
Martin Fireproofing Profit-Sharing Plan & Trust v. Com’r, 92 T.C. 1173, 1184
(1989).
The IRS’s determination is correct; the ESOP is
disqualified for 1989 and all subsequent plan years.
ESOPs are:
a. Only for large publicly-traded corporations
b. Can be used by anyone
c. Appropriate in some cases
d. Not subject to the ERISA tax rules
WB Acquisition, Inc. & Subsidiary v. Com’r, T.C. Memo
2011-36 (2-8-11)
This is a very fact intensive case
The Tax Court analyzed the joint venture agreement and
how the JV actually operated
Issue: We must determine whether the NTC Joint
Agreement created a legitimate joint venture between
WCI and WB Partners or was merely a vehicle to divert
income from the NTC project to WB Partners and away
from WCI.
1. Whether there is a partnership for tax purposes is a
matter of Federal, not local, law.
2.The principles applied to determine whether there is a
partnership for Federal tax purposes are equally
applicable to determine whether there is a joint venture
for Federal tax purposes.
3. The required inquiry for determining the existence of
a partnership for Federal income tax purposes is whether
the parties “really and truly intended to join together for
the purpose of carrying on business and sharing in the
profits or losses or both.”
In Luna v. Commissioner set forth the following factors as relevant
in evaluating whether parties intend to create a partnership for
Federal income tax purposes (the Luna factors):
1. The agreement of the parties and their conduct in executing its
terms; the contributions of each ; their control over income and
capital
2. Whether each party was a principal and coproprietor, sharing
profits and losses, or whether one party was the agent or employee
of the other
3. Whether business was conducted in the joint names of the
parties; whether separate books of account were maintained for the
venture; and whether the parties exercised mutual control over and
assumed mutual responsibilities for the enterprise.
See also Estate of Kahn v. Commissioner, supra at 1189.
We have held that both parties do not have to be active
participants to a venture, so long as there is an intent to
form a business together.
70 Acre Recognition Equip. Pship. v. Commissioner, T.C. Memo.
1996-547.
Nonetheless, both parties to the common enterprise
must contribute elements necessary to the business.
See Beck Chem. Equip. Corp. v. Commissioner, 27 T.C. at 852;
Wheeler v. Commissioner, T.C. Memo. 1978-208.
The Supreme Court has indicated that the services or
capital contributions of a partner need not meet an
objective standard.
See Commissioner v. Culbertson, 337 U.S. at 742-743.
Applying the various Luna factors, with no one factor being
conclusive, we hold there was no joint venture between WCI and
WB Partners during the taxable periods at issue.
Five of the eight Luna factors weigh against a finding of a joint
venture and three Luna factors are neutral.
We reach the same conclusion using the overall intent approach set
forth in Commissioner v. Culbertson, 337 U.S. 733 (1949).
WCI conducted all of the business of the NTC joint venture
throughout the NTC project. As discussed above, WB Partners did not
contribute anything of substance to the NTC joint venture.
Considering all the facts and circumstances and in accordance with
our analysis of the Luna factors, we find that WCI and WB Partners
did not intend to join together in the conduct of a joint venture.
DISC, ESOP, JV shows:
a. Tax law is all about knowing acronyms!
b. Meaningless letters
c. JV is short for joint venture
d. The IRS is trying to mislead you
Christy & Swan Profit Sharing Plan v. Com’r, T.C. Memo. 2011-62
(3-15-11)
Law: Section 401(a) sets forth the requirements that must be met
by a trust forming part of a profit-sharing plan in order for the trust
to be eligible for favorable tax treatment.
In a declaratory judgment action, we are limited to deciding
whether respondent, in making a determination as to the initial or
continuing qualification of a retirement plan under section 401(a),
properly applied the relevant law to the facts presented.
Stepnowski v. Commissioner, 124 T.C. 198, 204 (2005), affd. 456 F.3d
320 (3d Cir. 2006); Thompson v. Commissioner, 71 T.C. 32, 36-37
(1978); see also Simmons v. Commissioner, T.C. Memo. 1995-422
A qualified profit-sharing plan must meet statutory
requirements both by its terms and in its operations.
Buzzetta Constr. Corp. v. Commissioner, 92 T.C. 641, 646
(1989).
The evaluation of the plan’s failure to amend to meet
statutory changes must be made in the context of what might
have happened, not what actually occurred, during the years
in issue.
Basch Engg. Inc. v. Commissioner, T.C. Memo. 1990-212.
The requirements that a plan must satisfy for qualification
under section 401(a) must be strictly met.
“Congress has decided that these changes are necessary in the
retirement plan area and we do not second guess its wisdom.”
Hamlin Dev. Co. v. Commissioner, T.C. Memo. 1993-89.
Renkemeyer, Campbell & Weaver, LLP v. Com’r, 136 T.C.
No. 7 (2-9-11)
 A partner’s distributive share of income, gain, loss, deductions, or credits
generally is determined by the governing partnership agreement. Sec. 704(a). A
partnership agreement may be either written or oral.
Stern v. Commissioner, T.C. Memo. 1984-383; sec. 1.761-1(c) Income Tax Regs.
 If the partnership agreement does not provide how a partner’s distributive
share is to be determined, or if the allocation provided in the partnership
agreement does not have substantial economic effect, the partner’s distributive
share is determined in the accordance with the partner’s interest in the
partnership.
Sec. 704(b); Holdner v. Commissioner, T.C. Memo. 2010-175.
 A partner’s interest in a partnership refers to the manner “in which the partners
have agreed to share the economic benefit or burden corresponding to the
income, gain, loss, deduction, or credit (or item thereof) that is allocated.”
Sec. 1.704-1(b) (3) (i), Income Tax Regs.
 A partner’s interest in a partnership is determined by taking into account all
relevant facts and circumstances.
Sec. 704-1 (b); Vecchio v. Commissioner, 103 T.C. 170, 193 (1994); sec. 1.704-1 (b) (3)
(i), Income Tax Regs.
In determining the partners’ respective interests in a
partnership, the following factors are deemed relevant:
(a) The partners’ relative capital contributions to the
partnership
(b) The partners’ respective interests in partnership profits
and losses
(c) The partners’ relative interests in cash flow and other
nonliquidating distributions
(d) The partners’ rights to capital upon liquidation.
Holdner v. Commissioner, supra; Estate of Ballentyne v.
Commissioner, T.C. Memo. 2002-160, affd. 341 F3d 802 (8th
Cir, 2003); sec. 1.704-1(b) (3) (ii), Income Tax Regs.
By applying these factors to the specific facts of this case,
we conclude that the special allocation of the law firm’s
net business income for the 2004 tax year was improper.
Partnership taxation:
a. Is the easiest area of the tax law
b. Is just a matter of following the partnership
agreement
c. Is exactly like S corporation taxation
d. Is very complicated for several reasons
Factors to consider:
The partners’ relative capital contributions.
The partners’ interests in the profits and losses of the
partnership.
The partners’ interest in cashflow and other
nonliquidating distributions.
The partners’ rights to distributions of capital upon
liquidation of the partnership
In general, a partner must include his distributive share
of partnership income in calculating his net earning
from self-employment.
In particular, section 1402(a)(13) provides: There shall be
excluded the distributive share of any item of income or
loss of a limited partner, as such, other than guaranteed
payments described in section 707(c) to that partner for
services actually rendered to or on behalf of the
partnership to the extent that those payments are
established to be in the nature of remuneration for those
services
The insight provided reveals that the intent of section
1402(a)(13) was to ensure that individual who merely
invested in a partnership and who were not actively
participating in the partnership’s business operations
(which was the archetype of limited partners at the
time) would not receive credits toward Social Security
coverage.
We hold that the respective distributive shares of petitioner
and Messrs. Campbell, and Weaver arising from the legal
services they performed in their capacity as partners in the
law firm are subject to self-employment taxes for the 2004
and 2005 tax years.
Bulas v. Com’r, T.C. Memo. 2011-201 (8-17-11)
Deductions
The Cohan Rule
Exclusivity
Deductions are a matter of legislative grace, and the taxpayer
must prove he is entitled to the deductions claimed.
Rule 142(a); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440
(1934).
Section 162(a) provides that “There shall be allowed as a
deduction all the ordinary and necessary expenses paid or
incurred during the taxable year in carrying on any trade or
business”.
Taxpayers are required to maintain records sufficient to
establish the amounts of allowable deductions and to
enable the Commissioner to determine the correct tax
liability.
Sec. 6001; Shea v. Commissioner, 112 T.C. 183, 186 (1999).
If a factual basis exists to do so, the Court may in some
circumstances approximate an allowable expense,
bearing heavily against the taxpayer who failed to
maintain adequate records.
Cohan v. Commissioner, 39 F.2d 540, 543-544 (2d Cir. 1930); see
sec. 1.274-5T(a), Temporary Income Tax Regs., 50 Fed. Reg.
46014 (Nov. 6, 1985)
However, in order for the Court to estimate the amount
of an expense, the Court must have some basis upon
which an estimate may be made.
Vanicek v. Commissioner, 85 T.C. 731, 742-743 (1985). Without
such a basis, any allowance would amount to unguided largesse.
Williams v. United States, 245 F.2d 559, 560-561 (5th Cir. 1957)
In addition to the requirements discussed above,
section 280A(a) provides the general rule that
deductions with respect to the use of the taxpayer’s
residence are not allowable unless an exception
applies.
The exceptions are found in section 280A(c).
Determine what portion of the residence was used
regularly and exclusively for petitioner’s business.
See Intl. Trading Co. v. Commissioner, 275 F.2d 578, 584587 (7th Cir. 1960), affg. T.C. Memo. 1958-104; Deihl v.
Commissioner, T.C. Memo. 2005-287
Combined personal and business use of a section of
the residence precludes deductibility.
See generally Sam Goldberger, Inc. v. Commissioner, 88
T.C. 1532, 1557 (1987)
Petitioner used one of the bedrooms of his residence exclusively as
his office for his accounting business. Petitioner argued that he also
used the hallway and the bathroom adjacent to this bedroom
exclusively for his accounting business. Petitioner testified,
however, that his children and other personal guests occasionally
used the bathroom. Accordingly, the hallway and the bathroom
were not used exclusively for business purposes. The area of the
bedroom petitioner used for his accounting business is 226.30
square feet.
The total area of petitioner’s residence is 2,677.34 square feet. As
226.30/2,677.34 represents about 8.45 percent of the total area of
the residence, petitioner is entitled to 8.45 percent of his allowable
expenses allocable to the portion of the residence used exclusively
for business purposes.
Claiming a deduction involves:
a. Poking and hoping
b. Following the rules
c. Playing audit roulette
d. Guessing
We are asked to decide several issues:
 Whether petitioners properly allocated the purchase price to depreciable
equipment when the allocation in the purchase agreement remained unchanged
despite a 2-year delay in closing the transaction.
 Whether petitioners’ pledge of stock in a related S corporation is excluded
from the at-risk amount because it was “property used in the business.”
 Whether Alpine and Alpine PCS-Operating, LLC (Alpine Operating), an
equipment holding company, were engaged in an active trade or business
permitting them to deduct business expenses.
 Whether the related license holding companies are entitled to amortization
deductions for cellular licenses from the FCC upon the grant of the license or
upon commencement of an active trade or business.
The relevant inquiry is the respective fair market values
of the depreciable and nondepreciable property at the
time of acquisition.
Weis v. Commissioner, 94 T.C. 473, 482-483 (1990); Randolph
Bldg. Corp. v. Commissioner, 67 T.C. 804, 807 (1977).
Petitioners bear the burden of proving that
respondent’s allocation is incorrect.
See Rule 142(a); see Elliott v. Commissioner, 40 T.C. 304, 313
(1963).
An allocation in a purchase agreement is not necessarily
determinative, however, if it fails to reflect a bargainedfor amount.
See Sleiman v. Commissioner, 187 F.3d 1352, 1361 (11th Cir. 1999),
affg. T.C. Memo. 1997-530.
Petitioners have not provided any evidence beyond their
own self serving testimony to substantiate the
replacement cost. We need not accept the taxpayer’s selfserving testimony when the taxpayer fails to present
corroborative evidence.
Beam v. Commissioner, T.C. Memo. 1990-304 (citing
Tokarski v. Commissioner, 87 T.C. 74, 77 (1986)), affd.
without published opinion 956 F.2d 1166 (9th Cir. 1992).
Purchase price allocations:
a. Are nice but not required
b. Never are challenged by the IRS
c. Are always challenged by the IRS
d. Are governed by Code Section 1060
A taxpayer is not engaged in a trade or business even if he has
made a firm decision to enter into business and over a considerable
period of time spent money in preparing to enter that business.
Richmond Television Corp. v. United States, 345 F.2d 901, 907 (4th Cir.
1965).
The taxpayer is not engaged in any trade or business until the
business has begun to function as a going concern and has
performed the activities for which it was organized. Id. at 907. The
determination of whether an entity is actively engaged in a trade or
business must be made by viewing the entity in a standalone
capacity and not in conjunction with other entities.
See Bennett Paper Corp. & Subs. v. Commissioner, 78 T.C. 458, 463465 (1982), affd. 699 F.2d 450 (8th Cir. 1983).
Taxpayers are entitled to amortize and deduct startup
expenses only if they attach a statement to the return for
the taxable year in which the trade or business begins.
See sec. 195(b)(1), (c)
We must decide for the first time whether section 197
requires that the taxpayer be engaged in a trade or
business to claim amortization deductions. If we
determine that section 197 imposes a trade or business
requirement, we must also determine the extent of
that requirement.
New tax issues:
a. Arise periodically and may be called an issue of “first
impression”
b. Are easy to resolve
c. Never arise because taxes have been around forever
d. Are ignored
Intangibles were amortized and depreciated under
section 167 before the enactment of section 197.
Sec. 1.167(a)-3, Income Tax Regs.
Taxpayers could claim depreciation deductions for
intangible property used in a trade or business or held
for the production of income if the property had a useful
life that was limited and reasonably determinable. Id.
There was some uncertainty, however, over what
constituted an amortizable intangible asset and the proper
method and period for depreciation.
Congress enacted section 197 to resolve some of the uncertainty
surrounding the regulation.
H. Rept. 103-111, at 777 (1993), 1993-3 C.B. 167, 353
An “amortizable intangible” is now defined as an intangible
acquired by and held in connection with the conduct of a trade or
business.
The cost of the intangible is amortizable over a fixed 15-year
period.
An intangible is not amortizable under the general rule of
subsection (a) unless it is an “amortizable section 197 intangible.”
An amortizable section 197 intangible is defined as an intangible
that is held “in connection with the conduct of a trade or business.”
The statute requires that there be a trade or business for
amortization purposes.
It is a central tenet of statutory construction that,
when any provision of a statute is interpreted, the
entire statute must be considered.
See, e.g., Lexecon Inc. v. Milberg Bershad Hynes & Lerach,
523 U.S. 26, 36 (1998); Huffman v. Commissioner, 978 F.2d
1139, 1145 (9th Cir. 1992), affg. in part and revg. in part T.C.
Memo. 1991-144.
Section 197 was enacted to provide taxpayers acquiring
intangible assets with a deduction similar to the depreciation
deduction under section 167 for tangible assets.
Taxpayers are allowed a depreciation deduction for property
used in a trade or business. See sec. 167(a).
There is no indication in the legislative history of section 197
that Congress intended to change depreciation principles
established in section 167 to allow taxpayers to amortize
intangible assets without regard to whether there was a trade
or business
We now must determine the nature of the section 197 trade or
business requirement.
Several Code sections impose an active trade or business
requirement.
Taxpayers are allowed to deduct business expenses incurred in
carrying on a trade or business, sec. 162
Depreciation expenses for tangible personal property used in a
trade or business, sec. 167
Startup expenses for an “active trade or business”, sec. 195.
The taxpayer must be carrying on or engaged in a trade or
business at the time of the expenditure to be eligible for the
deduction. See Weaver v. Commissioner, T.C. Memo. 2004-108.
Only a passive trade or business is required for deductibility of
research and development costs under section 174. Smith v.
Commissioner, 937 F.2d 1089, 1097 n.9 (6th Cir. 1991) (quoting
Diamond v. Commissioner, 930 F.2d 372 (4th Cir. 1991)), revg. 91
T.C. 733 (1988).
We find, therefore, that section 197 contains an active
trade or business requirement similar to the
requirement imposed by section 162.
Moreover, regulations have been promulgated that reinforce
the trade or business requirement in sec. 197.
The regulations clarify that amortization under sec. 197
begins on the later of–
(A) The first day of the month in which the property is
acquired
(B) In the case of property held in connection with the
conduct of a trade or business or in an activity described
in section 212, the first day of the month in which * * *
the activity begins.
The program, designed to encourage tips in large-scale
cases, mandates awards of 15 to 30 percent of the amount
recouped.
The Whistleblower Office received nearly 1,000 tips
involving more than 3,000 taxpayers in fiscal years 2008 and
2009, according to its annual reports to Congress. Hundreds
of them alleged tax underpayments of more than $10 million,
and dozens more underpayments of $100 million or more.
The annual reports note a new policy of waiting to pay
awards until the two-year window for taxpayers to appeal
their payments has expired. The whistleblower program only
promises awards for returns of $2 million or more
Law:
Section 6901(a)(1) does not create or define a substantive liability but
merely provides the Commissioner a procedure to assess and collect from
the transferee of property the transferor’s existing tax liability. See
Commissioner v. Stern, 357 U.S. 39, 42 (1958) (discussing statutory
predecessor of section 6901).
Section 6902 provides that the Commissioner has the burden of proving
the taxpayer’s liability as a transferee but not that of proving that the
transferor was liable for the tax.
The substantive question of whether a transferee is liable for the
transferor’s obligation and the extent of his liability depends on State law.
See Commissioner v. Stern, supra at 45; Adams v. Commissioner, 70 T.C.
373, 389 (1978), affd. without published opinion 688 F.2d 815 (2d Cir.
1982).
CHC Industries, Inc. v. Com’r, T.C. Memo 2011-33 (2-2-11)
Taxpayer lost
Griffin v. Com’r, T.C. Memo 2011-61 (3-15-11) Taxpayer
won
Blowing the whistle:
a. Cause an award to be received
b. Should never be done
c. Is the way to win friends
d. Is best done in public
Email Dennis at [email protected]
Call 770-792-7444
See www.RegalSeminars.com