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  Copyright© 2004 to 2013 Colin M. Cody, CPA and TraderStatus.com, LLC, All Rights Reserved.
 

 

You may search the U.S. Code for most all the laws of the United States here:
http://www.law.cornell.edu/uscode/index.html#TITLES

Internal Revenue Code Title 26
Example: IRC §707(a)(2)(a)

GPO - United States Code (see Title 26):
http://www.gpo.gov/fdsys/browse/collectionUSCODE...
http://www.gpo.gov/fdsys/
http://uscode.house.gov/beta.shtml

Tax Code, Regulations and Official Guidance:
http://www.irs.gov/Tax-Professionals...

Hierarchy of Internal Revenue guidance:
http://www.irs.gov/uac/Understanding-IRS-Guidance---A-Brief-Primer  TAM v. TEAM
http://www.data.gov/list/agency/14/15?order=category_name&sort=asc

http://law.duke.edu/lib/researchguides/fedtax
http://checkpoint.riag.com/HELP/508/adv-01-03a.htm
   (Blue Book's Authority see below)

Internal Revenue Manual:
http://www.irs.gov/irm/
http://www.irs.gov/pub/irm/_Sorted_By_Date.html

IRS Forms & Publications - current:
http://www.irs.gov/app/picklist/list/formsPublications.html

Comment on IRS forms and Publications:  email the IRS  or  fill-in form:
http://www.irs.gov/uac/Comment-on-Tax-Forms-and-Publications

IRS Form & Instructions - current:
http://www.irs.gov/app/picklist/list/formsInstructions.html

IRS Publications and Notices:
http://www.irs.gov/app/picklist/list/publicationsNoticesPdf.html

IRS News Release and Fact Sheet Archives:
http://apps.irs.gov/app/picklist/list/newsReleases.html

Interim Guidance by IRS Business Process:
http://www.irs.gov/uac/Interim-Guidance-by-IRS-Business-Process

Audit Techniques Guides (ATGs):
http://www.irs.gov/Businesses/Small-Businesses ... (ATGs)

Frequently Asked Tax Questions and Answers:
http://www.irs.gov/faqs/....

See "Basic Tax Research"
http://law.nd.edu/library/students/legal-research-guides/
http://www.nd.edu/~lawlib/students/guides/tax_guide.pdf
http://www.nd.edu/~lawlib/students/guides/taxguidesamplepages.pdf

Federal Tax Collection Rules and Procedures:
https://irscollectionlaw.com/public_html/00_masterindex.php

 

Statutory elections: defined by statute.

Regulatory elections: defined by regulation.
The IRS has greater discretion to permit late filed regulatory elections.

You may search the Internal Revenue Regulations:

http://www.law.cornell.edu/cfr/text/26/chapter-I

Example: Reg. §301.7701-2 (c)(2)(iv)(C)(iii)
Example:
Reg. §1.707-1 (Justia US Law)
Example:
Reg. §1.731-1 (Tax Almanac)

IRS - Tax Code, Regulations and Official Guidance:
http://www.irs.gov/Tax-Professionals/Tax-Code,-Regulations-and-Official-Guidance

GPO - Code of Federal Regulations:
http://www.gpo.gov/fdsys/browse/collectionCFR...
http://ecfr.gpoaccess.gov/cgi/t/text/text-idx?c=ecfr&tpl=%2Findex.tpl

Federal Register:
https://www.federalregister.gov/

IRS forms - previous year forms. instructions & publications:
http://www.irs.gov/app/picklist/list/priorFormPublication.html

IRS Forms - future use (Drafts):
http://www.irs.gov/pub/irs-dft/

IRS Forms - expert interface:
http://www.irs.gov/pub/
http://www.irs.gov/pub/irs-drop/
http://www.irs.gov/pub/irs-pdf/
http://www.irs.gov/pub/irs-prior/

Stakeholder Outreach - Issue Management Resolution System (IMRS):
http://www.irs.gov/Businesses/Small-Businesses ... IMRS)

Various additional links:
http://www.traderstatus.com/daytrader.htm

Tax professional news links:
http://www.traderstatus.com/taxbriefing.htm

Post Filing Issues (Audits / Disputes):
http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Post-Filing-Issues

Legal bitstream - All IRS Materials:
http://www.legalbitstream.com/

LawThreads® Reviews
http://www.leimbergservices.com/lawthreads.cfm

Free Legal Forms:
http://www.getfreelegalforms.com/nominee-agreement/
http://www.rocketlawyer.com/
http://scholar.google.com/
http://www.docracy.com/

 


National Muffler Standard:

The Court went on to resolve that issue with the following observations and conclusions:

  • the Chevron and National Muffler standards "call for different analyses of an ambiguous statute";
  • National Muffler factors such as the agency’s inconsistency or the interpretation’s longevity or contemporaneity (or lack thereof) are not reasons for denying Chevron deference to a Treasury regulation;
  • whether litigation prompts a regulation is likewise "immaterial" to the question of Chevron-eligibility;
  • "[t]he principles underlying our decision in Chevron apply with full force in the tax context";
  • "the administrative landscape has changed significantly" since the Court counseled less deference for general authority Treasury regulations in Rowan Cos. v. United States, 452 U.S. 247, 253 91981), and United States v. Vogel Fertilizer Co., 455 U.S. 16, 24 (1982);
  • the determination of a regulation’s eligibility for Chevron deference "does not turn on whether Congress’s delegation of authority was general or specific"; and finally,
  • Chevron and Mead, rather than National Muffler and Rowan, provide the appropriate framework for evaluating" Treas. Reg. § 31.3121(b)(10)-2.

Chevron Standard (alternative link):

The Chevron standard is a two-step inquiry:
1. Is the statutory language ambiguous?, and, if so,
2. Is the regulation a reasonable interpretation of the statute?
If both questions can be answered in the affirmative, the regulation stands.


Use as a precedent and hierarchy of Internal Revenue guidance:

IRS Written Determinations are documents the IRS is required to make "...open to public inspection..." pursuant to the provisions of I.R.C. Sec. 6110. The documents prepared for release each week are made available to the public every Friday morning. In general, there are three types of IRS written determinations:

  1. Taxpayer-specific rulings or determinations are written memoranda furnished by the IRS National Office in response to requests by taxpayers under published annual guidelines. See Rev. Proc. 2008-1 and Rev.Proc. 2008-4 for more information about these guidelines.
  2. Technical advice memoranda (TAM) are written memoranda furnished by the National Office of the IRS upon request of a district director or chief appeals officer pursuant to annual review procedures. See Rev. Proc. 2008-2 for more information about these procedures.
  3. Chief Counsel Advice (CCA) materials are written advice or instructions prepared by the Office of Chief Counsel and issued to field or service center employees of the IRS or Office of Chief Counsel. See the Chief Counsel Advice Training Materials for more information about CCAs.IRS Written Determinations do not contain proprietary ("Official Use Only") information.

However, it is important to note that pursuant to 26 USC '§ 6110(k)(3) such items cannot be used or cited as precedent.

But then, note that pursuant to Reg §1.6662-4(d)(3)(iii)  regarding types of substantial authority:  The following are authority for purposes of determining whether there is substantial authority for the tax treatment of an item:

  • Applicable provisions of the Internal Revenue Code and other statutory provisions;
  • proposed, temporary and final regulations construing such statues;
  • revenue rulings and revenue procedures;
  • tax treaties and regulations thereunder, and Treasury Department and other official explanations of such treaties;
  • court cases;
  • congressional intent as reflected in committee reports, joint explanatory statements of managers included in conference committee reports, and floor statements made prior to enactment by one of a bill's managers;
  • General Explanations of tax legislation prepared by the Joint Committee on Taxation (the Blue Book);
  • private letter rulings and technical advice memoranda issued after October 31, 1976;
  • actions on decisions and general counsel memoranda issued after March 12, 1981 (as well as general counsel memoranda published in pre-1955 volumes of the Cumulative Bulletin);
  • Internal Revenue Service information or press releases; and
  • notices, announcements and other administrative pronouncements published by the Service in the Internal Revenue Bulletin.
  • Conclusions reached in treatises, legal periodicals, legal opinions or opinions rendered by tax professionals are not authority. The authorities underlying such expressions of opinion where applicable to the facts of a particular case, however, may give rise to substantial authority for the tax treatment of an item.

Notwithstanding the preceding list of authorities, an authority does not continue to be an authority to the extent it is overruled or modified, implicitly or explicitly, by a body with the power to overrule or modify the earlier authority. In the case of court decisions, for example, a district court opinion on an issue is not an authority if overruled or reversed by the United States Court of Appeals for such district. However, a Tax Court opinion is not considered to be overruled or modified by a court of appeals to which a taxpayer does not have a right of appeal, unless the Tax Court adopts the holding of the court of appeals. Similarly, a private letter ruling is not authority if revoked or if inconsistent with a subsequent proposed regulation, revenue ruling or other administrative pronouncement published in the Internal Revenue Bulletin.

But notwithstanding the above, pursuant to Reg §1.6662-4(d)(3)(ii)  regarding the nature of the analysis: "An older private letter ruling, technical advice memorandum, general counsel memorandum or action on decision generally must be accorded less weight than a more recent one. Any document described in the preceding sentence that is more than 10 years old generally is accorded very little weight."

 

Blue Book's Authority
The Blue Book's relative authority has been subject to various comments by the courts and Treasury. Notice 90-20(11) discusses substantial authority for purposes of Sec. 6662(d) (2) (B) (i) and implies that there are three levels of authority:

  1.  The Code and other statutory provisions, temporary and final regulations construing such statutes, court cases, administrative pronouncements, treaties, joint committee pronouncements and statements of managers;
  2. Pproposed regulations, the Blue Book, press releases, notices and announcements;
  3. Letter rulings, technical advice memoranda (TAMs) and AODs.

Letter Ruling (TAM) 9452005(12) states that the Blue Book "does not technically rise to the level of legislative history because it is authored by congressional staff and not by Congress." Est. of Hutchinson(13) discussed the General Explanation of the Tax Reform Act of 1976 and suggested that it should be given weight when supported by other indications of legislative intent. Similarly, in Rivera,(14) the Tax Court stated that the Blue Book (on the Economic Recovery Tax Act of 1981) is entitled en·ti·tle  
tr.v. en·ti·tled, en·ti·tling, en·ti·tles
1. To give a name or title to.

2. To furnish with a right or claim to something:
 to great respect, but does not technically rise to the level of legislative history.

However, Simon(15) essentially ignored the Blue Book, and Sharp(16) stated that General Explanations are not legislative history and are "utterly insignificant" because they are written so long after the enactment of the law. Slaven v. BP America,(17) a nontax case, states that after-the-fact legislative observations are not part of the legislative history. McDonald(18) states that the General Explanation of the Tax Reform Act of 1969 does not directly represent the views of the legislators or an explanation available to them

http://www.thefreelibrary.com/Can+an+individual+deduct+interest+paid+on+a+business-related+tax...-a018500179


Informal IRS Publications (including content found on irs.gov) are not authoritative sources of Federal Tax Law.  See Zimmerman v. Commissioner, 71 T.C. 367, 371 (1978), aff'd without published
opinion, 614 F.2d 1294 (2d Cir. 1979)  &  Endicott v. Commissioner, T.C. Memo 2013-199.


Filing status elections
§1.6012-1(a)(5) Election for a person to sign a tax return on behalf of his/her spouse or child

Special Handling of Signature Requests - Form 1040X, amended return of divorced spouses

§6013(a) Election to file an initial tax return for a given year jointly with your spouse

§1(d) Choosing to file an initial tax return for a given year separately from spouse

§7703 Determination of Marital Status

IRS Publication 504 Unmarried persons (divorce, legally separated, annulment, intent to remarry)

§1.6013-2 Election to file a joint return for a given year after filing separate return

§1.6013-1 Election to file a separate return for a given year after filing joint return

Rev. Proc. 96-61 Taxpayer's use of an alternate mailing address

Rev. Rul. §1.151-1(c)(2) and Rev. Proc. 2003-72 Special rules for birthday on January 1st

§1.441-1T Fiscal-year Individuals

§1.645-1(c) Election to treat certain revocable (living) trusts as part of the Decedent's Estate (Form 8855)

Late issued SS# to a Foreign National who was married to a U.S. Citizen



Deductions and losses
§461 What year to deduct an expense?

§162 Ordinary and Necessary expenses

§212 Expenses for the production of income

80% deductible meals expense - DOT "hours of service" limits

Deduction for water & sewer fees & assessments

Deduction for ad valorem taxes (motor vehicle property taxes)

T.C. Memo 2010-286 - itemized deduction allowed for expenses that were paid for, by a relative (as a gift)

T.C. Summary Opinion 2003-113 - major roof repair is expensed, not capitalized

§1031 Tax-Deferred Exchanges

§709(b)(1) election to deduct LLC, partnership and Sch. C start-up expenditures

Net Operating Loss (NOL) Carryback / Carryforward elections

Net Operating Loss (NOL) Helpful Hints

Net Operating Loss (NOL) form 1045 and 1040X preparation (corporations use 1138, 1139 & 1120X)

Built-in Gains and Losses Under Section 382(h)

Using form 1040X to deal with a CP2000 and CP2501 notification
(CP50X are collection notices CP2057 require an amended return and CP2100 is a wage garnishment)

Statute of Limitations limited to three years, not six years for traders that overstated basis and reported each individual sale (updated 9/24/2009)

Statute of Limitations limited to three years, not six years for partners who overstated basis (reversed January 2011 and re-reversed February 2011)

Statute of Limitations not limited to three years when NOL is carried forward

Statute of Limitations not limited to three years when there are mitigating factors pursuant to §1311 through §1314

Capital Loss Carryback / Carryforward election



Partnerships & LLCs filing form 1065
Partnership - Audit Technique Guide - Chapter 7 - Dispositions of Partnership Interest

Interest Expense deduction paid for Debt-Financed Acquisition of a "trade or business" pass-thru entity (dup below)

§761(f)(2) Spouses' Partnership (but generally not including a LLC ) may "Elect Out" of Partnership Rules - Qualified Joint Venture (QJV)

Rev. Proc. 2002-69 Community property state spouses' "Partnership" (such as a LLC) has option to be treated as a disregarded entity

§1.761-2(b) Investment Partnership may "Elect Out"  of Subchapter K Partnership Rules

FSA 200216005 Investment Limited Partnership may not "Elect Out"  of Subchapter K Partnership Rules

§301.7701-1(a)(2)  mere co-ownership of property is not a separate entity vs. §761(f) Qualified Joint Venture (QJV)

LLC members' tax deductions based on actual capital contribution / basis

Carried partnership interest election under IRS Code §83(b)

Rev. Rul. 87-115 regarding tiered partnerships §754 elections

Rev. Rul. 91-26 partner compensation (no form W-2 is to be issued to partners nor to sole-proprietors)

Treatment of Limited Liability Company members  (SECA tax) (dup below)

§704(b) Partner's distributive share of income and loss

§704(e) Family Partnerships

§707(c) Guaranteed Payments to Partners (GPP)

TEFRA POA and POA issues (and §6229 extensions)

Electing Investment Partnership (EIP)



S-Corporations (form 1120S)
Entity Classification Election

Late Entity Classification Election - form 8832 - Rev. Proc. 2009-41 (dup below)

S-Corp election: Rev. Proc. 2013-30 (effective 9/3/2013) late election of S-Corp status

S-Corp election: Rev. Proc. 2004-48, 2004-32 I.R.B. 172 (8/9/2004) for LLC's seeking S-Corp status

Rev. Proc. 2003-43, 2003-23 I.R.B. 998 (6/9/2003) for corporations or LLC's seeking S-Corp status

Interest Expense deduction paid for Debt-Financed Acquisition of a "trade or business" pass-thru entity (dup below)

Rev. Rul. 73-361 and Rev. Rul. 82-83 stockholder-officer of s-corporation is an employee, form W-2 is to be issued

S-Corp shareholders' medical deductions IRC §105 & §106  (belong on form W-2)

S-Corp shareholders' tax deductions based on loans made - and the taxable income based on repayments of those loans

S-Corp shareholders' pass-thru's ordering rule 1.1367-1(g) election

S corporation debt obligations - disqualifying second class of stock - Regs. §1.1361-1

One-shareholder s-corporation (or few shareholders) payroll issues

Selling s-corporation shareholder - IRC §1377(a)(2) issue (trap)



Trader Status / Trade or Business
Trader Status "election"

IRS Reg. §1.448-1T(f)(2)(iv(A) and  IRS Code §61(a) - A trader's Gross Receipts are his Net Gains (not his Gross Sales Proceeds)

IRS Reg. §1.183-2(b) Trade or Business

IRS Reg. §1.469-1T(e)(6) Partnership has non-passive activity

IRS Reg. §1.469-5T(a) LLC has non-passive activity

IRS Code §446 General Rule For Methods Of Accounting & Rev. Rul. 90-38 Two-Year rule

Mark-to-Market Accounting Method §475

Treatment of Mark-to-Market Gains of Electing Traders (SECA tax)

Treatment of Limited Liability Company members  (SECA tax) (dup above)

IRS Code §475(f) Mark-to-Market election for taxpayers who have filed at least one federal income tax return

IRS Code §475(f) Mark-to-Market elections for newly formed entities that have not filed a tax return yet

Safe Harbor for Valuation Under Mark-to-Market Accounting Method

M2M losses are excluded from Reportable Transactions

IRS Code §481 elections

IRS Code §1256 Mark-to-Market election for dealers

IRS Code §1256 hedging election



Extensions for elections
Deadline to be Extended for Elections Under Mark-to-Mark Accounting

Late Entity Classification Election - form 8832 - Rev. Proc. 2009-41 (dup above)

Extensions of Time to Make Elections

§301.9100-1 Extensions of time to make elections.

§301.9100-2 Automatic extensions.

§301.9100-3 Other extensions

Deadline for filing Amended Tax Return

Deadline for retroactively changing form 1040 credit elect

IRS Reg. §1.6081-1 & IRM 3.11.212.1 Extension of time for filing returns (automatic and by letter request for §6229 > 6 months)

Deadline for electing / revoking  §179 on an Amended Tax Return



Interest and Depreciation of Real Estate
Revenue Ruling 2010-25 - §163 Homeowner's qualified residence interest on indebtedness up to $1,100,000

IRS Reg. §1.163-1(b) Interest Expense deduction when property or mortgage is not in the name of the taxpayer

Interest Expense deduction paid for Debt-Financed Acquisition of a "trade or business" pass-thru entity (dup above)

Election to treat debt as not secured by a qualified residence §163 (instead, treat as business interest)

Credit card electronic payment convenience fees and Interest incurred to pay federal income tax liability

Election to Capitalize Carrying Costs (property taxes) §266

Election to Ratably Accrue Real Estate  Property Taxes §461(c)

Extension for forgotten rental election

Trick to catch-up for forgotten depreciation after the asset was sold (using form 3115 to correct for an impermissible method)

Fast depreciation under the "Whiteco test"

Does a principal residence converted to residential rental property still qualify for tax-free treatment?

IRS Reg. §1.469-2(f)(6) Self-Rental Rule

Taxation of Israel Mozel Tov Bonds

Gallenstein Decision of 1992

Garn-St. Germain Depository Institutions Act of 1982 - Due on Sale clause - LLC trick



Inventory and other special rules
Worthless Inventory Thor Power Tool Company v. Commissioner

§471 inventory rule under IRS Notice 2001-76 & Rev Proc 2001-10 & Rev Proc 2002-28

IRS Reg. §1.132-6(a) de minimis rule

Hot Assets  under  IRS Code §751 are taxable as ordinary (earned) income

Hot Stock under IRS Code §355 are taxed as dividend income

Hot Interest rule under IRS Code §6621(c) after a 30-day letter

Tax Benefit Rule under IRS Code §111   (recoveries or refunds received by taxpayer in a year after the year of payment / year of deduction)

Claim of Right Doctrine under IRS Code §1341   (payments returned from taxpayer in a year after the year of receipt / year of income)

Spiffs & Incentive Payments are not subject to employment taxes

Foreign Tax Paid election: to deduct on Schedule A, or to take as a foreign tax credit; - subject to a 10-year SOL for claiming a refund

Sale of "Personal Goodwill" Martin Ice Cream case

Demutualization a life insurance company

Sale of life Insurance policy by a terminally ill or chronically ill insured person "Viatical Settlements"


Penalties
Underpayment of withholding and estimated tax payments

Employee withholding taxes, form W-4

30-day letter, 90-day letter & tax court

Trick to waive penalties for late filing a partnership tax return  > the amount of the penalties

Trick to waive penalty for late payment of individual income tax

Trick to use when form W-2 is missing - new IRS/State crackdown starting 2007

Trick to use when form W-2 is checked as being an active participant in retirement plan

Presumption of correctness of 1099-MISC forms (in CP2000 and CP2501 cases)

Replacement of the annual Social Security form 1099-SSA
     This
is a US Gov't site, carefully review and consider clicking "Continue to this website (not recommended)" if prompted

IRS Penalty Handbook   (alt IRS)   Avoiding IRS Penalties


§1.6012-1(a)(5) Election for a person to sign a tax return on behalf of his/her spouse or child:

Where one spouse is physically unable by reason of disease or injury to sign a joint return, the other spouse may, with the oral consent of the one who is incapacitated, sign the incapacitated spouse's name in the proper place on the return followed by the words "By ................... Husband (or Wife)," and by the signature of the signing spouse in his own right, provided that a dated statement signed by the spouse who is signing the return is attached to and made a part of the return stating:

  • (i) The name of the return being filed,
  • (ii) The taxable year,
  • (iii) The reason for the inability of the spouse who is incapacitated to sign the return, and
  • (iv) That the spouse who is incapacitated consented to the signing of the return.

The taxpayer and his agent, if any, are responsible for the return as made and incur liability for the penalties provided for erroneous, false, or fraudulent returns.


IRS Notice 89-7:

Q.2. Who is responsible for filing a child's return?
A.2. A child is responsible for filing his or her own return. If for any reason, such as age, the child is unable to file a return, the child's parent or guardian is responsible for filing the child's return on the child's behalf. The parent or guardian should sign the child's name on the return in the proper place followed by: " By (signature), Parent (or Guardian) for minor child."

Q.8. Under what circumstances may the parent or guardian of a child deal with the Internal Revenue Service concerning a notice, examination, or collection matter pertaining to the child's return?
A.8. A parent or guardian who signs a return on a child's behalf may deal with the Service concerning all matters arising in connection with the return. A parent or guardian who does not sign the child's return may provide the Service with information concerning the return and pay the child's tax, but is not entitled to receive information form or otherwise deal with the Service unless designated as the child's representative by the child or the person signing the return on the child's behalf. Such a designation is made on Form 2848-D (subsequently replaced with Form 8821), Tax Information Authorization and Declaration of Representative.

While entitled to receive notices and information concerning the child's return, a parent or guardian named in Form 2848-D
(subsequently replaced with Form 8821) may not legally bind the child with respect to a tax liability unless authorized to do so by the state in which the child resides.


Special Handling of Signature Requests - Form 1040X, amended return of divorced spouses - Internal Revenue Manual, part 21, Chap 5 §3 21.5.3.4.4.1 (10-01-2002):

21.5.3.4.4.1  (10-01-2002)
Special Handling of Signature Requests
http://www.irs.gov/irm/part21/irm_21-005-003r.html#d0e1221

  1. The following table illustrates procedures to follow when a signature is missing due to extenuating circumstances:

    If Then
    One spouse is a Prisoner of War (POW) or Missing in Action (MIA) One spouse can sign if a statement attesting to those facts is attached.
    One spouse is deceased 1. Surviving spouse may sign and indicate the date of death.
    2. The court appointed representative signing the return must attach a court certificate showing they represent the deceased and have the right to sign.
    3. A POA may sign for a deceased taxpayer if they have a court certificate from the municipal government or Register of Wills attesting that the POA may continue to represent taxpayer after death.
    Taxpayer is divorced or separated and filing a claim or amended return requesting a tax decrease for their portion of a refund on a previously filed joint return Only the spouse who owns or has interest in the refund must sign. Refer to IRM 21.6.1.4.8, Allocating Jointly Filed Cases Procedures.
    A claim or amended return is filed to request a refund or credit of tax other than income tax Only the spouse who owns or has an interest in the refund must sign, unless credit is used as a credit against income tax.

    Note:

    This includes claims for overpayments of Excise Tax, Employment Tax, etc.

    A dependent child cannot sign The parent or guardian may sign as "parent or guardian of minor child."
    A corporate claim is filed Any of these officers may sign the claim:
    - President
    - Vice President
    - Treasurer
    - Assistant Treasurer
    - Chief Accounting Officer
    - Other corporate officer with authority to sign.

    Note:

    The signature on the claim is evidence that the individual is authorized to sign.

    Taxpayer files a partnership claim Any one partner may sign
    Taxpayer files a sole-proprietor claim The owner may sign
    An exempt organization files a claim Any of these officers may sign:
    - Executive Director
    - Director - President
    - Vice President
    - Treasurer
    - Assistant Treasurer
    - Chief Accounting Officer
    - Any other officer with authority to sign.

    Note:

    The signature on the claim is evidence that the individual is authorized to sign

Also see:
21.5.3.4.1  (10-21-2009)
Tax Increase or Credit Decrease Processing
http://www.irs.gov/irm/part21/irm_21-005-003r.html#d0e482

  1. Forward claims or amended returns showing a tax increase or credit decrease to the Statute function if it is within 90 days of the Assessment Statute Expiration Date (ASED). For additional information, see IRM 25.6.1.5, Basic Guide for Processing Cases With Statute of Limitations Issues.

  2. If more than 90 days remain on the ASED, input tax increases or credit decreases upon receipt of an amended return or written inquiry requesting a tax increase or credit decrease even without all required elements (forms, schedules, signature, etc.). Input net zero changes (TC 290 for .00) even without all required elements.


21.5.3.4.1.1  (10-02-2007)
Tax Increase and Credit Increase Processing
http://www.irs.gov/irm/part21/irm_21-005-003r.html#d0e580

 

25.6.1.5  (10-01-2010)
Basic Guide for Processing Cases with Statute of Limitations Issues
http://www.irs.gov/irm/part25/irm_25-006-001r.html#d0e573

 


Rev Rul. 74-611 

Rev Rul. 80-6   Chief Counsel Advice Memorandum 20042901F,  7/16/2003 

Rev Rul. 80-7 

Rev Rul. 2004-71 (Arizona and Wisconsin) 
 
Rev Rul. 2004-72 (California, Idaho, and Louisiana) 
 
Rev Rul. 2004-73 (Nevada, New Mexico, and Washington) 
 
Rev Rul. 2004-74 (Texas) 
 
UNITED STATES of America v. Nancy A. ELAM 
 
IRM Community Property / Injured Spouse 
 


§6013(a) Election to file an initial tax return for a given year jointly with your spouse:

A husband and wife may make a single return jointly of income taxes even though one of the spouses has neither gross income nor deductions, except as provided below:

  • no joint return shall be made if either the husband or wife at any time during the taxable year is a nonresident alien;
  • no joint return shall be made if the husband and wife have different taxable years; except that if such taxable years begin on the same day and end on different days because of the death of either or both, then the joint return may be made with respect to the taxable year of each. The above exception shall not apply if the surviving spouse remarries before the close of his taxable year, nor if the taxable year of either spouse is a fractional part of a year under section 443(a)(1);
  • in the case of death of one spouse or both spouses the joint return with respect to the decedent may be made only by his executor or administrator; except that in the case of the death of one spouse the joint return may be made by the surviving spouse with respect to both himself and the decedent if no return for the taxable year has been made by the decedent, no executor or administrator has been appointed, and no executor or administrator is appointed before the last day prescribed by law for filing the return of the surviving spouse. If an executor or administrator of the decedent is appointed after the making of the joint return by the surviving spouse, the executor or administrator may disaffirm such joint return by making, within 1 year after the last day prescribed by law for filing the return of the surviving spouse, a separate return for the taxable year of the decedent with respect to which the joint return was made, in which case the return made by the survivor shall constitute his separate return.

§6013(f)(1) Joint Return Where Individual Is In Missing Status as a result of service in a combat zone the spouse of such individual is otherwise entitled to file a joint return for any taxable year which begins on or before the day which is 2 years after the date designated under section 112 as the date of termination of combatant activities in such zone, then such spouse may elect under subsection (a) to file a joint return for such taxable year.

§6013(f)(2)(A) such election shall be valid even if such individual died before the beginning of such year, and


§1(d) Choosing to file an initial tax return for a given year separately from spouse:

1(d) Married Individuals Filing Separate Returns. --

There is hereby imposed on the taxable income of every married individual (as defined in section 7703) who does not make a single return jointly with his spouse under section 6013, a tax as determined. 

§7703(a) General Rule
7703(a)(1) the determination of whether an individual is married shall be made as of the close of his taxable year; except that if his spouse dies during his taxable year such determination shall be made as of the time of such death; and

7703(a)(2) an individual legally separated from his spouse under a decree of divorce or of separate maintenance shall not be considered as married.

7703(b) Certain Married Individuals Living Apart

For purposes of those provisions of this title which refer to this subsection, if--

7703(b)(1) an individual who is married (within the meaning of subsection (a)) and who files a separate return maintains as his home a household which constitutes for more than one-half of the taxable year the principal place of abode of a child (within the meaning of section 152(f)(1)) with respect to whom such individual is entitled to a deduction for the taxable year under section 151 (or would be so entitled but for section 152(e)),

7703(b)(2) such individual furnishes over one-half of the cost of maintaining such household during the taxable year, and

7703(b)(3) during the last 6 months of the taxable year, such individual's spouse is not a member of such household, such individual shall not be considered as married.




Filing Status: Married Filing Separately and Allocation of Deductions and Expenses

Most married taxpayers can choose whether to file joint returns or separate returns. Most couples will pay less tax if they file joint returns, but in some situations they will benefit from filing separate returns.

A married individual filing a separate return must report on that return his or her own items of gross income, exemptions, deductions and credits.54 A married resident of a community property state must report half of the combined community income and deductions along with his or her separate income and deductions, unless the husband and wife live apart at all times during the tax year.55  If a husband and wife jointly own income-producing property, each must report a share of the income in proportion to the fractional ownership interest in the property.

IRS Publication 504, Divorced or Separated Individuals (2002), includes a chart showing how itemized deductions are allocated when separate returns are filed in community and noncommunity property states.

Allowable deductions may be taken by the individual who actually makes the expenditure.56 However, if the husband and wife maintain a joint bank account in a common-law jurisdiction, a rebuttable presumption treats payments of deductible items from the account by one spouse as though each spouse paid one half of the payment.57 Similarly, in community property jurisdictions, obligations discharged with community funds are treated as though one half is paid by each spouse.58 In addition, if either spouse itemizes deductions, the standard deduction for the other spouse is zero.59

54 IRS Publication 17, Your Federal Income Tax, 22 (2001).
55 Code Sec. 66(a); IRS Publication 555, Community Property, 4 (1999).
56 A.L. Zeeman v US, CA-2, 68-1 USTC ¶9406, 395 F2d 861; A.E. Calvin v US, DC Colo., 65-1 USTC ¶9112, 235 FSupp 594, aff'd, CA-10, 66-1 USTC ¶9108, 354 F2d 202.
57 Rev. Rul. 59-66, 1959-1 CB 60.
58 Rev. Rul. 55-479, 1955-2 CB 57; Commr v D. Newcombe, 10 TCM 152, Dec. 18,140(M) (1951), aff'd, CA-9, 53-1 USTC ¶9241, 203 F2d 128; M.V. Godchaux v US, DC La., 52-1 USTC ¶9183, 102 FSupp 266, appeal dism'd, CA-5, 53-1 USTC ¶9375.
59 Code Sec. 63(c)(6)(A).


Filing Status: When Married Taxpayers Should File Separate Returns

Married couples usually have a lower tax liability if they file a joint return than if they file separately because of the tax rates and other provisions which are generally more generous to married individuals filing joint returns. However, circumstances may be such that one spouse does not want to incur the potential liability for tax on a joint return and would therefore rather file a separate return even though the resulting tax liability may be higher.
Comment
Professor Dennis Calfee and Professor David Hudson, Holland Law Center, University of Florida, Gainesville, FL note that: There are a few, somewhat unusual situations when a married couple might have a lower combined tax liability by filing separate returns rather than by filing a joint return. When these fact patterns appear, computations of tax liability should be made under both the married filing separate returns rules and the married filing jointly provisions so that a comparison can be made.

  • Miscellaneous Itemized Deductions
    Miscellaneous itemized deductions are allowed only to the extent they exceed 2 percent of an individual's adjusted gross income.84 Thus, if one spouse has a large amount of miscellaneous itemized deductions and a low adjusted gross income, while the other spouse has low miscellaneous itemized deductions and a high adjusted gross income, separate returns may result in lower combined tax liability. If one spouse itemizes deductions, however, the standard deduction for the other spouse is zero.85
    Example
    Husband and Wife has adjusted gross income of $100,000 and no miscellaneous deductions. Husband has $10,000 of gross income and $2,200 miscellaneous itemized deductions. If they file a joint return, no miscellaneous deductions would be allowed, because 2 percent of $110,000 combined adjusted gross income is $2,200. If separate returns are filed, Husband would be allowed to deduct $2,000 of the miscellaneous itemized deductions.
     
  • Personal Casualty Gains and Losses
    The excess of personal casualty losses over personal casualty gains in a tax year is deductible only to the extent the excess is greater than 10 percent of adjusted gross income.86  If personal casualty gains exceed personal casualty losses in a tax year, all the gains and losses are treated as capital gains and capital losses.87 Thus, if one spouse has a large personal casualty loss while the other spouse has a large personal casualty gain in the same tax year, if they file joint returns the personal casualty gain is offset by the personal casualty loss. If they file separate returns the loss would be deducted from ordinary income, while the gain would be taxed at the rates for capital gains.88
    Example
    Husband has adjusted gross income of $100,000 and Wife has adjusted gross income of $10,000, without including personal casualty gains or losses. Husband has a personal casualty gain of $8,000. Wife has a personal casualty loss of $8,000. If they file a joint return, the personal casualty gain is offset by the personal casualty loss. If they file separate returns, Husband must include in gross income an additional $8,000 of capital gain and Wife may deduct $7,000 of the personal casualty loss from ordinary income.
     
  • Medical Expenses
    The deduction for medical expenses is allowed only to the extent the expenses exceed 7.5 percent of a taxpayer's adjusted gross income.89 Thus, if one spouse has paid a large amount of qualifying medical expenses while the other spouse has not, it may be advantageous to file separate returns.
    Example
    Husband and Wife each have adjusted gross income of $50,000. Wife pays $10,000 of medical expenses. Husband does not have any medical expenses for the tax year. If Husband and Wife file a joint return, only $2,500 of the medical expenses are deductible. If they file separate returns, Wife may deduct $6,250 for medical expenses.
     
  • Sales or Exchanges of Business Property and Involuntary Conversions
    Taxpayers treat gains and losses from the sale or exchange of property used in a trade or business, or from the involuntary conversion of capital assets held in connection with a trade or business, as long-term capital gains and losses when recognized gains in a current tax year exceed recognized losses. When the gains do not exceed the losses, the gains and losses are treated as ordinary.90 Gains or losses from the sale or exchange of depreciable property, real property held for more than one year and used in a taxpayer's trade or business, capital assets held in connection with a trade or business or a transaction entered into for profit that are compulsorily or involuntarily converted all result in Section 1231 gain or loss. Thus, if one spouse has a large gain and the other spouse has a large loss, it may be advantageous to file separate returns.
    Example
    Husband has a $20,000 Section 1231 gain and a $10,000 long-term capital loss from the sale of investment property. Wife has a $10,000 Section 1231 loss. If Husband and Wife file a joint return, their aggregate Section 1231 gains exceed their Section 1231 losses, so the Section 1231 gain is a long-term capital gain and the Section 1231 loss is a long-term capital loss. The aggregate long-term capital losses of $20,000 may be deducted from the $20,000 long-term capital gain, resulting in no net effect on their taxable income. If they file separate returns, however, Husband's Section 1231 gain will be treated as long-term capital gain, while Wife's Section 1231 loss will be treated an ordinary loss. Husband's net capital gain is $10,000, taxable at more favorable rates. Wife's $10,000 loss is not subject to the limitations on the deductibility of capital losses,91 and may be deducted in full.

84 Code Sec. 67(a).
85 Code Sec. 63(c)(6)(A).
86 Code Sec. 165(h)(2)(A).
87 Code Sec. 165(h)(2)(B).
88 Code Sec. 1(h).
89 Code Sec. 213(a).
90 Code Sec. 1231(a)(1), (2).
91 Code Sec. 1211(b).


Tax Consequences for Married Taxpayers Filing Separate Returns

Most married taxpayers can choose whether to file joint returns or separate returns. Most couples will pay less tax if they file joint returns, but in some situations they will benefit from filing separate returns.

Individuals who are married filing separate returns have smaller amounts of taxable income taxed at the lower tax rates than do individuals with any other filing status.60  A number of other provisions treat taxpayers with this filing status in a manner that is generally more onerous than treatment of other taxpayers. These include:

  • the basic standard deduction is lower;61
  • the standard deduction is reduced to zero if the other spouse itemizes deductions;62
  • the credit for expenses for household and dependent care services necessary for gainful employment is disallowed;63
  • the credit for the elderly and the permanently and totally disabled has a lower initial amount, a lower adjusted gross income limitation, and is disallowed if the spouses live together at any time during the tax year;64
  • the credit for qualified adoption expenses is disallowed;65
  • the Hope scholarship and lifetime learning credit are disallowed;66
  • the earned income credit is disallowed;67
  • the limitation on the general business credit may be halved;68
  • the threshold for reducing the amount of otherwise allowable itemized deductions for higher-income taxpayers is halved;69
  • the threshold for including social security benefits in gross income is reduced to zero if the spouses live together at any time during the tax year, and the entire amount of benefits is subject to inclusion at the higher 85-percent level;70
  • the amount that can be excluded under the exclusion for gain on the sale of a principal residence is the lower amount generally available to single taxpayers, and one spouse's ownership and use are not attributed to the other spouse, as they are if a joint return is filed;71
  • the amount which may be excluded from gross income under dependent care assistance programs is halved;72
  • the exclusion from gross income provided for the proceeds of the redemption of U.S. savings bonds which are used to pay higher education tuition and fees is disallowed;73
  • the phaseout of deductions for personal exemptions for higher-income taxpayers begins with a lower threshold amount, and phases out more rapidly;74
  • the amount of acquisition indebtedness and home equity indebtedness which is deductible qualified residence interest is limited;75
  • the limitation on the amount of deductible losses in insolvent financial institutions which may be treated as an ordinary loss is halved;76
  • for purposes of the election to expense certain depreciable business assets, the two spouses are treated as one taxpayer in applying the dollar limitation and the reduction in the amount of the limitation;77
  • the dollar limitation on the deduction and/or amortization of reforestation expenditures is halved;78
  • the deduction for student loan interest is not allowed;79
  • the exception to the passive activity losses and credits limitation for certain real estate activities is restricted and is eliminated if the spouses live together at any time during the tax year;80
  • the amount of capital losses which may be offset by ordinary income is halved ;81
  • the threshold amounts for applying the limitations on the use of the preceding year's tax liability in computing the amount of required installments of payment of tax to avoid the penalty for underpayment are affected;82 and
  • tax tables are adjusted for inflation by rounding to the nearest $25, rather than to the nearest $50.83

60 Rev. Proc. 91-65, 1991-2 CB 867.
61 Code Sec. 63(c)(2)(D).
62 Code Sec. 63(c)(6)(A).
63 Code Sec. 21(e)(2).
64 Code Sec. 22(c)(2)(A)(iii), (d)(3), (e)(1).
65 Code Sec. 23(f)(1).
66 Code Sec. 25A(g)(6).
67 Code Sec. 32(d).
68 Code Sec. 38(c)(2)(A).
69 Code Sec. 68(b)(1); Code Sec. 68(f), (g), as added by the Economic Growth and Tax Relief Reconciliation Act of 2001, P.L. 107-16, Act §103(a) (June 7, 2001).
70 Code Sec. 86.
71 Code Sec. 121.
72 Code Sec. 129(a)(2)(A).
73 Code Sec. 135(d)(2).
74 Code Sec. 151(d)(3)(A) through (D); Code Sec. 151(d)(3)(E), (F), as added by the Economic Growth and Tax Relief Reconciliation Act of 2001, P.L. 107-16, Act §102(a) (June 7, 2001).
75 Code Sec. 163(h)(3)(B)(ii), (C)(ii).
76 Code Sec. 165(l)(5)(B)(ii).
77 Code Sec. 179(b)(4).
78 Code Sec. 194(b)(1), as amended by the American Jobs Creation Act of 2004, P.L. 108-357, Act §322(a) (October 22, 2004).
79 Code Sec. 221(b)(2).
80 Code Sec. 469(i)(5).
81 Code Sec. 1211(b)(1).
82 Code Sec. 6654(d)(1)(C)(ii).
83 Code Sec. 1(f)(6)(B).


§7703 Determination of Marital Status:

z7703(a)General Rule.
For purposes of part v of subchapter B of chapter 1 and those provisions of this title which refer to this subsection-

7703(a)(1) the determination of whether an individual is married shall be made as of the close of his taxable year; except that if his spouse dies during his taxable year such determination shall be made as of the time of such death; and


7703(a)(2) an individual legally separated from his spouse under a decree of divorce or of separate maintenance shall not be considered as married.


7703(b)Certain Married Individuals Living Apart.
For purposes of those provisions of this title which refer to this subsection, if

7703(b)(1) an individual who is married (within the meaning of subsection (a)) and who files a separate return maintains as his home a household which constitutes for more than one-half of the taxable year the principal place of abode of a child (within the meaning of section 152(f)(1)) with respect to whom such individual is entitled to a deduction for the taxable year under section 151 (or would be so entitled but for section 152(e)),

7703(b)(2) such individual furnishes over one-half of the cost of maintaining such household during the taxable year, and

7703(b)(3) during the last 6 months of the taxable year, such individual's spouse is not a member of such household, such individual shall not be considered as married.

IRS Publication 504 Unmarried persons (divorce, legally separated, annulment, intent to remarry):

Unmarried persons.   You are unmarried for the whole year if either of the following applies.
  • You have obtained a final decree of divorce or separate maintenance by the last day of your tax year. You must follow your state law to determine if you are divorced or legally separated.

    Exception. If you and your spouse obtain a divorce in one year for the sole purpose of filing tax returns as unmarried individuals, and at the time of divorce you intend to remarry each other and do so in the next tax year, you and your spouse must file as married individuals.

  • You have obtained a decree of annulment, which holds that no valid marriage ever existed. You must file amended returns (Form 1040X, Amended U.S. Individual Income Tax Return) for all tax years affected by the annulment that are not closed by the statute of limitations. The statute of limitations generally does not end until 3 years after the due date of your original return. On the amended return you will change your filing status to single, or if you meet certain requirements, head of household.


§1.6013-2 Election to file a joint return for a given year after filing separate return:

Where an individual has filed a separate return for a taxable year for which a joint return could have been made by him and his spouse under section 6013(a), and the time prescribed by law for filing the return for such taxable year has expired, such individual and his spouse may, under conditions hereinafter set forth, make a joint return for such taxable year.

§1.6013-2(b) Limitations with respect to making of election.
A joint return shall not be made under section 6013(b)(1) with respect to a taxable year:

  • After the expiration of three years from the last day prescribed by law for filing the return for such taxable year determined without regard to any extension of time granted to either spouse; or
  • After there has been mailed to either spouse, with respect to such taxable year, a notice of deficiency under section 6212, if the spouse, as to such notice, files a petition with the Tax Court of the United States within the time prescribed in section 6213; or
  • After either spouse has commenced a suit in any court for the recovery of any part of the tax for such taxable year; or
  • After either spouse has entered into a closing agreement under section 7121 with respect to such taxable year, or after any civil or criminal case arising against either spouse with respect to such taxable year has been compromised under section 7122.

§1.6013-1 Election to file a separate return for a given year after filing joint return:

Where a couple files a joint return for a taxable year, they cannot later file separate returns after the last date prescribed for filing the return.

On the other hand, where a couple files separate returns, they may later change their minds and file a joint return, provided it is not filed after any of the following events:

  • The expiration of three years from the last day for filing the return.
  • The mailing to either spouse of a notice of deficiency if the spouse files a timely petition with the Tax Court.

1.6013-1(a)(1) For any taxable year with respect to which a joint return has been filed, separate returns shall not be made by the spouses after the time for filing the return of either has expired. See, however, paragraph (d)(5) of this section for the right of an executor to file a late separate return for a deceased spouse and thereby disaffirm a timely joint return made by the surviving spouse.

1.6013-1(a)(2) A joint return of a husband and wife (if not made by an agent of one or both spouses) shall be signed by both spouses. The provisions of paragraph (a)(5) of § 1.6012-1, relating to returns made by agents, shall apply where one spouse signs a return as agent for the other, or where a third party signs a return as agent for one or both spouses.

1.6013-1(d)(5) If the surviving spouse makes the joint return provided for in subparagraph (3) of this paragraph and thereafter an executor or administrator of the decedent is appointed, the executor or administrator may disaffirm such joint return. This disaffirmance, in order to be effective, must be made within one year after the last day prescribed by law for filing the return of the surviving spouse (including any extension of time for filing such return) and must be made in the form of a separate return for the taxable year of the decedent with respect to which the joint return was made. In the event of such proper disaffirmance the return made by the survivor shall constitute his separate return, that is, the joint return made by him shall be treated as his return and the tax thereon shall be computed by excluding all items properly includible in the return of the deceased spouse. The separate return made by the executor or administrator shall constitute the return of the deceased spouse for the taxable year.


Office of Chief Counsel memorandum May 18, 2010
Treatment of Multiple Returns for the Same Tax Period:
http://www.irs.gov/pub/lanoa/pmta_2010-17.pdf

 


Rev. Proc. 96-61, 1996-2 C.B. 401 Taxpayer's use of an alternate mailing address:

SECTION 8. INFORMATION AN ELECTRONIC FILER MUST PROVIDE TO THE TAXPAYER

.01 The ERO must furnish the taxpayer with a complete paper copy of the taxpayer's return. A complete copy of a taxpayer's return includes: (1) Form 8453 and other paper documents that cannot be electronically transmitted, and (2) a printout of the electronic portion of the return. See section 2.02 of this revenue procedure. The electronic portion of the return can be contained on a replica of an official form or on an unofficial form. However, on an unofficial form, data entries must be referenced to the line numbers on an official form.

.02 The ERO must advise the taxpayer to retain a complete copy of the return and any supporting material.

.03 The ERO must advise the taxpayer than an amended return, if needed, must be filed as a paper return and mailed to the service center that would handle the taxpayer's paper return.

.04 The ERO must, upon request, provide the taxpayer with the Declaration Control Number and the date the electronic portion of the taxpayer's return was acknowledged as accepted for processing by the Service.

.05 The ERO must advise taxpayers that they can call the local IRS TeleTax number to inquire about the status of their tax refund. The ERO should also advise taxpayers to wait at least three weeks from the acceptance date of the electronic return before calling the TeleTax number.

.06 If a taxpayer chooses to use an address other than his or her home address on the return, the Electronic Filer must inform the taxpayer that the address on the electronic portion of the return once processed by the Service, will be used to update the taxpayer's address of record. The Internal Revenue Service uses the taxpayer's address of record for various notices that are required to be sent to a taxpayer's "last known address" under the Internal Revenue Code, and for refunds of overpayments of tax (unless otherwise specifically directed by the taxpayer, such as by Direct Deposit).


Rev. Rul. §1.151-1(c)(2) and Rev. Proc. 2003-72 Special rules for birthday on January 1st:

Determination of a child's specific age: A child attains an age on his or her birthday for purposes of Code sections 21 (child and dependent care credit), 23 (adoption credit), 24 (child tax credit), 32 (earned income credit), 129 (excludable dependent care benefits), 131 (excludable foster care benefits), 137 (excludable adoption assistance benefits), and 151 (dependency exemptions).

For purposes of each of the provisions identified in this revenue ruling, a child attains a given age on the anniversary of the date that the child was born. For example, a child born on January 1, 1993, attains the age of 17 on January 1, 2010.  http://www.irs.gov/irb/2003-33_IRB/ar06.html


There is an exception with regard to when a person turns age 65 for purpose of the standard deduction amount (the so-called old-age exemption).

"For the purposes of the old-age exemption, an individual attains the age of 65 on the first moment of the day preceding his sixty-fifth birthday. Accordingly, an individual whose sixty-fifth birthday falls on January 1 in a given year attains the age of 65 on the last day of the calendar year immediately preceding.

Personal and Dependency Exemptions


§1.441-1T Fiscal-year Individuals

An individual adopts a tax year when he is first required to file a return and he may adopt any tax year, provided it matches his annual accounting period and meets the requirement that books of account be maintained for that accounting period. Once adopted, the fiscal year applies to any business operated as a sole-proprietorship.

§1.441-1T Period for computation of taxable income (temporary).

(b) Taxable year--(1) Definition of taxable year--(i) In general. Except as otherwise provided in this paragraph (b)(1), the term "taxable year" means--

(A) The taxpayer's annual accounting period if it is a calendar year or a fiscal year; or

(B) The calendar year if section 441(g) (relating to taxpayers who keep no books or have no accounting period) applies. Except as provided in administrative provisions of the Internal Revenue laws, a taxable year may not cover a period of more than 12 calendar months. If a return is made under section 443 for a period of less than 12 months (a "short period"), the taxable year is the short period for which the return is made.


§1.645-1(c) Election to treat certain revocable (living) trusts as part of the Decedent's Estate (Form 8855)

Recognizing that a revocable inter vivos trust can be used to settle a decedent's affairs and distribute assets to the beneficiaries, Congress provided an irrevocable election to treat a "qualified revocable trust" as part of the decedents estate (and not as a separate trust) for federal income tax purposes.   Both the trustee of the qualified revocable trust and the executor of the decedent's estate must make the election.  Technically the election is only effective for two or more years.

The election is due by and is made with the first timely filed income tax return if the estate, thereby eliminating any need to file an initial short-year return for the trust.  See IRS Form 8855.  See §7508A for limited extensions to the deadline.

Some additional benefits:
Pursuant to §644 estates, unlike trusts, are not required to use a calendar year-end and thus, they may use a fiscal year-end to defer the recognition of income to the estate and its beneficiaries.  Also, pursuant to §6654(1)(2) estates, unlike trusts, are not required to pay estimated taxes for the first two years of their existence.  And pursuant to §642(b) estates are entitled to a $600 exemption, compared to a $100 exemption for a complex trust.  Further, a trust that is treated as an estate may be able to pass certain losses and deductions through to its beneficiaries at its termination as an estate, even though the trust itself may continue in the form of a trust thereafter.  And pursuant to §213(c) medical expenses incurred by the decedent that are paid by the estate during the one-year period after death may be deductible on the decedent's final return, whereas this medical deduction is not available if the medical expenses are paid by a trust.

Elect to Include Income Earned in the Decedent’s Trust on the Estate’s Income Tax Return

Trusts are required to use a calendar-year end. However, a tax adviser can elect to include the income from a decedent’s qualified revocable trust on the estate income tax return. Doing that provides an array of benefits not normally available to trusts, the most significant of which may be the ability to use the estate’s fiscal year end for trust income. This election lasts two years beyond the decedent’s date of death (longer if a Form 706 is required to be filed; consult the instructions to Form 8855, Election to Treat a Qualified Revocable Trust as Part of an Estate), which is normally plenty of time to deal with closing out a trust. Known as a Sec. 645 election, it is made by filing Form 8855 with the Form 1041. This election can be made even if there are no income-producing probate assets in the estate.

The 10 Most Powerful Postmortem Planning Pointers for Trusts and Estates

Internal Revenue Code: Sec. 645. Certain revocable trusts treated as part of estate

IRC Section 645 Is Your Friend

A Primer on Fiduciary Income Taxes


Late issued SS# to a Foreign National who was married to a U.S. Citizen

Q. Client is active duty military.  Spouse is foreign national with green card but did not have a SSAN until this past month.  Application for SSAN had been sent (I believe) prior to year 2013.  Client would like to file year 2012 personal tax return as MFJ using the just now received SSAN.  Is there any bar to using this just issued SSAN for filing the year 2012 tax return when the SSAN was actually issued in 2013?  It seems a little awkward, but I haven't encountered a situation such as this before.  Any advice and/or possible cite would be appreciated.  Thanks in advance.

A. I have done this MANY times with clients.  Go back to the furthest available open years for which they would be MFJ.  Works great. .


§461 What year to deduct an expense?:

see:
The 2½ month rule: Regs §1.404(b)-1T A-2(b)(1) regarding accrual of deferred compensation
The 3½ month rule: Regs §1.461-4(d)(6)(ii) regarding prepaid services  
The 8½ month rule: Regs §1.461-5(b)(1)(i) regarding accrual of reoccurring items



The 3½ month rule:
Regs §1.461-4(d)(6)(ii) A taxpayer is permitted to treat services or property as provided to the taxpayer as the taxpayer makes payment to the person providing the services or property (as defined in paragraph (g)(1)(ii) of this section), if the taxpayer can reasonably expect the person to provide the services or property within 3-1/2 months after the date of payment.

The 8½ month "recurring item" rule:
Under the recurring item exception, a liability is treated as incurred for a taxable year if --

1.461-5(b)(1)(i) As of the end of that taxable year, all events have occurred that establish the fact of the liability and the amount of the liability can be determined with reasonable accuracy;

(ii) Economic performance with respect to the liability occurs on or before the earlier of

(ii)(A) The date the taxpayer files a timely (including extensions) return for that taxable year; or

(ii)(B) The 15th day of the 9th calendar month after the close of that taxable year;

(iii) The liability is recurring in nature; and

(iv) Either

(iv)(A) The amount of the liability is not material; or

(iv)(B) The accrual of the liability for that taxable year results in a better matching of the liability with the income to which it relates than would result from accruing the liability for the taxable year in which economic performance occurs.



From IRS Publication 538

Under an accrual method of accounting, you generally deduct or capitalize a business expense when both the following apply.

  1. The all-events test has been met. The test is met when:
    •  All events have occurred that fix the fact of liability, and
    •  The liability can be determined with reasonable accuracy.
  2. Economic performance has occurred.

You generally cannot deduct or capitalize a business expense until economic performance occurs. If your expense is for property or services provided to you, or for your use of property, economic performance occurs as the property or services are provided or the property is used. If your expense is for property or services you provide to others, economic performance occurs as you provide the property or services.

Example. You are a calendar year taxpayer. You buy office supplies in December 2003. You receive the supplies and the bill in December, but you pay the bill in January 2004. You can deduct the expense in 2003 because all events have occurred to fix the fact of liability, the liability can be determined, and economic performance occurred in 2003.

Your office supplies may qualify as a recurring item, discussed later. If so, you can deduct them in 2003, even if the supplies are not delivered until 2004 (when economic performance occurs).

Workers' compensation and tort liability. If you are required to make payments under workers' compensation laws or in satisfaction of any tort liability, economic performance occurs as you make the payments. If you are required to make payments to a special designated settlement fund established by court order for a tort liability, economic performance occurs as you make the payments.

Taxes. Economic performance generally occurs as estimated income tax, property taxes, employment taxes, etc. are paid. However, you can elect to treat taxes as a recurring item, discussed later. You can also elect to ratably accrue real estate taxes. See chapter 6 of Publication 535 for information about real estate taxes.

Other liabilities. Other liabilities for which economic performance occurs as you make payments include liabilities for breach of contract (to the extent of incidental, consequential, and liquidated damages), violation of law, rebates and refunds, awards, prizes, jackpots, insurance, and warranty and service contracts.

Interest. Economic performance occurs with the passage of time (as the borrower uses, and the lender forgoes use of, the lender's money) rather than as payments are made.

Compensation for services. Generally, economic performance occurs as an employee renders service to the employer. However, deductions for compensation or other benefits paid to an employee in a year subsequent to economic performance are subject to the rules governing deferred compensation, deferred benefits, and funded welfare benefit plans. For information on employee benefit programs, see Publication 15-B, Employer's Tax Guide to Fringe Benefits.

Vacation pay. You can take a current deduction for vacation pay earned by your employees if you pay it during the year or, if the amount is vested, within 2 months after the end of the year. If you pay it later than this, you must deduct it in the year actually paid. An amount is vested if your right to it cannot be nullified or cancelled.

Exception for recurring items. An exception to the economic performance rule allows certain recurring items to be treated as incurred during the tax year even though economic performance has not occurred. The exception applies if all the following requirements are met.

  1. The all-events test, discussed earlier, is met.
  2. Economic performance occurs by the earlier of the following dates.
    • 8½ months after the close of the year.
    • The date you file a timely return (including extensions) for the year.
  3. The item is recurring in nature and you consistently treat similar items as incurred in the tax year in which the all-events test is met.
  4. Either:
    • The item is not material, or
    • Accruing the item in the year in which the all-events test is met results in a better match against income than accruing the item in the year of economic performance.

This exception does not apply to workers' compensation or tort liabilities.

Amended return. You may be able to file an amended return and treat a liability as incurred under the recurring item exception. You can do so if economic performance for the liability occurs after you file your tax return for the year, but within 8 1/2 months after the close of the tax year.

Recurrence and consistency. To determine whether an item is recurring and consistently reported, consider the frequency with which the item and similar items are incurred (or expected to be incurred) and how you report these items for tax purposes. A new expense or an expense not incurred every year can be treated as recurring if it is reasonable to expect that it will be incurred regularly in the future.

Materiality. Factors to consider in determining the materiality of a recurring item include the size of the item (both in absolute terms and in relation to your income and other expenses) and the treatment of the item on your financial statements.

An item considered material for financial statement purposes is also considered material for tax purposes. However, in certain situations an immaterial item for financial accounting purposes is treated as material for purposes of economic performance.

Matching expenses with income. Costs directly associated with the revenue of a period are properly allocable to that period. To determine whether the accrual of an expense in a particular year results in a better match with the income to which it relates, generally accepted accounting principles are an important factor. For example, if you report sales income in the year of sale, but you do not ship the goods until the following year, the shipping costs are more properly matched to income in the year of sale than the year the goods are shipped. Expenses that cannot be practically associated with income of a particular period, such as advertising costs, should be assigned to the period the costs are incurred. However, the matching requirement is considered met for certain types of expenses. These expenses include taxes, payments under insurance, warranty, and service contracts, rebates and refunds, and awards, prizes, and jackpots.

An expense you pay in advance is deductible only in the year to which it applies, unless the expense qualifies for the "12-month rule." Under the 12-month rule, a taxpayer is not required to capitalize amounts paid to create certain rights or benefits for the taxpayer that do not extend beyond the earlier of the following.

  • 12 months after the right or benefit begins, or
  • The end of the tax year after the tax year in which payment is made.

If you have not been applying the general rule (an expense paid in advance is deductible only in the year to which it applies) and/or the 12-month rule to the expenses you paid in advance, you must get IRS approval before using the general rule and/or the 12-month rule. See Change in Accounting Method, later, for information on how to get IRS approval. See Expense paid in advance under Cash Method, earlier, for examples illustrating the application of the general and 12-month rules.

Business expenses and interest owed to a related person who uses the cash method of accounting are not deductible until you make the payment and the corresponding amount is includible in the related person's gross income. Determine the relationship for this rule as of the end of the tax year for which the expense or interest would otherwise be deductible. If a deduction is denied, the rule will continue to apply even if your relationship with the person ends before the expense or interest is includible in the gross income of that person.

Related persons. For purposes of this rule, the following persons are related.

  1. Members of a family, including only brothers and sisters (either whole or half), husband and wife, ancestors, and lineal descendants.
  2. Two corporations that are members of the same controlled group as defined in section 26 USC 267(f).
  3. The fiduciaries of two different trusts, and the fiduciary and beneficiary of two different trusts, if the same person is the grantor of both trusts.
  4. A tax-exempt educational or charitable organization and a person (if an individual, including the members of the individual's family) who directly or indirectly controls such an organization.
  5. An individual and a corporation when the individual owns, directly or indirectly, more than 50% of the value of the outstanding stock of the corporation.
  6. A fiduciary of a trust and a corporation when the trust or the grantor of the trust owns, directly or indirectly, more than 50% in value of the outstanding stock of the corporation.
  7. The grantor and fiduciary, and the fiduciary and beneficiary, of any trust.
  8. Any two S corporations if the same persons own more than 50% in value of the outstanding stock of each corporation.
  9. An S corporation and a corporation that is not an S corporation if the same persons own more than 50% in value of the outstanding stock of each corporation.
  10. A corporation and a partnership if the same persons own more than 50% in value of the outstanding stock of the corporation and more than 50% of the capital or profits interest in the partnership.
  11. A PSC and any employee-owner, regardless of the amount of stock owned by the employee-owner.

Ownership of stock. To determine whether an individual directly or indirectly owns any of the outstanding stock of a corporation, the following rules apply.

  1. Stock owned directly or indirectly by or for a corporation, partnership, estate, or trust is treated as being owned proportionately by or for its shareholders, partners, or beneficiaries.
  2. An individual is treated as owning the stock owned directly or indirectly by or for the individual's family (as defined in item (1) under Related persons ).
  3. Any individual owning (other than by applying rule (2)) any stock in a corporation is treated as owning the stock owned directly or indirectly by that individual's partner.
  4. To apply rule (1), (2), or (3), stock constructively owned by a person under rule (1) is treated as actually owned by that person. But stock constructively owned by an individual under rule (2) or (3) is not treated as actually owned by the individual for applying either rule (2) or (3) to make another person the constructive owner of that stock.

Reallocation of income and deductions. Where it is necessary to clearly show income or prevent tax evasion, the IRS can reallocate gross income, deductions, credits, or allowances between two or more organizations, trades, or businesses owned or controlled directly or indirectly by the same interests.

If you use an accrual method of accounting and contest an asserted liability, you can deduct the liability either in the year you pay it (or transfer money or other property in satisfaction of it) or in the year you finally settle the contest. However, to take the deduction in the year of payment or transfer, you must meet certain conditions.

Conditions to be met. You must satisfy each of the following conditions to take the deduction in the year of payment or transfer.

Liability must be contested. You do not have to start a suit in a court of law to contest an asserted liability. However, you must deny its validity or accuracy by a positive act. A written protest included with payment of an asserted liability is enough to start a contest. Lodging a protest in accordance with local law is also enough to contest an asserted liability for taxes. You do not have to deny the validity or accuracy of an asserted liability in writing if you can show by all the facts and circumstances that you have asserted and contested the liability.

Contest must exist. The contest for the asserted liability must exist after the time of the transfer. If you make payment after the contest is settled, you must accrue the liability in the year in which the contest is settled.

Example. You are a calendar year taxpayer using an accrual method of accounting. You had a $500 liability asserted against you in 2000 for repair work completed that year. You contested the asserted liability and settled in 2002 for the full $500. You pay the $500 in January 2003. Since you did not make the payment until after the contest was settled, the liability accrues in 2002 and you can deduct it only in 2002.

Transfer to creditor. You must transfer to the creditor or other person money or other property to provide for the payment of the asserted liability. The money or other property transferred must be beyond your control. If you transfer it to an escrow agent, you have met this requirement if you give up all authority over the money or other property. However, buying a bond to guarantee payment of the asserted liability, making an entry on your books of account, transferring funds to an account within your control, transferring your indebtedness or your promise to provide services or property in the future, or transferring (except to the creditor) your stock or the stock or indebtedness of a related person will not meet this requirement.

Liability deductible. The liability must have been deductible in the year of payment, or in an earlier year when it would have accrued, if there had been no contest.

Economic performance rule satisfied. You generally cannot deduct contested liabilities until economic performance occurs. For workers' compensation or a tort liability, or a liability for breach of contract (to the extent of incidental, consequential, and liquidated damages), violation of law, rebates and refunds, awards, prizes, jackpots, insurance, warranty and service contracts, and taxes, economic performance occurs as payments are made to the person. The payment or transfer of money or other property into escrow to contest an asserted liability is generally not a payment to the claimant that discharges the liability. This payment does not satisfy the economic performance test, discussed earlier, except as provided in section 26 USC 468B or the regulations thereunder.

Recovered amounts. An adjustment is usually necessary when you recover any part of a contested liability. This occurs when you deduct the liability in the year of payment and recover any part of it in a later tax year when the contest is settled. Include in gross income in the year of final settlement the part of the recovered amount that, when deducted, decreased your tax for any tax year.

 

Also see:
http://www.traderstatus.com/prepaidexpenses.htm


§162 Ordinary and Necessary expenses:

Ordinary: normal, habitual, usual, customary, accepted, expected and common in a particular line of business.
Necessary: convenient, useful, essential, appropriate, and helpful to conducting business.

The facts and circumstances surrounding the transaction, the intention of the taxpayer, as well as the degree of the ordinariness and necessity of the transaction in carrying on the trade or business are all involved in the determination of whether an expense is ordinary and necessary and, therefore are tax deductible. 

To be deductible, a business expense must be both ordinary and necessary.  An ordinary expense is one that is common and accepted in your trade or business.  A necessary expense is one that is helpful and appropriate for your trade or business.  An expense does not have to be indispensable to be considered necessary.
 

Individuals who have unreimbursed ordinary and necessary business expenses often may claim a tax deduction using IRS form 2106 & Schedule A, line 21 or using  Schedule E, part II.


§212 Expenses for the production of income:

Nontrade or nonbusiness expenses paid or incurred by the taxpayer during the taxable year for the production or collection of income which, if and when realized, will be required to be included in income for Federal income tax purposes, or

are for the management, conservation, or maintenance of property held for the production of such income, or

are made in connection with the determination, collection, or refund of any tax; and

it is an ordinary and necessary expense for such purposes
.

Individuals who have incurrent expenses for the production of income often may claim a tax deduction using Schedule A, line 23.


80% deductible meals expense - DOT "hours of service" limits:

Individuals subject to "hours of service" limits. You can deduct a higher percentage of your meal expenses while traveling away from your tax home if the meals take place during or incident to any period subject to the Department of Transportation's "hours of service" limits. The percentage is 80%.

Individuals subject to the Department of Transportation's "hours of service" limits include the following persons.

  • Certain air transportation workers (such as pilots, crew, dispatchers, mechanics, and control tower operators) who are under Federal Aviation Administration regulations.
  • Interstate truck operators and bus drivers who are under Department of Transportation regulations.
  • Certain railroad employees (such as engineers, conductors, train crews, dispatchers, and control operations personnel) who are under Federal Railroad Administration regulations.
  • Certain merchant mariners who are under Coast Guard regulations.

50% deductible meals and entertainment



Deduction for water & sewer fees & assessments:

Internal Revenue Code (IRC) section 164 permits a deduction for state and local real property taxes. Under Federal law, a tax is an enforced contribution, collected for the purpose of raising revenue to be used for governmental purposes, and not as a payment for a service rendered. In addition, Section 1.164-3(b) of the Treasury Regulations defines "real property taxes" as taxes imposed on interests in real property and levied for the general public welfare, but does not include taxes assessed against local benefits.

Charges for services - Itemized charges for trash collection, water, sewer, etc. are not deductible as real estate taxes.

Special assessments-principal portion - Charges for improvements that tend to increase the value of the property are added to the basis of the property and are not deductible.  Example: an assessment to build a new sidewalk or to connect up to a city sewer system.

Charges to repair or maintain existing public facilities already in service - are deductible as real estate taxes.  Example: repairs to an existing sidewalk.

Special assessments-interest portion - IR Regs. §1.164-4(b)(1) say that any interest charged to the property owner on his sewer assessment is deductible, not as interest, but as property taxes regardless if the assessment was for improvements or a repair.


Fees for water/sewer services are not imposed on an interest in real property nor levied for the general public welfare. The charges by a water/sewer authority to its customers for water and sewer services are simply fees for a service and do not qualify as a tax. Consequently, no portion of the fees would qualify as a deduction on the customer's income tax return.

The confusion may come from a misunderstanding of Treasury Regulation 1.164-4(b)(1). This regulation states that:
"Insofar as assessments against local benefits are made for the purposes of maintenance or repair or for the purpose of meeting interest charges with respect to such benefits, they are deductible. In such cases, the burden is on the taxpayer to show the allocation of the amounts assessed to the different purposes. If the allocation cannot be made, none of the amount so paid is deductible."

In some circumstances, the local governments are attempting to calculate the portion of the water/sewer fees that go to maintenance and interest expenses of their systems. That figure is then provided as being tax deductible. The problem is the service fees do not qualify as a tax to begin with so the provisions of 1.164-4(b)(1) do not apply.

Below are some common situations, with the relevant law that clarifies the issue:

  1. A water authority charges its customers for water usage based on meter readings.
         The charges are
    not taxes but fees for receipts of water services.
         Revenue Ruling 79-201
     
  2. A sewer utility imposes a flat charge for each quarter to all residential customers.
         The charges are
    not taxes but fees for sewer services.
         Revenue Ruling 75-346
     
  3. Real estate taxes are increased on all property owners within a municipality to pay for a sewage disposal system.
         The taxes are levied for the general public welfare by the taxing authority at a like rate against all property over which the authority has jurisdiction.
         This is not a tax assessed against local benefits. The increased real estate taxes
    are deductible under section 164 of the IRC.
         Revenue Ruling 74-52
     
  4. Improvements are made by a municipal water authority to expand the coverage area of the water services. Properties that are benefited by the improvements have an assessment added to their property taxes. The amount of the increase is based on the value of the property.
         This is an example of a tax assessed against local benefits. According to IRC 164(c)(1) such charges are
    not deductible except to the extent that they are properly allocable to maintenance or interest charges.
         Revenue Ruling 75-455, Revenue Ruling 76-45

In summary, most of the time water and sewer fees are simply fees for services and are not deductible.
http://apps.irs.gov/pub/irs-
tege/p_4090_fed_1204_text.pdf

IRS-TE/GE is the Tax Exempt & Government Entities Division. The TE/GE Division was established in late 1999 as part of the IRS's modernization effort. This Division replaces the former Assistant Commissioner (Employee Plans and Exempt Organizations) function, which was established as a result of the Employee Retirement Income Security Act (ERISA) of 1974.


Deduction for ad valorem taxes (motor vehicle property taxes):

Automobile License Fees
You may not deduct an auto license fee based on weight, model, year, or horsepower. But you may deduct a fee based on the value of the car as a state personal property tax if these three tests are met:

  1. the fee is an ad valorem tax, based on a percentage of value of the property;
  2. it is imposed on an annual basis, even though it is collected more or less frequently; and
  3. it is imposed on personal property.
This third test is met even though the tax is imposed on the exercise of a privilege of registering a car or for using a car on the road. The majority of state motor vehicle registration fees are not ad valorem taxes and do not qualify for the deduction. Various states and localities impose ad valorem or personal property taxes on motor vehicles that may qualify for the deduction. Contact a state or local authority to determine whether a license fee qualifies.


Local governments in approximately 12 states impose a value-based (ad valorem) tax on motor vehicles at locally determined rates.
Approximately 16 states have a state value-based tax in lieu of a property tax on vehicles.
Approximately 3 states have a hybrid structure.

AL - based on the fair and reasonable value of the vehicle, therefore this is deductible for IRS itemized deduction purpose.
AR - based on 20% of the value of the vehicle, therefore this is deductible for IRS itemized deduction purpose. The mill rate is assessed by the Counties, Cities and the School Districts.
CA - the "License Fee" or "Vehicle License Fee" (VLF) portion of the Vehicle Registration Renewal Notice is based on the value of the vehicle, therefore the VLF is deductible for IRS itemized deduction purpose.
CT - based on 70% of the value of the vehicle, therefore this is deductible for IRS itemized deduction purpose.  For CT residents, it is also a limited, non-refundable state income tax credit.
FL - has no ad valorem tax assessed upon motor vehicles.
GA - based on a combination of the FMV and the wholesale value of the vehicle, therefore this is deductible for IRS itemized deduction purpose.
IL - has no ad valorem tax assessed upon motor vehicles.
KS - based on the value of the vehicle, therefore this is deductible for IRS itemized deduction purpose.
KY - based on the value of the vehicle, therefore this is deductible for IRS itemized deduction purpose.
LA - based on the value of the vehicle, therefore this is deductible for IRS itemized deduction purpose.
MD - has no ad valorem tax assessed upon motor vehicles.
MN - The "Car Tabs" are based on the value of the vehicle, therefore this is deductible for IRS itemized deduction purpose. 
MS - based on the value of the vehicle, therefore this is deductible for IRS itemized deduction purpose.
NY - has no ad valorem tax assessed upon motor vehicles.
OR - "Vehicle License Fee" is based on the value of the vehicle, therefore is deductible for IRS itemized deduction purpose.
SC - based on the value of the vehicle, therefore this is deductible for IRS itemized deduction purpose.
TX - DPS registration fee and county road bridge add-on fee are not based on the value of the vehicle, therefore not deductible for IRS itemized deduction purposes.
VA
- based on the value of the vehicle, therefore this is deductible for IRS itemized deduction purpose.
VT - has no ad valorem tax assessed upon motor vehicles.
WY - .


T.C. Memo 2010-286 - itemized deduction allowed for expenses that were paid for, by a relative (as a gift):

Child can take itemized deductions for her medical costs and real estate taxes that were paid for by parent.  Tax Court says the parent is deemed to make a gift to the child.  As such the money is treated as going to the child and then to the creditors, therefore the child gets the tax deduction. 

Since the medical costs were paid by parent directly to the doctor, the parent does not count this for gift tax purposes.

Judith F. Lang v. Comr of Internal Revenue 12/30/2010
http://www.ustaxcourt.gov/InOpHistoric/la5ng.TCM.WPD.pdf
 


T.C. Summary Opinion 2003-113 - major roof repair is expensed, not capitalized:

Thomas J. Northen, Jr & Shirley Cox v. Comr. IR referring to Oberman Manufascturing Co "...there was no replacement or substitution of the roof. Petitioner's only purpose in having the work done to the roof was to prevent the leakage and keep her commercial property in operating condition and not to prolong the life of the property, increase its value, or make it adaptable to another use.  Petitioner's expenditure merely restored her commercial to one with a roof free of leaks." 

Google search


§1031 Tax-Deferred Exchanges:

http://www.1031.org/


http://firstexchange.com/drop-and-swap

 


§709(b)(1) election to deduct LLC, partnership and Sch. C start-up expenditures:
(also see §195(b) and see §248(a) for corporations)

After October 22, 2004 a new law allows this election to be made for expenditures of $5,000 or less for start-up, §248 organizational, syndication and formation costs to be deducted  when it begins business. Otherwise, generally, these costs are amortized over a 15 year period starting with the month it begins business.

Prior to October 23, 2004 these costs were usually amortized straight-line over 60 months.

After September 8, 2008 and through July 8, 2011, the qualifying costs are expensed, by default.

How to make the election. You elect to deduct the start-up or organizational costs paid or incurred before 9/9/08 by claiming the deduction on the income tax return (filed by the due date including extensions) for the tax year in which the active trade or business begins. However, if you timely filed your return for the year without making the election, you can still make the election by filing an amended return within 6 months of the due date of the return (excluding extensions). Clearly indicate the election on your amended return and write "Filed pursuant to section 301.9100-2."   File the amended return at the same address you filed the original return. The election applies when computing taxable income for the current tax year and all subsequent years.

After September 8, 2008 and through July 8, 2011- the election to capitalize start-up or organizational costs is made similar to the above.

update: Effective August 17, 2011 final regulations made changes (at the taxpayer's option, retroactive to October 23, 2004 to the extent the period of limitations on assessment of tax has not expired for the year the election is deemed made), as follows:

Taxpayers are deemed to have made the election to deduct start-up or organizational expenditures. 

A taxpayer that wants to capitalize these costs must affirmatively elect capitalization (that is, elect not to recover its start-up or organizational costs) on a timely filed federal income tax return (including extensions). The final regulations provide no guidance on the manner for making this election.



Start-up costs are costs for creating an active trade or business or investigating the creation or acquisition of an active trade or business. Start-up costs include any amounts paid or incurred in connection with any activity engaged in for profit and for the production of income in anticipation of the activity becoming an active trade or business.

Qualifying costs. A start-up cost is amortizable if it meets both the following tests.

  • It is a cost you could deduct if you paid or incurred it to operate an existing active trade or business (in the same field as the one you entered into).
  • It is a cost you pay or incur before the day your active trade or business begins.

Start-up costs include costs for the following items.

  • An analysis or survey of potential markets, products, labor supply, transportation facilities, etc.
  • Advertisements for the opening of the business.
  • Salaries and wages for employees who are being trained and their instructors.
  • Travel and other necessary costs for securing prospective distributors, suppliers, or customers.
  • Salaries and fees for executives and consultants, or for similar professional services.

Disposition of business. If you completely dispose of your business before the end of the amortization period, you can deduct any remaining deferred start-up costs. However, you can deduct these deferred start-up costs only to the extent they qualify as a loss from a business.



A special note about educational seminars attended before you begin trading:
Education is deductible when it is not part of a program that will qualify you for a new trade or business.  Therefore for tax deduction purposes it is perhaps best to consider avoiding such controversy and defer your trader training seminars until after you have actually begun active trading. The trading needs to be done with appropriately significant dollars at stake - "paper trading" without dollars at stake does not necessarily qualify as a legitimate trade or business.

IRS Publication 17
Maintaining skills vs. qualifying for new job.
Education to maintain or improve skills needed in your present work is not qualifying education if it will also qualify you for a new trade or business.

IRS Publication 970
Temporary absence. If you stop working for a year or less in order to get education to maintain or improve skills needed in your present work and then return to the same general type of work, your absence is considered temporary. Education that you get during a temporary absence is qualifying work-related education if it maintains or improves skills needed in your present work.

Indefinite absence. If you stop work for more than a year, your absence from your job is considered indefinite. Education during an indefinite absence, even if it maintains or improves skills needed in the work from which you are absent, is considered to qualify you for a new trade or business. Therefore, it is not qualifying work-related education.
 


Net Operating Loss Carryback / Carryforward elections:

Individuals:
Planning stages: 2007 & 2008: Carry back five years (or elect to carry back two years), carryforward twenty years.
1998, 1999, 2000 and  2003 to present (2006): Carry back two years, carryforward twenty years.
2001 & 2002: Carry back five years (or elect to carry back two years), carryforward twenty years.
prior to 1998 Carry back three years, carryforward fifteen years.


Corporations:


Numerous special cases and exemptions exist for:
Losses on Sec 1256 contracts, futures, commodities
Losses of a Real Estate Investment Trust (REIT)
Losses from certain product liabilities and deferred statutory liabilities (ten year carryback)
Losses from certain Causalities, Thefts & Presidential Declared Disasters (three year carryback)
Farming Losses (five year carryback)
Certain timber losses (three & five year carrybacks)
Gulf Opportunity (GO) Zone losses (five year carryback)
Losses from a casualty or thief (three year carryback)
Losses from a Presidentially declared disaster for a qualified small business
Product liability (ten year carryback)
Reclamation of land (ten year carryback for accrual basis taxpayers three years after an act)
Dismantling of a drilling platform (ten year carryback for accrual basis taxpayers three years after an act)
Remediation of environmental contamination (ten year carryback for accrual basis taxpayers three years after an act)
Payment under any workers compensation act (ten year carryback for accrual basis taxpayers three years after an act)



The election to forgo the carrytback was added by the Tax Reform Act of 1976.  There are two basic requirements for elect to forgo the carryback: A properly worded election statement and a timing requirement. 

There has been litigation when ambiguous election statements have been made regarding the Regular Income Tax  NOL vs. the Alternative Minimum Tax (AMT) NOL.  Taxpayer may not make a split election (between regular and AMT NOL) but the election should refer to both to be valid.  Use language such as "net operating losses"  (Miller v. Comr., 99 F.3d 1042 11th Cir. 1996 Taxpayers' attempt to waive only carryback of their regular tax NOL rendered election invalid because attached statement was ambiguous on its face and thus invalid because taxpayer attempted to split election, rev'g, 104 T.C. 330 1995).

The irrevocable election must be filed no later than the due date (including extensions) for the filing of the tax return for the taxable year in which the net operating loss arises see IRC §172(b)(3).  There is much misunderstanding (general ignorance, or purposefully ignoring of the law) by many tax advisors regarding this requirement.

Once you choose to waive the carryback period, it is irrevocable. If you choose to waive the carryback period for more than one NOL, you must make a separate choice and attach a separate statement for each NOL year.

CAUTION: If you do not file this statement on time, you cannot waive the carryback period.


The form 1040 Election to Waive Net Operating Loss Carryback (NOL) under IRS Code Sec 172(b)(3) has a deadline for filing which is the due date including extensions of the tax return for the year of the NOL, which in no event generally would go beyond October 15, 2004 (or April 15, 2005 if filed pursuant to section 301.9100-2).

§172(b)(3). The right to choose to forgo the carryback period is lost if a timely election is not made. e.g., Young v. Comr., 83 T.C. 831 (1984), aff'd, 783 F.2d 1201 (5th Cir. 1986) (Statement electing to waive carryback made on an amended return for 1976 did not constitute a timely waiver where amended return was filed in 1980); Curran v. U.S., 88 AFTR2d 7172 (D. Md. 2001) (Election to waive carryback of a 1989 net operating loss untimely where the taxpayer filed the 1989 return more than four years late); Diesel Performance, Inc. v. Comr., T.C. Memo 1999-302, aff'd in unpub. opin., 2001-2 USTC ¶50,589 (9th Cir. 2001) (Statement electing to waive carryback on an amended return for 1992 did not constitute a timely waiver where amended return was filed in 1994); Menaged v. Comr., T.C. Memo 1991-079 (Statement of election to carry over unused net operating loss generated in 1979 made on amended return filed more than two years after due date of original return was not timely election to waive carryback period).

When the election is made on an amended return, the taxpayer must write "Filed pursuant to section 301.9100-2" on the election statement. IRS Pub. 536, Net Operating Losses (NOLs) for Individuals, Estates, and Trusts. Regs. §301.9100-2(b) authorizes an automatic six-month extension to make a regulatory election or a statutory election with a due date of the return including extensions, provided the taxpayer timely filed its return for the year the election should have been made and the taxpayer takes corrective action within the six-month extension period.

Regs. §301.9100-3 provides for discretionary extensions for regulatory elections that do not meet the requirements of Regs. §301.9100-2, if the taxpayer acted reasonably and in good faith and granting relief will not prejudice the government's interests. PLRs 200124007 and 200123048 involved consolidated groups that inadvertently failed to file waivers of carryback for consolidated net operating losses on their tax returns for the loss year. Although §172(b)(3) provides the general deadline for waiving carryback, Regs. §1.1502-21T(b)(3)(i) specifically addresses requirements for waiver by consolidated groups. Treating the elections by the consolidated groups as regulatory elections, the IRS granted discretionary extensions for making the election under Regs. §301.9100-3. See also PLRs 200214023 (45-day extension granted to relinquish carryback); 200209002 (45-day extension granted to relinquish carryback period).

Absent application of Regs. §301.9100-2 or Regs. §301.9100-3, the IRS will not grant an extension of time to elect waiver of carryback. PLRs 9435004, 8549057, 8339056, 8229035; TAMs 8333001, 8107001. Additionally, the IRS may postpone the deadline for making the election for taxpayers affected by a Presidentially declared disaster or terroristic or military action (§7508A) or serving in or in support of the Armed Forces in a combat zone or qualifying deployment in a contingency operation (§7508). Rev. Proc. 2004-13, 2004-4 I.R.B. 335.



The general rule provides a two-year carryback period and a 20-year carryover period; provided, however, that a five-year carryback period applies for net operating losses for taxable years ending during 2001 or 2002 and is planned again for 2007 & 2008.  264 To provide flexibility, taxpayers incurring net operating losses may elect to waive carryback of the losses and carry them forward for the applicable carryover period. 265

/Footnote/ 264 §172(b)(1)(A), (H). The two-year carryback and 20-year carryover periods were implemented by the Taxpayer Relief Act of 1997, P.L. 105-34, §1082(a), effective for tax years beginning after Aug. 5, 1997. The five-year carryback period for net operating losses for taxable years ending during 2001 or 2002 was implemented by the Job Creation and Worker Assistance Act of 2002, P.L. 107-147, §102(a).

/Footnote/ 265 The waiver of the two-year carryback period is discussed at ¶2410.04.C., below. The waiver of the five-year carryback period is discussed at ¶2410.04.A.2.b., below.


Personal Income Tax Net Operating Losses are carried back using form 1045.  You must file Form 1045 within 1 year after the end of the year in which an NOL, unused credit, a net section 1256 contracts loss, or claim of right adjustment arose.   Alternatively form 1040X may be filed before three years from the date the form 1040 was filed.


Corporate Income Tax Net Operating Losses are carried back using form 1139.  The corporation must file Form 1139 within 12 months of the end of the tax year in which an NOL, net capital loss, unused credit, or claim of right adjustment arose.  Alternatively form 1120X may be filed before three years from the date the form 1120 was filed.


Delinquent filers:

Unless the timely-filed 2005 return has an election to relinquish the carryback, the NOL must first be carried back and then carried forward. The number of years of the carryback depends on the type of loss. it can be as much as 10 years under IRC 172(b)(1)(C).

Assuming the 1040X carryback is not timely filed, the amount of loss (if any) that can be carried forward is determined as if the 1040X carryback had been filed. The only difference is that the refunds from the carryback years are lost.


The interplay of the two and three year rules that are normally looked at basically relate to the situation where the refund is being claimed for the "current" year, not a carryback year.

First, Reg. 301.6511(a)-1(a)(1) says that a refund claim must be filed within 3 years of the time the original return is filed or, if later, 2 years from the time the tax was paid. Note that the original return may, in itself, be a refund claim. Note also that, if no return is filed, Reg. 301.6511(a)-1(a)(2) also allows a refund claim of taxes paid within two years, which presumably would refer to an adjustment by the IRS, since I can't think of any other way a refund could be claimed without filing a return.

IRC 6511(b)(1) says there will be no refund or credit based on that refund claim unless it is timely. Note that neither Reg. 301.6511(a)-1 nor 6511(B)(1) refer to the due date of the return. Both refer to the timeliness of the refund claim.

Second, assuming that the claim is timely under Reg. 301.6511(a)-1, IRC 6511(b)(2) limits the amount that can be refunded. If the claim was filed within 3 years of filing the original return, the limit under IRC 6511(b)(2)(A) is the tax paid within 3 years plus, if an extension of time was granted for the original return, the period of the extension, prior to filing the refund claim.

If the refund claim is not filed within 3 years of filing the original return, the limit is the tax paid within 2 years of filing the refund claim, per IRC 6511(b)(2) (B).

Note that none of the periods involved refer to the due date of the return except to the extent that IRC 6513 deems a tax paid before the due date to be paid on the due date of the return.

If a form 1040 has not yet been filed but it shows an overpayment of tax, filing it before the three year statute would constitute a valid refund claim for the overpayment of tax. Filing after the three year statute would constitute a valid refund claim only for the tax paid 3 years plus the period of any extension granted prior to the date of filing. (Since this is the original return and, simultaneously a refund claim, the refund claim is filed within 3 years of the original return.)


Net Operating Loss (NOL) Helpful Hints:

http://www.irs.gov/businesses/small/article/0,,id=128495,00.html

Net Operating Loss (NOL) Helpful Hints

Headliner Volume 98 - August 16, 2004

Tax practitioners can speed up the processing of net operating losses (NOLs) by avoiding some common errors. Individuals, estates and trusts may have an NOL if deductions exceed income for the year. Taxpayers can use an NOL by deducting it from income in another year or years.

If you carry back your NOL, you can use Form 1045, Application for Tentative Refund, or Form 1040X Amended U. S. Individual Income Tax Return. Form 1045, is an application for a quick refund, resulting from a tentative adjustment of tax in a carryback year. Generally, Form 1045 must be filed after the NOL year tax return was filed, but not later than one year after the NOL year. Any claims filed more than one year after the end of the NOL year must be filed on Form 1040X, or an amended Form 1041, U.S. Income Tax Return for Estates and Trusts.

Here are some common errors that resulted in an NOL rejection during processing:

Error: Failure to provide documentation to support the NOL calculation.

Solution: Review the checklist of "What to Attach" in the Form 1045 instructions. Be sure to include all forms or schedules for items refigured in the carryback year. Also, provide a copy of any examination reports if the IRS has previously audited the return.

Error: Failure to separate all items shown on the return and tax account when an allocation is required because of a change in filing status or marital status.

Solution: Attach a complete breakdown of each spouse's income; a detailed capital gain calculation; deductions, including a list of total Schedule A Itemized Deductions; exemptions; taxable income; credits; other taxes, including separate Forms 6251, Alternative Minimum Tax; federal tax withheld; payments; offsets; and refunds. For information about figuring the NOL carrybacks and carryovers for married people whose filing status changes for any tax year involved in figuring an NOL carryback or carryover, see Publication 536, Net Operating Losses (NOLs) for Individuals, Estates, and Trusts.

Error: Incorrect "before carryback" figures on Form 1045 or Form 1040X.

Solution: "Before carryback" figures are the amounts from the original filed return. If there have been any adjustments made to the original tax return amounts, either by the taxpayer or the IRS, use personal records or order an IRS transcript of the tax account. To order a transcript, call (800) 829-1040 for Form 1040, U.S. Individual Income Tax Return, or (800) 829-4933 for business returns, or file Form 4506-T Request for Transcript of Tax Return.

Error: Incorrect use of Table 1. Worksheet for NOL Carryover From 2003 to 2004 (For an NOL Year Before 2003) in Publication 536 instead of Form 1045, Schedule B, NOL Carryover, to compute absorbed carryback.

Solution: Calculate the total NOL absorbed in each carryback year using Form 1045, Schedule B. Taxpayer should not use the carryforward worksheet shown in Publication 536 to calculate the absorbed NOL for carryback claims. The worksheet is used to figure the amount of an NOL from a prior year still remaining after applying it to the current year.

Error: Missing NOL and alternative tax net operating loss (ATNOL) calculations.

Solution: For NOL calculations attach Form 1045, Schedule A NOL. For ATNOL calculations attach the calculation and a Form 6251, Alternative Minimum Tax. If taxpayer did not file a Form 6251, with the loss year and/or carryover years' returns, IRS must have a copy of completed Forms 6251 to determine the total adjustments and preferences for the ATNOL deductions.

Error: Incorrect NOL and ATNOL calculations.

Solution: The NOL calculation on Form 1045, Schedule A and ATNOL calculations must include all non-business and business capital gains and losses equal to the net capital gains or losses from Form 1040, Schedule D Capitol Gains and Losses.

Error: Recalculating charitable contributions based on an NOL carryback.

Solution: The charitable contributions on Form 1040 Schedule A, Itemized Deductions, are not changed by an NOL carryback. Only carryforward losses (where the loss year occurred before the carryover year) will affect the adjusted gross income for computing the percentages for allowable contributions.

Deadline for NOL carryback elections:

Error: Election to waive carryback period filed late.

Solution: To make the election to carry an NOL and ATNOL forward without first carrying it back, the election must have been made with the original loss year return, or filed with a Form 1040X within six months of the original due date (excluding extensions) of the loss year return. If the election was not timely made, the NOL must be carried back before being carried forward. Remember to attach a copy of the timely election to the return where the NOL is carried forward.

Error: Failure to provide a breakdown of how each NOL changed the tax figures when combining multiple years' NOL carrybacks on the same Form1040X.

Solution: If you are carrying over more than one NOL, apply each one separately, starting with the earliest one to determine your NOL deduction. Attach a copy of each separate computation to your 1040X.

Error: Combining changes to other income/deductions on a prior year return that are not related to an NOL carryback adjustment.

Solution: NOLs have different processing dates and statutory requirements than regular tax changes. Therefore, non-NOL adjustments must be made on a separate amended return.

For additional information on net operating losses, see Publication 536, Form 1045 and instructions. Forms and publications are available by download from the IRS Web site, or by calling toll free 1-800-TAX-FORM (1-800-829-3676).

 

Deadline for NOL carryback refunds:

NOL carrybacks must be filed within three years of the original due date of the tax return for the tax year of the loss being carried back.  Otherwise the portion that must be carried back is in effect lost since any resulting refund is forfeited as a late filing penalty.  Any remaining carryback losses, that are then being carried forward are reduced by the portions used up in computing the forfeited refunds.


Net Operating Loss (NOL) form 1045 and 1040X preparation (corporations use 1138, 1139 & 1120X):

Instructions for form 1045:
http://www.irs.gov/pub/irs-pdf/i1045.pdf

What to Attach
Attach copies of the following, if applicable, to Form 1045 for the year of the loss or credit:

  • If you are an individual, page 1 and 2 of your loss-year Form 1040 and Schedule A, D and J (Form 1040), if applicable.
  • Any Form 4952, Investment Interest Expense Deduction, attached to your loss-year income tax return.
  • All Schedules K-1 you received from partnerships, S corporations, estates, or trusts that contribute to the carryback.
  • Any application for extension of time to file your loss-year income tax return
  • All Forms 8271, Investor Reporting of Tax Shelter Registration Number, attached to your loss-year income tax return.
  • All Form 8886 Reportable Transaction Disclosure Statement, attached to your loss-year income tax return.
  • Forms 8302. Electronic Deposit of Tax Refund of $1 Million or More.
  • All other forms and schedules from which the carryback results, such as Schedule C or F (Form 1040), Form 3800, General Business Credit, Form 6781, Gains and Losses Form 6781, gains and Losses From Section 1256 Contracts and Straddles, or Form 8586 Low-Income Housing Credit, and
     
  • All forms and schedules for items refigured in the carryback year(s), such as Form 3800, Form 6251, Alternative Minimum Tax - Individuals, Form 6781, Form 8586, From 8844, Empowerment Zone and Renewal Community Employment Credit, or Form 8884, New York Liberty Zone Business Employee Credit.

 

Instructions for form 1040X:
http://www.irs.gov/pub/irs-pdf/i1040x.pdf

Net operating loss (NOL). Attach a computation of your NOL using Schedule A (Form 1045) and any carryover using Schedule B (Form 1045). A refund based on an NOL should not include a refund of self-employment tax reported on Form 1040X, line 9. See Pub. 536, Net Operating Losses (NOLs) for Individuals, Estates, and Trusts, for details.

Carryback claims. You must attach copies of the following if Form 1040X is used as a carryback claim.

  • Both pages of Form 1040 and Schedules A and D, if applicable, for the year in which the loss or credit originated. Enter "Attachment to Form 1040X - Copy Only - Do Not Process" at the top of these forms.
  • Any Schedules K-1 you received from any partnership, S corporation, estate, or trust for the year of the loss or credit that contributed to the loss or credit carryback.
  • Any form or schedule from which the carryback results, such as Form 3800, Form 6781 or Schedule C or F.
  • Forms or schedule from which the carryback results, such as Form 6251, Form 3800, or Schedule A.

Built-in Gains and Losses Under Section 382(h):

IRS Notice 2003-65 

The 1374 Approach
The 1374 approach generally incorporates the rules of section 1374(d) and §§1.1374-3, 1.1374-4, and 1.1374-7 of the Income Tax Regulations in calculating NUBIG and NUBIL and identifying RBIG and RBIL. The following sections describe the application of those rules in the context of section 382(h) and describe those areas in which the 1374 approach departs from those rules.

The 338 Approach
The 338 approach identifies items of RBIG and RBIL generally by comparing the loss corporation's actual items of income, gain, deduction, and loss with those that would have resulted if a section 338 election had been made with respect to a hypothetical purchase of all of the outstanding stock of the loss corporation on the change date (the “hypothetical purchase”). As a result, unlike under the 1374 approach, under the 338 approach, built-in gain assets may be treated as generating RBIG even if they are not disposed of at a gain during the recognition period, and deductions for liabilities, in particular contingent liabilities, that exist on the change date may be treated as RBIL.


Using form 1040X to deal with a CP2000 and CP2501 notification:

CP2000 and CP2501 notices are sometimes so complicated that the preparation of an amended tax return, Form 1040X, is the best way to address any errors made on the original Form 1040. A problem in doing this is that the IRS mail room upon seeing a 1040X is not letting the CP2000 or CP2501 dept people see it, rather they reship it away to another dept that is very overworked.

The IRS CP2000 notices dept, fed up with the slow processing of 1040X's, now requests that you send them a full photocopy of the 1040X and it's supporting statements with the CP2000 notice firmly stapled on top of it (the trick is to hide the 1040X under the CP2000 paperwork).  ALSO in red ink across the top of the page #1 of the 1040X write "CP2000 RESPONSE" Send the package of materials to the address shown on the CP2000 notice.



Statute of Limitations limited to three years, not six years for traders that overstated basis and reported each individual sale:

A taxpayer overstated the tax basis (cost) of sales that were made during the year.  In Bakersfield Energy Partners, 128 TC No. 17   6/14/07 the Tax Court decided that the IRS was not entitled to assess the underpaid tax by using the special six year look-back statute of limitations that is applicable when a taxpayer omits more than 25% of gross income pursuant to IR Code §6501(e).  The logic as stated by the court in denying the IRS the six year statute of limitations was that there was no "omission" since the sale was actually reported on the tax return (see IR Code §6501(e)(1)(A)(ii)).



Statute of Limitations limited to three years, not six years for partners who overstated basis:

Partners overstated their deductible basis on a  §754 election by their partnership (husband and wife partnership).  In Grapeview Imports Ltd v. U.S., No 05-296T Fed. Cl. 7/17/07 the Court decided that the IRS was not entitled to assess the underpaid tax by using the special six year look-back statute of limitations that is applicable when a taxpayer omits more than 25% of gross income pursuant to IR Code §6501(e)(1)(A).  The logic as stated by the court in denying the IRS the six year statute of limitations was based on US Supreme Court Colony Inc v. Comr, 357 U.S. 28 1958 and Bakersfield Energy Partners LP (above) - that there was no "omission" since the sale was actually reported on the tax return (see IR Code §6501(e)(1)(A)(ii))

update: 9/24/2009 IRS issues proposed and temporary regulations to clarify that an overstatement of basis can create a  substantial omission of gross income under IR Code §§6229(c)(2) and 6501(e) for purposes of the six-year extended period for assessments and collections of tax attributable to partnership items. (see Treas. Reg. §301.6229(c)(2)-1T)

update: 1/26/2011 U.S. Court of Appeals for the 7th circuit in Beard v. Comr ruled in a case regarding a Son-of-BOSS (Bond and Option Sales Strategy) transaction, that the IRS is allowed six years to assess taxes when basis of the marketable security is overstated and results in the taxpayer effectively omitting 25% of income.

update: 2/7/2011 U.S. Court of Appeals for the 4th circuit in Home Concrete v. USA and for the 5th circuit in Burks v. USA ruled for the taxpayers, saying that the IRS is limited to three six years to assess taxes when basis is overstated and does not result in the taxpayer omitting 25% of gross income.

Tax Notes 7/26/10
http://www.woodporter.com/Publications/Articles/pdf/Capital_Gain_Three-Year_or_Six-Year_Statute_of_Limitations.pdf

Update: October 24, 2011 Bosamia v. Comr sidetracks the statue of limitation by applying §481 to the taxpayer's situation of relying on an inappropriate accounting method to avoid or delay recognizing taxable income.



Statute of Limitations not limited to three years when NOL is carried forward:

A taxpayer overstated the tax basis (cost) of partnership items.  In Curr-Spec Partners LP the Court decided that the IRS was entitled to assess the underpaid tax by ignoring the general three year statute of limitations. Partners had elected to carry forward a Net Operating Loss (NOL) and by the time the IRS audit was underway the three year statute of limitations had expired for the year that originally created the NOL.  The logic, as stated by the court in denying the taxpayer the right to the protection of three year statute of limitations, was that
IR Code §5118(a) says that the statute of limitations period "shall not expire before" three years from the date the partnership return was filed or, if later, when is was due.   The Fifth Circuit Court said that the phrase shall not expire before" is unambiguous; that is, it can extend but never shorten the §6501(a) period for assessing individual tax liabilities attributable to partnership items.



Statute of Limitations not limited to three years when there are mitigating factors pursuant to §1311 through §1314:

A taxpayer had ending inventories adjusted during an IRS audit, for a year for which a waiver of the three year Statute of Limitations was signed. The IRS then assessed an adjustment in the following year for a comparable adjustment to opening inventories.  Tax claimed IRS was barred because no waiver of the three year Statute of Limitations was signed for the following year.  The U.S. tax Court rules that the IRS shall be allowed to adjust the opening inventories but no other unrelated items may be changed.  Tuwana Jynne Anthory v. Comr of Internal Revenue (T.C. Summary Opinion 2011-50, April 18, 2011).


Capital Loss Carryback / Carryforward election:

TBA



Partnership - Audit Technique Guide - Chapter 7 - Dispositions of Partnership Interest:

http://www.irs.gov/Businesses/Partnerships/Partnership---Audit-Technique-Guide---Chapter-7---Dispositions-of-Partnership-Interest-(Rev.-3-2008)

Supporting Law

Revenue Ruling 84-52, 1984-1 C.B. 157  -  The conversion of a general partner interest into a limited partner interest, and vice versa, within the same partnership, generally will result in no gain or loss recognition by the partner under section 741 or 1001 of the Code.

Revenue Ruling 84-53, 1984-1 C.B. 159  -  Rev. Rul. 84-53 illustrates basis allocations and adjustments that may occur when a partner owns multiple interests in a partnership and disposes of only a portion of such interests.

Revenue Ruling 95-37, 1995-1 C.B. 130  -  This ruling treats the conversion of a partnership interest into an LLC interest in much the same manner as conversions described in Rev. Rul. 84-52.

Crenshaw v. United States , 450 F.2d 472 (5th Cir. 1971)  -  The court found, in a case of substance versus form, that a series of transactions in which the taxpayer claimed tax-free liquidation treatment under IRC section 736(b) followed by a tax-free exchange of like-kind property under IRC section 1031 amounted to a sale of a partnership interest.  (see Drop & Swap below)

Pollack v. Commissioner, 69 T.C. 142 (1977)  -  The Tax Court ruled that the loss resulting from the disposition of a partner’s interest in a partnership should be characterized as a capital loss pursuant to IRC section 741 rather than an ordinary business loss, as the taxpayer had claimed. Characterization of a partnership interest as a capital asset neither depends on the taxpayer’s motive when acquiring the interest nor the fact that treatment would be different if the taxpayer had established the enterprise as a business other than a partnership.


see Drop and Swap here: http://firstexchange.com/drop-and-swap

Dissolution of Partnerships in a 1031 Exchange - The Drop and Swap

When a partnership is selling property and some of the partners want to cash out and others want to reinvest, it can create complications with a 1031 exchange.  There are a couple of reasons for this.  First, under IRC § 1031(a)(2)(D), partnership interests are not exchangeable.  Second, the taxpayer that sold the relinquished property must acquire the replacement property.  For example, if a partnership sells the relinquished property, that same partnership must buy the replacement property.  If individual partners buy the replacement property, it will not be a valid exchange.

 

A common solution to this problem is to dissolve the partnership prior to the sale and distribute tenant in common interests in the property to the individual partners (this is the "drop").  Those individual owners then deed the property to the buyer.  Some former partners exchange their interests (here’s the "swap") into replacement property, and others take the cash proceeds and pay tax on the gain.    

 

While a drop and swap is a common structure, it is not without tax risk.  In order to qualify for 1031 treatment, the property sold and the property purchased must have been "held for investment."  Although the code does not include a specific minimum time frame for which property must be held, if property is acquired by the individual partners immediately prior to the sale, the IRS may take the position that the individual partners acquired the property not for investment purposes, but rather for the sole purpose of selling it.  Even if the original owner, the partnership, had owned the property for many years prior to the drop and swap, the individual partners may not be able to benefit from the partnership’s prior holding period.

 

There have been several IRS rulings which have disqualified exchanges due to transfers which occurred immediately before or immediately after an exchange.  See Revenue Rulings 77-337 and Revenue Ruling 75-292.  Courts, however, have often interpreted the holding requirement more liberally and have permitted non-recognition of gain, even when there is a transfer immediately before or after an exchange from or to an entity controlled by the taxpayer.  See Magneson v. Commissioner of Internal Revenue;   Bolker v. Commissioner of Internal Revenue. 

 

In addition to some favorable case law, the IRS decided in favor of the taxpayer in Private Letter Rulings 200521002and 200651030.  Both Private Letter Rulings addressed a testamentary trust that owned real estate and regularly did 1031 exchanges.  The trust was due to terminate at a certain time and, per the trust’s termination plan, the assets of the trust would eventually be held in an LLC.  The trust was expected to terminate during the exchange period in two of its transactions and immediately after the completion of a 1031 exchange in a third transaction.  In each ruling, the IRS held that the termination of the trust and subsequent transfer of the properties to the LLC would not ruin the 1031 exchange transactions.

 

Despite these positive decisions, the IRS has not published any rulings that give investors certainty regarding the ability to defer tax in an exchange if the taxpayer uses a drop and swap structure. 

 

Moreover, there are other methods by which the IRS may challenge a drop and swap transaction.  For example, partners who drop down to TIC owners but continue to operate as a partnership for their profit and loss allocations or for their purchase agreement negotiations may have a hard time arguing that individuals really dropped out of the partnership.  In this situation, the IRS would likely find that the substance of the transaction occurred at the partnership level, rather than the individual level.  See Chase v. Commissioner of Internal Revenue.

 

Within the last few years, the taxing authorities have started to pay attention to drop and swap transaction.  For example, in late 2007, the California Franchise Tax Board ("FTB") issued a notice with regard to its examination of like kind exchanges involving TIC interests.  The notice indicated that the FTB would be examining whether TIC interests were actually disguised partnership interests.  Although taxpayers have been relying on Revenue Procedure 2002-22to structure their TIC transactions, the FTB stated that the conditions set forth in the Revenue Procedure would be considered minimum requirements for determining the existence of a TIC interest in rental real estate.  This notice serves to remind investors that a TIC interest may be characterized as a partnership interest if the transaction is not structured properly.  Since the partnership interests are not exchangeable, this can ruin an exchange.

 

Additionally, beginning in 2008, Partnership Income Tax Returns included two new questions in Schedule B portion of form 1065.  Question 13 asks

 

"...during the current or prior tax year, the partnership distributed any property received in a like-kind exchange or contributed such property to another entity (other than entities wholly-owned by the partnership throughout the tax year)"

 

Question 14 asks

 

"At any time during the tax year, did the partnership distribute to any partner a tenancy-in-common or other undivided interest in partnership property?"

 

The addition of these questions is a clear indication that the IRS is starting to track drop and swap transactions.

 

A drop and swap is a complicated transaction with a variety of tax implications.  Below are some practical tips; however, investors should work closely with their CPA or attorney and analyze all of the tax issues involved with their specific transaction.

  • Drop out of the entity as early as possible before the closing of the relinquished property.
  • Hold the replacement property for a sufficient amount of time prior to transferring to any entity.
  • Maintain adequate records in order to establish evidence of intent to hold the relinquished or replacement property for business or investment purposes.
  • When dropping into TIC interests, follow as many of the criteria set forth in Rev. Proc. 2002-22 as possible, i.e., share in the profits and expenses on a pro rata basis.
  • Examine the case law in addition to Revenue Procedure 2002-22.
  • When selling the relinquished property, negotiate and enter into the sale agreement as individuals.
  • Consider the tax implication of alternatives, such as a swap and drop.

References:

Revenue Ruling 77-337, 1977 WL 43782 (1977)

Revenue Ruling 75-292, 1975 WL 35378 (1975)

Magneson v. Commissioner of Internal Revenue, 753 F.2d 1490 (US TC 1985)

Bolker v. Commissioner of Internal Revenue, 760 F.2d 1039 (1985)

PLR 2005-21002 (February 24, 2005)

PLR 2006-51030 (September 19, 2006)

California Franchise Tax Board Notice 2000 1107 02

Chase v. Commissioner of Internal Revenue, 92 T.C. 874 (1989)

- See more at: http://firstexchange.com/drop-and-swap#sthash.5Fr6MwjG.dpuf



The following list covers many of the considerations you may want to think about with respect to technical terminations:

1. The terminating partnership is required to file a short-year final return for the taxable year ending with and including the date of its termination. Notice 2001-5 provides that the "Final Return" box should be checked while the instructions to Form 1065 indicate that the "Final Return" box should not  be checked [note: in my experience, it seems that most practitioners follow the Notice].

2. The new partnership is required to file a return for its taxable year beginning after the date of termination of the terminated partnership. The tax year of the new partnership is determined by reference to its partners under section 706(b)(1)(B). Accordingly, the tax year of the new partnership may not necessarily be the same as that of the old partnership.

3. The new partnership retains the employer identification number of the terminated partnership.

4. 'Depreciation and amortization restart:' (i) the terminated partnership computes depreciation for its final-year return as if the assets were disposed of using appropriate conventions and using the short-year rules of Rev. Proc. 89-15; (ii) the new partnership computes depreciation as if the property transferred from the terminated partnership were newly acquired - the short-year rules of Rev. Proc. 89-15 apply [see also section 168(i)(7)]. In addition, Reg. Sec. 1.197-2(g)(2)(iv)(B) provides that the "step-in-the-shoes" rule under Reg. Sec. 1.197-2(g)(2)(ii) applies to transfers of section 197 intangibles pursuant to section 708(b)(1)(B) terminations.

5. 'Tax Elections:' tax elections made by the terminated partnership are no longer applicable to the new partnership. The new partnership should consider the following elections (among others): (i) Section 754 election to adjust the basis of partnership assets upon the transfer of partnership interests or upon certain distributions from the partnership; (ii) accounting methods; (iii) inventory methods; (iv) election to amortize organizational expenses under section 709; (v) election to amortize start-up expenditures under section 195; (vi) section 704(c) methods.

Also worth noting: because letter rulings are issued to specific taxpayers and the newly-formed partnership is a new taxpayer, it appears that the new partnership cannot rely on any letter rulings received by the old partnership(?)

6. 'Section 754 Elections:' a valid section 754 election with respect to the terminating transfer may be made by either the terminated partnership or the new partnership. If a section 754 election is beneficial for the incoming partner, and the terminating partnership does not have a section 754 election in effect, it is generally preferable to make the election with the terminating partnership (as opposed to the new partnership) so that the new partnership will not be bound by the section 754 election. This will allow the new partnership the flexibility to determine whether a section 754 election is beneficial with respect to future transactions.

7. 'Section 743(b) adjustments of existing partners:' if an existing partner has a section 743 basis adjustment in property held by a partnership that technically terminates, such partner will continue to have the same basis adjustment with respect to property deemed contributed by the terminated partnership to the new partnership, regardless of whether the new partnership makes a section 754 election.

8. Section 704(b) capital accounts of the partners and the book bases of the assets of the terminated partnership carry over to the new partnership. Accordingly, a technical termination does not create new section 704(c) property.

9. Deemed transfers resulting from a technical termination are ignored in applying the section 707 disguised sale rules.

10. A technical termination does not trigger the application of, or begin new periods with respect to, section 704(c)(1)(B) or section 737.

11. A technical termination does not trigger recapture of investment tax credits claimed by the terminated partnership under the “mere change in form” exception in Reg. Sec. 1.47-3(f).

I am less certain about the following items; accordingly, if they are important to you, support your position with your own research:

12. 'Acceleration of unamortized section 481(a) adjustments:' a taxpayer that ceases to engage in a trade or business or terminates its existence must take the remaining balance of any section 481(a) adjustment relating to that trade or business into account in computing its taxable income in the tax year of cessation (or termination). Additionally, the contribution to a partnership of the assets of a trade or business to which the section 481(a) adjustment relates accelerates the section 481(a) adjustment. In short, it appears that a section 708(b)(1)(B) termination accelerates any unamortized section 481(a) adjustments relating to assets that are deemed transferred.

13. 'Write-off unamortized section 709 organization costs:' if the organization costs are considered an asset of the partnership that can be transferred in the deemed section 721 transaction to a new partnership, the basis of the organization costs would presumably carry over and the new partnership would "step-in-the-shoes" of the old partnership. When a partnership is liquidated, unamortized organization costs may be deducted as a section 165 loss, provided that the partnership previously elected to amortize organization expenditures under section 709(b)(1). It is possible that unamortized section 709 costs may not be considered an asset of the terminated partnership that can be contributed to the new partnership. Such costs would remain with the terminated partnership and, therefore, become worthless and deductible when the terminating partnership liquidates. Accordingly, a position also exists to deduct the unamortized balance of the organization costs on the final return of the terminated partnership.

14. 'Write-off unamortized start-up costs:' again, the question is whether unamortized section 195 costs are assets that may be contributed to the new partnership. If not, they should become worthless and deductible at the time the terminating partnership liquidates. Section 195(b)(2) provides for the deduction of unamortized section 195 costs as a section 165 loss when a "trade or business is completely disposed of by the taxpayer" before the end of the amortization period. It is unclear to what extent the contribution/distribution construct of section 708(b)(1)(B) will be applicable outside of Subchapter K.

http://www.taxalmanac.org/index.php/Discussion:Partnership_-_Technical_Termination


§761(f)(2) Spouses' Partnership (but generally not including a LLC ) may "Elect Out" of Partnership Rules - Qualified Joint Venture (QJV):


First, please note that: §6231(a)(12) Husband and wife
Except to the extent otherwise provided in regulations, a husband and wife who have a joint interest in a partnership shall be treated as 1 person.



For tax years beginning after Dec. 31, 2006, a "qualified joint venture" that is conducted by a husband and wife who file a joint return for the tax year - may be elected out of and not treated as a partnership for tax purposes.

http://www.irs.gov/pub/irs-pdf/i1040sc.pdf

http://www.irs.gov/pub/irs-prior/i1040sc--2007.pdf


Husband-wife business. Beginning in 2007, you and your spouse, if you are filing married filing jointly, may be able to make a joint election to be taxed as a qualified joint venture instead of a partnership.

Husband-wife business. If you and your spouse jointly own and operate a business and share in the profits and losses, you are partners in a partnership, whether or not you have a formal partnership agreement. Do not use Schedule C or C-EZ. Instead, file Form 1065. See Pub. 541 for more details.

Exception - Qualified joint venture. If you and your spouse materially participate (see Material participation beginning on page C-2) as the only members of a jointly owned and operated business, and you file a joint return for the tax year, you can make a joint election to be taxed as a qualified joint venture instead of a partnership. To make this election, you must divide all items of income, gain, loss, deduction, and credit between you and your spouse in accordance with your respective interests in the venture. Each of you must file a separate Schedule C or C-EZ. On each line of your separate Schedule C or C-EZ, you must enter your share of the applicable income, deduction, or loss.

As long as you remain qualified, your election cannot be revoked without IRS consent.

Election for Husband and Wife Unincorporated Businesses

An unincorporated business jointly owned by a married couple is generally classified as a partnership for Federal tax purposes. For tax years beginning after December 31, 2006, the Small Business and Work Opportunity Tax Act of 2007 (Public Law 110-28) provides that a "qualified joint venture," whose only members are a husband and a wife filing a joint return, can elect not to be treated as a partnership for Federal tax purposes.

Reasons why a Husband and Wife might want to make the election not to be treated as a partnership

Because a business jointly owned and operated by a married couple is generally treated as a partnership for Federal tax purposes, the spouses must comply with filing and record keeping requirements imposed on partnerships and their partners. Married co-owners failing to file properly as a partnership may have been reporting on a Schedule C in the name of one spouse, so that only one spouse received credit for social security and Medicare coverage purposes. The election permits certain married co-owners to avoid filing partnership returns, provided that each spouse separately reports a share of all of the businesses’ items of income, gain, loss, deduction, and credit. Under the election, both spouses will receive credit for social security and Medicare coverage purposes. (ed. in other words, it is possible to pay double the Social Security portion of the S/E tax - once for the husband and then again for the spouse - which is the proper way to pay, unless for example, if only one spouse owned the business)

Definition of a qualified joint venture

A qualified joint venture is a joint venture that conducts a trade or business where (1) the only members of the joint venture are a husband and wife who file a joint return, (2) both spouses materially participate in the trade or business, and (3) both spouses elect not to be treated as a partnership. A qualified joint venture, for purposes of this provision, includes only businesses that are owned and operated by spouses as co-owners, and not in the name of a state law entity (including a limited partnership or limited liability company) (See below). Note also that mere joint ownership of property that is not a trade or business does not qualify for the election. The spouses must share the items of income, gain, loss, deduction, and credit in accordance with each spouse's interest in the business. The meaning of "material participation" is the same as under the passive activity loss rules in section 469(h) and the corresponding regulations (see Publication 925, Passive Activity and At-Risk Rules). Note that, except as provided in section 469(c)(7), rental real estate income or loss generally is passive under section 469, even if the material participation rules are satisfied, and filing as a qualified joint venture will not alter the character of passive income or loss.

How to make the election to be treated as a qualified joint venture

Spouses make the election on a jointly filed Form 1040 (PDF) by dividing all items of income, gain, loss, deduction, and credit between them in accordance with each spouse’s respective interest in the joint venture, and each spouse filing with the Form 1040 a separate Schedule C (Form 1040), Profit or Loss From Business (Sole Proprietorship) (PDF) or Schedule F (Form 1040), Profit of Loss From Farming (PDF), Form 4835, Farm Rental Income and Expenses(PDF) and, if otherwise required, a separate Schedule SE (Form 1040), Self-Employment Tax (PDF). For example, to make the election for 2009, jointly file your 2009 Form 1040, with the required schedules (see below). The partnership terminates at the end of the taxable year immediately preceding the year the election takes effect. For information on how to report the business for the taxable year before the election is made, see Publication 541 on Partnerships and terminations.

A business owned and operated by the spouses through a limited liability company does not qualify for the election (ed. for people not residing in a "community property" state)

Only businesses that are owned and operated by spouses as co-owners (and not in the name of a state law entity) qualify for the election. See Rev. Proc. 2002-69, 2002-2 C.B. 831, for special rules applicable to husband and wife state law entities in community property states.

Ed.
In a non-community property state, it is a little more confusing. For tax years beginning after December 31, 2006, the Small Business and Work Opportunity Tax Act of 2007 (Public Law 110-28) provides that a "qualified joint venture," whose only members are a husband and a wife filing a joint return, can elect not to be treated as a partnership for Federal tax purposes.  Reading the statute, it would seem that an LLC that does not elect to be treated as a corporation should be a "qualified joint venture" that can essentially be disregarded.  

However, the IRS states that with respect to the election provided by the statute, that "Only businesses that are owned and operated by spouses as co-owners (and not in the name of a state law entity) qualify for the election.
See Rev. Proc. 2002-69, 2002-2 C.B. 831, for special rules applicable to husband and wife state law entities in community property states."

So the IRS says that in non-community property states, a husband-and-wife LLC cannot be disregarded.

Even though a reading of the statute does not appear to support the IRS position, in may be wise, in a non-community property state, to file a partnership tax return for the LLC.

http://en.allexperts.com/q/Starting-Small-Business-1637/2008/5/LLC-single-member-disregard.htm 

How to report Federal income tax as a qualified joint venture (including self-employment tax)

Spouses electing qualified joint venture status are treated as sole proprietors for Federal tax purposes. The spouses must share the businesses’ items of income, gain, loss, deduction, and credit. Therefore, the spouses must take into account the items in accordance with each spouse's interest in the business. The same allocation will apply for calculating self-employment tax if applicable, and may affect each spouse’s social security benefits. Each spouse must file a separate Schedule C (or Schedule F) to report profits and losses and, if otherwise required, a separate Schedule SE to report self-employment tax for each spouse. Spouses with a rental real estate business not otherwise subject to self-employment tax must check the box on Line 1 of Schedule C and should not file Schedules SE (ed. or starting with 2011, Line 2 of Schedule E).  (ed. Just for tax years 2008, 2009 & 2010. Starting with 2011, the check box was moved to Line 2 of Schedule E)

However, if there are other net earnings from self-employment of $400 or more, the spouse(s) with the other net earnings from self-employment should file Schedule SE without including the amount of the net profit from the rental real estate business from Schedule C on line 2. If the election is made for a farm rental business that is not included in self-employment, file two Forms 4835 instead of Schedule F.

In general, spouses do NOT need an Employer Identification Number (EIN) for the qualified joint venture

Spouses electing qualified joint venture status are treated as sole proprietors for Federal tax purposes. Using the rules for sole proprietors, an EIN is not required for a sole proprietorship unless the sole proprietorship is required to file excise, employment, alcohol, tobacco, or firearms returns. If an EIN is required, the filing spouse should complete a Form SS-4 and request an EIN as a sole proprietor.

What to do if the spouses already have an EIN for the partnership

One spouse cannot continue to use that EIN for the qualified joint venture. The EIN must remain with the partnership (and be used by the partnership for any year in which the requirements of a qualified joint venture are not met). If you need EINs for the sole proprietorships, see above on EINs for sole proprietors.

How to handle requests from the IRS for a partnership return from the spouses for tax years for which the election is in effect

Once the election is made, if the spouses receive a notice from the IRS asking for a Form 1065 (PDF) for a year in which the spouses meet the requirements of a qualified joint venture, the spouses should contact the toll-free number that is shown on the notice and advise the telephone assistor that they reported the income on their jointly-filed individual income tax return as a qualified joint venture. Alternatively, the spouses can write to the address shown on the notice and provide the same information.

If the spouses elect to be treated as a qualified joint venture, how do they report and pay Federal employment taxes?

If the business has employees, either of the sole proprietor spouses may report and pay the employment taxes due on wages paid to the employees, using the EIN of that spouse’s sole proprietorship. If the business already filed Forms 941 or deposited or paid taxes for part of the year under the partnership's EIN, the spouse may be considered the "successor employer" of the employee for purposes of determining whether the wages have reached the social security and Federal unemployment wage base limits. See Publication 15 for more information on the successor employer rules. See above regarding the allocation of the deductions for income tax purposes.

Duration that the election remains in effect

Once the election is made, it can be revoked only with the permission of the IRS. However, the election technically remains in effect only for as long as the spouses filing as a qualified joint venture continue to meet the requirements for filing the election. (ed. for example, by bringing in a third partner, such as a child buying a 1% interest in the partnership, the election is automatically broken) If the spouses fail to meet the qualified joint venture requirements for a year, a new election will be necessary for any future year in which the spouses meet the requirements to be treated as a qualified joint venture. (ed. for example, if the child sells his 1% interest to one of his parents, the election can again be made)

Page Last Reviewed or Updated: December 07, 2011

http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Election-for-Husband-and-Wife-Unincorporated-Businesses


Rev. Proc. 2002-69 Community property state spouses' "Partnership" (such as a LLC) has option to be treated as a disregarded entity - when they reside in a Community Property State:

Generally for tax years beginning after Dec. 31, 2002, a "qualified entity" owned by a husband and wife in a community property state may be treated as a single Schedule C and not treated as a partnership for tax purposes at the discretion of the taxpayers.

http://www.irs.gov/pub/irs-prior/i1040sc--2003.pdf


http://www.irs.gov/pub/irs-drop/rp-02-69.pdf

 


§1.761-2(b) Investment Partnership may "Elect Out"  of Subchapter K Partnership Rules:

A "qualified investment partnership" - may be elected out of and not treated as a partnership for tax purposes, as follows:

Pursuant to Internal Revenue Code §761 all the members of ABC Associates elect to exclude the organization from the provisions of Subchapter K of the Internal Revenue Code. This election shall be effective beginning with the tax year ending December 31, ______. In connection with this election the members of ABC Associates represent the following:

1) ABC Associates is located at 100 Co-Ownership Road, Rockville, Maryland 20852. A copy of the operating agreement is available at that location.

2) ABC Associates qualifies for this election as an investing partnership that satisfies the requirements of Regulation §1.761-2(a)(1) & (2).

3) The members of ABC Associates are:

(a) Mr. W. Smith ###-##-####
100 Co-Ownership Road
Rockville, Maryland 20852

(b) Ms. J. Jones ###-##-####
102 Co-Ownership Road
Rockville, Maryland 20852


FSA 200216005 Investment Limited Partnership may not "Elect Out"  of Subchapter K Partnership Rules: FSA 200216005 Since partners in a limited partnership are not co-owners of partnership property under the section 761 regulations, Partnership cannot elect to be excluded from the application of the provisions of subchapter K pursuant to section 721(s).

Reg 1.761-2

Rev. Proc. 2002-16


§301.7701-1(a)(2) mere co-ownership of property is not a separate entity vs. §761(f) Qualified Joint Venture (QJV):

§301.7701-1(a)(2)  Certain joint undertakings give rise to entities for federal tax purposes. A joint venture or other contractual arrangement may create a separate entity for federal tax purposes if the participants carry on a trade, business, financial operation, or venture and divide the profits therefrom. For example, a separate entity exists for federal tax purposes if co-owners of an apartment building lease space and in addition provide services to the occupants either directly or through an agent. Nevertheless, a joint undertaking merely to share expenses does not create a separate entity for federal tax purposes. For example, if two or more persons jointly construct a ditch merely to drain surface water from their properties, they have not created a separate entity for federal tax purposes. Similarly, mere co-ownership of property that is maintained, kept in repair, and rented or leased does not constitute a separate entity for federal tax purposes. For example, if an individual owner, or tenants in common, of farm property lease it to a farmer for a cash rental or a share of the crops, they do not necessarily create a separate entity for federal tax purposes.


Any form of co-ownership of business property is a "partnership" under both IRC 761(a) and IRC 7701(a)(2).  There is at least one case (investment tax credit?) that held that an election not to be treated as a partnership under Reg. 1.761-2 applied only to Subchapter K (and the related reporting requirements of IRC 7031), but did not apply to other references to "partners" or "partnerships" under IRC 7701(a)(2).

That said, Reg. 1.761-2 provides for special circumstances under which an unincorporated organization can elect not to be treated as a "partnership" subject to Subchapter K.  This is the "traditional" route taken by co-owners of rental property who report their share of "partnership" income individually.  The advantage of doing this, aside from not preparing Form 1065, is that elections normally made by the "partnership" are, instead, made individually by the co-owners.

In 2007, the Small Business and Work Opportunity Tax Act of 2007 (P.L. 110-28) inserted IRC 761(f) as another method whereby co-ownership by husband and wife could elect not to be treated as a "partnership" for all purposes of the IRC, including those whose definition is under IRC 7701(a)(2), if the co-owners elect under IRC 761(f)(2)(C) to be a Qualified Joint Venture (QJV).  The wording of IRC 761(f) could lead one to conclude that Congress did not intend this subsection to apply to rental real estate operations, and the IRS has indicated that it does not apply when a state entity (such as an LLC) is the actual owner.

http://www.irs.gov/businesses/small/article/0,,id=177376,00.html


LLC members' tax deductions based on actual capital contribution / basis:

Proposed IRS Regulation §1.465-6(d) says that an LLC member MAY NOT DEDUCT LLC K-1 LOSSES to the extent that they exceed his capital contribution. Even if that LLC member has guaranteed the debts of the LLC - UNLESS, that particular LLC member has actually paid the debt AND has no right to be reimbursed from the LLC or from the other members.

Search this link of an IRS Auditor Guide excerpt for the word * Guarantees * for the IRS position on this: http://www.irs.gov/businesses/partnerships/article/0,,id=134694,00.html

If you deposit additional cash into an LLC before the end of the year that should help cure this issue.
But be aware that there's also new 2008 rules regarding the old-school s-corp trick of removing the cash back out early in the following year.
These new rules became effective for any money loaned to the entity after October 20, 2008. While the rules deal specifically with s-corps the implications can be that LLC members trying to circumvent §1.465-6(d) should be cautious as well. http://www.irs.gov/irb/2008-47_IRB/ar09.html


Carried partnership interest election under IRS Code §83(b):

On April 2, 2009, Congressman Sander Levin (D-Mich.) introduced H.R. 1935, the latest proposal to tax capital gains allocated to a fund manager holding a partnership carried interest as ordinary income. The bill would generally apply to carried interests in private equity, venture capital, real estate, LBO, mezzanine, distressed, and hedge funds. Most such funds have a general partner (the fund manager) that receives a management fee (e.g., 2%) and a carried interest equal to a percentage (e.g., 20%) of the profits including realized capital gains.

The Levin bill provides an opportunity to consider Congress’ latest thinking on this matter. While it is not clear that this version of the bill will be enacted, it appears increasingly likely that some sort of carried interest legislation will become law. In its recently released Green Book, the Obama administration indicated that it will push for carried interest legislation to be effective in 2011.

Under current law, when the partnership sells a long-term investment at a capital gain, the portion of the gain allocated to the fund manager’s carried interest is taxed at the favorable capital gains rate, currently 15%. By contrast, compensation income for services is taxed at ordinary income rates, currently, a maximum rate of 35%, and is subject to social security and other payroll taxes. In the Green Book, the Obama administration proposes to allow the maximum rates for capital gains to increase to 20% and for ordinary income to rise to 39.6%.

President Obama’s proposal would be effective for taxable years beginning after December 31, 2010 and would apply to all partnerships. Under the proposal, a partner’s share of income on a services partnership interest (SPI) would be taxed as ordinary income rather than capital gain, regardless of the character of the income at the partnership level. The proposal also requires the partner to pay self employment taxes on the share of income, and any gain recognized on the sale of an SPI would be taxed as ordinary income rather than capital gain.

http://www.nixonpeabody.com/services_pubdetail.asp?ID=2838&SID=442

http://www.lw.com/upload/pubContent/_pdf/pub2678_1.pdf


Rev. Rul. 87-115 regarding tiered partnerships §754 elections:

Rev. Rul. 87-115, 1987-2 C.B. 163

ISSUES
Under section 26 USC 743(b) of the Internal Revenue Code, does a sale of an interest in an upper-tier partnership (UTP) result in an adjustment to the basis of the property of a lower-tier partnership (LTP) in which UTP has an interest if:

  1. both UTP and LTP have made an election under section 26 USC 754?
  2. Only UTP has made the election under section 26 USC 754?
  3. only LTP has made the election under section 26 USC 754?

FACTS
UTP is a partnership in which A, B, C, and D are equal partners. A, B, C, and D each contributed 30x dollar interest in partnership capital and surplus. A's share of the adjusted basis of partnership property is 30x dollars, the sum of A's interest as a partner in partnership capital and surplus, plus A's share of partnership liabilities (neither UTP nor LTP have any liabilities). UTP is an equal partner in LTP, along with X and Y. LTP was formed by X, Y, and Z, who each contributed 110x dollars of cash to LTP upon its formation. UTP purchased its interest in LTP from Z for 80x dollars in a taxable year for which LTP did not have an election under section 26 USC 754 in effect. UTP, X, and Y each have a 110x dollar interest in partnership capital and surplus.

UTP has an adjusted basis of 120x dollars in its property as follows: an adjusted basis of 80 dollars in its partnership interest in LTP and an adjusted basis of 40x dollars in inventory. UTP's partnership interest in LTP has a fair market value of 120x dollars, and UTP's inventory has a fair market value of 80x dollars. LTP has only one asset, a capital asset that is not a section 26 USC 751 asset. LTP's asset has an adjusted basis of 330x dollars and a fair market value of 360x dollars.

In 1985, A sold A's entire interest in UTP to E for 50x dollars.

SITUATION 1
Both UTP and LTP have valid section 26 USC 754 elections in effect.

SITUATION 2
UTP has a section 26 USC 754 election in effect, but LTP does not.

SITUATION 3
UTP does not have a section 26 USC 754 election in effect, but LTP does.

LAW AND ANALYSIS
Section 26 USC 742 of the Code provides that the basis of an interest in a partnership acquired other than by contribution shall be determined under part II of subchapter O of chapter 1 (sections 26 USC 1011 through 26 USC 1015).

Section 26 USC 1012 of the Code provides, with certain exceptions, that the basis of property shall be the cost of such property.

Section 26 USC 754 of the Code provides that if a partnership files an election, in accordance with regulations prescribed by the Secretary, the basis of partnership property shall be adjusted, in the case of a transfer of a partnership interest, in the manner provided in section 26 USC 743(b). Such election shall apply with respect to all transfers of interests in the partnership during the taxable year with respect to which such election was filed and all subsequent years.

Section 26 USC 743(a) of the Code provides the general rule that the basis of partnership property shall not be adjusted as the result of a transfer of an interest in a partnership by sale or exchange or on the death of a partner unless the election provided by section 26 USC 754 is in effect with respect to such partnership.

Section 26 USC 743(b) of the Code provides that, in the case of a transfer of an interest in a partnership by sale or exchange or upon the death of a partner, a partnership with respect to which the election provided in section 26 USC 754 is in effect shall (1) increase the adjusted basis of partnership property by the excess of the basis to the transferee partner of such partner's interest in the partnership over the partner's proportionate share of the adjusted basis of partnership property; or (2) decrease the adjusted basis of partnership property by the excess of the transferee partner's proportionate share of the adjusted basis of partnership property over the basis of such partner's interest in the partnership. Section 26 USC 743(b) further provides that the increase or decrease shall be an adjustment to the basis of partnership property with respect to the transferee partner only.

Section 26 CFR 1.743-1(b)(1) of the Income Tax Regulations provides that, in general, a partner's share of the adjusted basis of partnership property is equal to the sum of that partner's interest as a partner in partnership capital and surplus, plus that partner's share of partnership liabilities.

Section 26 USC 755(a) of the Code requires that, in general, the amount of the basis adjustment be allocated among partnership assets in a manner which has the effect of reducing the difference between the fair market value and the adjusted basis of those assets, or in any other manner permitted by the regulations prescribed by the Secretary.

Section 26 USC 755(b) of the Code provides that in applying the allocation rules provided in section 26 USC 755(a), increases or decreases in the adjusted basis of partnership property arising from the transfer of an interest attributable to (1) capital assets and property described in section 26 USC 1231(b)("capital assets"), or (2) any other property of the partnership, shall in general be allocated to partnership property of like character.

Section 26 CFR 1.755-1(b)(2) of the Income Tax Regulations provides that to the extent an amount paid by a purchaser of a partnership interest is attributable to the value of capital assets, any difference between the amount so attributable and the transferee partner's share of the partnership basis of such property shall constitute a special basis adjustment with respect to partnership capital assets. Similarly, any such difference attributable to any other property of the partnership shall constitute a special basis adjustment with respect to such property.

Section 26 USC 741 of the Code provides that, except as provided in section 26 USC 751, the gain or loss on the exchange of an interest in a partnership shall be considered as a gain or loss from the sale of a capital asset.

Rev. Rul. 78-2, 1978-1 C.B. 202, concerns the transfer of an interest in an investment partnership, X, which is a partner of an operating partnership, Y. The ruling concludes that if elections under section 26 USC 754 of the Code are in effect for X and Y, the adjustment to the basis of partnership property under section 26 USC 743(b) includes (a) an adjustment to X's partnership interest in Y and (b) a corresponding basis adjustment to Y's property with respect to X and the transferee partner of X only.

In essence, if an election under section 26 USC 754 is not in effect, the partnership is treated as an independent entity, separate from its partners. Thus, absent a section 26 USC 754 election, even though the transferee receives a cost basis for the acquired partnership interest, the partnership does not adjust the transferee's share of the adjusted basis of partnership property. If, however, an election under section 26 USC 754 is in effect, the partnership is treated more like an aggregate of its partners, and the transferee's overall basis in the assets of the partnership is generally the same as it would have been had the transferee acquired a direct interest in its share of those assets. Nevertheless, the transferee's adjusted basis for specific partnership assets will not necessarily equal the basis the assets would have had if the transferee had acquired a direct interest in the assets. The difference is due to the fact that the transferee's basis in specific partnership assets is controlled by section 26 USC 755, which does not adopt a pure aggregate approach. See section 26 CFR 1.755-1(c) of the regulations.

SITUATION 1
E purchased A's interest for 50x dollars. Thus, under section 26 USC 742, E's basis in E's partnership interest is 50x dollars. Because UTP made a valid section 26 USC 754 election, under section 26 USC 743(b) UTP must increase the adjusted basis of its property by 20x dollars, the excess of the transferee partner's basis in the partnership interest (50x dollars) over the partner's share of the adjusted basis of such property. Under section 26 CFR 1.743-1(b)(1), E's share of the adjusted basis of partnership property is 30x dollars, because E succeeds to A's interest in partnership capital and surplus. See, e.g., section 26 CFR 1.743-1(b)(1) Example (2). The 20x dollar special basis adjustment raises UTP's adjusted basis in its partnership property to 140x dollars, but the additional 20x dollars must be segregated and allocated solely to E. Under section 26 USC 755, the 20x dollars must be allocated between capital assets (UTP's interest in LTP) and other assets (UTP's inventory).

Under section 26 CFR 1.755-1(b)(2) of the regulations, to the extent that an amount paid by a purchaser of a partnership interest (here, 50x dollars) is attributable to the value of capital assets (here, 120x dollars, the value of UTP's interest in LTP), any difference between the amount so attributable and the transferee partner's share of the partnership basis of such property constitutes a special basis adjustment with respect to such capital assets. In the instant case, 30x dollars (60 percent of 50x dollars) of E's purchase price is attributable to the value of UTP's interest in LTP, because 120x dollars, the value of UTP's interest in LTP, is 60 percent of 200x dollars, the total value of UTP's property. Thus, 10x dollars, the difference between the 30x dollars attributable to the value of UTP's interest in LTP and 20x dollars, E's proportionate share of UTP's basis in LTP, is a special basis adjustment to UTP's interest in LTP. This adjustment gives E an adjusted basis of 30x dollars in UTP's in LTP. The remaining 10x dollars of the 20x dollar special basis adjustment is allocated to the adjusted basis of UTP's inventory. This gives E a 20x dollar adjusted basis in UTP's inventory.

Because UTP made a section 26 USC 754 election manifesting an intent to be treated as an aggregate for purposes of sections 26 USC 754 and 26 USC 743, it is appropriate, for purposes of section 26 USC 743 and 26 USC 754, to treat the sale of A's partnership interest in UTP as a deemed sale of an interest in LTP. The selling price of E's share of UTP's interest in LTP is deemed to equal E's share of UTP's adjusted basis in LTP, 30x dollars (1/4 of 80x dollars plus 10x dollars, E's special basis adjustment). Further, this deemed sale of an interest in LTP triggers the application of section 26 USC 743(b) to LTP. Because LTP made a valid section 26 USC 754 election, under section 26 USC 743(b) LTP must increase the adjusted basis of its partnership property by 2.5x dollars, the excess of E's share of UTP's adjusted basis in LTP (30x dollars) over E's share of the adjusted basis of LTP's property (1/4 of 110x dollars, or 27.5 dollars). Section 26 USC 755 applies to LTP to allocate this basis adjustment, but because LTP has only one asset, no allocation is necessary. The 2.5x dollar adjustment must be segregated and allocated solely to UTP and E, the transferee partner of UTP.

SITUATION 2
UTP has made a valid section 26 USC 754 election. Thus, as in SITUATION 1, E gets an adjusted basis of 30x dollars in UTP's interest in LTP and an adjusted basis of 20x dollars in UTP's inventory. Also, as in SITUATION 1, because UTP made a section 26 USC 754 election, it is appropriate, for purposes of sections 26 USC 754 and 26 USC 743, to treat the sale of A's interest in UTP as the sale of an interest in LTP. However, in this situation, LTP does not have a section 26 USC 754 election in effect. That is, under section 26 USC 743(a), LTP chose not to have the basis of its property adjusted as the result of the transfer of an interest in it. Thus, E's purchase of a partnership interest in UTP has no effect on LTP's adjusted basis in its property.

SITUATION 3
LTP has made a valid election under section 26 USC 754, but UTP does not make a section 26 USC 754 election. On the sale by A of an interest in UTP, E succeeds to A's 20x dollar adjusted basis in UTP's interest in LTP and to A's 10x dollar adjusted basis in UTP's inventory. E succeeds to these bases because, by not making a section 26 USC 754 election, UTP chose not to have the basis of its property adjusted as the result of the transfer of an interest in UTP.

In addition, by not making a section 26 USC 754 election, UTP manifested an intent to be treated as an entity for purposes of sections 26 USC 754 and 26 USC 743. Thus, it is inappropriate, for purposes of sections 26 USC 754 and 26 USC 743, to treat A's sale of an interest in UTP as the sale of an interest in LTP. Consequently, UTP cannot increase E's share of the basis of LTP's property. Nevertheless, LTP's section 26 USC 754 election is not meaningless. If UTP were to sell its partnership interest in LTP, the purchaser's share of the adjusted basis of LTP's assets would be adjusted.

HOLDINGS

SITUATION 1
Upon the sale of A's partnership interest in UTP, the transferee's (E's) shares of UTP's adjusted basis in its assets is adjusted by the amount by which the basis in E's partnership interest differs from E's share of UTP's adjusted basis in its assets. In addition, E's share of LTP's adjusted basis in its assets is adjusted by the amount by which E's share of UTP's adjusted basis in LTP differs from E's share of the adjusted basis of LTP's property.

SITUATION 2
Upon the sale of A's partnership interest in UTP, E's share of UTP's adjusted basis in its assets is adjusted by the amount by which the basis in E's partnership interest differs from E's share of UTP's adjusted basis in its assets. However, because LTP did not make a section 26 USC 754 election, the transfer does not affect LTP's adjusted basis in its property.

SITUATION 3
The sale of A's partnership interest in UTP does not affect either UTP's adjusted basis in its property or LTP's adjusted basis in its property.

EFFECT ON OTHER REVENUE RULINGS.
Rev. Rul. 78-2 is clarified and amplified.
 


Rev. Rul. 91-26 partner compensation (no form W-2 is to be issued to partners nor to sole-proprietors):

Rev. Rul. 91-26 "Section 26 USC 707(c) of the Code provides that payments to a partner for services, to the extent the payments are determined without regard to the income of the partnership, are considered as made to one who is not a member of the partnership, but only for purposes of section 26 USC 61(a) (relating to gross income)and, subject to section 26 USC 263 (prohibiting deductions for capital expenditures), for purposes of section 26 USC 162(a) (relating to trade or business expenses). These payments are termed 'guaranteed payments.'"

Regs. §1.707-1(c) "a partner who receives guaranteed payments is not regarded as an employee of the partnership for the purposes of withholding of tax at source, deferred compensation plans, etc."

Rev. Rul. 81-300  "the statutory test for a guaranteed payment, that it be 'determined without regard to the income of the partnership'"

Rev. Rul. 81-300  "Section 26 USC 707(c) of the Code provides that to the extent determined without regard to the income of the partnership, payments to a partner for services, termed "guaranteed payments", shall be considered as made to one who is not a member of the partnership, but only for purposes of section 26 USC 61(a) and, subject to section 26 USC 263, for purposes of section 26 USC 162(a)."

Rev. Rul. 81-301  "Section 26 USC 707(c) of the Code provides that to the extent determined without regard to the income of the partnership, payments to a partner for services shall be considered as made to one who is not a member of the partnership, but only for purposes of section 26 USC 61(a) and, subject to section 26 USC 263, for purposes of section 26 USC 162(a). "

Rev. Rul. 69-184  "26 CFR 31.3121(d)-1: Who are employees.   Bona fide members of a partnership are not employees of the partnership within the meaning of the Federal Insurance Contributions Act, the Federal Unemployment Tax Act, and the Collection of Income Tax at Source on Wages (chapters 21, 23, and 24, respectively, subtitle C, Internal Revenue Code of 1954).  Such a partner who devotes his time and energies in the conduct of the trade or business of the partnership, or in providing services to the partnership as an independent contractor, is, in either event, a self-employed individual rather than an individual who, under the usual common law rules applicable in determining the employer-employee relationship, has the status of an employee. Sections 26 USC 1402(a) and 26 USC 3121(d)(2) of the Code."

Rev. Rul. 69-184  "Remuneration received by a partner from the partnership is not "wages" with respect to "employment" and therefore is not subject to the taxes imposed by the Federal Insurance Contributions Act and the Federal Unemployment Tax Act. Such remuneration also is not subject to Federal income tax withholding."

Rev. Rul. 69-183  "An individual is an employee for Federal employment tax purposes if he has the status of employee under the usual common law rules applicable in determining the employer-employee relationship. Guides for determining that status are found in three substantially similar sections of the Employment Tax Regulations: namely, sections 26 CFR 31.3121(d)-1(c), 26 CFR 31.3306(i)-1, and 26 CFR 31.3401(c)-1."

Rev. Rul. 72-467  "The right to discharge is also an important factor indicating that the person possessing that right is an employer. If the relationship of employer and employee exists, the designation or description of the relationship by the parties as anything other than employer and employee is immaterial. Thus, if such relationship exists, it is of no consequence that the employee is designated as a partner, co-adventurer, agent, independent contractor, or the like."


 Also see:
IR Code §707(a)(2)(a)
Reg. §1.707-1
Reg. §301.7701-2 (c)(2)(iv)(C)(iii)
Rev. Rul. 56-678
Rev. Rul. 69-184
http://www.taxresourcegroup.com/library/memo/1373.html
http://www.laweasy.com/t/20070702152956/limited-liability-companies-and-self-employment-tax
http://conferences.aicpa.org/ebp04/downloads/ses39,46.pdf

Rev. Rul. 72-596
Estate of Tilton 8 BTA at 917

 

THE FOLLOWING IS TEMPORARY (to be edited in the future)
§1.707-1(a) provides that a partner who engages in a transaction with a partnership other than in the capacity of a partner shall be treated as if the partner were not a member of the partnership with respect to such transaction. Such transactions include the rendering of services by the partner to the partnership and that the substance of the transaction will govern rather than its form.

§707(c) provides that to the extent determined without regard to the income of the partnership, payments to a partner for services, termed "guaranteed payments," shall be considered as made to one who is not a member of the partnership, but only for purposes of §61(a) and, subject to §263, for purposes of §162(a). If the payments were not termed "guaranteed payments," nor were they made in the capacity of a partner, then, maybe they were wages for services and should be treated as such for withholding and social security taxes. I believe for there to be guaranteed payments there needs to be a provision covering the payments in the partnership agreement.

Jerry DILTS, Barbara Dilts, Plaintiffs, v. UNITED STATES of America, Defendant. United States District Court, D. Wyoming. 845 F.Supp. 1505 No. 93-CV-1001-B. March 11, 1994. "In Armstrong , the taxpayer was a partner in a partnership which owned a 50,000 acre cattle ranch. The partnership provided a home at the ranch for the taxpayer and his family and purchased most of their groceries and utilities, insurance for the house, and maid service. The taxpayer did not include the value of those benefits in his income. In remanding the case for further consideration, the Fifth Circuit Court of Appeals held that, under IRC § 707(a), a partner could be an employer of his partnership. Section 707(a) provides that a partner who "engages in a transaction with the partnership other than in his capacity as a member of such partnership, . . . except as otherwise provided in this section, [shall] be considered as . . . one who is not a partner." The court stated that: The terms "outsider" and "one who is not a partner" are not defined by Congress; neither is the relationship between § 707 and other sections of the Code explained. However, we have found nothing to indicate that Congress intended that this section not relate to § 119. Consequently, it is now possible for a partner to stand in any on of a number of relationships with his partnership, including those of creditor-debtor, vendor-vendee, and employee-employer.

§ 1.707-1 Transactions between partner and partnership.

(a) Partner not acting in capacity as partner. A partner who engages in a transaction with a partnership other than in his capacity as a partner shall be treated as if he were not a member of the partnership with respect to such transaction. Such transactions include, for example, loans of money or property by the partnership to the partner or by the partner to the partnership, the sale of property by the partner to the partnership, the purchase of property by the partner from the partnership, and the rendering of services by the partnership to the partner or by the partner to the partnership. Where a partner retains the ownership of property but allows the partnership to use such separately owned property for partnership purposes (for example, to obtain credit or to secure firm creditors by guaranty, pledge, or other agreement) the transaction is treated as one between a partnership and a partner not acting in his capacity as a partner. However, transfers of money or property by a partner to a partnership as contributions, or transfers of money or property by a partnership to a partner as distributions, are not transactions included within the provisions of this section. In all cases, the substance of the transaction will govern rather than its form. See paragraph(c)(3) of §1.731-1.


§704(b) Partner's distributive share of income and loss:

704(a) Effect of partnership agreement.-
A partner’s distributive share of income, gain, loss, deduction, or credit shall, except as otherwise provided in this chapter, be determined by the partnership agreement.

704(b) Determination of distributive share.-
A partner’s distributive share of income, gain, loss, deduction, or credit (or item thereof) shall be determined in accordance with the partner’s interest in the partnership (determined by taking into account all facts and circumstances), if-

(1)the partnership agreement does not provide as to the partner’s distributive share of income, gain, loss, deduction, or credit (or item thereof), or

(2) the allocation to a partner under the agreement of income, gain, loss, deduction, or credit (or item thereof) does not have substantial economic effect.


704(c) Contributed property
(1) In general
Under regulations prescribed by the Secretary.-
(A) income, gain, loss, and deduction with respect to property contributed to the partnership by a partner shall be shared among the partners so as to take account of the variation between the basis of the property to the partnership and its fair market value at the time of contribution,


Reverse 704(c) revaluations (Audit Technique Guide)

A new partner who pays a FMV for a partnership interest will ordinarily not want to be taxed on the built-in gain that accrued in the partnership’s assets prior to the time of his arrival. Similarly, the existing partners will not want to allocate losses to the new partner that arose prior to his arrival. While IRC section 704(c) deals with newly contributed property, "reverse" IRC section 704(c) requires that the existing partners be taxed on the appreciation or depreciation that occurred prior to the admission of a new partner. See Treas. Reg. section 1.704-3(a)(6).

Assuming that the partnership follows the capital account maintenance rules, the entry of a new partner by contribution will ordinarily result in the restatement of the partnership’s book capital accounts to reflect the FMV of partnership assets. In partnership jargon, these restatements to FMV are usually referred to as "book-ups" or "book-downs." Since assets (other than cash) typically gain or lose value over time, there will likely be a disparity between the book and tax capital accounts of the existing partners, analogous to the book/tax disparity of a partner who contributes property with a built-in gain or loss.

All of the principles of IRC section 704(c) previously discussed are applied in this situation. The difference from the prior examples is that the "existing partners" are in the same position as the "contributing partner" and the "new partner" is analogous to the "noncontributing partner" (thus the term "reverse" IRC section 704(c) allocations). For example, the new partner will want to be allocated the amount of depreciation or amortization that he/she "paid" for; however, under the traditional method, the ceiling rule may prevent this.




§704(e) Family Partnerships:

704(e)(1) Recognition of interest created by purchase or gift.-
A person shall be recognized as a partner for purposes of this subtitle if he owns a capital interest in a partnership in which capital is a material income-producing factor, whether or not such interest was derived by purchase or gift from any other person.

704(e)(2) Distributive share of donee includible in gross income.-

In the case of any partnership interest created by gift, the distributive share of the donee under the partnership agreement shall be includible in his gross income, except to the extent that such share is determined without allowance of reasonable compensation for services rendered to the partnership by the donor, and except to the extent that the portion of such share attributable to donated capital is proportionately greater than the share of the donor attributable to the donor's capital. The distributive share of a partner in the earnings of the partnership shall not be diminished because of absence due to military service.

704(e)(3) Purchase of interest by member of family.-

For purposes of this section, an interest purchased by one member of a family from another shall be considered to be created by gift from the seller, and the fair market value of the purchased interest shall be considered to be donated capital. The "family" of any individual shall include only his spouse, ancestors, and lineal descendants, and any trusts for the primary benefit of such persons.





§707(c) Guaranteed Payments to Partners (GPP):

707(c) Guaranteed payments
To the extent determined without regard to the income of the partnership, payments to a partner for services or the use of capital shall be considered as made to one who is not a member of the partnership, but only for the purposes of section 61 (a) (relating to gross income) and, subject to section 263, for purposes of section 162 (a) (relating to trade or business expenses).
http://www.law.cornell.edu/uscode/text/26/707

Partnership - Audit Technique Guide (December 2002)
Guaranteed Payments ─ IRC section 707(c)

A guaranteed payment is deducted in the computation of partnership income.  Accordingly, it is considered a payment made to one who is not a member of the partnership and is deducted in full, just as if it were an ordinary expense under IRC section 162.  A guaranteed payment is an amount paid to a partner that is determined without regard to the partnership income and is made to a partner acting in his or her capacity as a partner.  Additionally, the amount paid must be deductible under IRC section 162 as an ordinary business expense.  Thus, illegal payments or payments that are capitalizable are not deductible under IRC section 707(c).

Prior to 1976 many taxpayers interpreted the law as providing that guaranteed payments were automatically deductible.  In 1976 IRC section 707(c) was amended to specifically hold that if the payment is a capital expense under IRC section 263 it must be considered as made to one who is not a member of the partnership.  Accordingly, it must be capitalized and is not automatically deductible.  At the same time, IRC section 709 was added and it became evident that a taxpayer cannot convert organization and syndication expenses into a current deduction by casting the payment as a guaranteed payment.

It is sometimes difficult to distinguish between payments to partners which fall under IRC section 707(a)(partner not acting in capacity as partner), and those which are governed by IRC section 707(c) (guaranteed payments).

  • The determining factor is whether the partner is acting other than in his or her capacity as a member of the partnership.
  • Generally, if the partner performs a service for the partnership that he/she also performs for others (such as an attorney, architect, stockbroker, etc.), payments will be deducted or capitalized by the partnership under IRC section 707(a).
  • However, if he or she works exclusively or primarily for the partnership, payments are more likely to be treated as guaranteed payments per IRC section 707(c) (if not based on partnership income) or as his or her distributive share under IRC section 702(a) (if based on partnership income).

Whether the payment is under IRC section 707(a) (payment to a partner not acting in his or her capacity as a partner), or under IRC section 707(c) (guaranteed payment), it cannot be treated as a distribution of partnership profits.  Also, if it is paid for any capital item, it cannot be expensed.

So why even make the distinction between IRC section 707(a) and IRC section 707(c)?  One of the most important reasons is the timing of receipt of income by the partner.  Guaranteed payments are always includable in the partner's taxable income as of the end of the tax year in which the partnership deducts or capitalizes the payment.  On the other hand, payments made under IRC section 707(a), and considered paid to a non-partner, retain their character and timing based on the nature of the payment and the accounting method of the partner as previously shown in Example 2-4.

http://www.irs.gov/Businesses/Partnerships/Partnership---Audit-Technique-Guide---Chapter-2---Initial-Year-Return-Issues-(Published-12-2002)#10

IRS Publication 541 - Partnerships (December 2013)
Guaranteed Payments

Guaranteed payments are those made by a partnership to a partner that are determined without regard to the partnership's income. A partnership treats guaranteed payments for services, or for the use of capital, as if they were made to a person who is not a partner. This treatment is for purposes of determining gross income and deductible business expenses only. For other tax purposes, guaranteed payments are treated as a partner's distributive share of ordinary income. Guaranteed payments are not subject to income tax withholding.

The partnership generally deducts guaranteed payments on line 10 of Form 1065 as a business expense. They are also listed on Schedules K and K-1 of the partnership return. The individual partner reports guaranteed payments on Schedule E (Form 1040) as ordinary income, along with his or her distributive share of the partnership's other ordinary income.

Guaranteed payments made to partners for organizing the partnership or syndicating interests in the partnership are capital expenses. Generally, organizational and syndication expenses are not deductible by the partnership. However, a partnership can elect to deduct a portion of its organizational expenses and amortize the remaining expenses (see Business start-up and organizational costs in the Instructions for Form 1065). Organizational expenses (if the election is not made) and syndication expenses paid to partners must be reported on the partners' Schedule K-1 as guaranteed payments.

http://www.irs.gov/publications/p541/ar02.html#en_US_201312_publink1000104261

 



TEFRA POA and POA issues:

Power of Attorney (POA), Form 2848

IRM 4.31.2.2.5   Power of Attorney (POA) Appointed by the Tax Matters Partner.
  1. A TMP may appoint a power of attorney (POA) to represent the partnership before the Service and to perform all acts for the partnership except for the execution of "legally significant documents" . The term "legally significant documents" includes, but is not limited to:

    1. A settlement agreement entered into pursuant to IRC 6224(c)(3) when the TMP is binding certain other partners (e.g., non-notice partners), including a formal closing agreement pursuant to IRC 7121; and

    2. An extension of the limitation period for assessment with respect to partnership items. The appointment of a POA may not meet the requirements of Treas. Reg. 301.6229(b)-1 for purposes of the POA being a person authorized in writing to sign a statute extension.

  2. Other situations in which it is necessary to deal directly with the duly designated TMP rather than the POA include, but are not limited to, mailing of required notices, such as NBAPs or FPAAs. However, a copy of the notice will also be mailed to the POA, but it should not be sent using certified mail.

  3. Form 2848, Power of Attorney and Declaration of Representative, should be completed as follows:

    1. The TMP should execute the POA in his or her capacity as TMP;

    2. The name and address of the entity should be clearly set forth;

    3. Under the heading "Type of Tax" , insert "TEFRA partnership proceedings" ; and

    4. Under the heading "Federal Tax Form Number" , enter "Form 1065 and consequential adjustments" .

  4. The POA for a TEFRA partnership becomes null and void upon the death of the duly designated TMP. A new TMP must be designated and a new POA executed.

 

IRS Publication 216, Sections 601-501 through 601-509 of Subpart E Conference and Practice Requirements:
http://www.irs.gov/pub/irs-pdf/p216.pdf
http://www.unclefed.com/IRS-Forms/PubsForTaxPros/p216.pdf



IRM 2.2.31 - Section 31. Command Codes CFINK , RPINK, KAFFQ and KAFTQ for CAF Inquiry
IRS may run the CFINK command on IDRS to show the POA is on file and they should honor it.  It’s just a transcript with no scanned images of the POA but accepted by another unit of the IRS.

 


8.1.6.1 (10-23-2007)
Practice Before Appeals

  1. Each Appeals Officer or Settlement Officer will verify the conference and practice requirements are met before disclosing confidential taxpayer information or allowing practice before Appeals. Disclosure rules and conference/practice requirements are identified in the following publications, regulation sections, IRM sections and IRC section:

    1. IRC 6103, Confidentiality and Disclosure of Returns and Return Information;

    2. IRM 11.3, Disclosure of Official Information;

    3. Treasury Regulation Sections 601.501 through 601.509, Conference and Practice Requirements(26 C.F.R. 601.501 through 26 C.F.R 601.509 and Publication 216);

    4. Treasury Department 230, Regulations Governing the Practice for Attorneys, Certified Public Accountants, Enrolled Agents, Enrolled Actuaries, and Appraisers before the Internal Revenue Service(31 C.F.R Subtitle A, Part 10, revised as of June 20, 2005);

    5. Witnesses at Conferences ( Rev. Proc. 68-29, 1968-2 C.B., 913);

    6. IRC 21.3.7, Processing Third Party Authorizations to the Centralized Authorization File (CAF);and

    7. Publication 947, Practice Before the IRS and Power of Attorney.

  2. IRM 11.3.3, Distinctions Between Disclosure to Designees and the Conference and Practice Requirements compares the effect of a Form 8821,Tax Information Authorization, with a Form 2848. These two forms are sometimes confused.

8.1.6.1.1 (10-23-2007)
Disclosure of Information— Department of Justice

  1. Tax returns and related data are open to inspection by a United States Attorney or an attorney of the Department of Justice only if they file a proper written application. See IRM 11.3, Disclosure of Official Information. This procedure also applies to other Justice Department employees such as Federal Bureau of Investigation agents. An application is unnecessary in an income tax case being litigated by the Department of Justice, but adequate receipts must be obtained for the material furnished. An application signed by the Chief of the Organized Crime and Racketeering Section does not meet the requirements.

8.1.6.1.2 (10-23-2007)
Disclosure of Information of a Confidential Nature

  1. Generally, confidential taxpayer information can only be disclosed upon a taxpayer's written authorization. Frequently encountered exceptions include:

    1. Representatives without a power of attorney or tax information authorization at a conference with the taxpayer;

    2. Estates, trusts and receiverships may be represented by their trustees, receiver, guardians, executors, or regular full-time employees;

    3. Committees of Congress, Treasury personnel outside the Service, other Federal agencies and States;

    4. Witnesses at Conferences . See Rev. Proc. 68-29, 1968-2 C.B., 913;

    5. Counsel of Record before the United States Tax Court; and

    6. Others as defined in Section 10.7 of Circular 230.

8.1.6.1.2.1 (10-23-2007)
Disclosure of Information - Informants

  1. The identity of informants shall not be disclosed to any Service official or employee except on a "need-to-know" basis in the performance of official duties.

  2. If you can avoid it, do not give any clues as to the existence or identity of an informant in an appeals case memo. If necessary, write essential information in a separate supplemental memorandum subject to security requirements. Do not place a copy in the administrative file or mail it to the Appeals Area Director or the Chief, Appeals, unless specifically requested.

8.1.6.1.2.2 (10-23-2007)
Authorizations to Disclose Information of a Confidential Nature - Forms 2848 and 8821

  1. Form 2848, Power of Attorney and Declaration of Representative or Form 8821, Tax Information Authorization, or other documents meeting the requirements of IRC 6103 may authorize a third party to receive or inspect confidential taxpayer information.

8.1.6.1.3 (10-23-2007)
Representatives Qualified to Practice Before Appeals

  1. Qualifications for Practice Before the Internal Revenue Service are defined in Circular No. 230, Regulations Governing the Practice of Attorneys, Certified Public Accountants, Enrolled Agents, Enrolled Actuaries, and Appraisers before the Internal Revenue Service, and 26 CFR 601.501–509 inclusive.

  2. Sections 10.5(c) and 10.7, Circular 230, permit defined individuals to practice without enrollment.

  3. Section 10.7(d) of Circular 230 permits the Director, Office of Professional Responsibility, to authorize individuals otherwise ineligible to practice to represent another person in a particular matter. Individuals authorized to practice under this provision are subject to the conditions set forth by the Director in his letter authorizing practice.

    1. Students working in a Low Income Taxpayer Clinic (LITC) or Student Tax Clinic Program (STCP) may represent taxpayers under a special order by the Director, Office of Professional Responsibility. The instructions to Form 2848, Power of Attorney and Declaration of Representative, require that such students attach a copy of the letter from the Office of Professional Responsibility authorizing practice before the Internal Revenue Service. Students who have been authorized to practice by special order may, subject to any limitations set forth in the letter from the Office of Professional Responsibility, represent taxpayers before any IRS office and should be viewed the same as any other taxpayer’s representative for which a Form 2848has been submitted.

8.1.6.1.3.1 (10-23-2007)
Prohibitions of Federal and State Officials or Employees in Representing Taxpayers Before the Service

  1. If a Federal or State official or employee appears to be representing a taxpayer under circumstances indicating a possible violation of Circular 230's provisions, Service employees should advise such individual concerning the existence and content of Circular 230. See sections 10.3(f) and (g) of Circular 230.

8.1.6.1.3.2 (10-23-2007)
Attorneys, Certified Public Accountants, Enrollees, Limited Practice and Special Orders

  1. Practice before the IRS includes all matters connected with a presentation to the IRS relating to a client's rights, privileges, or liabilities under laws or regulations administered by the IRS. Such presentations include preparing and filing necessary documents, corresponding and communicating with the IRS, and representing a client at conferences, hearings, and meetings. An individual who practices is a representative. In order for the IRS to recognize an individual as a representative, he or she must present evidence of representational authority.

  2. The following publications and forms are useful sources of information concerning practice before the IRS and powers of attorney.

    1. Treasury Department Circular No. 230, " Regulations Governing the Practice of Attorneys, Certified Public Accountants, Enrolled Agents, Enrolled Actuaries, and Appraisers Before the Internal Revenue Service". Circular 230 is a pamphlet publication of 31 C.F.R. Part 10.

    2. Publication 216, "Conference and Practice Requirements" . This publication sets out the rules applicable to recognition as a representative, including the requirements for powers of attorney. Publication 216 is a pamphlet publication of 26 C.F.R. 601.501 through 601.509.

    3. Publication 470, "Limited Practice Without Enrollment" . This publication sets out the rules applicable to limited practice by unenrolled return preparers. Publication 470 is a pamphlet publication of Rev. Proc. 81-38.

    4. Rev. Proc. 68-29 explains the function of witnesses.

    5. Form 2848, Power of Attorney and Declaration of Representative. The separately published four-page Form 2848. Instructions provide useful information concerning the validity of Form 2848.

    6. Form 8821, "Tax Information Authorization "

    7. Form 56, "Notice Concerning Fiduciary Relationship".

  3. In the event an authorized representative is not evident from the case file, the Appeals or Settlement Officer should make an effort to identify the authorized representative either by contacting the taxpayer, researching IDRS for a Centralized Authorization File (CAF) number via command code CFINK, or by any other means deemed appropriate. Special care should be taken to ensure that the rules of disclosure, as discussed in IRM 11.3, Disclosure of Official Information, are not violated when identifying an authorized representative.

8.1.6.1.3.3 (10-23-2007)
Powers, Authorizations, Declarations— Form 2848

  1. While other statements can be used, Form 2848, Power of Attorney and Declaration of Representative, is convenient.

    1. The form has declarations as to current qualifications.

    2. The form authorizes disclosures of information of a confidential nature.

    3. The form provides optional authorizations to perform various other acts for the taxpayer.

8.1.6.1.4 (10-23-2007)
Disposition of Powers of Attorney

  1. When you receive a new Form 8821 or Form 2848 during the consideration of a case by Appeals, you should make a copy and forward it directly to the appropriate service center function for processing.

    Note:

    Refer to Form 2848 and Form 8821 to determine "where to file" the forms, and the attached instructions on each form for what specific information is needed. Before you forward the form, handwrite the Appeals Office symbols and address in the top margin. Each service center will process the power of attorney for inclusion in their power of attorney files.

http://www.taxhelpattorney.com/irs/irm_08-001-006-d0e10.html

 


 

§ 301.6229(b)-1   Extension by agreement.

(a) In general. Any partnership may authorize any person to extend the period described in section 6229(a) with respect to all partners by filing a statement to that effect with the service center where the partnership return is filed (but, if the notice described in section 6223(a)(1) (beginning of an administrative proceeding) has already been mailed to the tax matters partner, the statement should be filed with the Internal Revenue Service office that mailed such notice). The statement shall-

(1) Provide that it is an authorization for a person other than the tax matters partner to extend the assessment period with respect to all partners;

(2) Identify the partnership and the person being authorized by name, address, and taxpayer identification number;

(3) Specify the partnership taxable year or years for which the authorization is effective; and

(4) Be signed by all persons who were general partners (or, in the case of an LLC, member-managers, as those terms are defined in §301.6231(a)(7)-2(b)) at any time during the year or years for which the authorization is effective.

(b) Effective date. This section is applicable to partnership taxable years beginning on or after October 4, 2001. For years beginning prior to October 4, 2001, see §301.6229(b)-1T contained in 26 CFR part 1, revised April 1, 2001.

 

§ 301.6231(a)(7)-2   Designation or selection of tax matters partner for a limited liability company (LLC).

(a) In general. Solely for purposes of applying section 6231(a)(7) and §301.6231(a)(7)-1 to an LLC, only a member-manager of an LLC is treated as a general partner, and a member of an LLC who is not a member-manager is treated as a partner other than a general partner.

(b) Definitions -  (1) LLC. Solely for purposes of this section, LLC  means an organization-

(i) Formed under a law that allows the limitation of the liability of all members for the organization's debts and other obligations within the meaning of §301.7701-3(b)(2)(ii); and

(ii) Classified as a partnership for Federal tax purposes.

(2) Member. Solely for purposes of this section, member means any person who owns an interest in an LLC.

(3) Member-manager. Solely for purposes of this section, member-manager means a member of an LLC who, alone or together with others, is vested with the continuing exclusive authority to make the management decisions necessary to conduct the business for which the organization was formed. Generally, an LLC statute may permit the LLC to choose management by one or more managers (whether or not members) or by all of the members. If there are no elected or designated member-managers (as so defined in this paragraph (b)(3)) of the LLC, each member will be treated as a member-manager for purposes of this section.



IRS CPE text, circa 1986


Electing Investment Partnership (EIP):

Contribution of assets to partnership with built-in losses.

 Each K-1 must disclose information regarding transferors and transferees.


§743(E)
IRS Notice 2005-32.





Entity Classification Election: 
see form 8832 and form 2553

Eligible entity are defined in §301.7701-3(a)In general. A business entity that is not classified as a corporation under section 301.7701-2(b)(1), (3), (4), (5), (6), (7), or (8) (an eligible entity) can elect its classification for federal tax purposes as provided in this section. An eligible entity with at least two members can elect to be classified as either an association (and thus a corporation under section 301.7701-2(b)(2)) or a partnership, and an eligible entity with a single owner can elect to be classified as an association or to be disregarded as an entity separate from its owner. Paragraph (b) of this section provides a default classification for an eligible entity that does not make an election. Thus, elections are necessary only when an eligible entity chooses to be classified initially as other than the default classification or when an eligible entity chooses to change its classification. An entity whose classification is determined under the default classification retains that classification (regardless of any changes in the members' liability that occurs at any time during the time that the entity's classification is relevant as defined in paragraph (d) of this section) until the entity makes an election to change that classification under paragraph (c)(1) of this section. Paragraph (c) of this section provides rules for making express elections. Paragraph (d) of this section provides special rules for foreign eligible entities. Paragraph (e) of this section provides special rules for classifying entities resulting from partnership terminations and divisions under section 708(b). Paragraph (f) of this section sets forth the effective date of this section and a special rule relating to prior periods. . . .

§301.7701-2(a) Business entities. For purposes of this section and section 301.7701-3, a business entity is any entity recognized for federal tax purposes (including an entity with a single owner that may be disregarded as an entity separate from its owner under section 301.7701-3) that is not properly classified as a trust under section 301.7701-4 or otherwise subject to special treatment under the Internal Revenue Code. A business entity with two or more members is classified for federal tax purposes as either a corporation or a partnership. A business entity with only one owner is classified as a corporation or is disregarded; if the entity is disregarded, its activities are treated in the same manner as a sole proprietorship, branch, or division of the owner.

§301.7701-1(a)(1) Organizations for federal tax purposes.  (1) In general. The Internal Revenue Code prescribes the classification of various organizations for federal tax purposes. Whether an organization is an entity separate from its owners for federal tax purposes is a matter of federal tax law and does not depend on whether the organization is recognized as an entity under local law.

§301.7701-3(f) Changes in number of members of an entity --
(1) Associations. The classification of an eligible entity as an association is not affected by any change in the number of members of the entity.
(2) Partnerships and single member entities. An eligible entity classified as a partnership becomes disregarded as an entity separate from its owner when the entity's membership is reduced to one member. A single member entity disregarded as an entity separate from its owner is classified as a partnership when the entity has more than one member. If an elective classification change under paragraph (c) of this section is effective at the same time as a membership change described in this paragraph (f)(2), the deemed transactions in paragraph (g) of this section resulting from the elective change preempt the transactions that would result from the change in membership.

Open question: Can a sole proprietorship (a Schedule C) elect to file form 1120S pursuant to the definition at §301.7701-3(a)?  A sole proprietorship files its own Sch. C, E or F (as appropriate), it can adopt its own method of accounting, etc.   Therefore it is a business entity for federal tax purposes. 

Or as a fall-back position, a husband and wife join as partners, the partnership elects to file form 1120S and then pursuant to §301.7701-3(f) one spouse exits leaving just one owner.

Open question: Can the sole proprietorship (a Schedule C) elect to file form 1120S retroactively, pursuant to Rev. Proc. 2009-41, Sec 4.01 due to the fact that the eligible entity has reasonable cause for its failure to timely make the entity classification election? And also elect Sec 475(f) M2M pursuant to Rev. Proc. 99-17 Sec 5.03(2)?

Conclusion: after discussion with Office of the Chief Counsel (IRM Handbook)  (IRM Mission Statement) is that a sole proprietorship (a Schedule C) electing to file 1120S would likely be challenged by the IRS, perhaps a couple years after-the-fact, and therefore it is probably best avoided.  Of course a sole proprietorship (a Schedule C) could form a SMLLC and then the SMLLC may file form 2553 to elect to file 1120S. 

§301.7701-3(g)(1)(iv) Disregarded entity to an association. If an eligible entity that is disregarded as an entity separate from its owner elects under paragraph (c)(1)(i) of this section to be classified as an association, the following is deemed to occur: The owner of the eligible entity contributes all of the assets and liabilities of the entity to the association in exchange for stock of the association.  

There are no solid answers.  Taxpayer beware and take careful consideration and planning before proceeding.

 

Rev. Rul. 2004-77
Disregarded entities. This ruling concludes that, if an eligible entity has two owners under local law, but one of the owners is, for federal tax purposes, disregarded as an entity separate from the other owner of the eligible entity, then the eligible entity cannot be classified as a partnership and is either disregarded as an entity separate from its owner or an association taxable as a corporation.

If an eligible entity has two members under local law, but one of the members of the eligible entity is, for federal tax purposes, disregarded as an entity separate from the other member of the eligible entity, then the eligible entity cannot be classified as a partnership and is either disregarded as an entity separate from its owner or an association taxable as a corporation.

 

Also see Rev. Proc. 2009-41, 2009-39 .R.B. (9/28/2009) below

Also see Rev. Proc. 2007-62, 2007-166 I.R.B. (10/9/2007) below

Also see Rev. Proc. 2004-48, 2004-32 I.R.B. 172 (8/9/2004) below

Also see Rev. Proc. 2003-43, 2003-23 I.R.B. 998 (6/9/2003) below

Also see IRS Publication 1635 Employer Identification Number

Also see IRS FAQ 12 from 2006

Also see IRS FAQ

Also see IRS Form SS-4 Instructions

Also see IRS Form SS-4 & Employer Identification Number (EIN)

Also see IRS "Do You Need a New EIN?"



S-Corp election: Rev. Proc. 2013-30 (effective 9/3/2013) late election of S-Corp status:

Under the procedure, S corporations that meet the following requirements are not subject to the three-year, 75-day deadline, but instead have no time limit on requesting relief:

  • The corporation is not seeking a late corporate entity classification election;
  • The corporation fails to qualify as an S corporation solely because Form 2553 was not timely filed;
  • The corporation and all of its shareholders reported their income consistent with S corporation status for the year the election should have been made and all later years;
  • At least six months have passed since the corporation filed its first S corporation year tax return;
  • The IRS did not notify the corporation and the shareholders of any problem with the S corporation status within six months after the return was filed; and
  • The completed election form includes statements from all shareholders from the date the election was to have been effective to the date of the filing stating that they have reported their income consistent with S corporation status. 

Rev. Proc. 2013-30




OLD S-Corp election: Rev. Proc. 2007-62, 2007-166 I.R.B. (10/9/2007) late election of S-Corp status:
Rev. Proc. 2007-62,

SECTION 1. PURPOSE
This revenue procedure provides an additional simplified method for taxpayers to request relief for late S corporation elections and supplements Rev. Proc. 2003-43, 2003-1 C.B. 998. In addition, this revenue procedure provides a simplified method for taxpayers to request relief for a late S corporation election and a late corporate classification election intended to be effective on the same date that the S corporation election was intended to be effective and supplements Rev. Proc. 2004-48, 2004-2, C.B. 172. Generally, this revenue procedure provides that certain eligible entities may be granted relief if the entity satisfies the requirements of sections 4 or 5 (as applicable) of this revenue procedure.

SECTION 2. BACKGROUND
.01 S Corporation Elections.
(1) In General. Section 1361(a)(1) of the Internal Revenue Code (Code) provides that the term "S corporation" means, with respect to any taxable year, a small business corporation for which an election under § 1362(a) is in effect for that year. Section 1362(b)(1) provides that a small business corporation may make an election to be an S corporation for any taxable year (A) at any time during the preceding taxable year, or (B) at any time during the taxable year and on or before the 15th day of the 3rd month of the taxable year. Section 1.1362-6(a)(2) of the Income Tax Regulations provides that a small business corporation makes an election to be an S corporation by filing a completed Form 2553, Election by a Small Business Corporation. Under ' 1362(b)(3), if an S corporation election is made after the 15th day of the 3rd month of the taxable year and on or before the 15th day of the 3rd month of the following taxable year, then the S corporation election is treated as made for the following taxable year.

(2) Late S Corporation Elections. Section 1362(b)(5) provides that if (A) an election under ' 1362(a) is made for any taxable year (determined without regard to ' 1362(b)(3)) after the date prescribed by ' 1362(b) for making the election for the taxable year or no election is made for any taxable year, and (B) the Secretary determines that there was reasonable cause for the failure to timely make the election, the Secretary may treat the election as timely made for the taxable year (and ' 1362(b)(3) shall not apply). Rev. Proc. 97-48, 1997-2 C.B. 521 provides special procedures to obtain automatic relief for certain late S corporation elections. Generally, relief is available in situations in which a corporation intends to be an S corporation, the corporation and its shareholders reported their income consistent with S corporation status for the taxable year the S corporation election should have been made and for every subsequent year, and the corporation did not receive notification from the Internal Revenue Service regarding any problem with the S corporation status within 6 months of the date on which the Form 1120S, U.S. Income Tax Return for an S Corporation, for the first year was timely filed.

Rev. Proc. 2003-43 provides, in part, a simplified method for a taxpayer to request relief for a late S corporation election where the entity fails to qualify as an S corporation solely because of the failure to file the election timely with the applicable campus. Under the revenue procedure, certain entities may be granted relief for failing to file the elections in a timely manner if the request for relief is filed within 24 months of the due date of the election.

.02 Entity Classification Elections.
(1) In General. Section 301.7701-2(a) of the Procedure and Administration Regulations defines a "business entity" as any entity recognized for federal tax purposes that is not properly classified as a trust under § 301.7701-4 or otherwise subject to special treatment under the Code. Section 301.7701-3(a) provides that a business entity that is not classified as a corporation under § 301.7701-2(b)(1), (3), (4), (5), (6), (7), or (8) (an "eligible entity") can elect its classification for federal tax purposes. Section 301.7701-3(b)(1) provides that, except as otherwise provided in paragraph (b)(3) of the section, unless the entity elects otherwise, a domestic eligible entity is (i) a partnership if it has two or more members; or (ii) disregarded as an entity separate from its owner if it has a single owner. Section 301.7701-3(c)(1) provides that, except as provided in § 301.7701- 3(c)(1)(iv) and (v), an eligible entity may elect to be classified other than as provided in § 301.7701-3(b) by filing Form 8832, Entity Classification Election, with the campus designated on Form 8832. Section 301.7701-3(c)(iii) provides that the entity classification election will be effective on the date specified by the entity on the Form 8832 or on the date filed if no date is specified on the election form. The effective date specified on Form 8832 can not (sic) be more than 75 days prior to the date on which the election is filed and can not (sic) be more than 12 months after the date on which the election is filed. If an election specifies an effective date more than 75 days prior to the date on which the election is filed, the election will be effective 75 days prior to the date it was filed. If an election specifies an effective date more than 12 months from the date on which the election is filed, the election will be effective 12 months after the date the election was filed. (2) Late Entity Classification Elections. Under § 301.9100-1(c), the Commissioner may grant a reasonable extension of time under the rules set forth in §§ 301.9100-2 and 301.9100-3 to make a regulatory election, or a statutory election (but no more than 6 months except in the case of a taxpayer who is abroad), under all subtitles of the Code, except subtitles E, G, H, and I. Section 301.9100-1(b) defines the term "regulatory election" as an election whose due date is prescribed by a regulation published in the Federal Register, or a revenue ruling, revenue procedure, notice, or announcement published in the Internal Revenue Bulletin.

Requests for relief under § 301.9100-3 will be granted when the taxpayer provides the evidence to establish to the satisfaction of the Commissioner that the taxpayer acted reasonably and in good faith, and the grant of relief will not prejudice the interests of the Government. Rev. Proc. 2002-59, 2002-2 C.B. 615, provides guidance for an entity newly formed under local law that requests relief for a late initial classification election filed by the due date of the entity's first federal income tax return (excluding extensions). Under §301.7701-3(c)(1)(v)(C), an eligible entity that timely elects to be an S corporation under § 1362(a)(1) is treated as having made an election to be classified as an association, provided that (as of the effective date of the election under § 1362(a)(1)) the entity meets all other requirements to qualify as a small business corporation under § 1361(b). Section 301.7701-3(c)(1)(v)(C), further provides that, subject to § 301.7701-3(c)(1)(iv), the deemed election to be classified as an association generally will apply as of the effective date of the S corporation election and will remain in effect until the entity makes a valid election under § 301.7701-3(c)(1)(i), to be classified as other than an association. Rev. Proc. 2004-48 provides a simplified method for taxpayers to request relief for a late S corporation election and a late corporate classification election which was intended to be effective on the same date the S corporation election was intended to be effective. Under Rev. Proc. 2004-48, generally, certain eligible entities may be granted relief if the requirements of section 4 of the revenue procedure are satisfied. To obtain relief under Rev. Proc. 2004-48, the entity must file a properly completed Form 2553 with the applicable campus within 6 months after the due date for the tax return, excluding extensions, for the first taxable year the entity intended to be an S corporation. Attached to the Form 2553 must be a statement explaining the reason for the failure to file timely the S corporation election and a statement explaining the reason for the failure to file timely the entity classification election.

SECTION 3. SCOPE

.01 In General. This revenue procedure supplements Rev. Proc. 2003-43 and provides an additional simplified method for obtaining relief for a late S corporation election, provided that the requirements of section 4 of this revenue procedure are satisfied. This revenue procedure also supplements Rev. Proc. 2004-48 and provides an additional simplified method for obtaining relief for a late S corporation election and a late corporate classification election, provided that the requirements of section 5 of this revenue procedure are satisfied. Section 4.01 of this revenue procedure provides the eligibility requirements for relief for a late S corporation election, and section 4.02 of this revenue procedure provides the procedural requirements for relief. Section 5.01 of this revenue procedure provides the eligibility requirements for relief for a late S corporation election and a late corporate classification election, and section 5.02 of this revenue procedure provides the procedural requirements for relief. This revenue procedure provides procedures in lieu of the letter ruling process ordinarily used to obtain relief for a late S corporation election and a late corporate classification election filed pursuant to ' 1362(b)(5), ' 301.9100-1 and ' 301.9100-3. Accordingly, user fees do not apply to corrective actions under this revenue procedure. .02 Entities T (1) Rev. Procs. 97-48, 2003-43, and 2004-48. An entity that does not meet the requirements for relief under this revenue procedure may request relief for a late S corporation election following the procedures of Rev. Proc. 97-48, or Rev. Proc. 2003- 43, or, for relief for a late S corporation election and a late corporate classification election following the procedures of Rev. Proc. 2004-48.

(2) Letter Rulings. If an entity does not qualify for relief for a late S corporation election, or relief for a late S corporation election and a late corporate classification election, under Rev. Proc. 97-48, Rev. Proc. 2003-43, or Rev. Proc. 2004-48, as appropriate, the entity may request relief by requesting a letter ruling. The Service will not ordinarily issue a letter ruling if the period of limitations on assessment under § 6501(a) has lapsed for any taxable year for which an election should have been made or any taxable year that would have been affected by the election had it been timely made. The procedural requirements for requesting a letter ruling are described in Rev. Proc. 2007-1, 2007-1 I.R.B. 1 (or its successor). SECTION 4. RELIEF FOR LATE S CORPORATION ELECTION UNDER THIS REVENUE PROCEDURE

.01 Eligibility for Relief. An entity may request relief under this revenue procedure if the following requirements are met: (1) The entity fails to qualify for its intended status as an S corporation on the first day that status was desired solely because of the failure to file a timely Form 2553 with the applicable campus; (2) The entity has reasonable cause for its failure to file a timely Form 2553; (3) The entity seeking to make the S corporation election has not filed a tax return for the first taxable year in which the election was intended; (4) The application for relief is filed under this revenue procedure no later than 6 months after the due date of the tax return (excluding extensions) of the entity seeking to make the election for the first taxable year in which the election was intended; and (5) No taxpayer whose tax liability or tax return would be affected by the S corporation election (including all shareholders of the S corporation) has reported inconsistently with the S corporation election, on any affected return for the year the S corporation election was intended.

.02 Procedural Requirements for Relief. An entity may request relief for a late S corporation election by filing with the applicable campus a properly completed Form 2553 (see Form 2553 and Instructions) with a Form 1120S for the first taxable year the entity intended to be an S corporation. A properly completed Form 2553 includes a statement establishing reasonable cause for the failure to file the S corporation election timely. The Form 2553 will be modified to allow for the inclusion of such statement. The forms must be filed together no later than 6 months after the due date of the tax return (excluding extensions) of the entity for the first taxable year in which the S corporation election was intended. These items constitute the application requesting relief.

.03 Relief for Late S Corporation Election. Upon receipt of a completed application requesting relief under section 4.02 of this revenue procedure, the Service will determine whether the requirements for granting relief for the late S corporation election have been satisfied.

SECTION 5. RELIEF FOR LATE S CORPORATION ELECTION AND LATE

CORPORATE CLASSIFICATION ELECTION UNDER THIS REVENUE PROCEDURE

.01 Eligibility for Relief. An entity may request relief under this revenue procedure if the following requirements are met:

(1) The entity is an eligible entity as defined in § 301.7701-3(a); (2) The entity intended to be classified as a corporation as of the intended effective date of the S corporation status; (3) The entity fails to qualify as a corporation solely because Form 8832 was not timely filed under § 301.7701-3(c)(1)(i), or Form 8832 was not deemed to have been filed under §301.7701-3(c)(1)(v)(C);

(4) In addition to section 5.01(3) of this section, the entity fails to qualify as an S corporation on the intended effective date of the S corporation status solely because the S corporation election was not timely filed pursuant to § 1362(b); (5) The entity has reasonable cause for its failure to file a timely Form 2553 and a timely Form 8832; (6) The entity seeking to make the S corporation election has not filed a tax return for the first taxable year in which the election was intended; (7) The application for relief is filed under this revenue procedure no later than 6 months after the due date of the S corporation return (excluding extensions) of the entity seeking to make the election for the first taxable year in which the election was intended, and

(8) No taxpayer whose tax liability or tax return would be affected by the S corporation election (including all shareholders of the S corporation) has reported inconsistently with the S corporation election, on any affected return for the year the S corporation election was intended.

.02 Procedural Requirements for Relief. An entity may request relief for a late S corporation election and a late corporate classification election by filing a properly completed Form 2553 (see Form 2553 and Instructions) with a Form 1120S for the first taxable year the entity intended to be an S corporation. A properly completed Form 2553 includes a statement explaining the reason for the failure to file the S corporation election timely and a statement explaining the reason for the failure to file the entity classification election timely. The Form 2553 will be modified to allow for the inclusion of such statements. The forms must be filed together no later than 6 months after the due date of the tax return (excluding extensions) of the entity for the first taxable year in which the S corporation election was intended. These items constitute the application requesting relief. .03 Relief for Late S Corporation Election and Late Corporate Classification Election. Upon receipt of a completed application requesting relief under section 5.02 of this revenue procedure, the Service will determine whether the requirements for granting relief for the late S corporation election and late corporate classification election have been satisfied. An entity receiving relief under this revenue procedure is treated as having made an election to be classified as an association taxable as a corporation under § 301.7701-3(c) as of the effective date of the S corporation election.

SECTION 6. EFFECT ON OTHER DOCUMENTS

This revenue procedure supplements Rev. Procs. 2003-43 and 2004-48.

SECTION 7. EFFECTIVE DATE

This revenue procedure is effective for S corporation elections and corporate classification elections intended to be effective for taxable years that end on or after December 31, 2007.

SECTION 8. DRAFTING INFORMATION

The principal author of this revenue procedure is Jian H. Grant of the Office of the Associate Chief Counsel (Passthroughs and Special Industries). For further information regarding this revenue procedure, contact Ms. Grant at (202) 622-3050 (not a toll free call).


S-Corp election: Rev. Proc. 2004-48, 2004-32 I.R.B. 172 (8/9/2004) for LLC's seeking S-Corp status:

Rev. Proc. 2004-48, 2004-32 I.R.B. 172 (8/9/2004)  for LLC's seeking S-Corp status

This revenue procedure provides a simplified method for taxpayers to request relief for a late S corporation election and a late corporate classification election which was intended to be effective on the same date that the S corporation election was intended to be effective. Generally, this revenue procedure provides that certain eligible entities may be granted relief if the entity satisfies the requirements of section 4 of this revenue procedure.

3.01 In General. An eligible entity that seeks to be classified as a subchapter S corporation must elect to be classified as an association under section 301.7701-3(c)(1)(i) by filing Form 8832 and must elect to be an S corporation under section 1362(a) by filing Form 2553, Election by a Small Business Corporation. In many situations, an entity may timely file Form 2553 but fail to file the Form 8832. Section
301.7701-3T(c)(1)(v)(C) applies to these situations and deems an eligible entity that timely files a Form 2553 to also have filed a Form 8832. In other situations, an eligible entity fails to file a timely Form 2553. In these situations, section 301.7701-3T(c)(1)(v)(C) does not apply and the entity would be required to obtain relief in a letter ruling. This revenue procedure provides a simplified method for requesting relief for those situations not covered by section 301.77013T , provided that the requirements of sections 4.01 and 4.02 of this revenue procedure are satisfied. The method provided in this revenue procedure is in lieu of to the letter ruling process ordinarily used to obtain relief for late elections under sections 1362(b)(5), 301.9100-1, and 301.9100-3. Accordingly, user fees do not apply to corrective action under this revenue procedure.

3.02 Relief if this Revenue Procedure is not Applicable. An entity that does not meet the requirements for relief or is denied relief under this revenue procedure may seek relief by requesting a letter ruling. The procedural requirements for requesting a letter ruling are described in Rev. Proc. 2004-1, 2004-1 B. 1., or its successors.


4.01 Eligibility for Relief. An entity may request relief under this revenue procedure if the following requirements are met:

(1) The entity is an eligible entity as defined in section 301.7701-3(a);

(2) (2) The entity intended to be classified as a corporation as of the intended effective date of the S corporation status;

(3) The entity fails to qualify as a corporation solely because Form 8832 was not timely filed under section 301.7100-3(c)(1)(i), or Form 8832 was not deemed to have been filed under section 301.7701-3T(c)(1)(v)(C);

(4) In addition to section 4.01(3) of this section, the entity fails to qualify as an S corporation on the intended effective date of the S corporation status solely because the S corporation election was not filed timely pursuant to section 1362(b); and n>

(5) The entity has reasonable cause for its failure to file timely the S corporation election and the entity classification election.

4.02 Procedural Requirements for Relief. Within 6 months after the due date for the tax return, excluding extensions, for the first year the entity intended to be an S corporation), the corporation must file a properly completed Form 2553 with the applicable service center. The Form 2553 must state at the top of the document "FILED PURSUANT TO REV. PROC. 2004-48." Attached to the Form 2553 must be a statement explaining the reason for the failure to file timely the S corporation election and a statement explaining the reason for the failure to file timely the entity classification election.

4.03 Relief for Late S Corporation Election and Relief for a Late Corporate Classification Election. Upon receipt of a completed application requesting relief under section 4 of this revenue procedure, the Service will determine whether the requirements for granting additional time to file the elections have been satisfied and will notify the entity of the result of this determination. An entity receiving relief under this revenue procedure is treated as having made an election to be classified as an association taxable as a corporation under section 301.7701-3(c) as of the effective date of the S corporation election.


Rev. Proc. 2003-43, 2003-23 I.R.B. 998 (6/9/2003) for corporations or LLC's seeking S-Corp status:

This revenue procedure provides a simplified method for taxpayers to request relief for late S corporation elections, Electing Small Business Trust (ESBT) elections, Qualified Subchapter S Trust (QSST) elections and Qualified Subchapter S Subsidiary (QSub) elections. Generally, this revenue procedure provides that certain eligible entities may be granted relief for failing to file these elections in a timely manner if the request for relief is filed within 24 months of the due date of the election. Accompanying this document is a flowchart designed to aid taxpayers in applying this revenue procedure.

This revenue procedure provides procedures in lieu of the letter ruling process ordinarily used to obtain relief for a late Election Under Subchapter S filed pursuant to section 1362(b)(5), section 1362(f), or section 301.9100-1 and section 301.9100-3.

4.02 Eligibility for Relief. Relief is available under section 4.04 of this revenue procedure if the following requirements are met:

(1) The entity fails to qualify for its intended status as an S corporation, ESBT, QSST, or QSub on the first day that status was desired solely because of the failure to file the appropriate Election Under Subchapter S timely with the applicable service center;

(2) Less than 24 months have passed since the original Due Date of the Election Under Subchapter S;

(3) Either,

(a) the entity is seeking relief for a late S corporation or QSub election and the entity has reasonable cause for its failure to make the timely Election Under Subchapter S, or

(b) the S corporation and the entity are seeking relief for an inadvertent invalid S corporation election or an inadvertent termination of an S corporation election due to the failure to make the timely ESBT or QSST election and the failure to file the timely Election Under Subchapter S was inadvertent; and

(4) Either,

(a) all of the following requirements are met: (i) the entity seeking to make the election has not filed a tax return (in the case of QSubs, the parent has not filed a tax return) for the first year in which the election was intended, (ii) the application for relief is filed under this revenue procedure no later than 6 months after the due date of the tax return (excluding extensions) of the entity seeking to make the election (in the case of QSubs, the due date of the tax return of the parent) for the first year in which the election was intended, and, (iii) no taxpayer whose tax liability or tax return would be affected by the Election Under Subchapter S (including all shareholders of the S corporation) has reported inconsistently with the S corporation election (as well as any ESBT, QSST or QSub elections), on any affected return for the year the Election Under Subchapter S was intended; or

(b) all of the following requirements are met: (i) the entity seeking to make the election has filed a tax return (in the case of QSubs, the parent has filed a tax return) for the first year in which the election was intended within 6 months of the due date of the tax return (excluding extensions), and (ii) all taxpayers whose tax liability or tax returns would be affected by the Election Under Subchapter S (including all shareholders of the S corporation) have reported consistently with the S corporation election (as well as any ESBT, QSST or QSub elections), on all affected returns for the year the Election Under Subchapter S was intended, as well as for any subsequent years.

4.03 Procedural Requirements for Relief.

(1) Procedural Requirements When a Tax Return Has Not Been Filed for the First Year of the Intended Election Under Subchapter S. If the entity seeking the election has not filed a tax return for the first taxable year of the intended Election Under Subchapter S, the entity may request relief for the late Election Under Subchapter S by filing with the applicable service center the properly completed election form(s). The election form(s) must be filed within 18 months of the original Due Date of the intended Election Under Subchapter S (but in no event later than 6 months after the due date of the tax return (excluding extensions) of the entity (in the case of QSubs, the due date of the tax return of the parent) for the first year in which the election was intended) and must state at the top of the document "FILED PURSUANT TO REV. PROC. 2003-43." Attached to the election form must be a statement establishing either reasonable cause for the failure to file the Election Under Subchapter S timely (in the case of S corporation or QSub elections), or a statement establishing that the failure to file the Election Under Subchapter S timely was inadvertent (in the case of ESBT or QSST elections.)

(2) Procedural Requirements When a Tax Return Has Been Filed for the First Year of the Intended Election Under Subchapter S. If the entity seeking the election has filed a tax return for the first taxable year of the intended Election Under Subchapter S within 6 months of the due date of that tax return (excluding extensions), then the entity may request relief for the late Election Under Subchapter S by filing with the applicable service center the properly completed election form(s) and the supporting documents described below. The election form(s) must be filed within 24 months of the original Due Date for the Election Under Subchapter S and must state at the top of the document "FILED PURSUANT TO REV. PROC. 2003-43." Attached to the election form must be a statement establishing either reasonable cause for the failure to file the Election Under Subchapter S timely (in the case of S corporation or QSub elections), or a statement establishing that the failure to file the Election Under Subchapter S timely was inadvertent (in the case of ESBT or QSST elections.) The following additional documents must be attached to the election form (if applicable):

(a) S Corporations. An entity seeking relief for a late S corporation election must file a completed Form 2553, signed by an officer of the corporation authorized to sign and all persons who were shareholders at any time during the period that began on the first day of the taxable year for which the election is to be effective and ends on the day the election is made. The completed election form must include the following material:

(i) Statements from all shareholders during the period between the date the S corporation election was to have become effective and the date the completed election was filed that they have reported their income (on all affected returns) consistent with the S corporation election for the year the election should have been made and for all subsequent years; and

(ii) A dated declaration signed by an officer of the corporation authorized to sign which states: "Under penalties of perjury, I declare that, to the best of my knowledge and belief, the facts presented in support of this election are true, correct, and complete."

(b) ESBTs and QSSTs. The trustee of an ESBT or the current income beneficiary of a QSST must sign and file the appropriate election with the applicable service center. The completed election form must include the following material:

(i) A statement from the trustee of the ESBT or the current income beneficiary of the QSST that includes the information required by section 1.1361-1(m)(2)(ii) (in the case of ESBT elections) or section 1.1361-1(j)(6)(ii) (in the case of QSST elections);

(ii) In the case of a QSST, a statement from the trustee that the trust satisfies the QSST requirements of section 1361(d)(3) and that the income distribution requirements have been and will continue to be met;

(iii) In the case of an ESBT, a statement from the trustee that all potential current beneficiaries meet the shareholder requirements of section 1361(b)(1) and that the trust satisfies the requirements of an ESBT under section 1361(e)(1) other than the requirement to make an ESBT election;

(iv) A statement from the trustee of the ESBT or the current income beneficiary of the QSST that the beneficiary or trustee acted diligently to correct the mistake upon its discovery;

(v) Statements from all shareholders during the period between the date the S corporation election terminated or was to have become effective and the date the completed election was filed that they have reported their income (on all affected returns) consistent with the S corporation election for the year the election should have been made and for all subsequent years; and

(vi) A dated declaration, signed by the trustee of the ESBT or the current income beneficiary of the QSST which states: "Under penalties of perjury, I declare that, to the best of my knowledge and belief, the facts presented in support of this election are true, correct, and complete."

(c) QSubs. An S corporation seeking relief for a late QSub election for a subsidiary must file a completed Form 8869. The completed election form must include the following material:

(i) A statement that the corporation satisfies the QSub requirements of section 1361(b)(3)(B), and that all assets, liabilities, and items of income, deduction, and credit of the QSub have been treated as assets, liabilities, and items of income, deduction, and credit of the S corporation (on all affected returns) consistent with the QSub election for the year the election was intended and for all subsequent years;

(ii) A dated declaration signed by an officer of the S corporation authorized to sign which states: "Under penalties of perjury, I declare that, to the best of my knowledge and belief, the facts presented in support of this election are true, correct, and complete."

4.04 Relief for Late Election Under Subchapter S. Upon receipt of a completed application requesting relief under section 4.03 of this revenue procedure, the Service will determine whether the requirements for granting additional time to file the Election Under Subchapter S have been satisfied and will notify the entity of the result of this determination.


Rev. Rul. 73-361 and Rev. Rul. 82-83 stockholder-officer of s-corporation is an employee, form W-2 is to be issued:

Rev. Rul. 73-361

Advice has been requested whether a stockholder-officer of an electing small business corporation should be treated as a partner or as an employee for purposes of the Federal Insurance Contributions Act (chapter 21, subtitle C, Internal Revenue Code of 1954).

The corporation is a small business corporation, as defined in section 1371 of the Code, that has elected, pursuant to section 1372(a), not to be subject to the corporate income tax, but to have all its income taxed directly to its shareholders.

During 1972, the majority stockholder was an officer of the corporation, and performed substantial services for the corporation in that capacity for which he was paid a salary.

Section 3121(d)(1) of the Federal Insurance Contributions Act provides that, for purposes of the taxes imposed by this Act, the term "employee" means any officer of a corporation.   Section 31.3121(d)-1(b) of the Employment Tax Regulations provides that an officer who, as such, does not perform any services or performs only minor services and who neither receives nor is entitled to receive, directly or indirectly, any remuneration is considered not to be an employee of the corporation.

Neither the election by the corporation as to the manner in which it will be taxed for Federal income tax purposes nor the consent thereto by the stockholder-officers has any effect in determining whether they are employees or whether payments made to them are "wages" for Federal employment tax purposes. A corporation does not lose its identity by reason of such an election but remains a legal corporate entity and is required, under section 6037 of the Code, to file a return containing information needed to comply with the provisions of Subchapter S of the Code.

Since the stockholder-officer in the instant case performed substantial services for the electing small business corporation, for which he received remuneration, he is an employee of the corporation.

Accordingly, the "wages" he received in 1972 for his services as an officer are subject to the taxes imposed by the Federal Insurance Contributions Act. This conclusion is also applicable for purposes of the Federal Unemployment Tax Act and the Collection of Income Tax at Source on Wages (chapters 23 and 24, respectively, subtitle C of the Code).


Rev. Rul. 82-83 EMPLOYER-EMPLOYEE; CORPORATE OFFICERS

ISSUE

Is a corporation that treats officers as independent contractors rather than as employees when they are performing duties normally within the scope of duties of a corporate officer entitled to relief under section 530 of the Revenue Act of 1978 (the Act), 1978-3 (Vol. 1) C.B. 1, 119, extended by section 9(d) of Pub. L. 96-167, 1980-1 C.B. 483, 486, and by section 1 of Pub. L. 96- 541, 1980-2 C.B. 596?

FACTS

A corporation, which is owned by its two officers (president and vice- president/treasurer, respectively) operates a summer theater. The officers perform substantial services for the corporation, including deciding on productions to be performed, setting admission prices, and hiring performers. The officers control and direct all of the operations of the theater and determine the amount of their own compensation, the hours of their employment, and the duties they will perform.

The corporation treats the officers as independent contractors rather than employees and pays them compensation characterized as 'draws' rather than 'salaries.' In treating the officers as independent contractors, the corporation does not rely on any basis that would fall within the 'safe haven' provisions of section 530(a)(2)(A), (B), or (C) of the Act.

LAW AND ANALYSIS

Section 530 of the Act provides relief from employment tax liability to eligible taxpayers who have failed to pay or withhold employment taxes on remuneration paid to workers because the taxpayers did not regard them as employees. Section 530(a)(1), as extended, provides, in general, that if a taxpayer did not treat an individual as an employee for any period ending before July 1, 1982, the individual will be deemed not to be an employee for purposes of applying employment taxes for the period unless the taxpayer had no reasonable basis for treating the individual as other than an employee.

Section 530(a)(2) provides several alternative standards that constitute 'safe havens' in determining whether a taxpayer has a 'reasonable basis' for not treating an individual as an employee. Reasonable reliance on any one of the following 'safe havens' is sufficient:

(A) Judicial precedent or published rulings (whether or not relating to the particular industry or business in which the taxpayer is engaged), technical advice, a letter ruling, or a determination letter pertaining to the taxpayer.

(B) A past Internal Revenue Service audit (not necessarily for employment tax purposes) of the taxpayer, if the audit entailed no assessment attributable to the taxpayer's employment tax treatment of individuals holding positions substantially similar to that held by the individual whose status is at issue. However, a taxpayer does not meet this test if, in the conduct of a prior audit, an assessment attributable to the taxpayer's treatment of the individual was offset by other claims asserted by the taxpayer.

(C) Long-standing recognized practice of a significant segment of the industry in which the individual was engaged. It is not necessary that the practice be uniform throughout an entire industry.

Taxpayers who fail to meet any of these three 'safe havens' may nevertheless be entitled to relief if they can demonstrate, in some other manner, a reasonable basis for not treating the individual as an employee. The term 'reasonable basis' should be construed liberally in favor of the taxpayer.

Sections 3121(d) and 3401(c) of the Internal Revenue Code, applicable to the Federal Insurance Contributions Act and income tax withholding, respectively, provide that the term 'employee' includes any officer of a corporation. Section 3306(i), applicable to the Federal Unemployment Tax Act, includes within the meaning of the term 'employee' the meaning assigned by section 3121(d).

Section 31.3121(d)-1(b) of the Employment Tax Regulations states that, generally, an officer of a corporation is an employee of the corporation. However, an officer of a corporation who as such does not perform any services or performs only minor services and who neither receives nor is entitled to receive, directly or indirectly, any pay is considered not to be an employee of the corporation. For instance, directors of corporations in their capacity as such are not employees of the corporations.

Rev. Rul. 71-86, 1971-1 C.B. 285, holds that when an individual who is the president and sole shareholder, except for qualifying shares, of a closely held corporation performs services as an officer of the corporation, the president is an employee for purposes of employment taxes and income tax withholding, even though all services performed and the amount of compensation for them are under the individual's complete control.

Rev. Rul. 73-361, 1973-2 C.B. 331, holds that a stockholder-officer of an electing small business corporation who performs substantial services as an officer of the corporation is its employee for purposes of the FICA, the FUTA, and income tax withholding.

In Royal Theatre Corp. v. United States, 66 F. Supp. 301 (D. Kan. 1946), the sole shareholder and president of two corporations contracted with each for him to manage each corporation's operations and to determine matters of policy for each corporation. The court observed that compensation an officer receives for services as an officer is subject to social security taxes, and held that the contracts by which the president of each corporation purportedly managed the affairs of each corporation as an independent contractor could be disregarded in determining the reality of the situation.

It is a question of fact in all cases whether officers of a corporation are performing services within the scope of their duties as officers or whether they are performing services as independent contractors. Here, the duties being performed customarily fall within the scope of duties of corporate officers. Involved are fundamental decisions regarding the operation of the corporation. Such decisions are rarely delegated to independent contractors, and are customarily made by corporate officers or other employees. Thus, since the officers are performing substantial services typical of officers and are paid for those services, they are employees of the corporation for purposes of federal tax law. Therefore, even though the corporation calls the officers' pay 'draws' rather than 'salaries,' there is no reasonable basis for treating the officers as other than employees, even under a liberal application of the reasonable basis rule of section 530 of the Act.

HOLDING

The corporation is not entitled to relief under section 530 of the Act.


S-Corp shareholders' medical deductions IRC §105 & §106 (belong on form W-2):

Do not confuse §106 Health insurance  vs. §105 Medical expenses

How should the payments/reimbursements be reported on the employee's W-2 and form 1040  and the S-corp's form 1120S?

Are payments/reimbursements totally tax-free fringe benefits?

Are payments/reimbursements included in gross wages?

Are the wages subject to FICA/Medicare?

http://www.taxalmanac.org/index.php/Discussion_Archives:S_Corp_Health_Insurance_No_FICA_on_'Wages'%3F

http://www.danaconsulting.com/downloads/Health_Premiums_Paid_S_Corps.pdf

http://www.aicpa.org/publications/taxadviser/2011/december/pages/case-study_dec11.aspx


Common oversight - there are different rules for S corporation shareholders holding more than 2% (as opposed to exactly 2% or less than 2%) of the issued and outstanding stock.

Subject to the satisfaction of certain non-discrimination and other requirements, (see, e.g., §§79(d), 105(h) and 125(b))  an employer can provide certain types of fringe benefits to its employees on a tax-free basis while deducting the cost of the fringe benefit.  Shareholder-employees of S corporations qualify for the exclusion of these fringe benefit items from income, although a special restriction applies to greater-than-2% shareholders. Self-employed persons (i.e., sole proprietors or partners) generally are not entitled to exclude fringe benefits from income, because the exclusion is limited to employees, and a sole proprietor or partner is not considered an "employee" for this purpose.

For fringe benefit purposes, an S corporation is treated as a partnership, and each more-than-2% shareholder is treated as a partner under §1372(a).  Thus, certain fringe benefits that can be provided on a tax-free basis to shareholder-employees of C corporations cannot be provided on a tax-free basis to a more-than-2% shareholder in an S corporation. Other employees of an S corporation, however, are not affected by this rule and can exclude the fringe benefits from income.


Example of "Indirect Ownership" - Husband owns all of the stock of an S corporation. His wife is employed by the S-corp.  The wife is treated as a more-than-2% shareholder for purposes of the S corporation fringe benefit rules, pursuant to §1372(b) & §318.

IR Code §162(l)(5) Treatment of certain S corporation shareholders .- This subsection shall apply in the case of any individual treated as a partner under section 1372(a), except that-

§162(l)(5)(A) for purposes of this subsection, such individual's wages (as defined in section 3121) from the S corporation shall be treated as such individual's earned income (within the meaning of section 401(c)(1)), and

§162(l)(5)(B) there shall be such adjustments in the application of this subsection as the Secretary may by regulations prescribe.

 

§1372(a) General Rule .- For purposes of applying the provisions of this subtitle which relate to employee fringe benefits-

§1372(a)(1) the S corporation shall be treated as a partnership, and

§1372(a)(2) any 2-percent shareholder of the S corporation shall be treated as a partner of such partnership.

§1372(b)      2-Percent Shareholder Defined .- For purposes of this section, the term "2-percent shareholder" means any person who owns (or is considered as owning within the meaning of section 318) on any day during the taxable year of the S corporation more than 2 percent of the outstanding stock of such corporation or stock possessing more than 2 percent of the total combined voting power of all stock of such corporation. (Added Pub. L. 97-354, 2, Oct. 19, 1982, 96 Stat. 1682.)

 

§318(a) General Rule .- For purposes of those provisions of this subchapter to which the rules contained in this section are expressly made applicable-

§318(a)(1) Members of family.-

§318(a)(1)(A) In general .- An individual shall be considered as owning the stock owned, directly or indirectly, by or for-

§318(a)(1)(A)(i) his spouse (other than a spouse who is legally separated from the individual under a decree of divorce or separate maintenance), and

§318(a)(1)(A)(ii) his children, grandchildren, and parents.




Whether medical expenses and insurance premiums are subject to FICA/Medicare depends on whether the payments are made pursuant to a plan qualifying under IRC §3121(a)(2).

Medical expenses (see §105) and insurance premiums (see §106) paid for the benefit of 2%(exactly) S corporation shareholders and for persons holding less than 2% on the company's stock are separately deducted on Form 1120S (on page 1, line 18 "employee benefit programs") when the appropriate plan qualifying under IRC §3121(a)(2) has been established.

Medical expenses and insurance premiums paid for a more than 2% shareholder are not separately deducted Form 1120S page 1, line 18.   Rather, these items are included as a salary deduction on page 1, line 7 of Form 1120S, and are also included on the shareholder's Form W-2 as income . These items are only shown as supplemental information on form 1120S, Schedules K and K-1 so that the shareholder may be reminded to deduct the health insurance on Form 1040, page 1, line 29 (for 2007) and deduct the medical expenses on Schedule A, line 1.  For the W-2 wages to be excluded from Social Security and Medicare taxes the payments must be made pursuant to a plan qualifying under IRC §3121(a)(2) which is non-discriminatory pursuant to IRC §105(h).

Treating Medical Insurance Premiums as Wages

Heath and accident insurance premiums paid on behalf of the greater than two percent S corporation shareholder-employee are deductible and reportable by the S corporation as wages for income tax withholding purposes on the shareholder-employee’s Form W-2.

These benefits are not subject to Social Security or Medicare (FICA) or Unemployment (FUTA) taxes. The additional compensation is included in Box 1 (Wages) of the Form W-2, Wage and Tax Statement, issued to the shareholder-employee, but would not be included in Boxes 3 and 5 of Form W-2.

A 2-percent shareholder-employee is eligible for an Adjusted Gross Income (AGI) deduction for amounts paid during the year for medical care premiums if the medical care coverage is established by the S corporation and the shareholder meets the other self-employed medical insurance deduction requirements.  If, however, the shareholder or the  shareholder’s spouse is eligible to participate in any subsidized health care plan then the shareholder is not entitled to the AGI deduction.

A medical plan can be considered established by the S corporation if the S corporation paid or reimbursed the shareholder-employee for premiums and reported:

  • The premium payment
  • Reimbursement as wages on the shareholder-employee’s W-2

Health Insurance Purchased in Name of Shareholder

The insurance laws in some states do not allow a corporation to purchase group health insurance when the corporation only has one employee. Therefore, if the shareholder was the sole corporate employee, the shareholder had to purchase his health insurance in his own name.

The IRS issued Notice 2008-1 which ruled that under certain situations the shareholder would be allowed an above-the-line deduction even if the health insurance policy was purchased in the name of the shareholder. Notice 2008-1 provided four examples, three of the examples had the shareholder purchasing the health insurance and the other example had the S corporation purchasing the health insurance.

The Notice held that if the shareholder purchased the health insurance in his own name and paid for it with his own funds the shareholder would not be allowed an above-the-line deduction. On the other hand, if the shareholder purchased the health insurance in his own name but the S corporation either directly paid for the health insurance or reimbursed the shareholder for the health insurance and also included the premium payment in the shareholder’s W-2, the shareholder would be allowed an above-the-line deduction.

The bottom line is that in order for a shareholder to claim an above-the-line deduction, the health insurance premiums had to be paid by the S corporation and had to be included in the shareholder’s W-2.

http://www.irs.gov/businesses/small/article/0,,id=203100,00.html#skiptocontent

 

(Ed. This Q&A is incorrect)
Q. As is quite common, the corporation forgets to include medical expenses and insurance premiums for more than 2% shareholder on any payroll tax returns (forms 940, 941 W-2 and related State forms and disability insurance forms), or taken as a salary deduction on the books.  In this situation, may the corporation simply report these items as "Other Deductions" on Schedules K and K-1?

A. When the maximum amount of Social Security tax has already been paid or withheld by the shareholder, and otherwise reporting in this manner does not place the corporation or shareholder in jeopardy for underpaid payroll taxes, then this might be a solution.  Of course, an obvious problem remains: Medicaid tax would still be underpaid, and State withholding tax may be underwithheld.

(But see below for another opinion)

For a 100% shareholder, there would be no difference provided that the shareholder deduction under IRC 162(l) would be allowable, keeping in mind that there are other requirements under IRC 162(l), such as FICA wages equal or greater than the amount of the health insurance deduction, that there is no other coverage available to the taxpayer or spouse, etc., that need to be addressed for the deduction to be allowable.



Some "double talk" to be aware of:
Generally, fringe benefits which are treated as compensation to a 2%-or-more shareholder are subject to payroll (i.e., FICA and FUTA) withholding.  But see §3121(a)(2)(C). Section 3121(a)(2) provides that these amounts are not subject to Social Security and Medicare taxes if the payments are made under a plan or system for employees or a class of employees. See Announcement 92-16, 1992-5 I.R.B. 53.

Announcement 92-16, 1992-5 I.R.B. 53

FICA Taxation of Health Insurance Premiums for 2%-Shareholder-Employees of S Corporations

Announcement 92-16

In response to taxpayer questions, this Internal Revenue Service announcement is intended to clarify the social security and Medicare tax treatment of accident and health insurance premiums paid by an S corporation on behalf of 2%-shareholder-employees.

On April 15, 1991, the Service published Revenue Ruling 91-26, 1991-1 C.B. 184, regarding employer-provided accident and health insurance for S corporations and 2%-shareholder-employees. Revenue Ruling 91-26 indicates that amounts paid by an S corporation for accident and health insurance covering a 2%-shareholder-employee must be reported as wages on his or her Form W-2, Wage and Tax Statement.

Revenue Ruling 91-26 does not directly address the treatment of the amounts for such purposes. The Service has been asked whether these amounts are wages for purposes of social security and Medicare taxes. The facts presented in the ruling are insufficient to ascertain whether tax would be imposed in these circumstances. A basic analysis is provided below to assist taxpayers.

Like other employees of an S corporation, 2%-shareholder employees are subject to social security and Medicare taxes on "wages" paid to them by the corporation. The term "wages" generally includes fringe benefits provided in cash or in kind to an employee. However, under section 3121(a) of the Code certain payments are expressly excluded from "wages" for purpose of social security and Medicare taxes.

Section 3121(a)(2)(B) excludes from wages certain amounts paid by an employer to or on behalf of an employee (including amounts paid by an employer for insurance, annuities, or into a fund) for medical and hospitalization expense in connection with sickness or accident disability. For this exclusion to apply, the payments must be made under a plan or system for employees and their dependents generally or for a class (or classes) of employees and their dependents. Thus, whether amounts of this type are actually subject to social security or Medicare tax depends on whether in the particular case the taxpayer satisfies the requirements for the exclusion.

If the requirements for the exclusion under section 3121(a)(2)(B) are satisfied, amounts paid by an S corporation for accident and health insurance covering a 2%-shareholder-employee are not wages for social security and Medicare tax purposes, even though the amounts must be included in wages for income tax withholding purposes on the 2%-shareholder-employee's Form W-2.

On the other hand, if the requirements for an exclusion are not satisfied, amounts paid by an S corporation for accident and health insurance covering a 2%-shareholder-employee must be included in wages for social security and Medical tax purposes, as well as for income tax withholding purposes, and reported in the appropriate boxes on the 2%-shareholder-employee's Form W-2.


IRS Notice 2005-8, 2005-4 (1/24/2005)  Health Savings Accounts - S Corporation’s Contributions to a 2-Percent Shareholder-Employee’s HSA

IRS Notice 2008-1, (PDF) 2008-2 I.R.B. 251 (1/14/2008)
Part III - Administrative, Procedural, and Miscellaneous
Special Rules for Health Insurance Costs of 2-Percent Shareholder-Employees

PURPOSE
This notice provides rules under which a 2-percent (sic) shareholder-employee in an S corporation is entitled to the deduction under §26 USC 162(l) of the Internal Revenue Code for accident and health insurance premiums that are paid or reimbursed by the S corporation and included in the 2-percent shareholder-employee's gross income.

LAW AND ANALYSIS
Section 26 USC 1372(a) provides that, for purposes of applying the income tax provisions of the Code relating to employee fringe benefits, an S corporation shall be treated as a partnership, and any 2-percent shareholder of the S corporation shall be treated as a partner of such partnership. For purposes of §26 USC 1372, the term "2-percent shareholder" is any person who owns (or is considered as owning within the meaning of §26 USC 318)on any day during the taxable year of the S corporation more than 2 percent of the outstanding stock of such corporation or stock possessing more than 2 percent of the total combined voting power of all stock of such corporation. Section 26 USC 1372(b).

Accident and health insurance premiums paid or furnished by an S corporation on behalf of its 2-percent shareholders in consideration for services rendered are treated for income tax purposes like partnership guaranteed payments under §26 USC 707(c) of the Code. Rev. Rul. 91-26, 1991-1 C.B. 184. An S corporation is entitled to deduct the cost of such employee fringe benefits under §26 USC 162(a) if the requirements of that section are satisfied (taking into account the rules of §26 USC 263). The premium payments are included in wages for income tax withholding purposes on the shareholder-employee's Form W-2, Wage and Tax Statement, but are not wages subject to Social Security and Medicare taxes if the requirements for exclusion under section 26 USC 3121(a)(2)(B) are satisfied. See §26 USC 3121(a)(2)(B); Ann. 92-16, 1992-5 I.R.B. 53. The 2-percent shareholder is required to include the amount of the accident and health insurance premiums in gross income under §26 USC 61(a).

Section 26 USC 106 provides an exclusion from the gross income of an employee for employer-provided coverage under an accident and health plan. A 2-percent shareholder is not an employee for purposes of §26 USC 106. Treas. Reg. §26 CFR 1.106-1; section 26 USC 1372(a). Accordingly, the premiums are not excludible from the 2-percent shareholder-employee's gross income under §26 USC 106.

Section 26 USC 162(l)(1)(A) allows an individual who is an employee within the meaning of §26 USC 401(c)(1) to take a deduction in computing adjusted gross income for amounts paid during the taxable year for insurance that constitutes medical care for the taxpayer, his or her spouse, and dependents. The deduction is not allowed to the extent that the amount of the deduction exceeds the earned income (within the meaning of section 26 USC 401(c)(2)) derived by the taxpayer from the trade or business with respect to which the plan providing the medical care coverage is established. Section 26 USC 162(l)(2)(A). Also, the deduction is not allowed for amounts during a month in which the taxpayer is eligible to participate in any subsidized health plan maintained by an employer of the taxpayer or of the spouse of the taxpayer. Section 26 USC 162(l)(2)(B).

A 2-percent shareholder-employee in an S corporation, who otherwise meets the requirements of section 26 USC 162(l), is eligible for the deduction under section 26 USC 162(l) if the plan providing medical care coverage for the 2-percent shareholder-employee is established by the S corporation. Rev. Rul. 91-26, 1991-1 C.B. 184. A plan providing medical care coverage for the 2-percent shareholder-employee in an S corporation is established by the S corporation if:

  1. the S corporation makes the premium payments for the accident and health insurance policy covering the 2-percent shareholder-employee (and his or her spouse or dependents, if applicable) in the current taxable year; or
     
  2. the 2-percent shareholder makes the premium payments and furnishes proof of premium payment to the S corporation and then the S corporation reimburses the 2-percent shareholder-employee for the premium payments in the current taxable year.

If the accident and health insurance premiums are not paid or reimbursed by the S corporation and included in the 2-percent shareholder-employee's gross income, a plan providing medical care coverage for the 2-percent shareholder-employee is not established by the S corporation and the 2-percent shareholder-employee in an S corporation is not allowed the deduction under §26 USC 162(l).

In order for the 2-percent shareholder-employee to deduct the amount of the accident and health insurance premiums, the S corporation must report the accident and health insurance premiums paid or reimbursed as wages on the 2-percent shareholder-employee's Form W-2 in that same year. In addition, the shareholder must report the premium payments or reimbursements from the S corporation as gross income on his or her Form 1040, U.S. Individual Income Tax Return.


EXAMPLES
The following examples illustrate these rules. The following examples assume that each shareholder is a 2-percent shareholder-employee in an S corporation, whose earned income from the S corporation exceeds the amount of the premiums for the accident and health insurance policies covering the shareholder, his or her spouse and dependents.
None of the shareholders in the following examples are eligible to participate in any subsidized health plan maintained by an employer of the shareholder or the shareholder's spouse.

Example 1. (i) For 2008, shareholder A obtains an accident and health insurance policy in the name of shareholder A and makes the premium payments on the policy. The S corporation makes no payments or reimbursements with respect to the premiums.
(ii) A plan providing medical care for shareholder A is not established by the S corporation and shareholder
A is not entitled to the deduction under §26 USC 162(l).

Example 2. (i) For 2008, the S corporation obtains an accident and health insurance plan in the name of the S corporation. The health plan provides coverage for shareholder B, B's spouse and dependents. The S corporation makes all the premium payments to the insurance company. The S corporation reports the amount of the premiums as wages on shareholder B's Form W-2 for 2008 and shareholder B reports that amount as gross income on Form 1040 for 2008.
(ii) A plan providing medical care for shareholder B has been established by the S corporation and shareholder B is allowed the deduction under §26 USC 162(l) for 2008.

Example 3. (i) For 2008, shareholder C obtains an accident and health insurance policy in the name of shareholder C. The S corporation makes all the premium payments to the insurance company. The S corporation reports the amount of the premiums as wages on shareholder C's Form W-2 for 2008 and shareholder C reports that amount as gross income on Form 1040 for 2008.
(ii) A plan providing medical care for shareholder C has been established by the S corporation and
shareholder C is allowed the deduction under §26 USC 162(l) for 2008.

Example 4. (i) For 2008, shareholder D obtains an accident and health insurance policy in the name of shareholder D. Shareholder D makes the premium payments to the insurance company and furnishes proof of premium payment to the S corporation. The S corporation then reimburses shareholder D for the premium payments. The S corporation reports the amount of the premium reimbursements as wages on shareholder D's Form W-2 for 2008 and shareholder D reports that amount as gross income on Form 1040 for 2008.
(ii) A plan providing medical care for shareholder D has been established by the S corporation and shareholder
D is allowed the deduction under §26 USC 162(l) for 2008.


Rev. Rul. 91-26, 1991-1 C.B. 184  Clarified by Ann. 92-16.

ISSUES

1. If a partner performs services in the capacity of a partner and the partnership pays accident and health insurance premiums for current year coverage on behalf of such partner without regard to partnership income, what is the Federal income tax treatment of the premium payments?

2. If an S corporation pays accident and health insurance premiums for current year coverage on behalf of a 2-percent shareholder-employee, what is the Federal income tax treatment of the premium payments?

FACTS

SITUATION 1. AB is a partnership in which individuals A and B are equal partners. During 1989, AB paid accident and health insurance premiums for 1989 coverage on behalf of each partner under AB's accident and health plan.

The premiums paid by AB on behalf of A and B were for services rendered by A and B in their capacities as partners and were payable without regard to partnership income. The premiums paid by AB would qualify as ordinary and necessary business expenses under section 26 USC 162(a) of the Code if paid by AB on behalf of individuals who were not partners of AB. The value of the premiums to A and B is equal to the cost of the premiums paid on behalf of A and B, respectively.

SITUATION 2. X corporation made a valid election to be an S corporation under section 26 USC 1362 of the Code effective for its taxable year beginning January 1, 1989. Three individuals own X's stock in the following proportions: C, 51 percent; D, 48 percent; and E, 1 percent. C, D, and E are also employees of X.

During 1989, X paid accident and health insurance premiums for 1989 coverage on behalf of each of its employees under X's accident and health plan. The premiums paid by X would qualify as ordinary and necessary business expenses under section 26 USC 162(a) of the Code if paid by X on behalf of individuals who were not "2-percent shareholders."The value of the premiums to C, D, and E is equal to the cost of the premiums paid on behalf of C, D, and E, respectively.

LAW AND ANALYSIS

Section 26 USC 106 of the Code excludes from the gross income of an employee coverage provided by an employer under an accident or health plan.

Section 26 USC 162(l) of the Code allows as a deduction, in the case of an individual who is an employee within the meaning of section 26 USC 401(c)(1), an amount equal to 25 percent of the amount paid during the taxable year for insurance that constitutes medical care for the individual and the individual's spouse and dependents. This provision applies to taxable years beginning after December 31, 1986, and before January 1, 1992.

Section 26 USC 401(c)(1) of the Code treats certain self-employed individuals as employees. Section 26 USC 401(c)(1)(B) defines a "self- employed individual,"with respect to any taxable year, as an individual who has earned income (as defined in section 26 USC 401(c)(2)) for the taxable year. Section 26 USC 401(c)(2) defines "earned income" as, in general, the net earnings from self-employment as defined in section 26 USC 1402(a). Under section 26 USC 1402(a), the term net earnings from self-employment is defined to include, with certain specified exceptions, a partner's distributive share of income or loss described in section 26 USC 702(a)(8) from any trade or business carried on by a partnership in which the individual is a partner. Guaranteed payments to a partner for services also are included in net earnings from self-employment. In addition, section 26 USC 162(l)(5)(A) provides that, for purposes of section 26 USC 162(l), if a shareholder owns more than 2 percent of the outstanding stock of an S corporation, the shareholder's wages (as defined in section 26 USC 3121) from the S corporation are treated as "earned income" within the meaning of section 26 USC 401(c)(1).

SITUATION 1. (Partnerships and most LLC's)

Section 26 USC 707(c) of the Code provides that payments to a partner for services, to the extent the payments are determined without regard to the income of the partnership, are considered as made to one who is not a member of the partnership, but only for purposes of section 26 USC 61(a) (relating to gross income) and, subject to section 26 USC 263 (prohibiting deductions for capital expenditures), for purposes of section 26 USC 162(a) (relating to trade or business expenses). These payments are termed "guaranteed payments."

Section 26 CFR 1.707-1(c) of the Income Tax Regulations provides that for a guaranteed payment under section 26 USC 707(c) of the Code to be deductible by the partnership, it must meet the same tests under section 26 USC 162(a) as it would if the payment had been made to a person who was not a member of the partnership. Generally, for purposes of Code provisions other than sections 26 USC 61(a) and 26 USC 162(a), guaranteed payments are treated as a partner's distributive share of ordinary income. The regulation states, by way of an illustration, that a partner who receives guaranteed payments is not entitled to exclude them from gross income as disability payments under section 26 USC 105(d) (as in effect prior to its repeal by section 122(b) of the Social Security Amendments of 1983, Pub. L. No. 98-21, 1983-2 C.B. 309, 315). The regulation also provides that a partner who receives guaranteed payments is not, by virtue of the payments, regarded as an employee of the partnership for purposes of withholding of tax at source, deferred compensation plans, and other purposes.

Amounts paid in cash or in kind by a partnership, without regard to its income, to or for the benefit of its partners, for services rendered in their capacities as partners, are guaranteed payments under section 26 USC 707(c) of the Code. A partnership is entitled to deduct such cash amounts, or the cost to the partnership of such in-kind benefits, under section 26 USC 162(a), if the requirements of that section are satisfied (taking into account the rules of section 26 USC 263). Under section 26 USC 61(a), the cash amount or the value of the benefit is included in the income of the recipient-partner. The cash amount or value of the benefit is not excludible from the partner's gross income under the general fringe benefit rules (except to the extent the Code provision allowing exclusion of a fringe benefit specifically provides that it applies to partners) because the benefit is treated as a distributive share of partnership income under section 26 CFR 1.707-1(c) of the regulations for purposes of all Code sections other than sections 26 USC 61(a) and 26 USC 162(a), and a partner is treated as self-employed to the extent of his or her distributive share of income. Section 26 USC 1402(a). See also Rev. Rul. 69-184, 1969-1 C.B. 256 (employment taxes); cf. section 26 USC 401(c), which recognizes that partners are self-employed individuals but treats them as employees for certain limited purposes.

Therefore, AB may deduct under section 26 USC 162(a) of the Code (subject to section 26 USC 263) the cost of the accident and health insurance premiums paid on behalf of A and B.  A and B may not exclude the cost of the premiums from their gross income under section 26 USC 106, but must include the cost of the premiums in gross income under section 26 USC 61(a). Provided all the requirements of section 26 USC 162(l) are met, however, A and B may deduct the cost of the premiums to the extent provided by section 26 USC 162(l).

A partnership may account for accident and health insurance premiums paid on behalf of a partner as a reduction in distributions to the partner. Under these circumstances, the premiums are not deductible by the partnership, so distributive shares of partnership income and deduction (and other payment items) are not affected by payment of the premiums. A partner may deduct the cost of the premiums paid on that partner's behalf to the extent allowed under section 26 USC 162(l).

SITUATION 2. (S-Corporations)

Section 26 USC 1372 of the Code provides that, for purposes of applying the income tax provisions of the Code relating to employee fringe benefits, an S corporation shall be treated as a partnership, and any person who is a "2-percent shareholder" of the S corporation shall be treated like a partner of a partnership. Section 26 USC 1372(b) defines a "2-percent shareholder" as any person who owns (or is considered as owning within the meaning of section 26 USC 318) on any day during the taxable year of the S corporation more than 2 percent of the outstanding stock of the corporation or stock possessing more than 2 percent of the total combined voting power of all stock in the corporation.

Under section 26 USC 1372 of the Code, for purposes of applying the provisions of the Code relating to employee fringe benefits, a 2- percent shareholder who is also an employee of an S corporation is treated like a partner of a partnership. Employee fringe benefits paid or furnished by an S corporation to or for the benefit of its 2- percent shareholder-employees in consideration for services rendered, therefore, are treated for income tax purposes like partnership guaranteed payments under section 26 USC 707(c). An S corporation is entitled to deduct the cost of such employee fringe benefits under section 26 USC 162(a) if the requirements of that section are satisfied (taking into account the rules of section 26 USC 263). Like a partner, a 2- percent shareholder is required to include the value of such benefits in gross income under section 26 USC 61(a) and is not entitled to exclude such benefits from gross income under provisions of the Code permitting the exclusion of employee fringe benefits (except to the extent the Code provision allowing exclusion of a fringe benefit specifically provides that it applies to partners).

Therefore, X may deduct under section 26 USC 162(a) of the Code the cost of the accident and health insurance premiums paid on behalf of C, D, and E. C and D may not exclude the cost of the premiums from their gross income under section 26 USC 106, but must include the cost of the premiums in gross income under section 26 USC 61(a). Provided all the requirements of section 26 USC 162(l) are met, however, C and D may deduct the cost of the premiums to the extent provided by section 26 USC 162(l). E (who does not own more than 2 percent of X's stock) may exclude from gross income under section 26 USC 106 the cost of the premiums paid by X on E's behalf.

Unlike a partnership, an S corporation may not account for accident and health insurance premiums paid on behalf of a shareholder-employee as a reduction in distributions to the shareholder-employee because the shareholder-employee's pro rata share of S corporation income would not be subject to employment taxes.

HOLDINGS

1. Accident and health insurance premiums paid by a partnership on behalf of a partner are guaranteed payments under section 26 USC 707(c) of the Code if the premiums are paid for services rendered in the capacity of partner and to the extent the premiums are determined without regard to partnership income. As guaranteed payments, the premiums are deductible by the partnership under section 26 USC 162 (subject to the capitalization rules of section 26 USC 263) and includible in the recipient-partner's gross income under section 26 USC 61. The premiums are not excludible from the recipient-partner's gross income under section 26 USC 106;however, provided all the requirements of section 26 USC 162(l) are met, the partner may deduct the cost of the premiums to the extent provided by section 26 USC 162(l).

A partnership must report the cost of accident and health insurance premiums that are guaranteed payments on its U.S. Partnership Return of Income (Form 1065) and the Schedule K-1s. A partnership is not required to file a Form 1099 or a Wage and Tax Statement (Form W-2) for accident and health insurance premiums that are guaranteed payments.

2. Under section 26 USC 1372 of the Code, accident and health insurance premiums paid by an S corporation on behalf of a 2-percent shareholder-employee as consideration for services rendered are treated like guaranteed payments under section 26 USC 707(c) of the Code. Therefore, the premiums are deductible by the corporation under section 26 USC 162 (subject to the capitalization rules of section 26 USC 263), and includible in the recipient shareholder-employee's gross income under section 26 USC 61. The premiums are not excludible from the recipient shareholder-employee's gross income under section 26 USC 106;however, provided all the requirements of section 26 USC 162(l) are met, the shareholder-employee may deduct the cost of the premiums to the extent provided by section 26 USC 162(l).

An S corporation may deduct as salary and wages accident and health insurance premiums paid on behalf of its 2-percent shareholder-employees on its U.S. Income Tax Return for an S Corporation. The S corporation is required to file a Wage and Tax Statement (Form W-2) for each 2-percent shareholder-employee. The Form W-2 must include for a 2-percent shareholder-employee the cost of accident and health insurance premiums paid on behalf of the shareholder-employee in the shareholder-employee's wages.

EFFECT ON OTHER REVENUE RULINGS

Rev. Rul. 72-596, 1972-2 C.B. 395, concerns the deductibility under section 162 of the Code of premiums paid by a partnership on behalf of its partners for workmen's compensation insurance. Rev. Rul. 72-596 relies on the general rule that a partner is not an employee and suggests that workmen's compensation premiums are deductible by the partnership only if paid on behalf of an employee.

The partners in Rev. Rul. 72-596 were acting in their capacities as partners and the workmen's compensation premiums were payable without regard to partnership income. Thus, the premiums are guaranteed payments under section 26 USC 707(c) of the Code, and as such are deductible by the partnership under section 26 USC 162 (if the requirements of that section are satisfied) and includible in the incomes of the partners under section 26 USC 61. Rev. Rul. 72-596 is incorrect to the extent it concludes otherwise. Rev. Rul. 72-596 is revoked.

ADMINISTRATIVE RELIEF

For S corporation tax years beginning before January 1, 1991, the Service will not challenge the treatment of accident and health insurance premiums paid by S corporations for 2-percent shareholder- employees in accordance with the instructions to the Form 1120S and Schedule K-1 to the Form 1120S. These instructions provide that such fringe benefits are nondeductible by the S corporation and cannot be treated as deductible or excludable employee fringe benefits (except for benefits allowed partners, such as section 26 USC 162(l)).

The Service does not consider payments of accident and health insurance premiums by an S corporation on behalf of 2-percent shareholder-employees to be distributions for purposes of the single class of stock requirement of section 26 USC 1361(b)(1)(D).


S-Corp shareholders' tax deductions based on loans made - and the taxable income based on repayments of those loans:

Income recapture can occur when debt basis is used to deduct corporate losses. When debt basis is reduced to zero due to corporate losses, and then payments are made against the zero-basis loam, income recapture may occur.

Generally:
For shareholder loans evidenced by a note, additional advances do not restore or prevent income recapture to zero-basis or low-basis loans repaid during the year. Because additional advances are deemed new loan, they provide the shareholder with additional basis for deducting additional losses, but do not prevent income recapture for the zero-basis or low-basis loans repaid during the period.

However, for open account debt, additional advances restore zero-basis or low-basis loans repaid during the year. Under Regs. Sec. 1.1367-2(b)(1), basis for open account debt is determined at the close of the year. Thus, advances and repayments are netted throughout the year; the final determination of debt basis for open account debt is determined at the dose of the year. This provision allows S shareholders time to make a corrective loan before the end of the year to restore debt basis.

In a court decision, Brooks, TC Memo 2005-204,  S shareholders advanced money to their S-corporation in one year, using those advances to enable them to deduct the corporate losses. Then at the beginning of the subsequent year the corporation repaid the loans.  Then before the end of the year, the shareholders made additional loans to restore debt basis. This situation continued over several years, allowing the shareholders to defer income recognition indefinitely.


Under Prop. Regs. Sec. 1.1367-2(a) (2)(ii), the shareholder must maintain a daily running log to account for the open account debt. If, at any point during the S corporation's tax year, the aggregate balance of the open account debt exceeds $10,000, it is treated in the same way as debt evidenced by a note. The resulting debt repayments are treated in this manner for the loan's remaining life; see Prop. Regs. Sec. 1.1367-2(d)(2)(ii).

Effect on open account debt: By limiting the definition of open account debt, the proposed regulations minimize S shareholders' ability to defer income recognition. Shareholders now must bear the administrative burden of maintaining a daily log to record advances and repayments on open account debt.


Below is a list of options that taxpayers can use in light of the proposed regulations:

  1. Treat all advances as capital, rather than debt. Under this strategy, the shareholder treats advances as additional paid-in capital, rather than debt. This allows the shareholder to avoid the open account debt rules. The shareholder can take repayments in the form of distributions, then simply contribute additional funds to the corporation to avoid distributions in excess of basis at year-end. However, if the corporation has undistributed C corporation earnings and profits and an insufficient S corporation accumulated adjustments account (AAA), the income potential Hill continue to exist for distributions in excess of the AAA.
     
  2. Keep open account debt balances under $10,000. This may seem to be more trouble than it is worth, but by reclassifying shareholder distributions to reduce the balance of the open account debt, a shareholder may be able to circumvent the $10,000 de minimis rule. Those looking to continue to use open account debt must keep a daily log, so there will be no more expended effort to track the account balance.
     
  3. Set up a formal note for open account debt exceeding $10,000. The IRS has not clarified whether debt repayments on zero- or low-basis open account debt will be treated as ordinary income recapture or receive capital gain treatment similar to that afforded loans evidenced by a note. To ensure capital gain treatment, set up a formal note for any debt that no longer qualifies for open account treatment.
    • Actually, if the debt is an open account, the gain is ordinary because a collection on that type of indebtedness is not considered to be a sale or exchange.
    • Whereas, collection of a corporate note is deemed to be a sale or exchange, so if the note is a capital asset to the shareholder, the gain is a capital gain (IR Code §1271(a)(a) - see page 111 http://www.belkcollege.uncc.edu/haburton/S%20Corporations.pdf )
    • If loan basis has been reduced, but not to zero, a partial payment to the shareholder on the loan cannot be applied solely to the basis portion. Rather, the payment must be allocated proportionately to represent (a) return of basis, and (b) taxable income to the shareholder (Rev. Rul. 64-162, 1964-1 CB 304, Rev. Rul. 68-537, 1968-2 CB 372).

  4. Use outside loans to increase the $10,000 limit. For S corporations with multiple shareholders, use outside loans between shareholders to circumvent the $10,000 limit.
     
  5. Use multiple small loans evidenced by a formal note. Under the existing regulations, income earned by an S corporation in any year will first restore the basis in zero- or low-basis loans, before it increases shareholder stock basis. If a loan with reduced basis is repaid during a year in which net income is recognized by the S corporation, the income is first applied to restore the basis of the loan that is partially or fully repaid. By using multiple small notes, a taxpayer can more easily control income recognition on repayment of a zero- or low-basis loan.

Effective October 20, 2008 (T.D. 9428):
Regulations apply to any and all shareholder advances to the S corporation made on or after October 20, 2008, and repayments on those advances by the S corporation.

Treasury Department and the IRS have concluded that the aggregate principal threshold dollar amount for open account debt should be increased and that other changes are necessary. Therefore, the final regulations adopt a $25,000 aggregate principal threshold amount per shareholder for open account debt. For example, an S corporation with ten shareholders could receive up to $250,000 of open account debt as long as no single shareholder advanced more than $25,000. The Treasury Department and the IRS believe that the $25,000 threshold, together with certain other changes noted below, balances concerns over deferral potential with normal business practices. Under the final regulations, for any particular shareholder advances and repayments on those advances for which, as of the specified determination date, the aggregate principal balance exceeds the $25,000 aggregate principal threshold amount will no longer constitute open account debt, but instead will be treated as debt evidenced by a separate written instrument subject to the basis adjustment and repayment accounting rules applicable to S corporation shareholder debt generally.


S-Corp shareholders' pass-thru's ordering rule 1.1367-1(g) election:

A S-Corp shareholder may elect to shift the ordering of Tier 3 and Tier 4 items.  If the election is not made, the Code strongly suggests that there is no carryover available of the Tier 3 items.  If the election is made, the shareholder generally may get to deduct Tier 4 items which otherwise may have to be deferred due to lack of tax basis

Schedule K-1 instructions:
You may elect to decrease your basis under (4) prior to decreasing your basis under (3). If you make this election, any amount described under (3) that exceeds the basis of your stock and debt owed to you by the corporation is treated as an amount described under (3) for the following tax year.

To make the election, attach a statement to your timely filed original or amended return that states you agree to the carryover rule of Regulations section 1.1367-1(g) and the name of the S corporation to which the rule applies. Once made, the election applies to the year for which it is made and all future tax years for that S corporation, unless the IRS agrees to revoke your election.

http://www.nysscpa.org/cpajournal/1996/mar96/depts/fed_tax96.htm

http://goliath.ecnext.com/coms2/gi_0199-3165763/S-corporation-elections-guide.html
http://www.docstoc.com/docs/1036730/S-Corporation-Elections-Guide---1

http://www.allbusiness.com/legal/laws-government-regulations/370149-1.html
http://tax.aicpa.org/Resources/S+Corporations/



1.1367-1(f) Ordering Rules For Taxable Years Beginning On Or After August 18, 1998.
For any taxable year of a corporation beginning on or after August 18, 1998, except as provided in paragraph (g) of this section, the adjustments required by section 1367(a) are made in the following order--

1.1367-1(f)(1)
Any increase in basis attributable to the income items described in section 1367(a)(1)(A) and (B), and the excess of the deductions for depletion described in section 1367(a)(1)(C);

1.1367-1(f)(2)
Any decrease in basis attributable to a distribution by the corporation described in section 1367(a)(2)(A);

1.1367-1(f)
(3)
Any decrease in basis attributable to noncapital, nondeductible expenses described in section
1367(a)(2)(D), and the oil and gas depletion deduction described in section 1367(a)(2)(E); and

1.1367-1(f)
(4)
Any decrease in basis attributable to items of loss or deduction described in section
1367(a)(2)(B) and (C).

1.1367-1(g) Elective Ordering Rule.
A shareholder may elect to decrease basis under paragraph (e)(3) or (f)(4) of this section, whichever applies, prior to decreasing basis under paragraph (e)(2) or (f)(3) of this section, whichever applies. If a shareholder makes this election, any amount described in paragraph (e)(2) or (f)(3) of this section, whichever applies, that is in excess of the shareholder's basis in stock and indebtedness is treated, solely for purposes of this section, as an amount described in paragraph (e)(2) or (f)(3) of this section, whichever applies, in the succeeding taxable year.
A shareholder makes the election under this paragraph by attaching a statement to the shareholder's timely filed original or amended return that states that the shareholder agrees to the carryover rule of the preceding sentence. Once a shareholder makes an election under this paragraph with respect to an S corporation, the shareholder must continue to use the rules of this paragraph for that S corporation in future taxable years unless the shareholder receives the permission of the Commissioner.



1367(a) General Rule
1367(a)(1) Increases In Basis
The basis of each shareholder's stock in an S corporation shall be increased for any period by the sum of the following items determined with respect to that shareholder for such period:
1367(a)(1)(A) the items of income described in subparagraph (A) of section 1366(a)(1),
1367(a)(1)(B) any nonseparately computed income determined under subparagraph (B) of section 1366(a)(1), and
1367(a)(1)(C) the excess of the deductions for depletion over the basis of the property subject to depletion.

1367(a)(2) Decreases In Basis
The basis of each shareholder's stock in an S corporation shall be decreased for any period (but not below zero) by the sum of the following items determined with respect to the shareholder for such period:
1367(a)(2)(A) distributions by the corporation which were not includible in the income of the shareholder by reason of section 1368,
1367(a)(2)(B) the items of loss and deduction described in subparagraph (A) of section 1366(a)(1),
1367(a)(2)(C) any nonseparately computed loss determined under subparagraph (B) of section 1366(a)(1),

1367(a)(2)(D) any expense of the corporation not deductible in computing its taxable income and not properly chargeable to capital account, and
1367(a)(2)(E) the amount of the shareholder's deduction for depletion for any oil and gas property held by the S corporation to the extent such deduction does not exceed the proportionate share of the adjusted basis of such property allocated to such shareholder under section 613A(c)(11)(B).

The decrease under subparagraph (B) by reason of a charitable contribution (as defined in section 170(c)) of property shall be the amount equal to the shareholder's pro rata share of the adjusted basis of such property. The preceding sentence shall not apply to contributions made in taxable years beginning after December 31, 2009.


S corporation payroll debt obligations - disqualifying second class of stock - Regs. §1.1361-1:

Straight Debt Safe Harbor:
Debt that meets the definition of "straight debt" is not a second class of stock, regardless of whether such debt is classified as equity under general tax law principles.

A straight debt instrument is a written unconditional promise to pay (whether or not embodied in a formal note) on demand or on a specific date a sum certain in money (§1361(c)(5)). In addition, straight debt must meet the following requirements:

1. The interest rate and payment dates are not contingent on profits, corporate discretion, etc.;

2. The instrument is not convertible into stock; and

3. The lender is an individual (other than a nonresident alien), an estate, a trust that is eligible to hold S corporation stock, or a person actively and regularly engaged in the business of lending money (e.g., a bank).


Short-Term Unwritten Advances:
Regs. §1.1361-1(1)(4)(ii)(B)  Unwritten advances that (1) do not exceed $10,000 in the aggregate at any time, (2) are treated as debt by the parties, and (3) are expected to be repaid within a reasonable time are not treated as a second class of stock (even if considered equity under general tax law principles).


Proportionately Held Debt:
Regs. §1.1361-1(1)(4)(ii)(B) Proportionately held debt includes any class of obligations considered equity under general tax law principles and held by the shareholders in the same proportion as the S corporation's outstanding stock. Note that debt held by a sole shareholder of an S corporation always meets the definition of proportionately held debt. Thus, debt held by shareholders in the same proportions as their stock ownership (including debt owed by the corporation to a sole shareholder) will not be considered a second class of stock.  The regulations explicitly state that obligations held by the sole shareholder of an S corporation are always considered proportionately held.


One-shareholder s-corporation (or few shareholders) payroll issues:

Watson, P.C. v. U.S., (DC IA 12/23/10) 107 AFTR 2d
$24,000 wages unreasonably low in comparison to $67,000 of dividend payments to the shareholder-officer.

David E Watson, P.C. v. USA:
http://media.ca8.uscourts.gov/opndir/12/02/111589P.pdf

Patrick & Suzanna Herbert v. Comr:
http://scholar.google.com/scholar_case?case=11328418329024231993&q=Herbert+v.+Commissioner++2012-124&hl=en&as_sdt=2,47&as_vis=1

CA Board of Accountancy v. Biyu Wong:
http://www.dca.ca.gov/cba/meetings/materials/2010/mat0510cba.pdf (see page 153 of 285)
http://www.dca.ca.gov/cba/discipline/accusations/ac-2009-26.pdf


Ken Ryan, Inc. v. Comr. T.C. Summary Opinion 2010-18
Payroll wages must not be reported solely on the 4th quarter form 941 (with the result that payment of withholding taxes are delayed until the end of the year)

Charlotte’s Office Boutique, Inc. v. Comr. (2005)
Royalty payments must not be made in lieu of payroll wages.  (with the result that Social Security, FICA and Medicare taxes are avoided)

Reasonable Compensation must be paid to shareholders
http://www.irs.gov/businesses/small/article/0,,id=203100,00.html#skiptocontent

So how do you figure out what a reasonable salary is?

IRS Fact Sheet FS-2008-25 Wage Compensation for S Corporation Officers

Wage Taxes and Compensating S Corporation Officers...

Payroll tax penalties case of some interest T.C. Memo 2011-155

Independent Contractor v. Common Law Employee case of some interest T.C. Memo 2011-48

Court Gives IRS Rare Win in 'John Edwards Sub S Tax Shelter' Case:
http://taxprof.typepad.com/taxprof_blog/2011/01/irs-targets-.html

Another Lesson on Unreasonably Low Compensation:
http://blog.aicpa.org/2013/07/another-lesson-on-unreasonably-low-compensation.html

 


Selling s-corporation shareholder - IRC §1377(a)(2) issue (trap)

If a shareholder terminates his or her interest in a s-corporation during the tax year, the corporation, with the consent of all affected shareholders (including those whose interest is terminated), may elect to allocate income and expenses, etc., as if the s-corporation's tax year consisted of 2 separate tax years, the first of which ends on the date of the shareholder's termination.

Selling shareholder should provide for the election in the stock buy-sell agreement.  For example: Seller sold his interest in a s-corporation and had a provision that if a terminating election was requested, that the buyer would consent to same.  If it turns out that the normal pro-rata was acceptable to seller, then the seller does not invoke the election for a closing of 2 separate tax years.

Example 2: A buyer, by not providing for an election in advance, and then once in control of the books after the sale, causes a temporary disproportionate amount of income post termination, thereby hitting an unsuspecting seller with phantom income.  This shifts taxable income away from the buyer and over to the terminating seller.

This shows why S corporation buyer and seller shareholders who may not be thoroughly familiar with s-corp rules should consult with a professional before buying or selling s-corporation shares
.

 



Trader Status "election":

Each year s taxpayer chooses whether to take the position of "trader status" rather than the default position of "investor status" merely by filing a tax return using trader status concepts rather than investor status concepts.

The IRS has the right to challenge the taxpayer's choice on a year-by-year basis.  The documentation and support for taxpayer's choice of filing under trader status should show that the buying and selling of securities (and/or commodities, futures or forex) during the year was substantial. and was carried on with continuity and regularity.  The taxpayer also should be intending to "make a living" from the trading activity (see Reg. §1.183-2(b)(8)).

Reg. §1.183-2(b)(8) Relevant factors:.The financial status of the taxpayer. The fact that the taxpayer does not have substantial income or capital from sources other than the activity may indicate that an activity is engaged in for profit. Substantial income from sources other than the activity (particularly if the losses from the activity generate substantial tax benefits) may indicate that the activity is not engaged in for profit especially if there are personal or recreational elements involved. .


IRS Reg. §1.448-1T(f)(2)(iv(A)and IRS Code §61(a) - A trader's Gross Receipts are his Net Gains (not his Gross Sales Proceeds):

It is well established that a taxpayer’s gross receipts from the sale of a particular share of stock is the excess of the amount realized over the adjusted basis of such share.

§61(a)   General Definition
 Except as otherwise provided in this subtitle, gross income means all income from whatever source derived, including (but not limited to) the following items:
§61(a)(1)    Compensation for services, including fees, commissions, fringe benefits, and similar items;
§61(a)(2)    Gross income derived from business;
§61(a)(3)    Gains derived from dealings in property;

Also see: Doyle v. Mitchell Bros. Co., 247 U.S.179 (1918).

§1.448-1T(f)(2)(iv)(A) In General.
The term "gross receipts" means gross receipts of the taxable year in which such receipts are properly recognized under the taxpayer's accounting method used in that taxable year (determined without regard to this section) for federal income tax purposes. For this purpose, gross receipts include total sales (net of returns and allowances) and all amounts received for services. In addition, gross receipts include any income from investments, and from incidental or outside sources. For example, gross receipts include interest (including original issue discount and tax-exempt interest within the meaning of section 103), dividends, rents, royalties, and annuities, regardless of whether such amounts are derived in the ordinary course of the taxpayer's trade of business. Gross receipts are not reduced by cost of goods sold or by the cost of property sold if such property is described in section 1221 (1), (3), (4) or (5). With respect to sales of capital assets as defined in section 1221, or sales of property described in 1221 (2) (relating to property used in a trade or business), gross receipts shall be reduced by the taxpayer's adjusted basis in such property. Gross receipts do not include the repayment of a loan or similar instrument (e.g., a repayment of the principal amount of a loan held by a commercial lender). Finally, gross receipts do not include amounts received by the taxpayer with respect to sales tax or other similar state and local taxes if, under the applicable state or local law, the tax is legally imposed on the purchaser of the good or service, and the taxpayer merely collects and remits the tax to the taxing authority. If, in contrast, the tax is imposed on the taxpayer under the applicable law, then gross receipts shall include the amounts received that are allocable to the payment of such tax. 1.448-1T


IRS Regs. §1.183-2(b) Trade or Business:

Nine nonexclusive factors under IRS Regs. §1.183-2(b) that the IRS looks to to determine if an activity is a "trade or business" are:

  1. The manner in which the taxpayer carried on the activity;
  2. the expertise of the taxpayer or his or her advisers;
  3. the time and effort expended by the taxpayer in carrying on the activity;
  4. the expectation that the assets used in the activity may appreciate in value;
  5. the success of the taxpayer in carrying on other similar or dissimilar activities;
  6. the taxpayer’s history of income or loss with respect to the activity;
  7. the amount of occasional profits, if any, which are earned;
  8. the financial status of the taxpayer; and  (ed note: does not have substantial income or capital from other sources)
  9. whether elements of personal pleasure or recreation are involved. Id.

Nine nonexclusive factors listed in Publication 535 Business Expenses show what the IRS looks to to determine if an activity is a "trade or business:"

  1. You carry on the activity in a businesslike manner,
  2. The time and effort you put into the activity indicate you intend to make it profitable,
  3. You depend on the income for your livelihood,
  4. Your losses are due to circumstances beyond your control (or are normal in the start-up phase of your type of business),
  5. You change your methods of operation in an attempt to improve profitability,
  6. You (or your advisors) have the knowledge needed to carry on the activity as a successful business,
  7. You were successful in making a profit in similar activities in the past,
  8. The activity makes a profit in some years, and
  9. You can expect to make a future profit from the appreciation of the assets used in the activity.

also see: http://www.traderstatus.com/entities.htm#parttime


IRS Regs. §1.469-1T(e)(6) Partnership has non-passive activity:

Non-Passive Income:
Once Trader Status is used by a pass-thru entity the income is not considered "passive income" pursuant to IRS Regs. §1.469-1T(e)(6) and IRS FSA 200111001   and is not considered "portfolio income" pursuant to IRS Regs. §1.469-2T(c)(3)(ii)(D).


§1.469-1T(e)(6) Activity of trading personal property

(i) In general. --An activity of trading personal property for the account of owners of interests in the activity is not a passive activity (without regard to whether such activity is a trade or business activity (within the meaning of paragraph (e)(2) of this section)).

(ii) Personal property. --For purposes of this paragraph (e)(6), the term "personal property" means personal property (within the meaning of section 1092(d), without regard to paragraph (3) thereof).

(iii) Example. --The following example illustrates the application of this paragraph (e)(6):

Example. A partnership is a trader of stocks, bonds, and other securities (within the meaning of section 1236(c)). The capital employed by the partnership in the trading activity consists of amounts contributed by the partners in exchange for their partnership interests, and funds borrowed by the partnership. The partnership derives gross income from the activity in the form of interest, dividends, and capital gains. Under these facts, the partnership is treated as conducting an activity of trading personal property for the account of its partners. Accordingly, under this paragraph (e)(6), the activity is not a passive activity.



§1.469-2T(c)(3) Items of portfolio income specifically excluded

§1.469-2T(c)(3)(i) In general. --Passive activity gross income does not include portfolio income. For purposes of the preceding sentence, portfolio income includes all gross income, other than income derived in the ordinary course of a trade or business (within the meaning of paragraph (c)(3)(ii) of this section), that is attributable to --



§1.469-2T(c)(3)(ii) Gross income derived in the ordinary course of a trade or business. --Solely for purposes of paragraph (c)(3)(i) of this section, gross income derived in the ordinary course of a trade or business includes only --

§1.469-2T(c)(3)(ii)(D) Income or gain derived in the ordinary course of an activity of trading or dealing in any property if such activity constitutes a trade or business (but see paragraph (c)(3)(iii)(A) of this section);


§1.469-2T(c)(3)(iii) Special rules
§1.469-2T(c)(3)(iii)(A) Income from property held for investment by dealer. --For purposes of paragraph (c)(3)(i) of this section, a dealer's income or gain from an item of property is not derived by the dealer in the ordinary course of a trade or business of dealing in such property if the dealer held the property for investment at any time before such income or gain is recognized.


IRS Regs. §1.469-5T(a) LLC has non-passive activity:

Paul D Garnett & Alicia Garnett v. Comr of the Internal Revenue, 132 TC No 19  June 30, 2009

Material participation is defined generally as regular, continuous, and substantial involvement in the business operations. Sec. 469(h)(1). The regulations provide
seven exclusive tests for material participation in an activity.10 Sec. 1.469-5T(a),

A taxpayer materially participates in an activity if he meets any one of these seven tests:

  1. The individual participates in the activity for more than "500 hours" during such year;

  2. The individual's participation in the activity for the taxable year constitutes "substantially all" of the participation in such activity of all individuals (including individuals who are not owners of interests in the activity) for such year;

  3. The individual participates in the activity for more than "100 hours" during the taxable year, and such individual's participation in the activity for the taxable year is not less than the participation in the activity of any other individual (including individuals who are not owners of interests in the activity) for such year;

  4. The activity is a "significant participation activity" for the taxable year, and the individual's aggregate participation in all significant participation activities during such year exceeds 500 hours;

  5. The individual materially participated in the activity for any five taxable years (whether or not consecutive) during the ten taxable years that immediately precede the taxable year;

  6. The activity is a personal service activity, and the individual materially participated in the activity for any three taxable years (whether or not consecutive) preceding the taxable year; (A personal service activity is an activity that involves (1) the performance of personal services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts or consulting, or (2) any other trade or business in which capital is not a material income-producing factor) or

  7. Based on all of the facts and circumstances if the individual participates in the activity on a regular, continuous, and substantial basis during such year.  The regulations establish 100+ hours as the minimum number for participation in an activity under this test, if an individual participates in the activity for 100 hours or less during the taxable year, he cannot be treated as materially participating in the activity for the taxable year under the facts and circumstances test.

For married taxpayers, any participation by your spouse in the activity during the year is treated as participation by you under all the above tests for material participation.  This rule applies even if the spouse does not own an interest in the activity and even if the spouses do not file a joint return for the taxable year.  There is no other attribution of hours for work done by other family members.

It is important to determine what work constitutes "participation" by an individual, to apply the first six material participation tests. In general, any work done by an individual in any capacity in connection with an activity in which the individual owns an interest at the time the work is done is treated as participation of the individual in the activity.  Such ownership interest may be indirect, as long as it is not through a C corporation.

There are a couple important exceptions to the above rules that any work done in any capacity is treated as participation.

  • Work done in connection with an activity is not treated as participation if the work is not of a type customarily done by an owner of such an activity and one of the principal purposes for the performance of the work is to avoid the disallowance of losses or credits under the passive loss rules.

  • Work done by an individual in the individual's capacity as an investor in an activity is not treated as participation in the activity unless the individual is directly involved in the day-to-day management of the activity.  Work done as an investor in an activity includes, for example, time spent studying and reviewing financial statements or reports on an activity, preparing studies or analyses of the activity's finances or operations for the investor's own use, or monitoring the activity's finances or operations in a nonmanagerial capacity.

 A trader may establish his participation in an activity by any reasonable means.  Reasonable would mean the identification of your activities performed over a period of time and the number of hours spent based on daybooks, spreadsheets or contemporaneously maintained summaries.  An individual is not required to maintain contemporaneous daily time reports, logs or similar documents, provided he can otherwise substantiate the level of his participation in an activity.  While the substantiation rule appears pretty liberal, taxpayers should keep careful records whenever at all possible. Taxpayers carry the burden of proving the amount of participation when challenged and so accurate detailed records will help meet this burden.  (Rule 142(a), Tax Court Rules of Practice and Procedure.)

 In light of the above the safest bet might be to make sure you meet the first test and well document that you actively trade for at least 500 hours each year.  Ideally these hours would be spread evenly throughout the year, say at least 10 hours per week.


IRS Code §446 General Rule For Methods Of Accounting & Rev. Rul. 90-38 Two-Year rule:

§446(c) Permissible Methods
Subject to the provisions of subsections (a) and (b), a taxpayer may compute taxable income under any of the following methods of accounting--
§446(c)(1) the cash receipts and disbursements method;
§446(c)(2) an accrual method;
§446(c)(3) any other method permitted by this chapter; or
§446(c)(4) any combination of the foregoing methods permitted under regulations prescribed by the Secretary.
§446(d) Taxpayer Engaged In More Than One Business
A taxpayer engaged in more than one trade or business may, in computing taxable income, use a different method of accounting for each trade or business.
§446(e) Requirement Respecting Change Of Accounting Method
Except as otherwise expressly provided in this chapter, a taxpayer who changes the method of accounting on the basis of which he regularly computes his income in keeping his books shall, before computing his taxable income under the new method, secure the consent of the Secretary.


Rev. Proc. 2002-28:
2.02 Section 446(c) generally allows a taxpayer to select the method of accounting it will use to compute its taxable income. A taxpayer is entitled to adopt any one of the permissible methods for each separate trade or business...



IRS Code §446(a) General Rule:
Taxable income shall be computed under the method of accounting on the basis of which the taxpayer regularly computes his income in keeping his books.

IRS Regs. §1.446-1 General rule for methods of accounting.
§1.446-1(1)(a)(1) Section 446(a) provides that taxable income shall be computed under the method of accounting on the basis of which a taxpayer regularly computes his income in keeping his books.

§1.446-1(b)(2) A taxpayer whose sole source of income is wages need not keep formal books in order to have an accounting method. Tax returns, copies thereof, or other records may be sufficient to establish the use of the method of accounting used in the preparation of the taxpayer's income tax returns.

§1.446-1(c)(1)(iv)(b) A taxpayer using one method of accounting in computing items of income and deductions of his trade or business may compute other items of income and deductions not connected with his trade or business under a different method of accounting.

§1.446-1(c)(2)(ii) No method of accounting will be regarded as clearly reflecting income unless all items of gross profit and deductions are treated with consistency from year to year. The Commissioner may authorize a taxpayer to adopt or change to a method of accounting permitted by this chapter although the method is not specifically described in the regulations in this part if, in the opinion of the Commissioner, income is clearly reflected by the use of such method. Further, the Commissioner may authorize a taxpayer to continue the use of a method of accounting consistently used by the taxpayer, even though not specifically authorized by the regulations in this part, if, in the opinion of the Commissioner, income is clearly reflected by the use of such method. See section 446(a) and paragraph (a) of this section, which require that taxable income shall be computed under the method of accounting on the basis of which the taxpayer regularly computes his income in keeping his books, and section 446(e) and paragraph (e) of this section, which require the prior approval of the Commissioner in the case of changes in accounting method.

§1.446-1(d) Taxpayer engaged in more than one business.
§1.446-1(d)(1) Where a taxpayer has two or more separate and distinct trades or businesses, a different method of accounting may be used for each trade or business, provided the method used for each trade or business clearly reflects the income of that particular trade or business. For example, a taxpayer may account for the operations of a personal service business on the cash receipts and disbursements method and of a manufacturing business on an accrual method, provided such businesses are separate and distinct and the methods used for each clearly reflect income. The method first used in accounting for business income and deductions in connection with each trade or business, as evidenced in the taxpayer's income tax return in which such income or deductions are first reported, must be consistently followed thereafter.
§1.446-1(d)(2) No trade or business will be considered separate and distinct for purposes of this paragraph unless a complete and separable set of books and records is kept for such trade or business.


§1.446-1(e) Requirement respecting the adoption or change of accounting method.
§1.446-1(e)(1) A taxpayer filing his first return may adopt any permissible method of accounting in computing taxable income for the taxable year covered by such return. See section 446(c) and paragraph (c) of this section for permissible methods. Moreover, a taxpayer may adopt any permissible method of accounting in connection with each separate and distinct trade or business, the income from which is reported for the first time. See section 446(d) and paragraph (d) of this section. See also section 446(a) and paragraph (a) of this section.

Two-Year rule

4.11.6.3  (05-13-2005)
Adoption of a Method of Accounting

  1. A taxpayer filing its first return may adopt any permissible method of accounting. See Treas. Reg. 1.446-1(e)(1). Once the taxpayer adopts a proper method of accounting by filing its return using such method, it may not adopt a different method of accounting by the filing of an amended return.

  2. However, a taxpayer filing its first return using an improper method of accounting may change to a proper method by the filing of an amended return. The amended return MUST be filed prior to the filing of the next year's return. See Rev. Rul. 72-491, 1972-2 C.B. 104.

  3. Two returns filed for consecutive years using an improper method, establishes a method of accounting from which consent to change is required. Amended returns may not be used to change such method. See Rev. Proc. 90-38.


Mark-to-Market Accounting Method §475:

IRS Issues Procedures for Electing Mark-to-Market Method for Dealers, Traders
The IRS issued exclusive procedures for dealers in commodities and traders in securities or commodities to make an election to use the mark-to-market method of accounting under §475(e) or (f).

A. Elections effective for tax years for which the original federal tax return was filed before March 18, 1999. For a taxpayer to make a §475(e) or (f) election that is effective for a taxable year for which the original federal income tax return was filed before March 18, 1999, the taxpayer must either: (1) have properly reflected the application of §475 (including any required §481(a) adjustment) in the calculation of the taxpayer's tax liability on its original federal income tax return for the election year; or (2) have failed to properly reflect the application of §475 (including any required §481(a) adjustment) in the calculation of the taxpayer's tax liability on its original federal income tax return for the election year, but clearly demonstrated on that return its intent to make the election for that year (for example, by a statement on, or attachment to, the return), and file an amended return for the election year on or before June 16, 1999, that properly reflects the application of §475 (including any required §481(a) adjustment). see Rev. Proc. 99-17 Sec 5.01
 
B. Elections effective for other taxable years beginning before January 1, 1999. For a taxpayer to make a §475(e) or (f) election that is effective for a taxable year which begins before January 1, 1999, and for which the original federal income tax return is filed on or after March 18, 1999, the taxpayer must make the election by attaching a statement to an original federal income tax return for the election year that is timely filed (including extensions). The required statement must describe the election being made, the first taxable year for which the election is effective, and, in the case on an election under §475(f), the trade or business for which the election is made. see Rev. Proc. 99-17 Sec 5.02 and Sec 5.04

C. Elections effective for a taxable year beginning on or after January 1, 1999.
(1) General procedure. Except for new taxpayers (discussed below), for a taxpayer to make a §475(e) or (f) election that is effective for a taxable year beginning on or after January 1, 1999, the taxpayer must file a required statement (described above). The statement must be filed not later than the due date (without regard to extensions) of the original federal income tax return for the taxable year immediately preceding the election year and must be attached either to that return or, if applicable, to a request for an extension of time to file that return. see Rev. Proc. 99-17 Sec 5.03(1)

(2) New taxpayers. A new taxpayer is a taxpayer for which no federal income tax return was required to be filed for the taxable year immediately preceding the election year. A new taxpayer makes the election by placing in its books and records no later than 2 months and 15 days after the first day of the election year a required statement (described above). The new taxpayer must attach a copy of the statement to its original federal income tax return for the election year. see Rev. Proc. 99-17 Sec 5.03 (2)

This revenue procedure is effective February 8, 1999.
Rev. Proc. 99-17 is scheduled to appear in I.R.B. 1999-7, dated February. 16, 1999.
Rev. Proc. 99-17, 1999-7 I.R.B. ___.
Rev. Proc. 99-49, Section 6 of Revenue Procedure 99-17 is superseded by Section 13 of Revenue Procedure 99-49.
Rev. Proc. 2002-9, (IRS)Section 6.02.
Rev. Proc. 2002-19, Section 4.04.
Rev. Proc. 2008-52, Section 6.02.
Rev. Proc. 2009-39, Section .
Rev. Proc. 2011-14, Section 6.02.



Treatment of Mark-to-Market Gains of Electing Traders (SECA tax):

TITLE VI. TECHNICAL CORRECTIONS (SECA portion as submitted to IRS Code draft writers by Colin M. Cody, CPA)
Technical Corrections to Taxpayer Relief Act of 1997
Effective Dates: The technical corrections of Title VI are effective as if included in the provisions of the Taxpayer Relief Act of 1997 to which they relate, unless otherwise indicated.

Treatment of Mark-to-Market Gains of Electing Traders

The Bill clarifies that, for securities or commodities traders, gain or loss that is treated as ordinary solely by reason of election of mark-to-market treatment is not treated as other than gain or loss from a capital asset for purposes of determining net-earnings from self-employment for Self-Employment Contributions Act tax purposes or for purposes of determining whether the passive type income exception to the publicly-traded partnership rules is met.

The provision applies to taxable years of electing securities and commodities traders ending after August 5, 1997, the date of enactment of the 1997 Act.

[Bill §6010(a)(3); Code §475(f)(1)(D)]


Treatment of Limited Liability Company members (SECA tax):

[Proposed Regulations, NPRM REG-209824-96], I.R.B. 1997-11,Internal Revenue Service, (Jan. 13, 1997)
[Code Sec. 1402]

Limited partner for self-employment tax purposes: Definition of.
Definition of Limited Partner for Self-Employment Tax Purposes

REG-209824-96   INTERNAL REVENUE SERVICE NOTICE OF PROPOSED RULEMAKING AND PUBLIC HEARING (REG-209824-96) ON DEFINITION OF LIMITED PARTNER FOR SELF-EMPLOYMENT TAX PURPOSES, ISSUED JAN. 10, 1997

ACTION: Notice of proposed rulemaking and notice of public hearing.

SUMMARY: This document contains proposed amendments to the regulations relating to the self-employment income tax imposed under section 1402 of the Internal Revenue Code of 1986. These regulations permit individuals to determine whether they are limited partners for purposes of section 1402(a)(13), eliminating the uncertainty in calculating an individual's net earnings from self-employment under existing law. This document also contains a notice of public hearing on the proposed regulations.

Background

This document contains proposed amendments to the Income Tax Regulations (26 CFR part 1) under section 1402 of the Internal Revenue Code and replaces the notice of proposed rulemaking published in the Federal Register on December 29, 1994, at 59 FR 67253, that treated certain members of a limited liability company (LLC) as limited partners for self-employment tax purposes. Written comments responding to the proposed regulations were received, and a public hearing was held on June 23, 1995.

Under the 1994 proposed regulations, an individual owning an interest in an LLC was treated as a limited partner if (1) the individual lacked the authority to make management decisions necessary to conduct the LLC's business (the management test), and (2) the LLC could have been formed as a limited partnership rather than an LLC in the same jurisdiction, and the member could have qualified as a limited partner in the limited partnership under applicable law (the limited partner equivalence test). The intent of the 1994 proposed regulations was to treat owners of an LLC interest in the same manner as similarly situated partners in a state law partnership.

Public comments on the 1994 proposed regulations were mixed. While some commentators were pleased with the proposed regulations for attempting to conform the treatment of LLCs with state law partnerships, others criticized the 1994 proposed regulations based on a variety of arguments.

A number of commentators discussed administrative and compliance problems with the 1994 proposed regulations. For example, it was noted that both the management test and the limited partner equivalence test depend upon legal or factual determinations that may be difficult for taxpayers or the IRS to make with certainty.

Another commentator pointed out that basing the self-employment tax treatment of LLC members on state law limited partnership rules would lead to disparate treatment between members of different LLCs with identical rights based solely on differences in the limited partnership statutes of the states in which the members form their LLC. For example, State A's limited partnership act may allow a limited partner to participate in a partnership's business while State B's limited partnership act may not. Thus, an LLC member, who is not a manager, that participates in the LLC's business would be a limited partner under the proposed regulations if the LLC is formed in State A, but not if the LLC is formed in State B. Commentators asserted that this disparate treatment is inherently unfair for federal tax purposes.

Some commentators argued for a ``material participation'' test to determine whether an LLC member's distributive share is included in the individual's net earnings from self-employment. The proposed regulations did not contain a participation test. Commentators advocating a participation test stressed that such a test would eliminate uncertainty concerning many LLC members' limited partner status and would better implement the self-employment tax goal of taxing compensation for services.

Other commentators argued for a more uniform approach, stating that a single test should govern all business entities (i.e., partnerships, LLCs, LLPs, sole proprietorships, et al.) whose members may be subject to self-employment tax. These commentators generally recognized, however, that a change in the treatment of a sole proprietorship or an entity that is not characterized as a partnership for federal tax purposes would be beyond the scope of regulations to be issued under section 1402(a)(13).

Finally, some commentators focused on whether the Service would respect the ownership of more than one class of partnership interest for self-employment tax purposes (bifurcation of interests). The proposed regulations treated an LLC member as a limited partner with respect to his or her entire interest (if the member was not a manager and satisfied the limited partner equivalence test), or not at all (if either the management test or limited partner equivalence test was not satisfied). Commentators, however, pointed to the legislative history of section 1402(a)(13) to support their argument that Congress only intended to tax a partner's distributive share attributable to a general partner interest. Under this argument, a partner that holds both a general partner interest and a limited partner interest is only subject to self-employment tax on the distributive share attributable to the partner's general partner interest. This intent also may be inferred from the statutory language of section 1402(a) (13) that the self-employment tax does not apply to ". . . the distributive share of any item of income or loss of a limited partner, as such . . . .'' Based on this evidence, these commentators requested that the proposed regulations be revised to allow the bifurcation of interests for self-employment tax purposes.

After considering the comments received, the IRS and Treasury have decided to withdraw the 1994 notice of proposed rulemaking and to re-propose amendments to the Income Tax Regulations (26 CFR part 1) under section 1402 of the Code.

Explanation of Provisions

The proposed regulations contained in this document define which partners of a federal tax partnership are considered limited partners for section 1402(a)(13) purposes. These proposed regulations apply to all entities classified as a partnership for federal tax purposes, regardless of the state law characterization of the entity. Thus, the same standards apply when determining the status of an individual owning an interest in a state law limited partnership or the status of an individual owning an interest in an LLC. In order to achieve this conformity, the proposed regulations adopt an approach which depends on the relationship between the partner, the partnership, and the partnership's business. State law characterizations of an individual as a ``limited partner'' or otherwise are not determinative.

Generally, an individual will be treated as a limited partner under the proposed regulations unless the individual (1) has personal liability (as defined in Section 301.7701-3(b)(2)(ii) of the Procedure and Administration Regulations) for the debts of or claims against the partnership by reason of being a partner; (2) has authority to contract on behalf of the partnership under the statute or law pursuant to which the partnership is organized; or, (3) participates in the partnership's trade or business for more than 500 hours during the taxable year. If, however, substantially all of the activities of a partnership involve the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, or consulting, any individual who provides services as part of that trade or business will not be considered a limited partner.

By adopting these functional tests, the proposed regulations ensure that similarly situated individuals owning interests in entities formed under different statutes or in different jurisdictions will be treated similarly. The need for a functional approach results not only from the proliferation of new business entities such as LLCs, but also from the evolution of state limited partnership statutes. When Congress enacted the limited partner exclusion found in section 1402(a)(13), state laws generally did not allow limited partners to participate in the partnership's trade or business to the extent that state laws allow limited partners to participate today. Thus, even in the case of a state law limited partnership, a functional approach is necessary to ensure that the self-employment tax consequences to similarly situated taxpayers do not differ depending upon where the partnership organized.

The proposed regulations allow an individual who is not a limited partner for section 1402(a)(13) purposes to nonetheless exclude from net earnings from self-employment a portion of that individual's distributive share if the individual holds more than one class of interest in the partnership. Similarly, the proposed regulations permit an individual that participates in the trade or business of the partnership to bifurcate his or her distributive share by disregarding guaranteed payments for services. In each case, however, such bifurcation of interests is permitted only to the extent the individual's distributive share is identical to the distributive share of partners who qualify as limited partners under the proposed regulation (without regard to the bifurcation rules) and who own a substantial interest in the partnership. Together, these rules exclude from an individual's net earnings from self-employment amounts that are demonstrably returns on capital invested in the partnership.

ed: In other words pursuant to Prop. Reg. §1.1402(a)-2(h)(6)(iv) at least one member of the LLC must own 20% or more as a limited partner and he must not own any other (bifurcated) interest in the LLC.
There are no related party rules here, therefore a spouse could be that 20% limited partner.

Bifurcation of a Member’s Interest

If an LLC member fails the limited partner test because that member participates in a nonprofessional LLC for more than 500 hours during the tax year, Proposed Treasury Regulations section 1.1402(a)-2(h)(4) allows that member to be taxed as a limited partner for SE tax purposes if she owns only one class of interest and if, immediately after acquiring the interest, the member has rights and obligations identical to those of the other members who are already classified as limited partners and who own a substantial (i.e., at least 20%) continuing interest in that class of interest.

In addition, Proposed Treasury Regulations section 1.1402(a)-2(h)(3) allows an LLC member of a nonprofessional LLC who fails one or more of the limited partner tests, but who holds more than one class of interest, to be treated as a limited partner with respect to a particular class of interest if, immediately after acquiring the interest, the member has rights and obligations identical to those of the other members who are already classified as limited partners and who own a substantial (i.e., at least 20%) continuing interest in that class of interest.

Because application of the SE tax to LLC members under the proposed regulations depends not only upon their formal status as members or managing-members but also on their level of participation in the entity, strategies for minimizing an LLC member’s SE tax exposure generally involve the governing provisions of the LLC. This is because issues such as the designation of a manager and the extent of authority given to nonmanaging members, while fundamentally business considerations, have significant tax implications.

The proposed regulations specifically allow bifurcation of an LLC member’s distributive share of income in situations where the member holds dual classes of interest, one of which is the same as nonmanaging members. Furthermore, the proposed regulations seem to sanction a nominal amount of income attributable to a general-partner interest as long as a reasonable guaranteed payment is made for services rendered to, or on behalf of, the LLC. One strategy for SE tax reduction is to issue two classes of interest, a managing interest and an investment interest, to the same individual.

Special Analyses

It has been determined that this notice of proposed rulemaking is not a significant regulatory action as defined in EO 12866. Therefore, a regulatory assessment is not required. It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations, and, because the regulations do not impose a collection of information on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of the Internal Revenue Code, this notice of proposed rulemaking will be submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.

Drafting Information

The principal author of these regulations is Robert Honigman of the Office of Assistant Chief Counsel (Passthroughs & Special Industries). However, other personnel from the IRS and Treasury Department participated in their development.

* * * * *

Proposed Amendments to the Regulations

Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

Paragraph 1. The authority citation for part 1 continues to read in part as follows:

Authority: 26 U.S.C. 7805 * * *

Par. 2. Section 1.1402(a)-2 is amended by:

1. Revising the first sentence of paragraph (d).

2. Removing the reference "section 702(a)(9)" in the first sentence of paragraph (e) and adding "section 702(a)(8)" in its place.

3. Revising the last sentence of paragraph (f).

4. Revising paragraphs (g) and (h).

5. Adding new paragraphs (i) and (j).

The revisions and additions read as follows:

§1.1402(a)-2 Computation of net earnings from self-employment.

* * * * * * * *

IRS Proposed Regulation Section 1.1402(a)-2

1.1402(a)-2(d) * * * Except as otherwise provided in section 1402(a) and paragraph (g) of this section, an individual's net earnings from self-employment include the individual's distributive share (whether or not distributed) of income or loss described in section 702(a)(8) from any trade or business carried on by each partnership of which the individual is a partner.

* * * * * * * *

1.1402(a)-2(f) * * * For rules governing the classification of an organization as a partnership or otherwise, see Sections 301.7701-1, 301.7701-2, and 301.7701-3 of this chapter.

1.1402(a)-2(g) Distributive share of limited partner.

An individual's net earnings from self-employment do not include the individual's distributive share of income or loss as a limited partner described in paragraph (h) of this section. However, guaranteed payments described in section 707(c) made to the individual for services actually rendered to or on behalf of the partnership engaged in a trade or business are included in the individual's net earnings from self-employment.

1.1402(a)-2(h) Definition of Limited Partner.

1.1402(a)-2(h)(1) In General.
Solely for purposes of section 1402(a)(13) and paragraph (g) of this section, an individual is considered to be a limited partner to the extent provided in paragraphs (h)(2), (h)(3), (h)(4), and (h)(5) of this section.

1.1402(a)-2(h)(2) Limited partner.
An individual is treated as a limited partner under this paragraph (h)(2) unless the individual--

1.1402(a)-2(h)(2)(i) Has personal liability (as defined in Section 301.7701-3(b)(2)(ii) of this chapter for the debts of or claims against the partnership by reason of being a partner;

1.1402(a)-2(h)(2)(ii) Has authority (under the law of the jurisdiction in which the partnership is formed) to contract on behalf of the partnership; or

1.1402(a)-2(h)(2)(iii) Participates in the partnership's trade or business for more than 500 hours during the partnership's taxable year.

1.1402(a)-2(h)(3) Exception for holders of more than one class of interest.

An individual holding more than one class of interest in the partnership who is not treated as a limited partner under paragraph (h)(2) of this section is treated as a limited partner under this paragraph (h)(3) with respect to a specific class of partnership interest held by such individual if, immediately after the individual acquires that class of interest--

1.1402(a)-2(h)(3)(i) Limited partners within the meaning of paragraph (h) (2) of this section own a substantial, continuing interest in that specific class of partnership interest; and,

1.1402(a)-2(h)(3)(ii) The individual's rights and obligations with respect to that specific class of interest are identical to the rights and obligations of that specific class of partnership interest held by the limited partners described in paragraph (h)(3)(i) of this section.

1.1402(a)-2(h)(4) Exception for holders of only one class of interest.

An individual who is not treated as a limited partner under paragraph (h)(2) of this section solely because that individual participates in the partnership's trade or business for more than 500 hours during the partnership's taxable year is treated as a limited partner under this paragraph (h)(4) with respect to the individual's partnership interest if, immediately after the individual acquires that interest--

1.1402(a)-2(h)(4)(i) Limited partners within the meaning of paragraph (h)(2) of this section own a substantial, continuing interest in that specific class of partnership interest; and

1.1402(a)-2(h)(4)(ii) The individual's rights and obligations with respect to the specific class of interest are identical to the rights and obligations of the specific class of partnership interest held by the limited partners described in paragraph (h)(4)(i) of this section.

1.1402(a)-2(h)(5) Exception for service partners in service partnerships.

An individual who is a service partner in a service partnership may not be a limited partner under paragraphs (h)(2), (h)(3), or (h)(4) of this section.

1.1402(a)-2(h)(6) Additional definitions.

Solely for purposes of this paragraph (h)--

1.1402(a)-2(h)(6)(i) A class of interest is an interest that grants the holder specific rights and obligations. If a holder's rights and obligations from an interest are different from another holder's rights and obligations, each holder's interest belongs to a separate class of interest. An individual may hold more than one class of interest in the same partnership provided that each class grants the individual different rights or obligations. The existence of a guaranteed payment described in section 707(c) made to an individual for services rendered to or on behalf of a partnership, however, is not a factor in determining the rights and obligations of a class of interest.

1.1402(a)-2(h)(6)(ii) A service partner is a partner who provides services to or on behalf of the service partnership's trade or business. A partner is not considered to be a service partner if that partner only provides a de minimis amount of services to or on behalf of the partnership.

1.1402(a)-2(h)(6)(iii) A service partnership is a partnership substantially all the activities of which involve the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, or consulting.

1.1402(a)-2(h)(6)(iv) A substantial interest in a class of interest is determined based on all of the relevant facts and circumstances. In all cases, however, ownership of 20 percent or more of a specific class of interest is considered substantial.

1.1402(a)-2(h)(6)(i) Example.

The following example illustrates the principles of paragraphs (g) and (h) of this section:

Example.

(i) A, B, and C form LLC, a limited liability company, under the laws of State to engage in a business that is not a service partnership described in paragraph (h)(6)(iii) of this section. LLC, classified as a partnership for federal tax purposes, allocates all items of income, deduction, and credit of LLC to A, B, and C in proportion to their ownership of LLC. A and C each contribute $1x for one LLC unit. B contributes $2x for two LLC units. Each LLC unit entitles its holder to receive 25 percent of LLC's tax items, including profits. A does not perform services for LLC; however, each year B receives a guaranteed payment of $6x for 600 hours of services rendered to LLC and C receives a guaranteed payment of $10x for 1000 hours of services rendered to LLC. C also is elected LLC's manager. Under State's law, C has the authority to contract on behalf of LLC.

(ii) Application of general rule of paragraph (h)(2) of this section. A is treated as a limited partner in LLC under paragraph (h)(2) of this section because A is not liable personally for debts of or claims against LLC, A does not have authority to contract for LLC under State's law, and A does not participate in LLC's trade or business for more than 500 hours during the taxable year. Therefore, A's distributive share attributable to A's LLC unit is excluded from A's net earnings from self-employment under section 1402(a)(13).

(iii) Distributive share not included in net earnings from self-employment under paragraph (h)(4) of this section. B's guaranteed payment of $6x is included in B's net earnings from self-employment under section 1402(a) (13). B is not treated as a limited partner under paragraph (h)(2) of this section because, although B is not liable for debts of or claims against LLC and B does not have authority to contract for LLC under State's law, B does participates in LLC's trade or business for more than 500 hours during the taxable year. Further, B is not treated as a limited partner under paragraph (h) (3) of this section because B does not hold more than one class of interest in LLC. However, B is treated as a limited partner under paragraph (h)(4) of this section because B is not treated as a limited partner under paragraph (h)(2) of this section solely because B participated in LLC's business for more than 500 hours and because A is a limited partner under paragraph (h)(2) of this section who owns a substantial interest with rights and obligations that are identical to B's rights and obligations. In this example, B's distributive share is deemed to be a return on B's investment in LLC and not remuneration for B's service to LLC. Thus, B's distributive share attributable to B's two LLC units is not net earnings from self-employment under section 1402(a)(13).

(iv) Distributive share included in net earnings from self-employment. C's guaranteed payment of $10x is included in C's net earnings from self-employment under section 1402(a). In addition, C's distributive share attributable to C's LLC unit also is net earnings from self-employment under section 1402(a) because C is not a limited partner under paragraphs (h)(2), (h)(3), or (h) (4) of this section. C is not treated as a limited partner under paragraph (h) (2) of this section because C has the authority under State's law to enter into a binding contract on behalf of LLC and because C participates in LLC's trade or business for more than 500 hours during the taxable year. Further, C is not treated as a limited partner under paragraph (h)(3) of this section because C does not hold more than one class of interest in LLC. Finally, C is not treated as a limited partner under paragraph (h)(4) of this section because C has the power to bind LLC. Thus, C's guaranteed payment and distributive share both are included in C's net earnings from self-employment under section 1402(a).

(j) EFFECTIVE DATE. Paragraphs (d), (e), (f), (g), (h), and (i) are applicable beginning with the individual's first taxable year beginning on or after the date this section is published as a final regulation in the Federal Register.

[62 FR 1702, January 13, 1997]

Self Employment Taxes

  • Amounts paid to members of corporate LLC may be deductible as salary (Treasury Regulations Section 1.162-8)

  • Amounts paid to members of partnership LLC may be treated as net earnings from self-employment, salary or wages, or distributable share of partnership income (IRC, Subchapter K)

  • A member's distributive share of LLC income is self-employment income, unless member is limited partner (Regulations Section 1.1402(a)-2(d); IRC Section 1402(a)(13))

Exceptions:

a) If activities of LLC involved services in the fields of health, law, engineering, architecture, accounting, actuarial science or consulting, individual who provided services would not be treated as limited partner (Proposed Regulations Sections 1.1402(a)-2(h)(5); 1.1402(a-2(h)(6)(iii))

b) A member that holds more than one class of interests of the LLC could be treated as a limited partner (Pro. Regulations 1.1402(a)-2(h)(3); 1.1402(a)-2(h)(6)(iv))

c) A member owning only one class of partnership interest who is disqualified as a limited partner (Prop. Regulations Section 1.1402(a)-2(h)(4))

 

http://www.nysscpa.org/cpajournal/2006/606/essentials/p32.htm

http://edocket.access.gpo.gov/cfr_2008/aprqtr/pdf/26cfr1.1402(a)-2.pdf

http://www.goralkalawfirm.com/CM/Custom/LLCright.asp

http://www.ftwlaw.com/page.php?page=articles&articles=175

http://www.ccim.com/cire-magazine/articles/self-employment-tax-can-snare-limited-partners-and-llc-members

 


IRS Code §475(f) Mark-to-Market election for taxpayers who have filed at least one federal income tax return (normally the year immediately preceding the election year):

Normal


Defective

TBA


IRS Code §475(f) Mark-to-Market elections for newly formed entities that have not filed a tax return yet:

No extension is available.  No extension is required.

For those taxpayers who are filing their first ever tax return, no filing deadlines for a timely mark-to-market election have been established, other than that the properly drafted election statement be placed in its books and records immediately in the first year and that a copy also be attached to the first original federal income tax return filed.  Typically this pertains to taxpaying entities other than individuals, such as a newly formed corporation or LLC.

Normal


Defective

TBA


Treasury Proposes Regulations on Safe Harbor for Valuation Under Mark-to-Market Accounting Method:

The Treasury Department proposes regulations setting forth an elective safe harbor for dealers in securities and commodities, and traders in securities and commodities, permitting an election pursuant to which values of positions reported on certain financial statements are fair market values of those positions for purposes of §475.

On May 5, 2003, the Treasury Department and the IRS published an Advance Notice of Proposed Rulemaking (ANPRM), REG-100420-03, and Announcement 2003-35, 2003-21 C.B. 956, setting forth a possible safe harbor using values reported on an applicable financial statements for valuing securities for purposes of §475 and requesting comments on various aspects of such a safe harbor. After receiving comments from the public, the Treasury Department proposed these regulations, setting forth a safe harbor for valuing securities and commodities under §475.

Safe Harbor. Under the proposed safe harbor, eligible taxpayers generally would be permitted to elect to have the values that are reported for eligible positions on certain financial statements treated as the fair market values reported for those eligible positions for purposes of §475, if certain conditions were met. To ensure minimal divergence from fair market value under tax principles, certain restrictions would be imposed on the financial accounting methods and financial statements that are eligible for the safe harbor and also require certain adjustments to the values of the eligible positions on those financial statements that may be used under the safe harbor. Further, the safe harbor would require that financial statement values be adjusted to comply with the requirements of §482 or §482 principles when applicable.

Eligible Taxpayers and Eligible Positions. The safe harbor would be available to any taxpayer subject to the mark-to-mark regime under §475 and, further, that a revenue procedure will be issued enumerating the types of securities and commodities subject to the safe harbor.

The preamble cautions that the valuation methodology under the safe harbor would apply only for positions that are properly marked under §475. For example, it notes that: (1) if a security is not marked under §475 because it has been identified as held for investment, then under the safe harbor it may not be marked for federal income tax purposes even though it is properly marked on the financial statement in accordance with U.S. Generally Accepted Accounting Principles (U.S. GAAP); and (2) if a security is not marked on the applicable financial statement because it is a hedge but §475(a) applies because the security was not identified as a hedge, then the security must still be marked under §475.

Eligible Method. To qualify for the safe harbor, a financial accounting method would be required to satisfy four basic requirements—it would be required: (1) to mark eligible positions to market through valuations made as of the last business day of each taxable year; (2) to recognize into income on the income statement any gain or loss from marking eligible positions to market; (3) to recognize into income on the income statement any gain or loss on disposition of an eligible position as if a year-end mark occurred immediately before the disposition; and (4) to arrive at fair value in accordance with U.S. GAAP.

In addition to the basic requirements, the safe harbor would also impose certain limitations that ensure minimal divergence from fair market value. First, in the case of securities and commodities dealers, except for eligible positions that are traded on a qualified board or exchange (as defined in §1256(g)(7)), the financial accounting method must not result in values at or near the bid or ask values, even if the use of bid or ask values is permissible in accordance with U.S. GAAP. Second, if the method of valuation consists of determining the present value of projected cash flows from an eligible position or positions, then the method must not take into account any cash flows of income or expense that are attributable to a period or time before the valuation date. Third, no cost or risk may be accounted for more than once, either directly or indirectly.

Election and Revocation. The election to use the safe harbor would be made by filing a statement with the taxpayer's timely filed federal income tax return for the taxable year for which the election is first effective. Such statement: (1) would be required to declare that the taxpayer makes the safe harbor election for all of its eligible positions; and (2) in addition to any other information that the Commissioner may require, the statement would be required to describe the taxpayer's applicable financial statement for the first taxable year for which the election is effective and to state that the taxpayer agrees to timely provide upon the request of the Commissioner all information, records, and schedules required by the safe harbor. The election would continue to be in effect for all subsequent taxable years unless it is revoked.

A taxpayer would not be allowed to revoke the election without the consent of the Commissioner. However, the Commissioner would be permitted to revoke the election if: (1) the taxpayer fails to comply with any of the recordkeeping and production requirements and cannot show reasonable cause for the failure; (2) the taxpayer ceases to use an eligible method; (3) the taxpayer ceases to have an applicable financial statement, as described below; or (4) the taxpayer holds a de minimis quantity of eligible positions that are subject to the safe harbor. A revocation would not be required if the taxpayer ceased to qualify as an eligible taxpayer, or §475 did not otherwise apply, because the safe harbor would only be permitted to be used to determine values and could not be used unless §475 applied. Once revoked by either the Commissioner or the taxpayer, neither the taxpayer nor any of its successors would be permitted to make the election for any taxable year that begins before the date that is six years after the first day of the earliest taxable year affected by the revocation without the consent of the Commissioner.

Applicable Financial Statements. Three categories of financial statements would qualify under the safe harbor and are set forth in order of priority, from highest to lowest. In the first and highest category are those financial statements that must be filed with the Securities and Exchange Commission (SEC) (e.g., 10-Ks and the Annual Statements to Shareholders). In the second category are those financial statements that must be provided to the federal government or any of its agencies other than the IRS (e.g., statements filed by foreign-controlled financial institutions engaged in trade or business within the United States who report their mark-to-market results to the Federal Reserve or the Office of the Comptroller of the Currency). In the third category are certified audited financial statements that are provided to creditors to make lending decisions, that are provided to equity holders to evaluate their investment, or that are provided for other substantial non-tax purposes and are reasonably anticipated to be directly relied on for the purposes for which the statements were created. For a financial statement described in any of the three categories above to qualify as an applicable financial statement, it would be required to be prepared in accordance with U.S. GAAP. Further, if a taxpayer has two statements in the same category, each of which would qualify under the safe harbor, then the statement that results in the highest aggregate valuation of eligible positions would be the only financial statement that may qualify for the safe harbor.

The preamble to the proposed regulations notes that statements filed with the SEC provide a high degree of confidence that the values used on those statements reflect reasonable approximations of fair value, and, consequently, there would be no additional business use requirements for those statements. However, the for the second category (statements filed with other agencies of the federal government) and the third category of statements (the other certified audited financial statements), this degree of confidence is ensured by requiring some substantial non-tax use in the taxpayer's business. Accordingly, the safe harbor would require that the values for eligible positions contained in these financial statements be used by the taxpayer in most of the significant management functions of all or substantially all of its business. This use includes activities such as: (1) senior management review of business-unit profitability; (2) market risk measurement or management; (3) credit risk measurement or management; (4) internal allocation of capital; and (5) compensation of personnel but would not include either tax accounting or reporting the results of operations to other persons.

The preamble notes that the IRS and the Treasury Department understand that some dealers maintain internal books of account, not prepared in accordance with U.S. GAAP, for separate segments of their business and that these internal books of account may include a charge to each operating segment of an internal "cost of carry" calculated in the manner of interest (and the derivatives dealer book may be treated as a separate business segment for that purpose). The preamble states that the maintenance of these segmented accounts, which may apply an accounting approach that does not qualify as an eligible accounting method, does not prevent some other financial statement prepared in accordance with U.S. GAAP from qualifying as the taxpayer's applicable financial statement.

Record Retention and Production; Use of Different Values. The proposed regulations provide specific requirements for the types of records that would be required to be maintained and provided to enable ready verification. In general, electing taxpayers would be required to clearly show: (1) that the same value used for financial reporting was used on the federal income tax return; (2) that no eligible position subject to §475 is excluded from the application of the safe harbor; and (3) that only eligible positions subject to §475 are carried over to the federal income tax return under the safe harbor. The proposed regulations outline what records would be required to be retained and produced, including certain forms and schedules filed with the Federal income tax return, such as the Schedule M-1, Net Income (Loss) Reconciliation for Corporations With Total Assets of $10 Million or More; Schedule M-3, Net Income (Loss) Reconciliation for Corporations With Total Assets of $10 Million or More; and Form 1120F, U.S. Income Tax Return of a Foreign Corporation. The proposed regulations also provide that the Commissioner would be permitted to enter into an advance agreement with a taxpayer on how records are to be maintained and how long the records are to be retained. All of the necessary records would be required to be retained as long as their contents may become material in the administration of any internal revenue law.

To encourage rapid examinations of the federal income tax returns of electing taxpayers, all necessary records would be required to be produced within 30 days after the Commissioner requests them. If the required records are not provided as required, the proposed regulations would permit the Commissioner to use his discretion to: (1) extend the 30-day period; (2) excuse minor or inadvertent failures to provide the requested records; (3) require use of values that clearly reflect income but which are different from those used on the applicable financial statement; or (4) revoke the election if a taxpayer does not demonstrate reasonable cause for the failure to maintain and produce the required records.


M2M losses are excluded from Reportable Transactions:

IRS Issues Revenue Procedure Excluding Certain Losses from Reportable Transactions

The IRS released a revenue procedure that provides that certain losses are not taken into account in determining whether a transaction is a reportable loss transaction for purposes of the tax shelter disclosure rules under Regs. §1.6011-4(b)(5).

The IRS stated that the revenue procedure applies to taxpayers required to disclose reportable transactions under Regs. §1.6011-4, material advisors required to disclose reportable transactions under §6111 (as amended by the 2004 American Jobs Creation Act, P.L. 108-357, §815), and material advisors required to maintain lists under former and new §6112.

Under the revenue procedure, stated the IRS, a loss under §165 from the sale or exchange of an asset is not taken into account if: (1) the basis of the asset (for purposes of determining the loss) is a "qualifying basis;" (2) the asset is not an interest in a passthrough entity under §1260(c)(2), other than regular interests in a REMIC as defined in §860G(a)(1); (3) the loss from the sale or exchange of the asset is not treated as ordinary under §988; (4) the asset has not been separated from any portion of the income it generates; and (5) the asset is not, and has never been, part of a straddle under §1092(c), excluding mixed straddles under Regs. §1.1092(b)-4T. The IRS provided further guidance on in what situations a taxpayer's basis in an asset is a "qualifying basis."

The IRS stated that the revenue procedure also provides that the following losses under §165 are also not taken into account under Regs. §1.6011-4(b)(5): (1) a loss under §165(c)(3) from fire, storm, shipwreck, or other casualty, or from theft; (2) a loss from a compulsory or involuntary conversion under §1231(a)(3)(A)(ii) or (4)(B); (3) a loss to which §475(a) or §1256(a) applies; (4) a loss arising from any mark-to-market treatment of an item under §475(f), §1296(a), Regs. §1.446-4(e), Regs. §1.988-5(a)(6), or Regs. §1.1275-6(d)(2), and any loss from a sale or disposition of an item to which one of the foregoing provisions applied, provided that the taxpayer computes its loss by using a qualifying basis or a basis resulting from previously marking the item to market, or computes its loss by making appropriate adjustments for previously determined mark-to-market gain or loss; (5) a loss arising from a §1221(b) hedging transaction, if the taxpayer properly identifies the transaction as a hedging transaction, or from a mixed straddle account under Regs. §1.1092(b)-4T; (6) a loss attributable to basis increases under §860C(d)(1) during the period of the taxpayer's ownership; (7) a loss attributable to the abandonment of depreciable tangible property that was used by the taxpayer in a trade or business and that has a qualifying basis; (8) a loss arising from the bulk sale of inventory if the basis of the inventory is determined under §263A; (9) a loss that is equal to, and is determined solely by reference to, a payment of cash by the taxpayer; (10) a loss from the sale to a person other than a related party under §267(b) or §707(b) of property described in §1221(a)(4) in a factoring transaction in the ordinary course of business; or (11) a loss arising from the disposition of an asset to the extent that the taxpayer's basis in the asset is determined under §338(b).
The revenue procedure modifies and supersedes Rev. Proc. 2003-24, 2003-11 I.R.B. 599.
Rev. Proc. 2004-66 is effective November 16, 2004, and applies to transactions that are entered into on or after January 1, 2003.
Rev. Proc. 2004-66 is scheduled to appear in I.R.B. 2004-50, dated December 13, 2004.


IRS Code §481 elections:

See lower portion of the form 3115 web page


IRS Code §1256 Mark-to-Market election for dealers:

TBA


IRS Code §1256 hedging election:

TBA



Deadline to be Extended for Elections Under Mark-to-Mark Accounting:

Mark-to-Market Method §475

Deadline to Be Extended for Elections Under Mark-to-Mark Accounting
The IRS plans to issue additional guidance on how securities dealers may elect out of exemptions provided for in the final regulations under §475 tro The regulations contain elections out of certain exemptions, including the intragroup-customer election (Regs. §1.475(c)-1(a)(3)(iii)(B)), the customer paper election (Regs. §1.475(c)-1(b)(4)(i)), and the negligible sales election (Regs. §1.475(c)-1(c)(1)(ii)). Regs. §1.475(c)-1(b)(4)(i)(B) provides a June 23, 1997, deadline to make the customer paper election on an amended return.

The IRS intends to issue guidance that will address the interplay of the elections under Regs. §1.475(c)-1, the extent to which these elections are available on a retroactive basis, and the application of the §475(b)(2) identification requirements to taxpayers making these elections. The additional guidance will extend the filing deadline from June 23, 1997, to at least 45 days after that guidance is released.
Notice 97-37 is scheduled to appear in I.R.B. 1997-27, dated July 7, 1997.
Notice 97-37, 1997-27 I.R.B. ___.



  Late Entity Classification Election - form 8832 - Rev. Proc. 2009-41:font size="2">

SECTION 1. PURPOSE
This revenue procedure provides guidance under § 7701 of the Internal Revenue Code for an eligible entity that requests relief for a late classification election filed with the applicable IRS service center within 3 years and 75 days of the requested effective date of the eligible entity’s classification election. The revenue procedure also provides guidance for those eligible entities that do not qualify for relief under this revenue procedure and that are required to request a letter ruling in order to request relief for a late entity classification election.

SECTION 2. BACKGROUND
.01
Section 301.7701-3(a) of the Procedure and Administration Regulations provides in part that a business entity that is not classified as a corporation under § 301.7701-2(b)(1), (3), (4), (5), (6), (7), or (8) (an eligible entity) can elect its classification for federal tax purposes as provided in § 301.7701-3. An eligible entity with at least two members can elect to be classified as either an association (and thus as a corporation under § 301.7701-2(b)(2)) or a partnership, and an eligible entity with a single owner can elect to be classified as an association or to be disregarded as an entity separate from its owner. Section 301.7701-3(b) provides a default classification for an eligible entity that does not file an entity classification election. Thus, an entity classification election is necessary only when an eligible entity chooses to be classified initially as other than its default classification or when an eligible entity chooses to change its classification.

.02 Section 301.7701-3(c)(1)(i) provides the general rules for the time and place for filing an entity classification election. Section 301.7701-3(c)(1)(i) provides that, except as provided in paragraphs (c)(1)(iv) (limitation) or (c)(1)(v) (deemed elections) of § 301.7701-3, an eligible entity may elect to be classified other than as provided under § 301.7701-3(b), or to change its classification, by filing Form 8832, "Entity Classification Election," with the IRS service center designated on Form 8832. An election will not be accepted unless all of the information required by the form and instructions, including the taxpayer identifying number of the entity, is provided on Form 8832. See § 301.6109-1 for rules on applying for and displaying Employer Identification Numbers.

.03 Section 301.7701-3(c)(1)(ii) provides that an eligible entity required to file a federal tax or information return for the taxable year for which an election is made must attach a copy of its Form 8832 to its federal tax or information return for that year. If the entity is not required to file a return for that year, a copy of its Form 8832 must be attached to the federal income tax or information return of any direct or indirect owner of the entity for the taxable year of the owner that includes the date on which the election was effective.

.04 Section 301.7701-3(c)(1)(iii) provides that an election made under § 301.7701-3(c)(1)(i) will be effective on the date specified by the entity on Form 8832 or on the date filed if no such date is specified on the election form. The effective date specified on Form 8832 cannot be more than 75 days prior to the date on which the election is filed and cannot be more than 12 months after the date on which the election is filed. If an election specifies an effective date more than 75 days prior to the date on which the election is filed, it will be effective 75 days prior to the date it was filed. If an election specifies an effective date more than 12 months from the date on which the election is filed, it will be effective 12 months after the date it was filed.

.05 Section 301.7701-3(d)(1) provides in general that a foreign eligible entity’s classification is relevant when its classification affects the liability of any person for federal tax or information purposes.

.06 Under § 301.9100-1(c) the Commissioner may grant a reasonable extension of time to make a regulatory election or certain statutory elections under all subtitles of the Code, except subtitles E, G, H, and I.

.07 Section 301.9100-1(b) defines the term "regulatory election" as an election whose due date is prescribed by a regulation published in the Federal Register, or a revenue ruling, revenue procedure, notice, or announcement published in the Internal Revenue Bulletin. An entity classification election made pursuant to § 301.7701-3(c) is a regulatory election.

.08 The Commissioner has authority under § 301.9100-1 and § 301.9100-3 to grant an extension of time if a taxpayer fails to file a timely election under § 301.7701-3(c). Section 301.9100-3 provides that the Commissioner will grant an extension of time when the taxpayer provides the evidence to establish to the satisfaction of the Commissioner that the taxpayer has acted reasonably and in good faith and the grant of relief will not prejudice the interests of the government.

.09 Rev. Proc. 2002-59, 2002-2 C.B. 615, provides guidance under § 301.7701-3 for entities newly formed under local law to request relief for a late initial classification election filed by the due date for the first federal tax return (excluding extensions) of the entity’s desired classification for the year of the entity’s formation.

SECTION 3. SCOPE
.01 This revenue procedure supersedes Rev. Proc. 2002-59 by extending late entity classification relief to both initial classification elections and changes in classification elections along with extending the time for filing late entity classification elections to within 3 years and 75 days of the requested effective date of the eligible entity’s classification. Thus, the extended filing period no longer is limited, as it was under Rev. Proc. 2002-59, to entities newly formed under local law requesting relief to file an initial classification election and to the due date for the first federal tax return (excluding extensions) of the entity’s desired classification for the year of the entity’s formation. For those entities that satisfy the requirements set forth in Section 4.01, this revenue procedure is the exclusive means for obtaining relief for a late entity classification election and is in lieu of the letter ruling procedure that is used to obtain relief for a late entity classification election under § 301.9100-1 and § 301.9100-3. Accordingly, user fees do not apply to action under this revenue procedure.

.02 An eligible entity may qualify for alternative relief under §301.7701-3(c)(1)(v)(C), which treats an entity as having made a classification election to be treated as an association when it timely elects to be an S corporation under § 1362(a)(1). Also, see Rev. Proc. 2004-48, 2004-2 C.B. 172, and Rev. Proc. 2007-62, 2007-41 I.R.B. 786, or their successors for special rules applicable to late S corporation elections and late entity classification elections.

.03 An entity that does not satisfy the requirements for relief under this revenue procedure may request relief by applying for a letter ruling. Additionally, eligible entities that do not qualify for relief under this revenue procedure, because they do not satisfy all of the requirements set forth in Section 4.01, and that request a letter ruling for late entity classification relief either must include as part of their letter ruling request the affirmative representation in Section 4.04 or an explanation why the entity cannot make the affirmative representation in Section 4.04. The procedural requirements for requesting a letter ruling are described in Rev. Proc. 2009-1, 2009-1 I.R.B. 1 (or its successor).

SECTION 4. RELIEF FOR LATE CLASSIFICATION ELECTIONS
.01 Eligibility for relief. An entity is eligible for relief under Section 4.03 of this revenue procedure for a late classification election if the following requirements are met: (1)(a) the entity failed to obtain its requested classification as of the date of its formation or upon the entity’s classification becoming relevant within the meaning of § 301.7701-3(d) solely because Form 8832 was not filed timely under § 301.7701-3(c)(1)(iii); or (b) the entity failed to obtain its requested change in classification (subject to the limitations of § 301.7701-3(c)(1)(iv)) solely because Form 8832 was not filed timely under § 301.7701-3(c)(1)(iii); and

(2)(a) the eligible entity seeking an extension of time to make an entity classification election has not filed a federal tax or information return for the first year in which the election was intended because the due date has not passed for that year’s federal tax or information return; or

(b) the eligible entity seeking an extension of time to make an entity classification election timely filed all required federal tax returns and information returns consistent with its requested classification for all of the years the entity intended the requested election to be effective and no inconsistent tax or information returns have been filed by or with respect to the entity during any of the taxable years. For changes in an eligible entity’s classification election, consistent filing of returns includes filing returns consistent with the deemed treatment of elective changes under § 301.7701-3(g).

Under this revenue procedure, if the eligible entity is not required to file a federal tax return or information return, each affected person, who is required to file a federal tax return or information return, must have timely filed all such returns consistent with the entity’s requested classification for all of the years the entity intended the requested election to be effective and no inconsistent tax or information returns have been filed during any of the taxable years. Solely for purposes of this section 4.01(2)(b), an entity and an affected person will be treated as having timely filed a required tax or information return if the return is filed within 6 months after its due date, excluding extensions. An indirect owner of an eligible entity (such as a partner in a partnership that holds an interest in the eligible entity) is not an affected person if an entity in which the indirect owner holds a direct or indirect interest would be required to attach a copy of the eligible entity’s Form 8832 to its federal tax or information return in the circumstances described in section 4.01(2)(b)(i) or (ii) . An affected person is either:

(i) with respect to the effective date of the eligible entity’s classification election, a person who would have been required under § 301.7701-3(c)(1)(ii) to attach a copy of the Form 8832 for the eligible entity to its federal tax or information return for the taxable year of the person which includes that date; or

(ii) with respect to any subsequent date after the entity’s requested effective date of the classification election, a person who would have been required under § 301.7701-3(c)(1)(ii) to attach a copy of the Form 8832 for the eligible entity to its federal tax or information return for the person’s taxable year that includes that subsequent date had the election first become effective on that subsequent date; and

(3) the eligible entity has reasonable cause for its failure to timely make the entity classification election; and

(4) 3 years and 75 days from the requested effective date of the eligible entity’s classification election have not passed.

.02 Procedural requirements for requesting relief. Within 3 years and 75 days from the requested effective date of the eligible entity’s classification election, the eligible entity must file with the applicable IRS service center (determined in accordance with the instructions to Form 8832) a completed Form 8832, signed in accordance with § 301.7701-3(c)(2). The Form 8832 must indicate that it is being filed pursuant to this revenue procedure in accordance with the Form 8832 and accompanying instructions. The Form 8832 must include both a declaration that the elements required for relief in Section 4.01 of this revenue procedure have been satisfied and a statement explaining the reason for the failure to file a timely entity classification election (referred to as "the reasonable cause statement"). (Until Form 8832 is modified to include the declaration contained in this revenue procedure and space for a reasonable cause statement, the eligible entity should write "Filed Pursuant to Rev. Proc. 2009-39(sic)"  { ed. (preferably in red )  and it should actually say: "Filed Pursuant to Rev. Proc. 2009-41"  }  at the top of Form 8832 and attach both the declaration and the reasonable cause statement to its Form 8832 that is filed with the applicable IRS service center. The declaration and reasonable cause statement must be accompanied by a dated declaration, signed by an authorized representative of the eligible entity and the affected person(s), if any, which states: "Under penalties of perjury, I (we) declare that I (we) have examined this election, including accompanying documents, and, to the best of my (our) knowledge and belief, the election contains all the relevant facts relating to the election, and such facts are true, correct, and complete." The individual or individuals who sign must have personal knowledge of the facts and circumstances related to the election. The copy of the Form 8832 that is required under §301.7701-3(c)(1)(ii) to be attached to either the eligible entity’s or the affected person’s return does not need the writing at the top of the Form 8832 or the attachments described in this section 4.02.)

.03 Relief for late entity classification elections. Upon receipt of a completed Form 8832 requesting relief under Section 4.01 of this revenue procedure, the IRS service center will determine whether the requirements for granting the late entity classification election have been satisfied and will notify the entity of the result of its determination. An entity receiving relief under this revenue procedure is treated as having made a timely entity classification election as of the requested effective date of the election.

.04 Eligible entities that do not meet all of the eligibility requirements under Section 4.01 of this revenue procedure. Eligible entities requesting a letter ruling because they do not meet all of the eligibility requirements of Section 4.01 of this revenue procedure must include either the following representation as part of the entity’s request for a letter ruling or an explanation regarding why they do not qualify to do so: "All required U.S. tax and information returns of the entity (or, if the entity was not required to file any such returns under the desired classification, then all required U.S. tax and information returns of each affected person as defined in Section 4.02 of Rev. Proc. 2009-39) were filed timely or within 6 months of the due date of the respective return (excluding extensions) as if the entity classification election had been in effect on the requested date. No U.S. tax or information returns were filed inconsistently with those described in the prior sentence."

SECTION 5. EFFECTIVE DATE
.01
In general. Except as provided in section 5.02, this revenue procedure is effective September 28, 2009, the date of publication of this revenue procedure in the Internal Revenue Bulletin. This revenue procedure applies to requests pending with the IRS service center pursuant to Rev. Proc. 2002-59 on September 28, 2009, and to requests received thereafter. It also applies to all ruling requests pending in the national office on September 28, 2009, and to requests for relief received thereafter.

.02 Transition rule for pending letter ruling requests. If an entity has filed a request for a letter ruling seeking relief for a late entity classification election and that letter ruling request is pending in the national office on September 28, 2009, the entity may rely on this revenue procedure, withdraw that letter ruling request and receive a refund of its user fee. However, the national office will process letter ruling requests pending on September 28, 2009, unless, prior to the earlier of November 12, 2009, or the issuance of the letter ruling, the entity notifies the national office that it will rely on this revenue procedure and withdraw its letter ruling request.

SECTION 6. EFFECT ON OTHER DOCUMENTS
Rev. Proc. 2002-59 is superseded.

SECTION 7. PAPERWORK REDUCTION ACT
The collections of information contained in this revenue procedure have been reviewed and approved by the Office of Management and Budget (OMB) in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 3507(d)) under control number 1545-1771.

The collection of information in these regulations is in Sections 4.02 and 4.04 of this revenue procedure. The information will help the IRS to determine if an eligible entity meets the requirements of Section 4.01 of this revenue procedure. The collection of information is required to obtain permission to file a late entity classification election. The information will be reported on Form 8832 or submitted as part of a letter ruling request. The time needed to complete and file a letter ruling request or a Form 8832 will vary depending on individual circumstances. The estimated burden for eligible entities filing a letter ruling request or Form 8832 are included in the estimates shown in the Paperwork Reduction Act of the annually published letter ruling revenue procedure and the instructions for Form 8832 respectively. An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless the collection of information displays a valid control  number.

Books or records relating to a collection of information must be retained as long as their contents may become material in the administration of any internal revenue law. Generally, tax returns and tax return information are confidential, as required by 26 U.S.C. 6103.


Extensions of Time to Make Elections:

DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 301 and 602
[TD 8680]
RIN 1545-AU41
Extensions of Time to Make Elections
AGENCY:  Internal Revenue Service (IRS), Treasury.
ACTION:  Temporary regulations.
SUMMARY:  This document contains temporary regulations concerning extensions of time for making certain elections under the Internal Revenue Code (Code).  The regulations provide the standards that the Commissioner will use to grant taxpayers extensions of time for making these elections.  The text of these temporary regulations also serves as the text of the proposed regulations set forth in the notice of proposed rulemaking on this subject in the Proposed Rules section of this issue of the Federal Register.

DATES:  These regulations are effective June 27, 1996.    For dates of applicability, see
§301.9100-1T(h) of these regulations.
FOR FURTHER INFORMATION CONTACT:  Robert A. Testoff at (202) 622-4960 (not a toll-free number).

SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
     These regulations are being issued without prior notice and public procedure pursuant to the Administrative Procedure Act  
(5 U.S.C. 553).  For this reason, the collection of information contained in these regulations has been reviewed and, pending receipt and evaluation of public comments, approved by the Office of Management and Budget under control number 1545-1488. 
Responses to this collection of information are required to obtain an extension of time for making an election. 
     An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless the collection of information displays a valid control number.
     For further information concerning this collection of information, where to submit comments on the collection of information and the accuracy of the estimated burden, and suggestions for reducing this burden, please refer to the preamble to the cross-referencing notice of proposed rulemaking published in the Proposed Rules section of this issue of the Federal Register.
     Books or records relating to a collection of information must be retained as long as their contents may become material in the administration of any internal revenue law.  Generally, tax returns and tax return information are confidential, as required by 26 U.S.C. 6103. Background
     This document contains temporary regulations amending the Regulations on Procedure and Administration (26 CFR part 301) concerning extensions of time for making certain elections.  The regulations provide the standards that the Commissioner will use to grant taxpayers extensions of time for making these elections.
These standards provide relief to taxpayers who reasonably and in good faith fail to make a timely election when granting relief will not prejudice the interests of the government.  The regulations provide a means by which taxpayers can be in the same position they would have been in had they made their elections in a timely fashion.
Explanation of Provisions
     These temporary regulations provide the standards the Commissioner will use to determine whether to grant an extension of time to make an election when the deadline for making the election is prescribed by regulation, revenue ruling, revenue procedure, notice, or announcement published in the Federal Register or the Internal Revenue Bulletin (regulatory election). Under section 6081(a), these regulations also provide an automatic extension of time to make an election when the deadline for making the election is prescribed by statute (statutory election) and the deadline for making the election is the due date of the return or the due date of the return including extensions.  These regulations adopt and revise the standards for relief provided in Rev. Proc. 92-85, 1992-2 C.B. 490.  
Automatic Extensions
     Rev. Proc. 92-85 provides an automatic 12-month extension for certain regulatory elections listed in Appendix A of that revenue procedure.  The temporary regulations continue the automatic 12-month extension and update the list of eligible regulatory elections. 

     Rev. Proc. 92-85 also provides an automatic 6-month extension for statutory elections when the deadline for making the election is prescribed as the due date of the return or the due date of the return including extensions.  The temporary regulations expand the automatic 6-month extension to include regulatory elections.  

Other Extensions
     Rev. Proc. 92-85 provides relief for certain regulatory elections that do not qualify for relief under the automatic extensions.  Rev. Proc. 92-85 requires a taxpayer to demonstrate that (1) it acted reasonably and in good faith and (2) granting relief will not prejudice the interests of the government.  The temporary regulations continue to provide extensions for such regulatory elections upon a showing of reasonable action and good faith and no prejudice to the interests of the government. 
     The temporary regulations adopt the standards for reasonable action and good faith in Rev. Proc. 92-85.  The regulations provide that a taxpayer is deemed to have acted reasonably and in good faith if: (1) the taxpayer applies for relief before the failure to make the regulatory election is discovered by the IRS; (2) the taxpayer inadvertently failed to make the election because of intervening events beyond its control; (3) the taxpayer failed to make the election because after exercising reasonable diligence the taxpayer was unaware of the necessity for the election; (4) the taxpayer reasonably relied on written advice of the IRS; or (5) the taxpayer relied on a qualified tax professional, including a professional employed by the taxpayer, and the professional failed to make or advise the taxpayer to make the election.  However, a taxpayer is deemed to have not acted reasonably and in good faith if: (1) the taxpayer is requesting relief for an election to alter a return position for which an accuracy-related penalty could have been imposed under section 6662; (2) the taxpayer was fully informed of the required election and related tax consequences and chose not to file the election; or (3) the taxpayer uses hindsight in requesting relief.

     The temporary regulations adopt the standards for prejudice to the interests of the government in Rev. Proc. 92-85.  The regulations provide that the interests of the government are deemed to be prejudiced if granting relief would result in a taxpayer having a lower tax liability than the taxpayer would have had if the regulatory election had been timely made.  In addition, the interests of the government are ordinarily deemed to be prejudiced if the tax year in which the election should have been made or any affected tax years are closed by the statute of limitations.

Accounting Method and Period Elections
     Rev. Proc. 92-85 provides limited relief (ordinarily not to exceed 90 days from the deadline for filing Form 3115, Application for Change in Accounting Method) for requests to change an accounting method subject to the procedure described in §1.446-1(e)(3)(i) (requiring the advance written consent of the Commissioner).  The temporary regulations continue this limited relief.  Rev. Proc. 92-85 provides an automatic 12-month extension for the election to use the last-in, first-out (LIFO) inventory method under section 472 and also provides relief for the section 472 election beyond the automatic 12-month extension.
Rev. Proc. 92-85 is otherwise inapplicable to accounting method regulatory elections, except for three specific elections listed in Appendix B of that revenue procedure. 
     The temporary regulations provide relief for all accounting method regulatory elections.  For example, relief will now be available for elections under sections 197 (amortization of goodwill and certain other intangibles) and 468A (special rules for nuclear decommissioning costs).
       The temporary regulations provide additional rules regarding what constitutes prejudice to the interests of the government for accounting method regulatory elections.  The temporary regulations provide that the interests of the government are deemed to be prejudiced except in unusual and compelling circumstances if: (1) the election requires an adjustment under section 481(a); (2) the taxpayer is under examination, requests relief to change from an impermissible method of accounting, and granting relief will provide the taxpayer a more favorable method of accounting or more favorable terms and conditions than the taxpayer would receive if the change is made as part of the examination; or (3) the election provides a more favorable method of accounting or more favorable terms and conditions if the election is made by a certain date or taxable year.

Rev. Proc. 92-85 provides an automatic 12-month extension for elections to use other than the required taxable year under section 444. 

Rev. Proc. 92-85 also provides limited relief (ordinarily not to exceed 90 days from the deadline for filing Form 1128, Application to Adopt, Change, or Retain a Tax Year) for accounting period regulatory elections subject to Rev. Proc. 87-32, 1987-2 C.B. 396.  Rev. Proc. 92-85 is otherwise inapplicable to accounting period regulatory elections.  The temporary regulations extend the limited relief for elections subject to Rev. Proc. 87-32 to all other accounting period regulatory elections except for the section 444 election, and provide relief for the section 444 election beyond the automatic 12-month extension.   

Effect on other documents
     Rev. Proc. 92-85, 1992-2 C.B. 490, as modified and clarified by Rev. Proc. 93-28, 1993-2 C.B. 344, is obsolete as of June 27, 1996. 
     Rev. Proc. 92-20, 1992-1 C.B. 685, is modified as of June 27, 1996, to the extent that the provisions of this regulation apply to applications for relief with respect to requests to change an accounting method subject to the procedures of Rev. Proc. 92-20.
     Rev. Proc. 87-32, 1987-2 C.B. 396, is modified as of June 27, 1996, to the extent that the provisions of this regulation apply to applications for relief with respect to requests to change an accounting period subject to the procedures of Rev. Proc. 87-32.
Special Analyses
     It has been determined that this Treasury decision is not a significant regulatory action as defined in EO 12866.  Therefore, a regulatory assessment is not required.  It has also been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do not apply to these regulations, and, therefore, a Regulatory Flexibility Analysis is not required.
Pursuant to section 7805(f) of the Internal Revenue Code, these temporary regulations will be submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on their impact on small businesses.
Drafting Information
     The principal author of these regulations is Robert A. Testoff of the Office of Assistant Chief Counsel (Income Tax and Accounting).  However, other personnel from the IRS and Treasury Department participated in their development.
List of Subjects
26 CFR Part 301
     Employment taxes, Estate taxes, Excise taxes, Gift taxes, Income taxes, Penalties, Reporting and recordkeeping requirements.
26 CFR Part 602
     Reporting and recordkeeping requirements.
Adoption of Amendments to the Regulations
     Accordingly, 26 CFR parts 301 and 602 are amended as follows:
PART 301--PROCEDURE AND ADMINISTRATION
     Paragraph 1.  The authority citation for part 301 is amended by adding entries in numerical order to read as follows:
     Authority:  26 U.S.C. 7805 * * *
Section 301.9100-1T also issued under 26 U.S.C. 6081;
Section 301.9100-2T also issued under 26 U.S.C. 6081;
Section 301.9100-3T also issued under 26 U.S.C. 6081; * * *
     Par. 2.  Sections 301.9100-1T through 301.9100-3T are added to read as follows: 

§ 301.9100-1T  Extensions of time to make elections (temporary). [Removed]
     (a) - (c) [Reserved].
     (d) Introduction.  The regulations under this section and
§§301.9100-2T through 301.9100-3T provide the standards the Commissioner will use to determine whether to grant an extension of time to make a regulatory election.  The regulations under this section and §§301.9100-2T through 301.9100-3T also provide an automatic extension of time to make certain statutory elections.  An extension of time is available for elections that a taxpayer is otherwise eligible to make and the granting of an extension of time is not a determination that the taxpayer is otherwise eligible to make the election.  Section 301.9100-2T provides automatic extensions of time for making regulatory and statutory elections when the deadline for making the election is the due date of the return or the due date of the return including extensions.  Section 301.9100-3T provides extensions of time for making regulatory elections that do not meet the requirements of §301.9100-2T. 

     (e) Terms.  The following terms have the meanings provided below:
      Election includes an application for relief in respect of tax; a request to adopt, change, or retain an accounting method or accounting period; but does not include an application for an extension of time for filing a return under section 6081.

     Regulatory election means an election whose deadline is prescribed by a regulation published in the Federal Register, or a revenue ruling, revenue procedure, notice, or announcement published in the Internal Revenue Bulletin.

     Statutory election means an election whose deadline is prescribed by statute.

     Taxpayer means any person within the meaning of section 7701(a)(1). 

     (f) General standards for relief.  The Commissioner in the Commissioner's discretion may grant a reasonable extension of time to make a regulatory election, or a statutory election (but no more than 6 months except in the case of a taxpayer who is abroad), under all subtitles of the Internal Revenue Code except subtitles E, G, H, and I, provided the taxpayer demonstrates to the satisfaction of the Commissioner that--
     (1) The taxpayer acted reasonably and in good faith; and
     (2) Granting relief will not prejudice the interests of the government. 
     (g) Exceptions.  Notwithstanding the provisions of paragraph (f) of this section, an extension of time will not be granted-- 
     (1) For elections under section 4980A(f)(5);
     (2) For elections required to be made prior to November 20, 1970, in the case of an election--
     (i) Required to be made in or with the taxpayer's original
income tax return;
     (ii) Required to be exercised by filing a claim for credit or refund, unless the election is required to be exercised on or before a date that precedes the date of expiration of the period of limitations provided in section 6511;
     (iii) Required to be filed in a petition to the Tax Court;
     (iv) To change a previous election;
     (v) To change an accounting method as described in
§§1.77-1 of this chapter and 1.446-1 of this chapter;
     (vi) To change an accounting period as described in
§1.442-1 of this chapter; or
     (vii) To change the method of treating bad debts as described in
§1.166-1 of this chapter; or
     (3) For elections that are expressly excepted from relief or where alternative relief is provided by a statute, a regulation published in the Federal Register, or a revenue ruling, revenue procedure, notice, or announcement published in the Internal Revenue Bulletin.   
     (h) Effective dates.  In general, this section and
§§301.9100-2T through 301.9100-3T are effective for all requests for relief being considered by the IRS on June 27, 1996, and for all requests for relief submitted on or after June 27, 1996.
However, the automatic 12-month extension and the automatic 6-month extension provided in
§301.9100-2T are effective for elections whose due dates are on or after June 27, 1996. 

§ 301.9100-2T  Automatic extensions (temporary). [Removed]
     (a) Automatic 12-month extension--(1) In general.  An automatic extension of 12 months from the original deadline for making a regulatory election is granted to make elections described in paragraph (a)(2) of this section provided the taxpayer takes corrective action as defined in paragraph (c) of this section within that 12-month extension period.
     (2) Elections eligible for automatic 12-month extension. The following regulatory elections are eligible for the automatic 12-month extension described in paragraph (a)(1) of this section--
     (i) The election to use other than the required taxable year under section 444;
     (ii) The election to use the last-in, first-out (LIFO) inventory method under section 472;
     (iii) The 15-month rule for filing an exemption application for a section 501(c)(9), 501(c)(17), or 501(c)(20) organization under section 505;
     (iv) The 15-month rule for filing an exemption application for a section 501(c)(3) organization under section 508;
     (v) The election to be treated as a homeowners association under section 528;
     (vi) The election to adjust basis on partnership transfers and distributions under section 754;
     (vii) The estate tax election to specially value qualified real property (where the IRS has not yet begun an examination of the filed return) under section 2032A(d)(1);
     (viii) The chapter 14 gift tax election to treat a qualified payment right as other than a qualified payment under section 2701(c)(3)(C)(i); and
     (ix) The chapter 14 gift tax election to treat any distribution right as a qualified payment under section
2701(c)(3)(C)(ii).
     (b) Automatic 6-month extension.  An automatic extension of 6 months from the due date of a return excluding extensions is granted to make regulatory or statutory elections whose deadlines are prescribed as the due date of the return or the due date of the return including extensions in the case of a taxpayer that timely filed its return for the year the election should have been made, provided the taxpayer takes corrective action as defined in paragraph (c) of this section within that 6-month extension period.  This extension does not apply, however, to regulatory or statutory elections that must be made by the due
date of the return excluding extensions.
     (c) Corrective action.  For purposes of this section, corrective action means filing an original or an amended return for the year the regulatory or statutory election should have been made and attaching the appropriate form or statement for making the election.  For those elections not required to be filed with a return, corrective action means taking the steps required to file the election in accordance with the statute, the regulation published in the Federal Register, or the revenue ruling, revenue procedure, notice, or announcement published in the Internal Revenue Bulletin.  Taxpayers who make an election under an automatic extension (and all taxpayers whose tax liability would be affected by the election) must report their income in a manner that is consistent with the election and comply with all other requirements for making the election for the year the election should have been made and for all affected years; otherwise, the Service may invalidate the election.
     (d) Procedural requirements.  Any return, statement of election, or other form of filing that must be made to obtain an automatic extension must provide the following statement at the top of the document: "FILED PURSUANT TO
§ 301.9100-2T".  Any filing made to obtain an automatic extension must be sent to the same address that the filing to make the election would have been sent had the filing been timely made.  No request for a letter ruling is required to obtain an automatic extension. Accordingly, user fees do not apply to taxpayers taking corrective action to obtain an automatic extension. 
     (e) The following example illustrates the rules of this section:
     Example.  Taxpayer A fails to make a certain election when filing A's 1996 income tax return on March 17, 1997, the due date of the return.  This election does not affect the tax liability of any other taxpayer.  The applicable regulation requires that the election be made by attaching the appropriate form to a timely filed return including extensions.  In accordance with paragraphs (b) and (c) of this section, A may make the regulatory election by filing an amended return with the appropriate form by September 15, 1997 (6 months from the March 17, 1997, due date).

§ 301.9100-3T  Other extensions (temporary). [Removed]
     (a) In general.  Requests for extensions of time for regulatory elections that do not meet the requirements of §301.9100-2T must be made under the rules of this section.
Requests for relief subject to this section will be granted when the taxpayer provides the evidence (including affidavits described in paragraph (e) of this section) to establish that the taxpayer acted reasonably and in good faith, and granting relief will not prejudice the interests of the government.
     (b) Reasonable action and good faith--(1) In general.
Except as provided in paragraphs (b)(3)(i) through (iii) of this section, a taxpayer is deemed to have acted reasonably and in good faith if the taxpayer--
     (i) Requests relief under this section before the failure to make the regulatory election is discovered by the IRS;
     (ii) Inadvertently failed to make the election because of intervening events beyond the taxpayer's control;
     (iii) Failed to make the election because, after exercising reasonable diligence (taking into account the taxpayer's experience and the complexity of the return or issue), the taxpayer was unaware of the necessity for the election;
      (iv) Reasonably relied on the written advice of the IRS; or
      (v) Reasonably relied on a qualified tax professional, including a tax professional employed by the taxpayer, and the tax professional failed to make, or advise the taxpayer to make,
the election.
     (2) Reasonable reliance on a qualified tax professional. For purposes of this paragraph (b), a taxpayer will not be considered to have reasonably relied on a qualified tax professional if the taxpayer knew or should have known that the professional was not--
     (i) Competent to render advice on the regulatory election; or
    (ii) Aware of all relevant facts.
    (3) Taxpayer deemed to have not acted reasonably or in good faith.  For purposes of this paragraph (b), a taxpayer is deemed to have not acted reasonably and in good faith if the taxpayer--
    (i) Seeks to alter a return position for which an accuracy-related penalty has been or could be imposed under section 6662 at the time the taxpayer requests relief (taking into account any qualified amended return filed within the meaning of §1.6664-2(c)(3)) of this chapter and the new position requires or permits a regulatory election for which relief is requested;
    (ii) Was fully informed of the required election and related tax consequences, but chose not to file the election; or
    (iii) Uses hindsight in requesting relief.  If specific facts have changed since the original deadline for making the election that make the election advantageous to a taxpayer, the IRS will not ordinarily grant relief.  In such a case, the IRS will grant relief only when the taxpayer provides strong proof that the taxpayer's decision to seek relief did not involve hindsight.
    (c) Prejudice to the interests of the government--(1) In general--(i) Lower tax liability.  The interests of the
government are prejudiced if granting relief would result in a taxpayer having a lower tax liability in the aggregate for all years to which the regulatory election applies than the taxpayer would have had if the election had been timely made (taking into account the time value of money).  Similarly, if the tax consequences of more than one taxpayer are affected by the election, the government's interests are prejudiced if extending the time for making the election may result in the affected taxpayers, in the aggregate, having a lower tax liability than if the election had been timely made. 
    (ii) Closed years.  The interests of the government are ordinarily prejudiced if the tax year in which the regulatory election should have been made or any tax years that would have been affected by the election had it been timely made are closed by the period of limitations on assessment under section 6501(a) before the taxpayer's receipt of a ruling granting relief under this section.  The IRS may condition a grant of relief on the taxpayer providing the IRS with a statement from an independent auditor (other than an auditor providing an affidavit pursuant to paragraph (e)(3) of this section) certifying that the requirements of paragraph (c)(1)(i) of this section are satisfied.
    (2) Special rules for accounting method regulatory elections.  The interests of the government are deemed to be prejudiced except in unusual and compelling circumstances if the accounting method regulatory election is--
    (i) Subject to the procedure described in §1.446-1(e)(3)(i) of this chapter (requiring the advance written consent of the Commissioner), and the request for relief under this section is filed more than 90 days after the deadline for filing the Form 3115, Application for Change in Accounting Method;
    (ii) Not an election described in paragraph (c)(2)(i) of this section and requires an adjustment under section 481(a) (or would require an adjustment under section 481(a) if the taxpayer changed to the method of accounting for which relief is requested in a taxable year subsequent to the taxable year the election should have been made);
    (iii) Not an election described in paragraph (c)(2)(i) of this section, the taxpayer is under examination and requests relief under this section to change from an impermissible method of accounting, and granting relief will provide the taxpayer a more favorable method of accounting or more favorable terms and conditions than the taxpayer would receive if the change from the impermissible method is made as part of the examination; or 
    (iv) Not an election described in paragraph (c)(2)(i) of this section and the election provides a more favorable method of accounting or more favorable terms and conditions if the election is made by a certain date or taxable year.
    (3) Special rules for accounting period regulatory elections.  The interests of the government are deemed to be prejudiced except in unusual and compelling circumstances if an  election is an accounting period regulatory election (other than the election to use other than the required taxable year under section 444) and the request for relief is filed more than 90 days after the deadline for filing the Form 1128, Application to Adopt, Change, or Retain a Tax Year (or other required statement).
    (d) Effect of amended returns--(1) Second examination under section 7605(b).  Taxpayers requesting and receiving an extension of time under this section waive any objections to a second examination under section 7605(b) for the issue(s) that is the subject of the relief request and any correlative adjustments.
    (2) Suspension of the period of limitations under  section 6501(a).  A request for relief under this section does not suspend the period of limitations on assessment under section 6501(a).  Thus, for relief to be granted, the IRS may require the taxpayer to consent under section 6501(c)(4) to an extension of the period of limitations on assessment for the tax year in which the regulatory election should have been made and any tax years that would have been affected by the election had it been timely made.
    (e) Procedural requirements--(1) In general.  Requests for relief under this section must provide evidence that satisfies the requirements in paragraphs (b) and (c) of this section, and must provide additional information as required by this paragraph (e).
    (2) Affidavit and declaration from taxpayer.  The taxpayer, or the individual who acts on behalf of the taxpayer with respect to tax matters, must submit a detailed affidavit describing the events that led to the failure to make a valid regulatory election and to the discovery of the failure.  When the taxpayer relied on a qualified tax professional for advice, the taxpayer's affidavit must describe the engagement and responsibilities of the professional as well as the extent to which the taxpayer relied on the professional.  The affidavit must be accompanied by a dated declaration, signed by the taxpayer, which states: "Under
penalties of perjury, I declare that, to the best of my knowledge and belief, the facts presented herein are true, correct, and complete."  The individual who signs for an entity must have personal knowledge of the facts and circumstances at issue. 
    (3) Affidavits and declarations from other parties.  The taxpayer must submit detailed affidavits from the individuals having knowledge or information about the events that led to the failure to make a valid regulatory election and to the discovery of the failure.  These individuals must include the taxpayer's income tax return preparer, any individual (including an employee of the taxpayer) who made a substantial contribution to the preparation of the return, and any accountant or attorney, knowledgeable in tax matters, who advised the taxpayer with regard to the election.  An affidavit must describe the engagement and responsibilities of the individual as well as the advice that the individual provided to the taxpayer.  Each affidavit must include the name, current address, and taxpayer identification number of the individual, and be accompanied by a dated declaration, signed by the individual, which states: "Under penalties of perjury, I declare that, to the best of my knowledge and belief, the facts presented herein are true, correct, and complete."
    (4) Other Information.  The request for relief filed under this section must also contain the following information--
    (i) The taxpayer must state whether the taxpayer's return(s) for the tax year in which the regulatory election should have been made or any tax years that would have been affected by the election had it been timely made is being examined by a district director, or is being considered by an appeals office or a federal court.  The taxpayer must notify the IRS office considering the request for relief if the IRS starts an examination of any such return while the taxpayer's request for relief is pending; 
    (ii) The taxpayer must state when the applicable return, form, or statement used to make the election was required to be filed and when it was actually filed;
    (iii) The taxpayer must submit a copy of any documents that refer to the election;
    (iv) When requested, the taxpayer must submit a copy of the taxpayer's income tax return for any taxable year for which the taxpayer requests an extension and any return affected by the
election; and
    (v) When applicable, the taxpayer must submit a copy of the income tax returns of other taxpayers affected by the election.
    (5) Filing instructions.  A request for relief under this section is a request for a letter ruling.  Requests for relief should be submitted in accordance with the applicable procedures for requests for a letter ruling and must be accompanied by the applicable user fee. 
    (f) Examples.  The following examples illustrate the provisions of this section: 
    Example 1.  Taxpayer discovers own error.  Taxpayer A prepares A's 1996 income tax return.  A is unaware that a particular regulatory election is available to report a transaction in a particular manner.  A files the 1996 return without making the election and reporting the transaction in a different manner.  In 1998, A hires a qualified tax professional to prepare A's 1998 return.  The professional discovers that A
did not make the election.  A promptly files for relief in accordance with this section.  Assuming paragraphs (b)(3)(i) through (iii) of this section do not apply, A is deemed to have acted reasonably and in good faith.  

    Example 2.  Reliance on qualified tax professional.  Taxpayer B hires a qualified tax professional to advise B on preparing B's 1996 income tax return and provides the professional with all the information requested.  The professional fails to advise B that a regulatory election is necessary in order for B to report income on B's 1996 return in a particular manner.  Nevertheless, B reports this income in a manner that is consistent with having made the election.  In 1999, during the examination of the 1996 return by the IRS, the examining agent discovers that the election has not been filed. B promptly files for relief in accordance with this section, including attaching an affidavit from B's professional stating that the professional failed to advise B that the election was necessary.  Assuming paragraphs (b)(3)(i) through (iii) of this section do not apply, B is deemed to have acted reasonably and in good faith.

    Example 3.  Accuracy-related penalty.  Taxpayer C reports income on its 1996 income tax return in a manner that contravenes a statutory provision.  C was aware of the statutory provision that prohibited the manner in which C reported this income, but did not provide adequate disclosure of the return position within the meaning of §1.6662-3(c) of this chapter.  In 1999, during the examination of the 1996 return, the IRS raises an issue regarding the reporting of this income on C's return.  C requests relief under this section to elect an alternative method of reporting the income.  Under paragraph (b)(3)(i) of this section, C is deemed to have not acted reasonably and in good faith because C seeks to alter a return position for which an accuracy-related penalty could be imposed under section 6662.

    Example 4.  Election not requiring adjustment under section 481(a).  Taxpayer D prepares D's 1996 income tax return.  D is unaware that a particular accounting method regulatory election is available.  D files the 1996 return using another method of accounting.  In 1998, D hires a qualified tax professional to prepare D's 1998 return.  The professional discovers that D did not make the election.  D promptly files for relief in accordance with this section.  Assume the applicable regulation provides that the election does not require an adjustment under section 481(a) and the election is not subject to the procedure described
in §1.446-1(e)(3)(i) of this chapter.  Further assume that if D were granted an extension of time to make the election, D would pay no less tax than if the election had been timely made.  Under paragraph (c) of this section, the interests of the government are not deemed to be prejudiced. 

         Example 5.  Election requiring adjustment under section 481(a).  The facts are the same as in Example 4 of this paragraph (f) except that the applicable regulation provides that the election requires an adjustment under section 481(a).  Under paragraph (c)(2)(ii) of this section, the interests of the government are deemed to be prejudiced except in unusual or compelling circumstances.   

    Example 6.  Under examination.  A regulation permits an automatic change from an impermissible method of accounting on a cut-off basis.  Any change to this method made as part of an examination is made with a section 481(a) adjustment.  Taxpayer E reports income on E's 1996 income tax return using the impermissible method of accounting.  In 1999, during the examination of the 1996 return by the IRS, the examining agent questions the propriety of E's method of accounting.  E requests relief under this section to make the change pursuant to the regulation for 1996.  E will receive less favorable terms and conditions if the change in method of accounting is made with a section 481(a) adjustment by the examining agent than if the change is made on a cut-off basis pursuant to the regulation.  Under paragraph (c)(2)(iii) of this section, the interests of the government are deemed to be prejudiced except in unusual and compelling circumstances. PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT
    Par. 3.  The authority citation for part 602 continues to read as follows:
    Authority:  26 U.S.C. 7805
    Par. 4.  Section 602.101(c) is amended by adding the following entries in numerical order to the table:
602.101  OMB Control numbers
* * * * *
(c)  * * *
                                                                 
CFR part or section where                    Current OMB
identified and described                     control number     
* * * * *

301.9100-2T.................................1545-1488
301.9100-3T.................................1545-1488

 

 


§ 301.9100-1 Extensions of time to make elections:

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301.9100-1(a) Introduction.
The regulations under this section and Sections 301.9100-2 and 301.9100-3 provide the standards the Commissioner will use to determine whether to grant an extension of time to make a regulatory election. The regulations under this section and Section 301.9100-2 also provides an automatic extension of time to make certain statutory elections. An extension of time is available for elections that a taxpayer is otherwise eligible to make. However, the granting to an extension of time is not a determination that the taxpayer is otherwise eligible to make the election. Section 301.9100-2 provides automatic extensions of time for making regulatory and statutory elections when the deadline for making the election is the due date of the return or the due date of the return including extensions. Section 301.9100-3 provides extensions of time for making regulatory elections that do not meet the requirements of Section 301.9100-2.
301.9100-1(b) Terms.
The following terms have the meanings provided below -
Election includes an application for relief in respect of tax; a request to adopt, change, or retain an accounting method or accounting period; but does not include an application for an extension of time for filing a return under section 6081.
Regulatory election means an election whose due date is prescribed by a regulation published in the Federal Register, or a revenue ruling, revenue procedure, notice, or announcement published in the Internal Revenue Bulletin (see Section 601.601(d)(2) of this chapter).
Statutory election means an election whose due date is prescribed by statute.
Taxpayer means any person within the meaning of section 7701(a)(1).
301.9100-1(c) General standards for relief.
The Commissioner in exercising the Commissioner's discretion may grant a reasonable extension of time under the rules set forth in Sections 301.9100-2 and 301.9100-3 to make a regulatory election, or a statutory election (but no more than 6 months except in the case of a taxpayer who is abroad), under all subtitles of the Internal Revenue Code except subtitles E, G, H, and I.
301.9100-1(d) Exceptions.
Notwithstanding the provisions of paragraph (c) of this section, an extension of time will not be granted -
301.9100-1(d)(1) For elections under section 4980A(f)(5); or
301.9100-1(d)(2) For elections that are expressly excepted from relief or where alternative relief is provided by a statute, a regulation published in the Federal Register, or a revenue ruling, revenue procedure, notice, or announcement published in the Internal Revenue Bulletin (see Section 601.601(d)(2) of this chapter).
301.9100-1(e) Effective dates.
In general, this section and Sections 301.9100-2 and 301.9100-3 apply to all requests for an extension of time submitted to the Internal Revenue Service (IRS) on or after Dec. 31, 1997. However, the automatic 12-month and 6-month extensions provided in Section 301.9100-2 apply to elections for which corrective action is taken on or after Dec. 31, 1997. For other requests for an extension of time, see Sections 301.9100-1T through 301.9100-3T in effect prior to Dec. 31, 1997, (Sections 301.9100-1T through 301.9100-3T as contained in the 26 CFR part 1 edition revised as of April 1, 1997).
[T.D. 8342, 56 FR 14024, Apr. 5, 1991, as amended by T.D. 8378, 56 FR 64982, Dec. 13, 1991; T.D. 8481, 58 FR 34886-34887, June 30, 1993; as revised by T.D. 8742, 62 FR 68167-68173, Dec. 31, 1997.]
 


§ 301.9100-2 Automatic extensions:

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301.9100-2(a) Automatic 12-month extension -
301.9100-2(a)(1) In general.
An automatic extension of 12 months from the due date for making a regulatory election is granted to make elections described in paragraph (a)(2) of this section provided the taxpayer takes corrective action as defined in paragraph (c) of this section within that 12-month extension period. For purposes of this paragraph (a), the due date for making a regulatory election is the extended due date of the return if the due date of the election is the due date of the return or the due date of the return including extensions and the taxpayer has obtained an extension of time to file the return. This extension is available regardless of whether the taxpayer timely filed its return for the year the election should have been made.
301.9100-2(a)(2) Elections eligible for automatic 12-month extension.
The following regulatory elections are eligible for the automatic 12-month extension described in paragraph (a)(1) of this section -
301.9100-2(a)(2)(i) The election to use other than the required taxable year under section 444;
301.9100-2(a)(2)(ii) The election to use the last-in, first-out (LIFO) inventory method under section 472;
301.9100-2(a)(2)(iii) The 15-month rule for filing an exemption application for a section 501(c)(9), 501(c)(17), or 501(c)(20) organization under section 505;
301.9100-2(a)(2)(iv) The 15-month rule for filing an exemption application for a section 501(c)(3) organization under section 508;
301.9100-2(a)(2)(v) The election to be treated as a homeowners association under section 528;
301.9100-2(a)(2)(vi) The election to adjust basis on partnership transfers and distributions under section 754;
301.9100-2(a)(2)(vii) The estate tax election to specially value qualified real property (where the Internal Revenue Service (IRS) has not yet begun an examination of the filed return) under section 2032A(d)(1);
301.9100-2(a)(2)(Viii) The chapter 14 gift tax election to treat a qualified payment right as other than a qualified payment under section 2701(c)(3)(C)(i); and
301.9100-2(a)(2)(ix) The chapter 14 gift tax election to treat any distribution right as a qualified payment under section 2701(c)(3)(C)(ii).
301.9100-2(b) Automatic 6-month extension.
An automatic extension of 6 months from the due date of a return excluding extensions is granted to make regulatory or statutory elections whose due dates are the due date of the return or the due date of the return including extensions provided the taxpayer timely filed its return for the year the election should have been made and the taxpayer takes corrective action as defined in paragraph (c) of this section within that 6-month extension period.
This paragraph (b) does not apply to regulatory or statutory elections that must be made by the due date of the return excluding extensions.
301.9100-2(c) Corrective action.
For purposes of this section, corrective action means taking the steps required to file the election in accordance with the statute or the regulation published in the Federal Register, or the revenue ruling, revenue procedure, notice, or announcement published in the Internal Revenue Bulletin (see Section 601.601(d)(2) of this chapter). For those elections required to be filed with a return, corrective action includes filing an original or an amended return for the year the regulatory or statutory election should have been made and attaching the appropriate form or statement for making the election. Taxpayers who make an election under an automatic extension (and all taxpayers whose tax liability would be affected by the election) must file their return in a manner that is consistent with the election and comply with all other requirements for making the election for the year the election should have been made and for all affected years; otherwise, the IRS may invalidate the election.
301.9100-2(d) Procedural requirements.
Any return, statement of election, or other form of filing that must be made to obtain an automatic extension must provide the following statement at the top of the document: "FILED PURSUANT TO Section 301.9100-2". Any filing made to obtain an automatic extension must be sent to the same address that the filing to make the election would have been sent had the filing been timely made. No request for a letter ruling is required to obtain an automatic extension. Accordingly, user fees do not apply to taxpayers taking corrective action to obtain an automatic extension.
301.9100-2(e) Examples.
The following examples illustrate the provisions of this section:
Example 1. Automatic 12-month extension.
Taxpayer A fails to make an election described in paragraph (a)(2) of this section when filing A's 1997 income tax return on March 16, 1998, the due date of the return. This election does not affect the tax liability of any other taxpayer. The applicable regulation requires that the election be made by attaching the appropriate form to a timely filed return including extensions. In accordance with paragraphs (a) and (c) of this section. A may make the regulatory election by taking the corrective action of filing an amended return with the appropriate form by March 15, 1999 (12 months from the March 16, 1998 due date of the return). If A obtained a 6-month extension to file its 1997 income tax return, A may make the regulatory election by taking the corrective action of filing an amended return with the appropriate form by September 15, 1999 (12 months from the September 15, 1998 extended due date of the return).
Example 2. Automatic 6-month extension.
Taxpayer B fails to make an election not described in paragraph (a)(2) of this section when filing B's 1997 income tax return on March 16, 1998, the due date of the return. This election does not affect the tax liability of any other taxpayer. The applicable regulation requires that the election be made by attaching the appropriate form to a timely filed return including extensions. In accordance with paragraphs (b) and (c) of this section, B may make the regulatory election by taking the corrective action of filing an amended return with the appropriate form by September 15, 1998 (6 months from the March 16, 1998 due date of the return).
[T.D. 8742, 62 FR 68167-68173, Dec. 31, 1997.]
 

 

From STEVEN A. AND PATRICIA A. KNISH, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent December 18, 2006
Relief under sec. 301.9100-2, Proced. & Admin. Regs., is unavailable for extensions of time to file mark-to-market elections under sec. 475(f) because it does not apply to elections, like the mark-to-market election, that must be made by the due date of the return without regard to extensions. Sec. 301.9100-2(b), Proced. & Admin. Regs.; Rev. Proc. 99-17, 1999-1 C.B. 503.


§ 301.9100-3 Other extensions:

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301.9100-3(a) In general.
Requests for extensions of time for regulatory elections that do not meet the requirements of Section 301.9100-2 must be made under the rules of this section. Requests for relief subject to this section will be granted when the taxpayer provides the evidence (including affidavits described in paragraph (e) of this section) to establish to the satisfaction of the Commissioner that the taxpayer acted reasonably and in good faith, and the grant of relief will not prejudice the interests of the Government.
301.9100-3(b) Reasonable action and good faith -
301.9100-3(b)(1) In general.
Except as provided in paragraphs (b)(3)(i) through (iii) of this section, a taxpayer is deemed to have acted reasonably and in good faith if the taxpayer -
301.9100-3(b)(1)(i) Requests relief under this section before the failure to make the regulatory election is discovered by the Internal Revenue Service (IRS);
301.9100-3(b)(1)(ii) Failed to make the election because of intervening events beyond the taxpayer's control;
301.9100-3(b)(1)(iii) Failed to make the election because, after exercising reasonable diligence (taking into account the taxpayer's experience and the complexity of the return or issue), the taxpayer was unaware of the necessity for the election;
301.9100-3(b)(1)(iv) Reasonably relied on the written advice of the Internal Revenue Service (IRS); or
301.9100-3(b)(1)(v) Reasonably relied on a qualified tax professional, including a tax professional employed by the taxpayer, and the tax professional failed to make, or advise the taxpayer to make, the election.
301.9100-3(b)(2) Reasonable reliance on a qualified tax professional.
For purposes of this paragraph (b), a taxpayer will not be considered to have reasonably relied on a qualified tax professional if the taxpayer knew or should have known that the professional was not -
301.9100-3(b)(2)(i) Competent to render advice on the regulatory election; or
301.9100-3(b)(2)(ii) Aware of all relevant facts.
301.9100-3(b)(3) Taxpayer deemed to have not acted reasonably or in good faith.
For purposes of this paragraph (b), a taxpayer is deemed to have not acted reasonably and in good faith if the taxpayer -
301.9100-3(b)(3)(i) Seeks to alter a return position for which an accuracy-related penalty has been or could be imposed under section 6662 at the time the taxpayer requests relief (taking into account any qualified amended return filed within the meaning of Section 1.6664-2(c)(3) of this chapter) and the new position requires or permits a regulatory election for which relief is requested;
301.9100-3(b)(3)(ii) Was informed in all material respects of the required election and related tax consequences, but chose not to file the election; or
301.9100-3(b)(3)(iii) Uses hindsight in requesting relief. If specific facts have changed since the due date for making the election that make the election advantageous to a taxpayer, the IRS will not ordinarily grant relief. In such a case, the IRS will grant relief only when the taxpayer provides strong proof that the taxpayer's decision to seek relief did not involve hindsight.
301.9100-3(c) Prejudice to the interests of the Government -
301.9100-3(c)(1) In general.
The Commissioner will grant a reasonable extension of time to make a regulatory election only when the interests of the Government will not be prejudiced by the granting of relief. This paragraph (c) provides the standards the Commissioner will use to determine when the interests of the Government are prejudiced.
301.9100-3(c)(1)(i) Lower tax liability.
The interests of the Government are prejudiced if granting relief would result in a taxpayer having a lower tax liability in the aggregate for all taxable years affected by the election than the taxpayer would have had if the election had been timely made (taking into account the time value of money). Similarly, if the tax consequences of more than one taxpayer are affected by the election, the Government's interests are prejudiced if extending the time for making the election may result in the affected taxpayers, in the aggregate, having a lower tax liability than if the election had been timely made.
301.9100-3(c)(1)(ii) Closed years.
The interests of the Government are ordinarily prejudiced if the taxable year in which the regulatory election should have been made or any taxable years that would have been affected by the election had it been timely made are closed by the period of limitations on assessment under section 6501(a) before the taxpayer's receipt of a ruling granting relief under this section. The IRS may condition a grant of relief on the taxpayer providing the IRS with a statement from an independent auditor (other than an auditor providing an affidavit pursuant to paragraph (e)(3) of this section) certifying that the interests of the Government are not prejudiced under the standards set forth in paragraph (c)(1)(i) of this section.
301.9100-3(c)(2) Special rules for accounting method regulatory elections.
The interests of the Government are deemed to be prejudiced except in unusual and compelling circumstances if the accounting method regulatory election for which relief is requested -
301.9100-3(c)(2)(i) Is subject to the procedure described in Section 1.446-1(e)(3)(i) of this chapter (requiring the advance written consent of the Commissioner);
301.9100-3(c)(2)(ii) Requires an adjustment under section 481(a) (or would require an adjustment under section 481(a) if the taxpayer changed to the method of accounting for which relief is requested in a taxable year subsequent to the taxable year the election should have been made);
301.9100-3(c)(2)(iii) Would permit a change from an impermissible method of accounting that is an issue under consideration by examination, an appeals office, or a federal court and the change would provide a more favorable method or more favorable terms and conditions than if the change were made as part of an examination; or
301.9100-3(c)(2)(iv) Provides a more favorable method of accounting or more favorable terms and conditions if the election is made by a certain date or taxable year.
301.9100-3(c)(3) Special rules for accounting period regulatory elections.
The interests of the Government are deemed to be prejudiced except in unusual and compelling circumstances if an election is an accounting period regulatory election (other than the election to use other than the required taxable year under section 444) and the request for relief is filed more than 90 days after the due date for filing the Form 1128, Application to Adopt, Change, or Retain a Tax Year (or other required statement).
301.9100-3(d) Effect of amended returns -
301.9100-3(d)(1) Second examination under section 7605(b).
Taxpayers requesting and receiving an extension of time under this section waive any objections to a second examination under section 7605(b) for the issue(s) that is the subject of the relief request and any correlative adjustments.
301.9100-3(d)(2) Suspension of the period of limitations under section 6501(a).
A request for relief under this section does not suspend the period of limitations on assessment under section 6501(a). Thus, for relief to be granted, the IRS may require the taxpayer to consent under section 6501(c)(4) to an extension of the period of limitations on assessment for the taxable year in which the regulatory election should have been made and any taxable years that would have been affected by the election had it been timely made.
301.9100-3(e) Procedural requirements -
301.9100-3(e)(1) In general.
Requests for relief under this section must provide evidence that satisfies the requirements in paragraphs (b) and (c) of this section, and must provide additional information as required by this paragraph (e).
301.9100-3(e)(2) Affidavit and declaration from taxpayer.
The taxpayer, or the individual who acts on behalf of the taxpayer with respect to tax matters: must submit a detailed affidavit describing the events that led to the failure to make a valid regulatory election and to the discovery of the failure. When the taxpayer relied on a qualified tax professional for advice, the taxpayer's affidavit must describe the engagement and responsibilities of the professional as well as the extent to which the taxpayer relied on the professional. The affidavit must be accompanied by a dated declaration, signed by the taxpayer, which states: "Under penalties of perjury, I declare that I have examined this request, including accompanying documents, and, to the best of my knowledge and belief, the request contains all the relevant facts relating to the request, and such facts are true, correct, and complete." The individual who signs for an entity must have personal knowledge of the facts and circumstances at issue.
301.9100-3(e)(3) Affidavits and declarations from other parties.
The taxpayer must submit detailed affidavits from the individuals having knowledge or information about the events that led to the failure to make a valid regulatory election and to the discovery of the failure. These individuals must include the taxpayer's return preparer, any individual (including an employee of the taxpayer) who made a substantial contribution to the preparation of the return, and any accountant or attorney, knowledgeable in tax matters, who advised the taxpayer with regard to the election. An affidavit must describe the engagement and responsibilities of the individual as well as the advice that the individual provided to the taxpayer. Each affidavit must include the name, current address, and taxpayer identification number of the individual, and be accompanied by a dated declaration, signed by the individual, which states: "Under penalties of perjury, I declare that I have examined this request, including accompanying documents, and, to the best of my knowledge and belief, the request contains all the relevant facts relating to the request, and such facts are true, correct, and complete."
301.9100-3(e)(4) Other information.
The request for relief filed under this section must also contain the following information -
301.9100-3(e)(4)(i) The taxpayer must state whether the taxpayer's return(s) for the taxable year in which the regulatory election should have been made or any taxable years that would have been affected by the election had it been timely made is being examined by a district director, or is being considered by an appeals office or a federal court. The taxpayer must notify the IRS office considering the request for relief if the IRS starts an examination of any such return while the taxpayer's request for relief is pending;
301.9100-3(e)(4)(ii) The taxpayer must state when the applicable return, form, or statement used to make the election was required to be filed and when it was actually filed;
301.9100-3(e)(4)(iii) The taxpayer must submit a copy of any documents that refer to the election;
301.9100-3(e)(4)(iv) When requested, the taxpayer must submit a copy of the taxpayer's return for any taxable year for which the taxpayer requests an extension of time to make the election and any return affected by the election; and
301.9100-3(e)(4)(v) When applicable, the taxpayer must submit a copy of the returns of other taxpayers affected by the election.
301.9100-3(e)(5) Filing instructions.
A request for relief under this section is a request for a letter ruling. Requests for relief should be submitted in accordance with the applicable procedures for requests for a letter ruling and must be accompanied by the applicable user fee.
301.9100-3(f) Examples.
The following examples illustrate the provisions of this section:
Example 1. Taxpayer discovers own error.
Taxpayer A prepares A's 1997 income tax return. A is unaware that a particular regulatory election is available to report a transaction in a particular manner. A files the 1997 return without making the election and reporting the transaction in a different manner. In 1999, A hires a qualified tax professional to prepare A's 1999 return. The professional discovers that A did not make the election. A promptly files for relief in accordance with this section. Assume paragraphs (b)(3)(i) through (iii) of this section do not apply. Under paragraph (b)(1)(i) of this section, A is deemed to have acted reasonably and in good faith because A requested relief before the failure to make the regulatory election was discovered by the IRS.
Example 2. Reliance on qualified tax professional.
Taxpayer B hires a qualified tax professional to advise B on preparing B's 1997 income tax return. The professional was competent to render advice on the election and B provided the professional with all the relevant facts. The professional fails to advise B that a regulatory election is necessary in order for B to report income on B's 1997 return in a particular manner. Nevertheless, B reports this income in a manner that is consistent with having made the election. In 2000, during the examination of the 1997 return by the IRS, the examining agent discovers that the election has not been filed. B promptly files for relief in accordance with this section, including attaching an affidavit from B's professional stating that the professional failed to advise B that the election was necessary. Assume paragraphs (b)(3)(i) through (iii) of this section do not apply. Under paragraph (b)(1)(v) of this section, B is deemed to have acted reasonably and in good faith because B reasonably relied on a qualified tax professional and the tax professional failed to advise B to make the election.
Example 3. Accuracy-related penalty.
Taxpayer C reports income on its 1997 income tax return in a manner that is contrary to a regulatory provision. In 2000, during the examination of the 1997 return, the IRS raises an issue regarding the reporting of this income on C's return and asserts the accuracy-related penalty under section 6662. C requests relief under this section to elect an alternative method of reporting the income. Under paragraph (b)(3)(i) of this section, C is deemed to have not acted reasonably and in good faith because C seeks to alter a return position for which an accuracy-related penalty could be imposed under section 6662.
Example 4. Election not requiring adjustment under section 481(a).
Taxpayer D prepares D's 1997 income tax return. D is unaware that a particular accounting method regulatory election is available. D files D's 1997 return without making the election and uses another permissible method of accounting. The applicable regulation provides that the election is made on a cut-off basis (without an adjustment under section 481(a)). In 1998, D requests relief under this section to make the election under the regulation. If D were granted an extension of time to make the election, D would pay no less tax than if the election had been timely made. Assume that paragraphs (c)(2)(i), (iii), and (iv) of this section do not apply. Under paragraph (c)(2)(ii) of this section, the interests of the Government are not deemed to be prejudiced because the election does not require an adjustment under section 481(a).
Example 5. Election requiring adjustment under section 481(a).
The facts are the same as in Example 4 of this paragraph (f) except that the applicable regulation provides that the election requires an adjustment under section 481(a). Under paragraph (c)(2)(ii) of this section, the interests of the Government are deemed to be prejudiced except in unusual or compelling circumstances.
Example 6. Under examination by the IRS.
A regulation permits an automatic change in method of accounting for an item on a cut-off basis. Taxpayer E reports income on E's 1997 income tax return using an impermissible method of accounting for the item. In 2000, during the examination of the 1997 return by the IRS, the examining agent notifies E in writing that its method of accounting for the item is an issue under consideration. Any change from the impermissible method made as part of an examination is made with an adjustment under section 481(a). E requests relief under this section to make the change pursuant to the regulation for 1997. The change on a cut-off basis under the regulation would be more favorable than if the change were made with an adjustment under section 481(a) as part of an examination. Under paragraph (c)(2)(iii) of this section, the interests of the Government are deemed to be prejudiced except in unusual and compelling circumstances because E seeks to change from an impermissible method of accounting that is an issue under consideration in the examination on a basis that is more favorable than if the change were made as part of an examination.
[T.D. 8742, 62 FR 68167-68173, Dec. 31, 1997.]


Deadline for filing Amended Tax Return:

Chief Counsel Advice Memorandum
201052003, 12/30/2010

An amended tax return is considered timely filed if it is postmarked by the due date (the timely mailed/timely filed rule) if the amended tax return includes a claim for a refund - because, as the CCA memorandum explains,  taxpayers are required under the Internal Revenue laws to file a claim in such cases.

The due date for filing an amended tax return is generally three years after the original due date of a timely filed tax return or, when applicable, three years after the extended due date.


But an amended tax return is considered timely filed only if actually received by the IRS by the due date if the amended tax return that show additional tax due because, as the CCA memorandum explains,  taxpayers are not required under the Internal Revenue laws to file in these cases.
 


Deadline for retroactively changing form 1040 credit elect:

Administratively, a taxpayer may contact the IRS and request his overpayment "credit elect" to be reversed, if such request is made by March 1st of the following year.

Example: taxpayer filed 2009 form 1040 on October 15, 2010 showing an overpayment and electing to have some or all of it applied to 2010 estimated tax (applied retroactively to the later of April 15, 2010 or to the date the money was received by the IRS).  Later on the taxpayer desires that the credit elect not go into 2010 as estimated tax, and wishes to have the amount of the credit elect returned to 2009.  In such a case, the request needs to be made by March 1, 2011.

(per Practitioner's Hot Line on 9/29/2011)


IRS Reg. §1.6081-1 & IRM 3.11.212.1 Extension of time for filing returns (automatic and by letter request for > 6 months):

Contrary to popular belief, business taxpayers may write a letter to apply for and be granted an extension of time to file for longer than five or six months.

§1.6081-1   Extension of time for filing returns. (4-1-2012) (12-7-2004)

(a) In general. The Commissioner is authorized to grant a reasonable extension of time for filing any return, declaration, statement, or other document which relates to any tax imposed by subtitle A of the Code and which is required under the provisions of subtitle A or F of the Code or the regulations thereunder. However, other than in the case of taxpayers who are abroad, such extensions of time shall not be granted for more than 6 months, and the extension of time for filing the return of a DISC (as defined in section 992(a)), as specified in section 6072(b), shall not be granted. Except in the case of an extension of time pursuant to §1.6081-5, an extension of time for filing an income tax return shall not operate to extend the time for the payment of the tax unless specified to the contrary in the extension. For rules relating to extensions of time for paying tax, see §1.6161-1.

(b) Application for extension of time-(1) In general. A taxpayer desiring an extension of the time for filing a return, statement, or other document shall submit an application therefor on or before the due date of such return, statement, or other document. Except as provided in subparagraph (3) of this paragraph and, except as provided in paragraph (b) of §301.6091-1 (relating to hand-carried documents), such application shall be made to the internal revenue officer with whom such return, statement, or other document is required to be filed. Such application shall be in writing, properly signed by the taxpayer or his duly authorized agent, and shall clearly set forth (i) the particular tax return, information return, statement, or other document, including the taxable year or period thereof, with respect to which the extension of the time for filing is desired, and (ii) a full recital of the reasons for requesting the extension to aid such internal revenue officer in determining the period of extension, if any, which will be granted. In the case of a cemetery perpetual care fund trust, a distributee cemetery's failure to make timely expenditures of distributions which prevents accurate determination of the allowable deduction under section 642(i) will be considered reasonable grounds for a 6-month extension of time for filing the trust's return. See §1.642(i)-1(c)(2).

§1.6081-1   Extension of time for filing returns. (4-1-2003) (2-23-1989)

(a) In general. District directors and directors of service are authorized to grant a reasonable extension of time for filing any return, declaration, statement, or other document which relates to any tax imposed by subtitle A of the code by and which is required under the provisions of subtitle A or F of the code or the regulations thereunder. However, other than in the case of taxpayers who are abroad, such extensions of time shall not be granted for more than 6 months, and the extension of time for filing the return of a DISC (as defined in section 992(a)), as specified in section 6072(b), shall not be granted. Except in the case of an extension of time pursuant to §1.6081-2, an extension of time for filing an income tax return shall not operate to extend the time for the payment of the tax or any installment thereof unless specified to the contrary in the extension. In the case of an extension of time pursuant to §1.6081-2, an extension of time for filing an income-tax return shall operate to extend the time for the payment of the tax or any installment therefo unless specified to the contrary in the extension. For rules relating to extensions of time for paying tax, see §1.6161-1.

IRM 3.11.212.1  (01-01-2013) - Automatic Applications for Extension of Time to File

  1. The Individual Master File (IMF) extension request forms are as follows:

    • Form 4868, Application for Automatic Extension of Time to File U.S. Individual Income Tax Return

    • Form 2350, Application for Extension of Time to File U.S. Income Tax Return (Austin Submission Processing Center (AUSPC) only)

  2. The Business Master File (BMF) extension request forms covered by this IRM are:

    • Form 7004, Application for Automatic Extension of Time To File Certain Business Income Tax, Information, and Other Returns

    • Form 8892, Application for Automatic Extension of Time To File Form 709 and/or Payment of Gift/Generation-Skipping Transfer Tax

IRM 3.11.212.1.3  (01-01-2010) - Letter Requests

  1. A taxpayer wanting an extension of time for filing a return may submit a letter to the submission processing center where the return is to be filed.

  2. If the letter contains a request for gift tax only (Form 709), transship to CSPC.

  3. If the letter request is for a Non Master File (NMF) form, forward to CSPC NMF Accounting. See IRM 3.11.212.1.4(5) for the list of NMF forms.

IRM 3.11.212.1.5  (01-01-2012) - 6 Month Extension Limit

  1. Under normal circumstances, an extension of time to file can legally be granted for no longer than a total of 6 months from the due date of the return. Internal Revenue Code (IRC) Section 6081(a) and Treas. Reg. section 1.6081-1 (a) state that an extension of time to file generally "shall not be granted for more than 6 months" from the due date of the return required to be filed.

    Exception:
    The maximum extension time for Form 1041 (except Form 1041 for bankruptcy estates), Form 1065 and Form 8804 is 5 months from the due date of the return.

  2. In some cases, however, individual taxpayers who are abroad may receive more than 6 months. Only AUSPC may grant extensions beyond 6 months for individual taxpayers. See IRM 3.11.212.4.6.2

  3. OSPC (Ogden Submission Processing Center) may grant an extension longer than 6 months for business taxpayers. These requests must be processed through IDRS (Integrated Data Retrieval System) using Command Code (CC) REQ77. "98" must be entered in the ULC field on line 9 of the FRM77 screen. For input instructions, see IRM 2.4.19, Command Codes REQ77, FRM77 and FRM7A.

IRM 3.11.212.4.8  (01-01-2010) - Extension Request Listings - AUSPC Only
  1. Tax preparation firms may submit a list of taxpayers with a cover letter instead of filing separate Forms 4868 to request an automatic 6 month extension of time to file. /p>

  2. The listing must include the taxpayer's name and valid SSN or ITIN.


Office of Chief Counsel memorandum January 2, 2003, Notification Requirements for Extensions of Time to File (PDF)



Deadline for electing / revoking §179 on an Amended Tax Return:

Office of Chief Counsel No. INFO 2009-0056

26 CFR 1.179-1 - Election to expense certain depreciable assets.

26 CFR 1.179-2 - Limitations on amount subject to section 179 election.

26 CFR 1.179-3 - Carryover of disallowed deduction.

26 CFR 1.179-4 - Definitions.

26 CFR 1.179-5 - Time and manner of making election.

26 CFR 1.179-6 - Effective dates.



Revenue Ruling 2010-25 - §163 Homeowner's qualified residence interest on indebtedness up to $1,100,000:

Interest Limitations on qualified residence interest.
This ruling holds that indebtedness in excess of $1 million that a taxpayer incurs to acquire, construct, or substantially improve a qualified residence may constitute home equity indebtedness within the meaning of section 163(h)(3)(C) of the Code.

Rev. Rul. 2010-25
ISSUE
Whether indebtedness that is incurred by a taxpayer to acquire, construct, or substantially improve a qualified residence can constitute "home equity indebtedness" (within the meaning of §163(h)(3)(C) of the Internal Revenue Code) to the extent it exceeds $1 million.

FACTS
In 2009, an unmarried individual (Taxpayer) purchased a principal residence for its fair market value of $1,500,000. Taxpayer paid $300,000 and financed the remainder by borrowing $1,200,000 through a loan that is secured by the residence.  In 2009, Taxpayer paid interest that accrued on the indebtedness during that year. Taxpayer has no other debt secured by the residence.

LAW
Section 163(a) allows as a deduction all interest paid or accrued within the taxable year on indebtedness. However, for individuals §163(h)(1) disallows a deduction for personal interest. Under §163(h)(2)(D), qualified residence interest is not personal interest. Section 163(h)(3)(A) defines qualified residence interest as interest paid or accrued during the taxable year on acquisition indebtedness or home equity indebtedness secured by any qualified residence of the taxpayer. Under §163(h)(4)(A), "qualified residence" means a taxpayer's principal residence, within the meaning of §121, and one other residence selected and used by the taxpayer as a residence.

Section 163(h)(3)(B)(i) provides that acquisition indebtedness is any indebtedness that is incurred in acquiring, constructing, or substantially improving a qualified residence and is secured by the residence. However, §163(h)(3)(B)(ii) limits the amount of indebtedness treated as acquisition indebtedness to $1,000,000 ($500,000 for a married individual filing separately). Accordingly, any indebtedness described in §163(h)(3)(B)(i) in excess of $1,000,000 is, by definition, not acquisition indebtedness for purposes of §163(h)(3).

Section 163(h)(3)(C)(i) provides that home equity indebtedness is any indebtedness secured by a qualified residence other than acquisition indebtedness, to the extent the fair market value of the qualified residence exceeds the amount of acquisition indebtedness on the residence. However, §163(h)(3)(C)(ii) limits the amount of indebtedness treated as home equity indebtedness to $100,000 ($50,000 for a married individual filing separately). Accordingly, any indebtedness described in §163(h)(3)(C)(i) in excess of $100,000 is, by definition, not home equity indebtedness for purposes of §163(h)(3).

In Pau v. Commissioner, T.C. Memo. 1997-43, the Tax Court limited the taxpayers' deduction for qualified residence interest to the interest paid on $1 million of the $1.33 million indebtedness incurred to purchase their residence. The court stated that §163(h) restricts home mortgage interest deductions to interest paid on $1 million of acquisition indebtedness and $100,000 of home equity indebtedness. Citing §163(h)(3)(B), the court stated that acquisition indebtedness is defined as indebtedness that is incurred in acquiring, constructing, or substantially improving any qualified residence of the taxpayer, and is secured by the residence. Citing §163(h)(3)(C), the court further stated that home equity indebtedness is defined as any indebtedness (other than acquisition indebtedness) secured by a qualified residence. The court concluded that the taxpayers failed to demonstrate that any of their debt was not incurred in acquiring, constructing, or substantially improving their residence and thus was not acquisition indebtedness. However, the court did not address the effect of the $1 million limitation in §163(h)(3)(B)(ii) on the definition of acquisition indebtedness for purposes of §163(h)(3). The Tax Court followed Pau in Catalano v. Commissioner, T.C. Memo. 2000-82.

ANALYSIS
Taxpayer may deduct, as interest on acquisition indebtedness under §163(h)(3)(B), interest paid in 2009 on $1,000,000 of the $1,200,000 indebtedness used to acquire the principal residence. The $1,200,000 indebtedness was incurred in acquiring a qualified residence of Taxpayer and was secured by the residence. Thus, indebtedness of $1,000,000 is treated as acquisition indebtedness under §163(h)(3)(B).

Taxpayer also may deduct, as interest on home equity indebtedness under §163(h)(3)(C), interest paid in 2009 on $100,000 of the remaining indebtedness of $200,000. The $200,000 is secured by the qualified residence, is not acquisition indebtedness under §163(h)(3)(B), and does not exceed the fair market value of the residence reduced by the acquisition indebtedness secured by the residence. Thus, $100,000 of the $200,000 is treated as home equity indebtedness under §163(h)(3)(C).

Under §163(h)(3)(A), the interest on both acquisition indebtedness and home equity indebtedness is qualified residence interest. Therefore, for 2009 Taxpayer may deduct interest paid on indebtedness of $1,100,000 as qualified residence interest. Any interest Taxpayer paid on the remaining indebtedness of $100,000 is nondeductible personal interest under §163(h).

The Internal Revenue Service will not follow the decisions in Pau v. Commissioner and Catalano v. Commissioner. The holding in Pau was based on the incorrect assertion that taxpayers must demonstrate that debt treated as home equity indebtedness "was not incurred in acquiring, constructing or substantially improving their residence." The definition of home equity indebtedness in §163(h)(3)(C) contains no such restrictions, and accordingly the Service will determine home equity indebtedness consistent with the provisions of this revenue ruling, notwithstanding the decisions in Pau and Catalano.

HOLDING
Indebtedness incurred by a taxpayer to acquire, construct, or substantially improve a qualified residence can constitute home equity indebtedness to the extent it exceeds $1 million (subject to the applicable dollar and fair market value limitations imposed on home equity indebtedness by §163(h)(3)(C)).


IRS Reg. §1.163-1(b) Interest Expense deduction when property or mortgage is not in the name of the taxpayer:

As the "Equitable Owner" of the property the taxpayer can take the mortgage interest deduction. See Reg Sec 1.163-1(b) and Uslu V Commissioner, T.C. Memo 1997-551 (also referred to as Usher V Commissioner, T.C. Memo 1997-551)

Interest paid by the taxpayer on a mortgage secured by real estate of which the taxpayer is the legal or equitable owner, even though the taxpayer is not directly liable upon the bond or note secured by such mortgage, may be deducted as interest on his indebtedness.  Usher v. Commissioner, T.C. Memo. 1997-551  where the court held that the "equitable owner", not the person liable to the bank, was entitled to the deduction.  Also see T.C. Summary Opinion 2007-16

While it is necessary that the taxpayer pay the interest to deduct it, it is NOT necessary that he be liable on the note. See Reg. 1.163-1(b).

It is also not necessary that the taxpayer be the legal owner of the property, as long as he is the equitable owner. It is, of course, necessary that the debt meet the requirements of IRC 163(h)(3) (and Reg. 1.163-10T) with respect to the taxpayer.

Where two or more persons are jointly and severally liable for a debt, each is primarily liable on the debt and each is entitled to deduct the interest that he pays (if the other requirements for a deduction have been satisfied). Arrigoni v. Commissioner, 73 T.C. 792 (1980), acq., 1980-2 C.B. 1. For example, the IRS ruled that a father was allowed to deduct the interest he paid on a note for a student loan that he co-signed with his son. Rev. Rul. 71-179, 1971-1 C.B. 58. The Tax Court held that a father was allowed to deduct mortgage interest he paid on property held in common with his daughter, even though he had recently temporarily conveyed legal title to his daughter to avoid creditor's claims. Conroy v. Commissioner, T.C. Memo. 1958-6.

 


Interest Expense deduction paid for Debt-Financed Acquisition of a trade or business pass-thru entity:

IRS Notice 88-37, 1988-1 C.B. 522
Individuals should report interest expense paid or incurred in connection with debt-financed acquisitions on either Schedule E or Schedule A of Form 1040.

2. Interest expense allocated to trade or business expenditures
Interest expense allocated to a trade or business expenditure (within the meaning of Section 1.163-8T(b)(7)) of a passthrough entity
should be reported in Part II of Schedule E. This interest expense should be identified on a separate line in column (a) as "business interest," followed by the name of the passthrough entity to which the interest expense relates, and the amount of such interest expense should be entered in column (h). This interest expense is deductible without limitation and should not be entered on Form 8582, relating to passive activity loss limitations, or Form 4952, relating to investment interest.
 

IRS Notice 89-35, 1989-1 C.B. 675
Individuals should report allowable interest expense paid or incurred in connection with debt-financed acquisitions on either Schedule E or Schedule A of Form 1040.
Taxpayers other than individuals should report interest expense on debt- financed acquisitions on the line for interest expense on their returns, in accordance with section IV.B. of Notice 88-37
 

IRS Notice 88-20, 1988-9 I.R.B. 5
Debt proceeds and associated interest expense for debt proceeds allocated to the purchase of an interest in a passthrough entity may be allocated using any reasonable method, including pro rata allocations based on fair market value, book value, or adjusted basis of the assets of the passthrough entity.

Also modified the 15-day rule for debt proceeds deposited in an account before January 1, 1988, by granting 30 days for tracing the expenditures for purposes of the interest allocation rules of regulation section 1.163-8T(c).

Passive Activity Loss ATG - Exhibit 7.1: Investment Income And Investment Interest Expense

2011-21006 May 38, 2011   PLR-138911-10

 

... And Other Expenses:

Partnership tax law has historically been an amalgamation of aggregate theory and/or entity theory. The recipient may well argue that there is a reasonable basis under the aggregate theory that he was carrying on a trade or business in the form of his partnership interest and therefore sufficient nexus exists to treat the legal fess in connection with the recovery as above the line. There are several cases that stand for this proposition.

Legal fees incurred in a trade or business are allowed under Sec. 62(a)(1). The aggregate argument is that if each of the partners were engaged in a contractual relationship to share profits, then the legal fee expenses incurred in a lawsuit over those profits would clearly be deductible (on both sides).

The IRS counter is that the entity theory applies and the partners LLC interests are "investment property" and they are not otherwise engaged in the partnership's trade or business. There may be a reasonable basis for the aggregate theory providing sufficient law (based on the facts of the case) to deduct the payments above-the-line (or net them). Consequently, with disclosure no penalty under either 6662 or 6694 will be imposed on the taxpayer or the preparer.

The limitations discussed in Sec. 62(a)(20) applies to discrimination suits.

Reasonable basis with disclosure satisfies the threshold tests to avoid penalties under both 6662 and 6694 and reasonable basis in any factual situation may as low as a 15% chance of succeeding on the merits in either an administrative or judicial proceeding. One doesn't need a lot of case law to get there.

If one doesn't approach partnership issues from the aggregate theory vs. entity theory, it's difficult to solve these types of issues.


Election to treat debt as not secured by a qualified residence §163 (instead, treat as business interest):

A taxpayer can elect to treat any debt secured by a qualified residence as not secured by a qualified residence. The election is effective for the tax year when made and for all subsequent tax years.

Apparently, Congress intended that such interest would not be characterized as business interest without the election being made. The Conference Report accompanying TRA ‘86 noted, for example, that interest on a refinancing secured by the taxpayer's residence "is treated as qualified residence interest, regardless of the purpose for which the borrowed funds are used by the taxpayer." [H.R. Rep. No. 841, 99th Cong., 2d Sess. II-155 (1986)]

Temporary Regulation 1.163-8T(m)(3) provides: "... qualified residence interest (as defined in IRC Sec 163(h)(3) is not taken into account in determining the income or loss ... for purposes of (passive activities) ... or in determining the amount of investment interest ...".

This election may be advantageous when, for example, interest on the debt is otherwise deductible as investment interest. The election then preserves the taxpayer's ability to incur other debt that is secured by the qualified residence. (see IRS Letter Ruling 9335043, June 8, 1993).

Temporary Reg. §1.163-10T(o)(5) Election to treat debt as not secured by a qualified residence

(i) In general. --For purposes of this section, a taxpayer may elect to treat any debt that is secured by a qualified residence as not secured by the qualified residence. An election made under this paragraph shall be effective for the taxable year for which the election is made and for all subsequent taxable years unless revoked with the consent of the Commissioner.

(ii) Example. --T owns a principal residence with a fair market value of $75,000 and an adjusted purchase price of $40,000. In 1988, debt A, the proceeds of which were used to purchase the residence, has an average balance of $15,000. The proceeds of debt B, which is secured by a second mortgage on the property, are allocable to T's trade or business under §1.163-8T and has an average balance of $25,000. In 1988, T incurs debt C, which is also secured by T's principal residence and which has an average balance in 1988 of $5,000. In the absence of an election to treat debt B as unsecured, the applicable debt limit for debt C in 1988 under paragraph (e) of this section would be zero dollars ($40,000 - $15,000 - $25,000) and none of the interest paid on debt C would be qualified residence interest. If, however, T makes or has previously made an election pursuant to paragraph (o)(5)(i) of this section to treat debt B as not secured by the residence, the applicable debt limit for debt C would be $25,000 ($40,000 - $15,000), and all of the interest paid on debt C during the taxable year would be qualified residence interest. Since the proceeds of debt B are allocable to T's trade or business under §1.163-8T, interest on debt B may be deductible under other sections of the Internal Revenue Code.

How to elect
By deducting the interest on the appropriate lines of the tax return. Attaching a statement to the tax return is recommended, although not required.  Such as: "Taxpayer hereby elects for this tax year and all subsequent years to treat the following debt as not secured by a qualified residence $XXX,XXX  borrowed from ABC Bank & Trust Co."


Credit card electronic payment convenience fees and Interest incurred to pay federal income tax liability:

Interest expense is generally not deductible.  The typical 2.5% Credit card and Debit card convenience fee was also deemed not deductible under the same concept, pursuant to SCA 200115032 February 12, 2001 because such convenience fees do not relate to the determination of tax liability under §212(3) in the same manner as CPA fees are.

update: Office of Chief Counsel memorandum PMTA 2009-002 January 5, 2009 has reversed this position, and ruled that electronic payment fees are properly deductible as expenses paid in connection with the collection of tax under §212(3).

    Sec. 212. Expenses for production of income
       In the case of an individual, there shall be allowed as a
    deduction all the ordinary and necessary expenses paid or incurred
    during the taxable year -
        (1) for the production or collection of income;
        (2) for the management, conservation, or maintenance of
      property held for the production of income; or
        (3) in connection with the determination, collection, or refund
      of any tax.


Election to Capitalize Carrying Costs (property taxes) §266:

§1.266-1. Taxes and carrying charges chargeable to capital account and treated as capital items
§1.266-1
(a)(1) In general. --In accordance with section 266, items enumerated in paragraph (b)(1) of this section may be capitalized at the election of the taxpayer. Thus, taxes and carrying charges with respect to property of the type described in this section are chargeable to capital account at the election of the taxpayer, notwithstanding that they are otherwise expressly deductible under provisions of subtitle A of the Code. No deduction is allowable for any items so treated.

§1.266-1(a)(2) See §§1.263A-8 through 1.263A-15 for rules regarding the requirement to capitalize interest, that apply prior to the application of this section. After applying §§1.263A-8 through 1.263A-15, a taxpayer may elect to capitalize interest under section 266 with respect to designated property within the meaning of §1.263A-8(b), provided a computation under any provision of the Internal Revenue Code is not thereby materially distorted, including computations relating to the source of deductions.

§1.266-1(b) Taxes and carrying charges

§1.266-1(b)(1) The taxpayer may elect, as provided in paragraph (c) of this section, to treat the items enumerated in this subparagraph which are otherwise expressly deductible under the provisions of subtitle A of the Code as chargeable to capital account either as a component of original cost or other basis, for the purposes of section 1012, or as an adjustment to basis, for the purpose of section 1016(a)(1). The items thus chargeable to capital account are --

§1.266-1(b)(i) In the case of unimproved and unproductive real property:

Annual taxes, interest on a mortgage, and other carrying charges. /font>

§1.266-1(b)(ii) In the case of real property, whether improved or unimproved and whether productive or unproductive:

(a) Interest on a loan (but not theoretical interest of a taxpayer using his own funds),

(b) Taxes of the owner of such real property measured by compensation paid to his employees,

(c) Taxes of such owner imposed on the purchase of materials, or on the storage, use, or other consumption of materials, and

(d) Other necessary expenditures,

paid or incurred for the development of the real property or for the construction of an improvement or additional improvement to such real property, up to the time the development or construction work has been completed. The development or construction work with respect to which such items are incurred may relate to unimproved and unproductive real estate whether the construction work will make the property productive of income subject to tax (as in the case of a factory) or not (as in the case of a personal residence), or may relate to property already improved or productive (as in the case of a plant addition or improvement, such as the construction of another floor on a factory or the installation of insulation therein).

§1.266-1(b)(iii) In the case of personal property:

(a) Taxes of an employer measured by compensation for services rendered in transporting machinery or other fixed assets to the plant or installing them therein,

(b) Interest on a loan to purchase such property or to pay for transporting or installing the same, and

(c) Taxes of the owner thereof imposed on the purchase of such property or on the storage, use, or other consumption of such property, paid or incurred up to the date of installation or the date when such property is first put into use by the taxpayer, whichever date is later.

§1.266-1(b)(iv) Any other taxes and carrying charges with respect to property, otherwise deductible, which in the opinion of the Commissioner are, under sound accounting principles, chargeable to capital account.

§1.266-1(2) The sole effect of section 266 is to permit the items enumerated in subparagraph (1) of this paragraph to be chargeable to capital account notwithstanding that such items are otherwise expressly deductible under the provisions of subtitle A of the Code. An item not otherwise deductible may not be capitalized under section 266.

(3) In the absence of a provision in this section for treating a given item as a capital item, this section has no effect on the treatment otherwise accorded such item. Thus, items which are otherwise deductible are deductible notwithstanding the provisions of this section, and items which are otherwise treated as capital items are to be so treated. Similarly, an item not otherwise deductible is not made deductible by this section. Nor is the absence of a provision in this section for treating a given item as a capital item to be construed as withdrawing or modifying the right now given to the taxpayer under any other provisions of subtitle A of the Code, or of the regulations thereunder, to elect to capitalize or to deduct a given item.

§1.266-1(c) Election to charge taxes and carrying charges to capital account

§1.266-1(c)(1) If for any taxable year there are two or more items of the type described in paragraph (b)(1) of this section, which relate to the same project to which the election is applicable, the taxpayer may elect to capitalize any one or more of such items even though he does not elect to capitalize the remaining items or to capitalize items of the same type relating to other projects. However, if expenditures for several items of the same type are incurred with respect to a single project, the election to capitalize must, if exercised, be exercised as to all items of that type. For purposes of this section, a "project" means, in the case of items described in paragraph (b)(1)(ii) of this section, a particular development of, or construction of an improvement to, real property, and in the case of items described in paragraph (b)(1)(iii) of this section, the transportation and installation of machinery or other fixed assets.

§1.266-1(c)(2)(i) An election with respect to an item described in paragraph (b)(1)(i) of this section is effective only for the year for which it is made.

§1.266-1(c)(2)(ii) An election with respect to an item described in --

(a) Paragraph (b)(1)(ii) of this section is effective until the development or construction work described in that subdivision has been completed;

(b) Paragraph (b)(1)(iii) of this section is effective until the later of either the date of installation of the property described in that subdivision, or the date when such property is first put into use by the taxpayer;

(c) Paragraph (b)(1)(iv) of this section is effective as determined by the Commissioner.

Thus, an item chargeable to capital account under this section must continue to be capitalized for the entire period described in this subdivision applicable to such election although such period may consist of more than one taxable year.

§1.266-1(c)(3) If the taxpayer elects to capitalize an item or items under this section, such election shall be exercised by filing with the original return for the year for which the election is made a statement indicating the item or items (whether with respect to the same project or to different projects) which the taxpayer elects to treat as chargeable to capital account. Elections filed for taxable years beginning before January 1, 1954, and for taxable years ending before August 17, 1954, under section 24(a)(7) of the Internal Revenue Code of 1939, and the regulations thereunder, shall have the same effect as if they were filed under this section. See section 7807(b)(2).



Deadline as late as three years under §301.9100-1(c)
PLR 200629024 allowed retroactive election to capitalize property taxes not otherwise deductible due to the AMT.  Extension of time to elect granted under §§301.9100-1 and 301.9100-3.


Election to Ratably Accrue Real Estate Property Taxes §461(c):

An accrual basis taxpayer may elect to ratably accrue real estate property taxes over the period to which they relate rather than per the general rule of §461(h)

For example, if the property tax year is October 1, 2011  through September 30, 2012 and billed to taxpayers on June 30, 2013,  a calendar year taxpayer accrues and deducts on its 2011tax return 75% of the amount of property tax for tax year ending September 2011 and 25% of the amount of property tax for tax year ending September 2012 - even though the tax bills for  those two tax years have not even been issued yet.

This election overrides the general rule and allows real property taxes to be accrued ratably over the period to which they relate.

"Pursuant to IRC Sec 461(c), the taxpayer herby elects to ratably accrue real estate property taxes."

461(c) Accrual Of Real Property Taxes
461(c)(1) In General
If the taxable income is computed under an accrual method of accounting, then, at the election of the taxpayer, any real property tax which is related to a definite period of time shall be accrued ratably over that period.
461(c)(2) When Election May Be Made
461(c)(2)(A) Without Consent
A taxpayer may, without the consent of the Secretary, make an election under this subsection for his first taxable year in which he incurs real property taxes. Such an election shall be made not later than the time prescribed by law for filing the return for such year (including extensions thereof).
461(c)(2)(B) With Consent
A taxpayer may, with the consent of the Secretary, make an election under this subsection at any time.

 

461(h) Certain Liabilities Not Incurred Before Economic Performance
461(h)(1) In General
For purposes of this title, in determining whether an amount has been incurred with respect to any item during any taxable year, the all events test shall not be treated as met any earlier than when economic performance with respect to such item occurs.

461(h)(2) Time When Economic Performance Occurs
Except as provided in regulations prescribed by the Secretary, the time when economic performance occurs shall be determined under the following principles:
461(h)(2)(A) Services And Property Provided To The Taxpayer
If the liability of the taxpayer arises out of--
461(h)(2)(A)(i) the providing of services to the taxpayer by another person, economic performance occurs as such person provides such services,
461(h)(2)(A)(ii) the providing of property to the taxpayer by another person, economic performance occurs as the person provides such property, or
461(h)(2)(A)(iii) the use of property by the taxpayer, economic performance occurs as the taxpayer uses such property.
461(h)(2)(B) Services And Property Provided By The Taxpayer
If the liability of the taxpayer requires the taxpayer to provide property or services, economic performance occurs as the taxpayer provides such property or services.
461(h)(2)(C) Workers Compensation And Tort Liabilities Of The Taxpayer
If the liability of the taxpayer requires a payment to another person and--
461(h)(2)(C)(i) arises under any workers compensation act, or
461(h)(2)(C)(ii) arises out of any tort, economic performance occurs as the payments to such person are made. Subparagraphs (A) and (B) shall not apply to any liability described in the preceding sentence.
461(h)(2)(D) Other Items
In the case of any other liability of the taxpayer, economic performance occurs at the time determined under regulations prescribed by the Secretary.

461(h)(3) Exception For Certain Recurring Items
461(h)(3)(A) In General
Notwithstanding paragraph (1) an item shall be treated as incurred during any taxable year if--
461(h)(3)(A)(i) the all events test with respect to such item is met during such taxable year (determined without regard to paragraph (1)),
461(h)(3)(A)(ii) economic performance with respect to such item occurs within the shorter of--
461(h)(3)(A)(ii)(I) a reasonable period after the close of such taxable year, or
461(h)(3)(A)(ii)(II) 8-1/2 months after the close of such taxable year,
461(h)(3)(A)(iii) such item is recurring in nature and the taxpayer consistently treats items of such kind as incurred in the taxable year in which the requirements of clause (i) are met, and
461(h)(3)(A)(iv) either--
461(h)(3)(A)(iv)(I) such item is not a material item, or
461(h)(3)(A)(iv)(II) the accrual of such item in the taxable year in which the requirements of clause (i) are met results in a more proper match against income than accruing such item in the taxable year in which economic performance occurs.
461(h)(3)(B) Financial Statements Considered Under Subparagraph (A)(iv)
In making a determination under subparagraph (A)(iv), the treatment of such item on financial statements shall be taken into account.
461(h)(3)(C) Paragraph Not To Apply To Workers Compensation And Tort Liabilities
This paragraph shall not apply to any item described in subparagraph (C) of paragraph (2).

461(h)(4) All Events Test
For purposes of this subsection, the all events test is met with respect to any item if all events have occurred which determine the fact of liability and the amount of such liability can be determined with reasonable accuracy.

461(h)(5) Subsection Not To Apply To Certain Items
This subsection shall not apply to any item for which a deduction is allowable under a provision of this title which specifically provides for a deduction for a reserve for estimated expenses.



Extension for forgotten rental election:

IRS Issues Private Letter Ruling extension time to make election to treat multiple rental properties and a single entity

To avoid the passive-loss rules landlords must send over half their working time and at least 750 hours a year being materially involved with the property.  Unless the election to treat multiple rental properties as a single entity is made few taxpayers would meet the time tests.  (Kiplinger Tax Letter Vol. 82 #15  7/27/2007)



Trick to catch-up for forgotten depreciation after the asset was sold (using form 3115 to correct for an impermissible method):

General comments:
Often, not taking depreciation is not an "error," but rather it is the use of an impermissible accounting method, which means that it can only be fixed currently pursuant to the timely filing requirement in the method change rules. This often is a better result than treating it as an error, which could mean losing the unclaimed depreciation from the older, closed years. 


The correction can be done even before the year of sale of the property.  The correction can be done for the year that it was uncovered. All the forgotten prior-year depreciation is then deducted at once in that year.

Depreciation "Allowed or Allowable" overview: http://www.hoven.com/articles/pdf/allowedorallowable.pdf     archive copy

IRS Publication 946 - How Do You Correct Depreciation Deductions?   

Terms you may need to know (see Glossary):

Basis
If you deducted an incorrect amount of depreciation in any year, you may be able to make a correction by filing an amended return for that year. See Filing an Amended Return, next. If you are not allowed to make the correction on an amended return, you may be able to change your accounting method to claim the correct amount of depreciation. See Changing Your Accounting Method, later.

Filing an Amended Return
You can file an amended return to correct the amount of depreciation claimed for any property in any of the following situations.

  • You claimed the incorrect amount because of a mathematical error made in any year.
  • You claimed the incorrect amount because of a posting error made in any year.
  • You have not adopted a method of accounting for property placed in service by you in tax years ending after December 29, 2003.
  • You claimed the incorrect amount on property placed in service by you in tax years ending before December 30, 2003.
     

Adoption of accounting method defined. Generally, you adopt a method of accounting for depreciation by using a permissible method of determining depreciation when you file your first tax return, or by using the same impermissible method of determining depreciation in two or more consecutively filed tax returns. For an exception to this 2-year rule, see Revenue Procedure 2002-9 on page 327 of Internal Revenue Bulletin 2002-3, available at www.irs.gov/pub/irs-irbs/irb02-03.pdf as modified by Revenue Procedure 2004-11 on page 311 of Internal Revenue Bulletin 2004-3, available at www.irs.gov/pub/irs-irbs/irb04-03.pdf.

When to file. If an amended return is allowed, you must file it by the later of the following.
 

  • 3 years from the date you filed your original return for the year in which you did not deduct the correct amount. A return filed before an unextended due date is considered filed on that due date.
  • 2 years from the time you paid your tax for that year.
     

Changing Your Accounting Method
Generally, you must get IRS approval to change your method of accounting. You generally must file Form 3115, Application for Change in Accounting Method, to request a change in your method of accounting for depreciation.

The following are examples of a change in method of accounting for depreciation.

  • A change in the treatment of an asset from nondepreciable to depreciable or vice versa.
  • A change in the depreciation method, period of recovery, or convention of a depreciable asset.
  • A change from not claiming to claiming the special depreciation allowance if you did not make the election to not claim any special allowance.
  • A change from claiming a 50% special depreciation allowance to claiming a 30% special depreciation allowance for qualified property (including property that is included in a class of property for which you elected a 30% special allowance instead of a 50%special allowance).
     

Changes in depreciation that are not a change in method of accounting (and may only be made on an amended return) include the following.

  • An adjustment in the useful life of a depreciable asset for which depreciation is determined under section 167.
  • A change in use of an asset in the hands of the same taxpayer.
  • Making a late depreciation election or revoking a timely valid depreciation election (including the election not to deduct the special depreciation allowance). If you elected not to claim any special allowance, a change from not claiming to claiming the special allowance is a revocation of the election and is not an accounting method change. Also, if the property is qualified property, a change from not claiming to claiming any special allowance is a late election and is not an accounting method change.
  • Any change in the placed-in-service date of a depreciable asset.
     

See section 1.446-1T(e)(2)(ii)(d) of the regulations for more information and examples.

IRS approval. In some instances, you may be able to get approval from the IRS to change your method of accounting for depreciation under the automatic change request procedures generally covered in Revenue Procedure 2002-9. If you do not qualify to use the automatic procedures to get approval, you must use the advance consent request procedures generally covered in Revenue Procedure 97-27, 1997-1 C.B. 680. Also see the Instructions for Form 3115 for more information on getting approval, including lists of scope limitations and automatic accounting method changes.

Additional guidance. For additional guidance and special procedures for changing your accounting method, automatic change procedures, amending your return, and filing Form 3115, see Revenue Procedure 2004-11, Revenue Procedure 2005-43 on page 107 of Internal Revenue Bulletin 2005-29, available at www.irs.gov/pub/irs-irbs/irb05-29.pdf, and Revenue Procedure 2006-12 on page 310 of Internal Revenue Bulletin 2006-3, available at www.irs.gov/pub/irs-irbs/irb06-03.pdf

Section 481(a) adjustment. If you file Form 3115 and change from an impermissible method to a permissible method of accounting for depreciation, you can make a section 481(a) adjustment for any unclaimed or excess amount of allowable depreciation. The adjustment is the difference between the total depreciation actually deducted for the property and the total amount allowable prior to the year of change. If no depreciation was deducted, the adjustment is the total depreciation allowable prior to the year of change. A negative section 481(a) adjustment results in a decrease in taxable income. It is taken into account in the year of change and is reported on your business tax returns as "other expenses." A positive section 481(a) adjustment results in an increase in taxable income. It is generally taken into account over 4 tax years and is reported on your business tax returns as "other income." However, you can elect to use a one-year adjustment period and report the adjustment in the year of change if the total adjustment is less than $25,000. Make the election by completing the appropriate line on Form 3115.

If you file a Form 3115 and change from one permissible method to another permissible method, the section 481(a) adjustment is zero.


Rev. Proc. 2004-11, 2004-3 I.R.B. 311 (1/20/2004)
Change in Method of Accounting For Depreciable or Amortizable Property After Disposition by Taxpayer

Part III

Administrative, Procedural, and Miscellaneous

26 CFR 601.204: Changes in accounting periods and in methods of accounting. (Also Part I, Sections 446, 1016; 1.446-1T, 1.1016-3T.)

Rev. Proc. 2004-11

SECTION 1. PURPOSE

This revenue procedure provides an automatic consent procedure allowing a taxpayer to make a change in method of accounting under section 446(e) of the Internal Revenue Code for depreciable or amortizable property after its disposition. This revenue procedure also waives the application of the two-year rule set forth in Rev. Rul. 90-38, 1990-1 C.B. 57, for certain changes in depreciation or amortization. Finally, this revenue procedure modifies Rev. Proc. 2002-9, 2002-1 C.B. 327 (as modified by Rev. Proc. 2002-54, 2002-2 C.B. 432, Rev. Proc. 2002-19, 2002-1 C.B. 696, Rev. Proc. 2002-33, 2002-1 C.B. 963, and as modified and clarified by Announcement 2002-17, 2002-1 C.B. 561), and other revenue procedures to conform with section 1.446-1T(e)(2)(ii)(d) of the temporary Income Tax Regulations.

SECTION 2. BACKGROUND

.01 Section 446(e) and section 1.446-1T(e) provide that, except as otherwise provided, a taxpayer must secure the consent of the Commissioner of Internal Revenue before changing a method of accounting for federal income tax purposes. Section 1.446-1T(e)(3)(ii) authorizes the Commissioner to prescribe administrative procedures setting forth the limitations, terms, and conditions deemed necessary to permit a taxpayer to obtain consent to change a method of accounting.

.02 Concurrently with the issuance of this revenue procedure, sections 1.446-1T(e)(2)(ii)(d) and 1.1016-3T(h) have been promulgated. Section 1.446-1T(e)(2)(ii)(d) provides the changes in depreciation or amortization (hereinafter, both are referred to as "depreciation") that are (and are not) changes in method of accounting under section 446(e). Section 1.1016-3T(h) provides that the "allowed or allowable" rule under section 1016(a)(2) does not permanently affect a taxpayer's lifetime income for purposes of determining whether a change in depreciation or amortization is a change in method of accounting under section 446(e).

.03 If a taxpayer uses an impermissible method of determining depreciation for a depreciable or amortizable property, the taxpayer adopts that method of accounting for the property when the taxpayer treats the property in the same way in determining gross income or deductions in two or more consecutively filed federal tax returns. See Rev. Rul. 90-38. The Internal Revenue Service and Treasury Department recognize that this two-year rule increases administrative and compliance costs associated with changes in depreciation because many taxpayers changing from an impermissible to permissible method of accounting for depreciation used the impermissible method for depreciable or amortizable properties placed in service in two or more taxable years before the year of change as well as for depreciable and amortizable properties placed in service in the taxable year immediately preceding the year of change. Accordingly, in the interest of sound tax administration, the Service and Treasury Department have decided to waive the two-year rule in Rev. Rul. 90-38 for a change in depreciation to which section 1.446-1T(e)(2)(ii)(d) applies.

.04 If a depreciable or amortizable property is transferred in a transaction in which the transferee is treated as the transferor for purposes of computing the depreciation allowance for the property with respect to so much of the basis in the hands of the transferee as does not exceed the adjusted depreciable basis in the hands of the transferor (for example, in transactions subject to section 168(i)(7) or section 381(c)(6)), the transferee may file a Form 3115, Application for Change in Accounting Method, to change from an impermissible method of accounting adopted by the transferor for that portion of the basis of the property to a permissible method of accounting for depreciation for the same portion of the basis of the property, provided the impermissible method of accounting for that portion of the basis of the property has not been changed by the transferor (through filing, for example, a Form 3115 or an amended return) or by the Internal Revenue Service upon examination of the transferor's tax returns. In this case, the section 481 adjustment will include any necessary adjustments since the property's placed-in-service date by the transferor.

SECTION 3. METHOD CHANGE PROCEDURE FOR DISPOSED DEPRECIABLE OR AMORTIZABLE PROPERTY

.01 Scope.

(1) Applicability. Except as provided in section 3.01(2) of this revenue procedure, section 3 of this revenue procedure applies to a taxpayer that is changing from an impermissible method of accounting for depreciation to a permissible method of accounting for depreciation for any item of depreciable or amortizable property subject to section 1.446-1T(e)(2)(ii)(d):

(a) that has been disposed of by the taxpayer during the year of change (as defined in section 3.02(2)(b) of this revenue procedure); and

(b) for which the taxpayer did not take into account any depreciation allowance, or did take into account some depreciation but less than the depreciation allowable (hereinafter, both are referred to as "claimed less than the depreciation allowable"), in the year of change (as defined in section 3.02(2)(b) of this revenue procedure) or any prior taxable year.

(2) Inapplicability. Section 3 of this revenue procedure does not apply to:

(a) any property to which section 1016(a)(3) (regarding property held by a tax-exempt organization) applies;

(b) any property for which a taxpayer is revoking a timely valid depreciation election, or making a late depreciation election, under the Code or regulations thereunder, or under other guidance published in the Internal Revenue Bulletin (including under section 13261(g)(2) or (3) of the Revenue Reconciliation Act of 1993, 1993-3 C.B. 1, 128 (relating to amortizable section 197 intangibles));

(c) any property for which the taxpayer deducted the cost or other basis of the property as an expense; or

(d) any property disposed of by the taxpayer in a transaction to which a nonrecognition section of the Code applies (for example, section 1031, transactions subject to section 168(i)(7)(B)(i)). However, this section 3.01(2)(d) does not apply to property disposed of by the taxpayer in a section 1031 or section 1033 transaction if the taxpayer elects to treat the entire basis (that is, both the carryover and excess basis) of the acquired MACRS property as property placed in service by the taxpayer at the time of replacement and treat the adjusted depreciable basis of the exchanged or involuntarily converted MACRS property as being disposed of by the taxpayer at the time of disposition.

.02 Change in method of accounting.

(1) In general. A taxpayer within the scope of section 3 of this revenue procedure may change from an impermissible method of accounting for depreciation to a permissible method of accounting for depreciation for any item of depreciable or amortizable property within the scope of section 3 of this revenue procedure, provided:

(a) the taxpayer files the original Form 3115 in accordance with section 3.02(2)(c) of this revenue procedure, prior to the expiration of the period of limitation for assessment under section 6501(a) for the taxable year in which the item of depreciable or amortizable property was disposed of by the taxpayer; and

(b) the taxpayer files an amended federal tax return for the year of change (as defined in section 3.02(2)(b) of this revenue procedure) that includes the adjustments to taxable income and any collateral adjustments to taxable income or tax liability (for example, adjustments to the amount or character of the gain or loss of the disposed depreciable or amortizable property) resulting from the change in method of accounting for depreciation made by the taxpayer under this section 3.

(2) Application Procedures. A taxpayer making a change in method of accounting under section 3 of this revenue procedure must follow the automatic change in method of accounting provisions in Rev. Proc. 2002-9 (or its successor), with the following modifications:

(a) The scope limitations in section 4.02 of Rev. Proc. 2002-9 do not apply. If the taxpayer is under examination, before an appeals office, or before a federal court at the time that a copy of the Form 3115 is filed with the national office, the taxpayer must provide a copy of the Form 3115 to the examining agent, appeals officer, or counsel for the government, as appropriate, at the time the copy of the Form 3115 is filed with the national office. The Form 3115 must contain the name(s) and telephone number(s) of the examining agent, appeals officer, or counsel for the government, as appropriate.

(b) The year of change is the taxable year in which the item of depreciable or amortizable property was disposed of by the taxpayer.

(c) Section 6.02(3)(a) of Rev. Proc. 2002-9 is modified to require the original of the Form 3115 to be attached to the taxpayer's timely filed amended federal tax return for the year of change and a copy (with signature) of the Form 3115 to be filed with the national office no later than when the original Form 3115 is filed with the amended federal tax return for the year of change.

(d) For purposes of section 6.02(4)(a) of Rev. Proc. 2002-9, the taxpayer should include on line 1a of the Form 3115 (revised December 2003) the designated automatic accounting method change number for the change in method of accounting for depreciation made under this section 3. This number for this method change is "9."

SECTION 4. WAIVER OF TWO-YEAR RULE IN REV. RUL. 90-38

.01 In general. Notwithstanding Rev. Rul. 90-38, a taxpayer may file a Form 3115 under Rev. Proc. 97-27, 1997-1 C.B. 680 (or its successor), or Rev. Proc. 2002-9, as applicable, to change from an impermissible method of accounting for depreciation to a permissible method of accounting for depreciation under section 1.446-1T(e)(2)(ii)(d) for any depreciable or amortizable property subject to section 1.446-1T(e)(2)(ii)(d) and placed in service by the taxpayer in the taxable year immediately preceding the year of change (as defined in section 5.02(2) of Rev. Proc. 97-27 or section 5.02 of Rev. Proc. 2002-9, as applicable) (hereinafter, this property is referred to as "1-year depreciable property"), provided the additional term and condition in section 4.02 of this revenue procedure is satisfied. Alternatively, the taxpayer may make the change from the impermissible depreciation method to the permissible depreciation method for the 1-year depreciable property by filing an amended federal tax return for the placed-in-service year prior to the date the taxpayer files its federal tax return for the taxable year succeeding the placed-in-service year.

.02 Additional term and condition for filing a Form 3115. In addition to the terms and conditions provided in Rev. Proc. 97-27 or Rev. Proc. 2002-9, as applicable, the section 481 adjustment reported on a Form 3115 that is filed by a taxpayer in accordance with section 4.01 of this revenue procedure to make a change in method of accounting for depreciation under section 1.446-1T(e)(2)(ii)(d) for any 1-year depreciable property, must include the amount of any adjustment attributable to all property (including the 1-year depreciable property) subject to the Form 3115.

SECTION 5. EFFECT ON OTHER DOCUMENTS

.01 Rev. Proc. 2002-9 is modified and amplified to include the accounting method change provided under section 3 of this revenue procedure in section 2.05 of the APPENDIX. See section 4 of the APPENDIX of this revenue procedure for the text of section 2.05 of the APPENDIX of Rev. Proc. 2002-9.

.02 The heading for section 2 of the APPENDIX of Rev. Proc. 2002-9 is modified to read as follows: "SECTION 2. DEPRECIATION OR AMORTIZATION (section 56(a)(1), 56(g)(4)(A), 167, 168, 197, 1400I, OR 1400L, OR FORMER SECTION 168)".

.03 Rev. Proc. 2002-9 (as modified by Rev. Proc. 2002-33) is modified by deleting sections 2.01, 2.02, and 2B of the APPENDIX and replacing them with the text in, respectively, sections 1, 2, and 3 of the APPENDIX of this revenue procedure.

.04 Section 6.03 of Rev. Proc. 2000-38, 2000-2 C.B. 310, 313, is modified by deleting "See section 1.446-1(e)(2)(ii)(b)." and replacing it with "See section 1.446-1T(e)(2)(ii)(d)(3)(i)."

.05 Section 8.01 of Rev. Proc. 2000-50, 2000-2 C.B. 601, is modified to read as follows: "A change in a taxpayer's treatment of costs paid or incurred to develop, purchase, lease, or license computer software to a method described in section 5, 6, or 7 of this revenue procedure is a change in method of accounting to which §§446 and 481 apply. Further, a change in useful life under the method described in section 5.01(2) or 6.01(2) of this revenue procedure is a change in method of accounting. See section 1.446-1T(e)(2)(ii)(d)(3)(i) and, for the effective date, see section 1.446-1T(e)(4)(ii)(A)."

SECTION 6. EFFECTIVE DATE

.01 In general. Except as provided in section 6.02 of this revenue procedure, this revenue procedure is effective for a Form 3115 filed for taxable years ending on or after December 30, 2003.

.02 Transition rule for previously filed Forms 3115 for automatic consent.

(1) For a taxable year ending on or after December 30, 2003, a taxpayer may make a change in method of accounting previously authorized in section 2.01, 2.02, or 2B of the APPENDIX of Rev. Proc. 2002-9 before any amendments were made to those sections by this revenue procedure if:

(a) before December 30, 2003, the taxpayer filed a completed Form 3115 with the national office to make that change in method of accounting; and

(b) the taxpayer makes that change in method of accounting in compliance with all the applicable provisions of Rev. Proc. 2002-9 for the requested year of change (as defined in section 5.02 of Rev. Proc. 2002-9) on that Form 3115.

(2) If a taxpayer filed a Form 3115 with the national office to make a change in method of accounting previously authorized in section 2.01, 2.02, or 2B of the APPENDIX of Rev. Proc. 2002-9 before any amendments were made to those sections by this revenue procedure for a year of change for which this revenue procedure is effective (see section 6.01 of this revenue procedure) and the taxpayer's original federal tax return for that year of change was not filed before December 30, 2003, the taxpayer may make the change in method of accounting authorized under section 2.01, 2.02, or 2B, as applicable, of the APPENDIX of Rev. Proc. 2002-9 as revised by this revenue procedure. However, the Service will process the Form 3115 in accordance with the section of the APPENDIX of Rev. Proc. 2002-9 in effect on the date on which the Form 3115 was filed with the national office by the taxpayer unless on or before the due date (including extensions) of the taxpayer's federal tax return for the requested year of change (as defined in section 5.02 of Rev. Proc. 2002-9) on that Form 3115, the taxpayer completes a new Form 3115 to make the change under section 2.01, 2.02, or 2B, as applicable, of the APPENDIX of Rev. Proc. 2002-9 as revised by this revenue procedure and files this newly completed Form 3115 in duplicate in accordance with section 6.02(3)(a) of Rev. Proc. 2002-9. Additionally, the newly completed Form 3115 must include the statement: "Section [insert, as appropriate: 2.01, 2.02, or 2B] of the APPENDIX of Rev. Proc. 2002-9 as revised by Rev. Proc. 2004-11." This statement must be legibly printed or typed on the appropriate line on, or at the top of page 1 of, the Form 3115.

SECTION 7. DRAFTING INFORMATION

The principal author of this revenue procedure is Sara Logan of the Office of Associate Chief Counsel (Passthroughs and Special Industries). For further information regarding this revenue procedure, contact Ms. Logan or Douglas Kim at (202) 622-3110 (not a toll free call).

APPENDIX

SECTION 1. Section 2.01 of the APPENDIX of Rev. Proc 2002-9 is deleted and replaced with the following:

".01 Impermissible to permissible method of accounting for depreciation or amortization.

(1) Description of change and scope.

(a) Applicability. This change applies to a taxpayer that wants to change from an impermissible to a permissible method of accounting for depreciation or amortization (depreciation) for any item of depreciable or amortizable property:

(i) for which the taxpayer used the impermissible method of accounting in at least the two taxable years immediately preceding the year of change (but see section 2.01(1)(b) of this APPENDIX for property placed in service in the taxable year immediately preceding the year of change);

(ii) for which the taxpayer is making a change in method of accounting under section 1.446-1T(e)(2)(ii)(d);

(iii) for which depreciation is determined under section 56(a)(1), section 56(g)(4)(A), section 167, section 168, section 197, section 1400I, section 1400L(b), or section 1400L(c), or under section 168 prior to its amendment in 1986 (former section 168); and

(iv) that is owned by the taxpayer at the beginning of the year of change (but see section 2.05 of this APPENDIX for property disposed of before the year of change).

(b) Taxpayer has not adopted a method of accounting for the item of property. If a taxpayer does not satisfy section 2.01(1)(a)(i) of this APPENDIX for an item of depreciable or amortizable property because this item of property is placed in service by the taxpayer in the taxable year immediately preceding the year of change ("1-year depreciable property"), the taxpayer may change from the impermissible depreciation method to the permissible depreciation method for the 1-year depreciable property by filing a Form 3115 for this change, provided the section 481 adjustment reported on the Form 3115 includes the amount of any adjustment that is attributable to all property (including the 1-year depreciable property) subject to the Form 3115. Alternatively, the taxpayer may change from the impermissible depreciation method to the permissible depreciation method for a 1-year depreciable property by filing an amended federal tax return for the property's placed-in-service year prior to the date the taxpayer files its federal tax return for the taxable year succeeding the placed-in-service year.

(c) Certain scope limitations inapplicable. The scope limitations in sections 4.02(7) and 4.02(8) of this revenue procedure are not applicable to this change.

(d) Inapplicability. This change does not apply to:

(i) any property to which section 1016(a)(3) (regarding property held by a tax-exempt organization) applies;

(ii) any taxpayer that is subject to section 263A and that is required to capitalize the costs with respect to which the taxpayer wants to change its method of accounting under section 2.01 of this APPENDIX, if the taxpayer is not capitalizing the costs as required;

(iii) any property for which a taxpayer is making a change in depreciation under section 1.446-1T(e)(2)(ii)(d)(2)(vi) or (vii);

(iv) any property subject to section 167(g) (regarding property depreciated under the income forecast method);

(v) any section 1250 property that a taxpayer is reclassifying to an asset class of Rev. Proc. 87-56, 1987-2 C.B. 674, or Rev. Proc. 83-35, 1983-1 C.B. 745, as appropriate, that does not explicitly include section 1250 property (for example, asset class 57.0, Distributive Trades and Services);

(vi) any property for which a taxpayer is revoking a timely valid election, or making a late election, under section 167, section 168, section 1400I, section 1400L, former section 168, or section 13261(g)(2) or (3) of the Revenue Reconciliation Act of 1993 (1993 Act), 1993-3 C.B. 1, 128 (relating to amortizable section 197 intangibles). A taxpayer may request consent to revoke or make the election by submitting a request for a letter ruling under Rev. Proc. 2003-1, 2003-1 I.R.B. 1 (or any successor). See section 1.446-1T(e)(2)(ii)(d)(3)(iii);

(vii) any property for which depreciation is determined under section 56(g)(4)(A) or section 167 (other than under section 168, section 1400I, section 1400L, or former section 168) and a taxpayer is changing the useful life of the property. A change in the useful life of property is corrected by adjustments in the applicable taxable year provided under section 1.446-1T(e)(2)(ii)(d)(3)(i). However, this section 2.01(1)(d)(vii) of this APPENDIX does not apply if the taxpayer is changing to or from a useful life, recovery period, or amortization period that is specifically assigned by the Internal Revenue Code (for example, section 167(f)(1), section 168(c)), the regulations thereunder, or other guidance published in the Internal Revenue Bulletin and, therefore, this change is a change in method of accounting (unless section 2.01(1)(d)(xv) of this APPENDIX applies). See section 1.446-1T(e)(2)(ii)(d)(3)(i);

(viii) any depreciable property for which the use changes in the hands of the same taxpayer. See section 1.446-1T(e)(2)(ii)(d)(3)(ii);

(ix) any property for which depreciation is determined in accordance with section 1.167(a)-11 (regarding the Class Life Asset Depreciation Range System (ADR));

(x) any change in method of accounting involving a change from deducting the cost or other basis of any property as an expense to capitalizing and depreciating the cost or other basis;

(xi) any change in method of accounting involving a change from one permissible method of accounting for the property to another permissible method of accounting for the property. For example:

(A) a change from the straight-line method of depreciation to the income forecast method of depreciating for videocassettes. See Rev. Rul. 89-62, 1989-1 C.B. 78; or

(B) a change from charging the depreciation reserve with costs of removal and crediting the depreciation reserve with salvage proceeds to deducting costs of removal as an expense (provided the costs of removal are not required to be capitalized under any provision of the Code, such as, section 263(a)) and including salvage proceeds in taxable income (see section 2.02 of this APPENDIX for making this change for property for which depreciation is determined under section 167);

(xii) any change in method of accounting involving both a change from treating the cost or other basis of the property as nondepreciable or nonamortizable property to treating the cost or other basis of the property as depreciable or amortizable property and the adoption of a method of accounting for depreciation requiring an election under section 167, section 168, section 1400I, section 1400L(b), former section 168, or section 13261(g)(2) or (3) of the 1993 Act (for example, a change in the treatment of the space consumed in landfills placed in service in 1990 from nondepreciable to depreciable property (assuming section 2.01(1)(d)(xiii) of the APPENDIX does not apply) and the making of an election under section 168(f)(1) to depreciate this property under the unit of production method of depreciation under section 167);

(xiii) any change in method of accounting for any item of income or deduction other than depreciation, even if the change results in a change in computing depreciation under section 1.446-1T(e)(2)(ii)(d)(2)(i), (ii), (iii), (iv), (v), (vi), (vii), or (viii). For example, a change in method of accounting involving:

(A) a change in inventory costs (for example, when property is reclassified from inventory property to depreciable property, or vice versa) (but see section 3.02 of this APPENDIX for making a change from inventory property to depreciable property for unrecoverable line pack gas or unrecoverable cushion gas); or

(B) a change in the character of a transaction from sale to lease, or vice versa (but see section 2.03 of this APPENDIX for making this change);

(xiv) a change from determining depreciation under section 168 to determining depreciation under former section 168 for any property subject to the transition rules in section 203(b) or 204(a) of the Tax Reform Act of 1986, 1986-3 (Vol. 1) C.B. 1, 60-80; or

(xv) any change in the placed-in-service date of a depreciable or amortizable property. This change is corrected by adjustments in the applicable taxable year provided under section 1.446-1T(e)(2)(ii)(d)(3)(v).

(2) Additional requirements. A taxpayer also must comply with the following:

(a) Permissible method of accounting for depreciation. A taxpayer must change to a permissible method of accounting for depreciation for the item of depreciable or amortizable property. The permissible method of accounting is the same method that determines the depreciation allowable for the item of property (as provided in section 2.01(5) of this APPENDIX).

(b) Statements required. A taxpayer must provide the following statements, if applicable, and attach them to the completed application:

(i) a detailed description of the former and new methods of accounting. A general description of these methods of accounting is unacceptable (for example, MACRS to MACRS, erroneous method to proper method, claiming less than the depreciation allowable to claiming the depreciation allowable);

(ii) to the extent not provided elsewhere on the application, a statement describing the taxpayer's business or income-producing activities. Also, if the taxpayer has more than one business or income-producing activity, a statement describing the taxpayer's business or income-producing activity in which the item of property at issue is primarily used by the taxpayer;

(iii) to the extent not provided elsewhere on the application, a statement of the facts and law supporting the new method of accounting, new classification of the item of property, and new asset class in, as appropriate, Rev. Proc. 87-56 or Rev. Proc. 83-35. If the taxpayer is the owner and lessor of the item of property at issue, the statement of the facts and law supporting the new asset class also must describe the business or income-producing activity in which that item of property is primarily used by the lessee;

(iv) to the extent not provided elsewhere on the application, a statement identifying the year in which the item of property was placed in service;

(v) if the item of property is depreciated under former section 168, a statement identifying the asset class in Rev. Proc. 83-35 that applies under the taxpayer's former and new methods of accounting (if none, state and explain);

(vi) if any item of property is public utility property within the meaning of section 168(i)(10) or former section 167(l)(3)(A), as applicable, a statement providing that the taxpayer agrees to the following additional terms and conditions:

(A) a normalization method of accounting (within the meaning of former section 167(l)(3)(G), former section 168(e)(3)(B), or section 168(i)(9), as applicable) will be used for the public utility property subject to the application;

(B) as of the beginning of the year of change, the taxpayer will adjust its deferred tax reserve account or similar reserve account in the taxpayer's regulatory books of account by the amount of the deferral of federal income tax liability associated with the section 481(a) adjustment applicable to the public utility property subject to the application; and

(C) within 30 calendar days of filing the federal income tax return for the year of change, the taxpayer will provide a copy of the completed application to any regulatory body having jurisdiction over the public utility property subject to the application;

(vii) if the taxpayer is changing the classification of an item of section 1250 property placed in service after August 19, 1996, to a retail motor fuels outlet under section 168(e)(3)(E)(iii), a statement containing the following representation: "For purposes of section 168(e)(3)(E)(iii) of the Internal Revenue Code, the taxpayer represents that (A) 50 percent or more of the gross revenue generated from the item of section 1250 property is from the sale of petroleum products (not including gross revenue from related services, such as the labor cost of oil changes and gross revenue from the sale of nonpetroleum products such as tires and oil filters), (B) 50 percent or more of the floor space in the item of property is devoted to the sale of petroleum products (not including floor space devoted to related services, such as oil changes and floor space devoted to nonpetroleum products such as tires and oil filters), or (C) the time of section 1250 property is 1,400 square feet or less."; and

(viii) if the taxpayer is changing the classification of an item of property from section 1250 property to section 1245 property under section 168 or former section 168, a statement of the facts and law supporting the new section 1245 property classification, and a statement containing the following representation: "Each item of depreciable property that is the subject of the application filed under section 2.01 of the APPENDIX of Rev. Proc. 2002-9 for the year of change beginning [Insert the date], and that is reclassified from [Insert, as appropriate: nonresidential real property, residential rental property, 19-year real property, 18-year real property, or 15-year real property] to an asset class of [Insert, as appropriate, either: Rev. Proc. 87-56, 1987-2 C.B. 674, or Rev. Proc. 83-35, 1983-1 C.B. 745] that does not explicitly include section 1250 property, is section 1245 property for depreciation purposes."

(3) Section 481(a) adjustment. Because the adjusted basis of the property is changed as a result of a method change made under section 2.01 of this APPENDIX (see section 2.01(4) of this APPENDIX), items are duplicated or omitted. Accordingly, this change is made with a section 481(a) adjustment. This adjustment may result in either a negative section 481(a) adjustment (a decrease in taxable income) or a positive section 481(a) adjustment (an increase in taxable income) and may be a different amount for regular tax, alternative minimum tax, and adjusted current earnings purposes. This section 481(a) adjustment equals the difference between the total amount of depreciation taken into account in computing taxable income for the property under the taxpayer's former method of accounting (including the amount attributable to any property described in section 2.01(1)(b) of this APPENDIX that is included in the taxpayer's Form 3115), and the total amount of depreciation allowable for the property under the taxpayer's new method of accounting (as determined under section 2.01(5) of this APPENDIX, and including the amount attributable to any property described in section 2.01(1)(b) of this APPENDIX that is included in the taxpayer's Form 3115), for open and closed years prior to the year of change. However, the amount of the section 481(a) adjustment must be adjusted to account for the proper amount of the depreciation allowable that is required to be capitalized under any provision of the Code (for example, section 263A) at the beginning of the year of change.

(4) Basis adjustment. As of the beginning of the year of change, the basis of depreciable property to which section 2.01 of this APPENDIX applies must reflect the reductions required by section 1016(a)(2) for the depreciation allowable for the property (as determined under section 2.01(5) of this APPENDIX).

(5) Meaning of depreciation allowable.

(a) In general. Section 2.01(5) of this APPENDIX provides the amount of the depreciation allowable determined under section 56(a)(1), section 56(g)(4)(A), section 167, section 168, section 197, section 1400I, or section 1400L(c), or former section 168. This amount, however, may be limited by other provisions of the Code (for example, section 280F).

(b) Section 56(a)(1) property. The depreciation allowable for any taxable year for property for which depreciation is determined under section 56(a)(1) is determined by using the depreciation method, recovery period, and convention provided for under section 56(a)(1) that applies for the property's placed-in-service date.

(c) Section 56(g)(4)(A) property. The depreciation allowable for any taxable year for property for which depreciation is determined under section 56(g)(4)(A) is determined by using the depreciation method, recovery period or useful life, as applicable, and convention provided for under section 56(g)(4)(A) that applies for the property's placed-in-service date.

(d) Section 167 property. Generally, for any taxable year, the depreciation allowable for property for which depreciation is determined under section 167, is determined either:

(i) under the depreciation method adopted by a taxpayer for the property; or

(ii) if that depreciation method does not result in a reasonable allowance for depreciation or a taxpayer has not adopted a depreciation method for the property, under the straight-line depreciation method.

For determining the estimated useful life and salvage value of the property, see section 1.167(a)-1(b) and (c), respectively.

The depreciation allowable for any taxable year for property subject to section 167(f) (regarding certain property ex csuded from section 197) is determined by using the depreciation method and useful life prescribed in section 167(f). If computer software is depreciated under section 167(f)(1) and is qualified property (as defined in §168(k)(2) and section 1.168(k)-1T of the temporary Income Tax Regulations), 50-percent bonus depreciation property (as defined in §168(k)(4) and section 1.168(k)-1T), or qualified New York Liberty Zone (Liberty Zone) property (as defined in section 1400L(b)(2) and section 1.1400L(b)-1T), the depreciation allowable for that computer software under section 167(f)(1) is also determined by taking into account the additional first year depreciation deduction provided by section 168(k) or section 1400L(b), as applicable, unless the taxpayer made a timely valid election not to deduct any additional first year depreciation for the computer software.

(e) Section 168 property. The depreciation allowable for any taxable year for property for which depreciation is determined under section 168, is determined as follows:

(i) by using either:

(A) the general depreciation system in section 168(a); or

(B) the alternative depreciation system in section 168(g) if the property is required to be depreciated under the alternative depreciation system pursuant to section 168(g)(1) or other provisions of the Code (for example, property described in section 263A(e)(2)(A) or section 280F(b)(1)). Property required to be depreciated under the alternative depreciation system pursuant to section 168(g)(1) includes property in a class (as set out in section 168(e)) for which the taxpayer made a timely valid election under section 168(g)(7); and

(ii) if the property is qualified property, 50-percent bonus depreciation property, or Liberty Zone property, by taking into account the additional first year depreciation deduction provided by section 168(k) or section 1400L(b), as applicable, unless the taxpayer made a timely valid election not to deduct the additional first year depreciation (or made a deemed election not to deduct the additional first year depreciation; for further guidance, see Rev. Proc. 2002-33, 2002-1 C.B. 963, or Rev. Proc. 2003-50, 2003-29 I.R.B. 119) for the class of property (as defined in section 1.168(k)-1T(e)(2) or section 1.1400L(b)-1T(e)(2), as applicable) in which that property is included.

(f) Section 197 property. The depreciation allowable for any taxable year for an amortizable section 197 intangible (including any property for which a timely election under section 13261(g)(2) of the 1993 Act was made) is determined in accordance with section 1.197-2(f).

(g) Former section 168 property. The depreciation allowable for any taxable year for property subject to former section 168 is determined by using either:

(i) the accelerated method of cost recovery applicable to the property (for example, for 5-year property, the recovery method under former section 168(b)(1)); or

(ii) the straight-line method applicable to the property if the property is required to be depreciated under the straight-line method (for example, property described in former section 168(f)(12) or former section 280F(b)(2)) or if the taxpayer elected to determine the depreciation allowance under the optional straight-line percentage (for example, the straight-line method in former section 168(b)(3)).

(h) Qualified revitalization building. The depreciation allowable for any taxable year for any qualified revitalization building (as defined in section 1400I(b)(1)) for which the taxpayer has made a timely valid election under section 1400I(a) is determined as follows:

(i) if the taxpayer elected to deduct one-half of any qualified revitalization expenditures (as defined in section 1400I(b)(2)) chargeable to a capital account with respect to the qualified revitalization building for the taxable year in which the building is placed in service by the taxpayer, the depreciation allowable for the property's placed-in-service year is equal to one-half of the qualified revitalization expenditures for the property and the depreciation allowable for the remaining recovery period of the property is determined using the general depreciation system of section 168(a) or the alternative depreciation system of section 168(g), as applicable; or

(ii) if the taxpayer elected to amortize all of the qualified revitalization expenditures chargeable to a capital account with respect to the qualified revitalization building ratably over the 120-month period beginning with the month in which the building is placed in service, the depreciation allowable is determined in accordance with this election.

(i) Qualified New York Liberty Zone leasehold improvement property. The depreciation allowable for any taxable year for qualified New York Liberty Zone leasehold improvement property (as defined in section 1400L(c)(2)) is determined by using the depreciation method and recovery period prescribed in section 1400L(c)."

SECTION 2. Section 2.02 of the APPENDIX of Rev. Proc. 2002-9 is deleted and replaced with the following:

".02 Permissible to permissible method of accounting for depreciation.

(1) Description of change. This change applies to a taxpayer that wants to change from a permissible method of accounting for depreciation under section 56(g)(4)(A)(iv) or section 167 to another permissible method of accounting for depreciation under section 56(g)(4)(A)(iv) or section 167. Pursuant to section 1.167(a)-7(a) and (c), a taxpayer may account for depreciable property either by treating each individual asset as an account or by combining two or more assets in a single account and, for each account, depreciation allowances are computed separately.

(2) Scope.

(a) Applicability. This change applies to any taxpayer wanting to make a change in method of accounting for depreciation specified in section 2.02(3) of this APPENDIX for the property in an account:

(i) for which the present and proposed methods of accounting for depreciation specified in section 2.02(3) of this APPENDIX are permissible methods for the property under section 56(g)(4)(A)(iv) or section 167; and

(ii) that is owned by the taxpayer at the beginning of the year of change.

(b) Certain scope limitations inapplicable. The scope limitations in sections 4.02(7) and 4.02(8) of this revenue procedure are not applicable to this change.

(c) Inapplicability. This change does not apply to:

(i) any taxpayer that is subject to section 263A and that is required to capitalize the costs with respect to which the taxpayer wants to change its method of accounting under section 2.02 of this APPENDIX, if the taxpayer is not capitalizing the costs as required;

(ii) any property to which section 1016(a)(3) (regarding property held by a tax-exempt organization) applies;

(iii) any property described in section 167(f) (regarding certain property excluded from section 197);

(iv) any property subject to section 167(g) (regarding property depreciated under the income forecast method);

(v) any property for which depreciation is determined under section 56(a)(1), section 56(g)(4)(A)(i), (ii), (iii), or (v), section 168, section 1400I, section 1400L(b), or section 1400L(c), or section 168 prior to its amendment in 1986 (former section 168);

(vi) any property that the taxpayer elected under section 168(f)(1) or former section 168(e)(2) to exclude from the application of, respectively, section 168 or former section 168;

(vii) any property for which depreciation is determined in accordance with section 1.167(a)-11 (regarding the Class Life Asset Depreciation Range System (ADR));

(viii) any depreciable property for which the taxpayer is changing the depreciation method pursuant to section 1.167(e)-1T(b) of the temporary Income Tax Regulations (change from declining-balance method to straight-line method), section 1.167(e)-1T(c) (certain changes for section 1245 property), or section 1.167(e)-1T(d) (certain changes for section 1250 property). These changes must be made prospectively and are not permitted under the cited regulations for property for which the depreciation is determined under section 168, section 1400I, section 1400L, or former section 168; or

(ix) any distributor commissions (as defined by section 2 of Rev. Proc. 2000-38, 2000-2 C.B. 310) for which the taxpayer is changing the useful life under the distribution fee period method or the useful life method (both described in Rev. Proc. 2000-38). A change in this useful life is corrected by adjustments in the applicable taxable year provided under section 1.446-1T(e)(2)(ii)(d)(3)(i).

(3) Changes covered. Section 2.02 of this APPENDIX only applies to the following changes in methods of accounting for depreciation:

(a) a change from the straight-line method to the sum-of-the-years-digits method, the sinking fund method, the unit-of-production method, or the declining-balance method using any proper percentage of the straight-line rate;

(b) a change from the declining-balance method using any percentage of the straight-line rate to the sum-of-the-years-digits method, the sinking fund method, or the declining-balance method using a different proper percentage of the straight-line rate;

(c) a change from the sum-of-the-years-digits method to the sinking fund method, the declining-balance method using any proper percentage of the straight-line rate, or the straight-line method;

(d) a change from the unit-of-production method to the straight-line method;

(e) a change from the sinking fund method to the straight-line method, the unit-of-production method, the sum-of-the-years-digits method, or the declining-balance method using any proper percentage of the straight-line rate;

(f) a change in the interest factor used in connection with a compound interest method or sinking fund method;

(g) a change in averaging convention as set forth in section 1.167(a)-10(b). However, as specifically provided in section 1.167(a)-10(b), in any taxable year in which an averaging convention substantially distorts the depreciation allowance for the taxable year, it may not be used (see Rev. Rul. 73-202, 1973-1 C.B. 81);

(h) a change from charging the depreciation reserve with costs of removal and crediting the depreciation reserve with salvage proceeds to deducting costs of removal as an expense and including salvage proceeds in taxable income as set forth in section 1.167(a)-8(e)(2). See Rev. Rul. 74-455, 1974-2 C.B. 63. This change, however, may be made under this revenue procedure only if:

(i) the change is applied to all items in the account for which the change is being made; and

(ii) the removal costs are not required to be capitalized under any provision of the Code (for example, section 263(a), 263A, or 280B);

(i) a change from crediting the depreciation reserve with the salvage proceeds realized on normal retirement sales to computing and recognizing gains and losses on the sales (see Rev. Rul. 70-165, 1970-1 C.B. 43);

(j) a change from crediting ordinary income (including the combination method of crediting the lesser of estimated salvage value or actual salvage proceeds to the depreciation reserve, with any excess of salvage proceeds over estimated salvage value credited to ordinary income) with the salvage proceeds realized on normal retirement sales, to computing and recognizing gains and losses on the sales (see Rev. Rul. 70-166, 1970-1 C.B. 44);

(k) a change from item accounting for specific assets to multiple asset accounting for the same assets, or vice versa;

(l) a change from one type of multiple asset accounting (pooling) for specific assets to a different type of multiple asset accounting (pooling) for the same assets;

(m) a change from one method described in Rev. Proc. 2000-38 for amortizing distributor commissions (as defined by section 2 of Rev. Proc. 2000-38, 2000-2 C.B. 310) to another method described in Rev. Proc. 2000-38 for amortizing distributor commissions; or

(n) a change from pooling to a single asset, or vice versa, for distributor commissions (as defined by section 2 of Rev. Proc. 2000-38, 2000-2 C.B. 310) for which the taxpayer is using the distribution fee period method or the useful life method (both described in Rev. Proc. 2000-38).

(4) Additional requirements. A taxpayer also must comply with the following:

(a) Basis for depreciation. At the beginning of the year of change, the basis for depreciation of property to which this change applies is the adjusted basis of the property as provided in section 1011 at the end of the taxable year immediately preceding the year of change (determined under the taxpayer's present method of accounting for depreciation). If applicable under the taxpayer's proposed method of accounting for depreciation, this adjusted basis is reduced by the estimated salvage value of the property (for example, a change to the straight-line method).

(b) Rate of depreciation. The rate of depreciation for property changed to:

(i) the straight-line or the sum-of-the-years-digits method of depreciation must be based on the remaining useful life of the property as of the beginning of the year of change; or

(ii) the declining-balance method of depreciation must be based on the useful life of the property measured from the placed-in-service date, and not the expected remaining life from the date the change becomes effective.

(c) Regulatory requirements. For changes in method of depreciation to the sum-of-the-years-digits or declining-balance method, the property must meet the requirements of section 1.167(b)-0 or 1.167(c)-1, as appropriate.

(d) Public utility property. If any item of property is public utility property within the meaning of former section 167(l)(3)(A), the taxpayer must attach to the application a statement providing that the taxpayer agrees to the following additional terms and conditions:

(i) a normalization method of accounting within the meaning of former section 167(l)(3)(G) will be used for the public utility property subject to the application; and

(ii) within 30 calendar days of filing the federal income tax return for the year of change, the taxpayer will provide a copy of the completed application to any regulatory body having jurisdiction over the public utility property subject to the application.

(5) Section 481(a) adjustment. Because the adjusted basis of the property is not changed as a result of a method change made under section 2.02 of this APPENDIX, no items are being duplicated or omitted. Accordingly, no section 481(a) adjustment is required or necessary."

SECTION 3. Section 2B of the APPENDIX of Rev. Proc. 2002-9 is deleted and replaced with the following:

"SECTION 2B. COMPUTER SOFTWARE EXPENDITURES (SECTIONS 162, 167, AND 197)

.01 Description of change. This change applies to a taxpayer that wants to change its method of accounting for the costs of computer software to a method described in Rev. Proc. 2000-50, 2000-2 C.B. 601. Section 5 of Rev. Proc. 2000-50 describes the methods applicable to the costs of developing computer software. Section 6 of Rev. Proc. 2000-50 describes the method applicable to the costs of acquired computer software. Section 7 of Rev. Proc. 2000-50 describes the method applicable to leased or licensed computer software. If a taxpayer treats the costs of computer software in accordance with the applicable method described in Rev. Proc. 2000-50, the Service will not disturb the taxpayer's treatment of its costs of computer software.

.02 Scope. This change applies to all costs of computer software as defined in section 2 of Rev. Proc. 2000-50. However, this change does not apply to any computer software that is subject to amortization as an "amortizable section 197 intangible" as defined in section 197(c) and the regulations thereunder, or to costs that a taxpayer has treated as research and experimentation expenditures under section 174.

.03 Statement required. If a taxpayer is changing to the method described in section 5.01(2) of Rev. Proc. 2000-50, the taxpayer must attach to the application a statement providing the information required in section 8.02(2) of Rev. Proc. 2000-50."

SECTION 4. Section 2.05 of the APPENDIX of Rev. Proc. 2002-9 is added to read as follows:

".05 Impermissible to permissible method of accounting for depreciation or amortization for disposed depreciable or amortizable property.

(1) Description of change. This change applies to a taxpayer that wants to make the change in method of accounting for depreciation or amortization (depreciation) provided under section 3 of Rev. Proc. 2004-11, 2004-3 I.R.B. 311, for an item of depreciable or amortizable property that has been disposed of by the taxpayer. Section 3 of Rev. Proc. 2004-11 allows a taxpayer to make a change in method of accounting for depreciation for the disposed property if the taxpayer used an impermissible method of accounting for depreciation for the property under which the taxpayer did not take into account any depreciation allowance, or did take into account some depreciation but less than the depreciation allowable, in the year of change (as defined in section 2.05(3) of this APPENDIX) or any prior taxable year.

(2) Scope. This change applies to a taxpayer and an item of depreciable or amortizable property that are within the scope of section 3.01 of Rev. Proc. 2004-11, provided:

(a) the taxpayer files the original Form 3115 with the taxpayer's amended federal tax return for the year of change (as defined in section 2.05(3) of this APPENDIX) prior to the expiration of the period of limitation for assessment under section 6501(a) for the taxable year in which the item of depreciable or amortizable property was disposed of by the taxpayer; and

(b) the taxpayer's amended federal tax return for the year of change (as defined in section 2.05(3) of this APPENDIX) includes the adjustments to taxable income and any collateral adjustments to taxable income or tax liability (for example, adjustments to the amount or character of the gain or loss of the disposed depreciable or amortizable property) resulting from the change in method of accounting for depreciation made by the taxpayer under section 2.05 of this APPENDIX.

(3) Year of change. The year of change for this change is the taxable year in which the item of depreciable or amortizable property was disposed of by the taxpayer.

(4) Scope limitations inapplicable. The scope limitations in section 4.02 of this revenue procedure do not apply. If the taxpayer is under examination, before an appeals office, or before a federal court at the time that a copy of the Form 3115 is filed with the national office, the taxpayer must provide a copy of the Form 3115 to the examining agent, appeals officer, or counsel for the government, as appropriate, at the time the copy of the Form 3115 is filed with the national office. The Form 3115 must contain the name(s) and telephone number(s) of the examining agent, appeals officer, or counsel for the government, as appropriate.

(5) Filing requirements. Notwithstanding section 6.02(3)(a) of this revenue procedure, a taxpayer making this change must attach the original Form 3115 to the taxpayer's timely filed amended federal tax return for the year of change and must file the required copy (with signature) of the Form 3115 with the national office no later than when the original Form 3115 is filed with the amended federal tax return for the year of change.

(6) Section 481(a) adjustment period. A taxpayer must take the section 481(a) adjustment into account in the year of change."


Fast depreciation under the "Whiteco test"

In JFM, Inc. & Subs., TC Memo 1994-239 , the Tax Court used a six factor test it articulated in Whiteco Industries, Inc (1975) 65 TC No. 664 (Whiteco test) to distinguish between land improvements in asset class 57.1 and asset class 57.0 property. The Whiteco test, aimed at determining whether property is "inherently permanent," is as follows:

  1. Is the property capable of being moved, and has it in fact been moved?
  2. Is the property designed or constructed to remain permanently in place?
  3. Are there circumstances which tend to show the expected or intended length of affixation (i.e., are there circumstances which show that the property may or will have to be moved)?
  4. How substantial a job is removal of the property and how time-consuming is it?
  5. How much damage will the property sustain upon its removal?
  6. What is the manner of affixation of the property to the land?

1. Is the property capable of being moved and has it in fact been moved?

To facilitate off-site construction, modular construction requires the manufacture and transport of sectional units from the factory to another site where they will be connected together. The practice of assembly and disassembly of modular units is an everyday industry occurrence. The modular units are designed to be legally transported form the factory over the public highway before use, therefore, reuse after disassembly is commonplace in practice and intended. Further, under contractual obligation, typically the structure must be removed at the termination of the contract of when needed. This most likely will not be the case for on-site constructed facilities.

2. Is the property designed or constructed to remain permanently in place?

Non-residential modular construction typically is designed and manufactured to be readily relocatable. Foundation systems that are used by modular structures are a function of compliance with locally prescribed model construction codes to support the structure. Depending on the prevailing local construction codes, foundation systems, not the structure, may or may not be sedentary or appear to be permanent.

For buildings leased, the term of the average original operating lease contract is, typically less than five years. At the termination of the lease, the structure must be removed from the site, relocated, and then would be utilized at another site.

Since the structure's modular units are initially intrinsically designed to be transported for highway movement from the factory to the first site, these structural units maintain their transportability for secondary, and subsequent moves. For these secondary moves, the act of disassembly typically does not substantially damage these sectional modular units. Additionally, it is common that once the modular units are removed, many of these units may be inventoried, re-configured, and reused at other sites.

3. Are there circumstances that show that the property may or will be moved?

The term of the lease or the use of the structure dictates the removal of the modular sections. At the termination of the lease or use, lessor or user is required to disassemble and transport each of the modular section to another site or return to inventory for re-use at a later time.

Since these structure are initially constructed in a remote factory, this design allows an industry-wide marketing application of short use of the structure in one location and the ready relocation to another site. This practice is prevalent in the educational, office, airport, institutional, restaurant, correctional, and medical facilities' markets to name but a few.

Since these structures have been transported over public highways at least once, the ability exists universally to disassemble and re-transport sectional units with minimal costs for permits and transit. The fees to obtain local disassembly permits are nominal in cost as well.

4. How substantial a job is removal of the property, and how time consuming?

The job of removing the modular sections of the structures is facilitated by the very initial design and manufacture of the sectional units. Because of the inherent sectional design, disassembly time is minimal. Typical of costs, including time consumed and materials for disassembly and removal, are less the 20% of the replacement costs of the total structure.

Typical disassembly time is less than the time spent in the initial assembly.

Typical removal includes disassembly and transportation to another site or to storage. Once in storage, the sectional units may again be transported and reassembled or reconfigured to suit the needs of the next lessee or owner. It is common industry practice to inventory sectional units, and re-configure on a site, as directed by the lessee of owner.

The question of cost, time and intrinsic design provide the contrast between readily relocatable and improbability and costly relocation of a structure.

5. How much damage will the property sustain upon removal?

Since these sectional units are inherently designed, manufactured, and transported in sectional format for site coupling, these units suffer minimal damage during disassembly. Typically disassembly and removal damage is less the 10% percent of replacement costs to the property. Once disassembled and transported, each sectional unit is capable of being readily re-used in another application or site.

Site restoration costs are minimal after removal, and is usually addressed in contract language, therefore the intent to remove the structure is an integral part of the design and application. Contract leases typically specify that the structure is personal property in finite land and structure leases.

6. What is the manner of affixation to the property to the land?

For the non-residential modular industry, the manner of affixation to the property is typically determined by local prevailing model construction codes. The manner of affixation to the site is not an indication of intent of permanence, rather it is a commonplace, as most states have a preemptive state-wide construction code for the structure, and local agencies determine appropriate foundation, utility, and land use issues.

The affixation between the structure and the foundation system can be varied. With pier and pad systems, it is gravity or bolted systems or tack-welded systems. The attachment to the foundation is determined by structural requirements and not by intention of permanence.

Typical foundation systems used in conjunction with modular units allow for ready return to pre-installation status with little or minor site reconstruction costs. Foundation selection factors include wind, seismic, support, use, and access requirements in determination of appropriate systems. Typically, the termination of real or personal property is not one of the factors in the selection of foundation systems.

Conclusion:

Any structure can be relocated with enough time and money. The factors of intrinsic design and the reality that every modular section has already moved over public highways proves their relocatability. Designs that are constructed on site, which might be relocated, rarely take into consideration these costly relocation factors:

The tremendous structural stress of relocation and transportation. This stresses multiples of typical earthquake stress loads. Is the site constructed building specifically designed for this stress and does it have the means to be lifted and transported by truck?

The ability to move over public highways without significant permit costs and efforts.

The destruction of the structural integrity of the building, the high cost of material loss due to disassembly, and the high costs of re-assembly.

Relocation of site constructed structures regularly requires an entirely new review process of structural and systems approval, since the design of the structure did not initially consider, and was not approved as, a relocatable structure. This frequently adds significant additional agency review time, engineering, material, and labor costs to the relocation process.


Does a principal residence converted to residential rental property still qualify for tax-free treatment?

Q. I lived in a home as my principal residence for the first 2 of the last 5 years. For the last 3 years, the home was a rental property before selling it. Can I still avoid the capital gains tax and, if so, how should I deal with the depreciation I took while it was rented out?

Ans. If, during the 5-year period ending on the date of sale, you owned the home for at least 2 years and lived in it as your main home for at least 2 years, you can exclude up to the maximum dollar limit. However, you cannot exclude the portion of the gain equal to depreciation allowed or allowable for periods after May 6, 1997. This gain is reported on Form 4797 (PDF),Sale of Business Property. Refer to Publication 523, Selling Your Home, and Form 4797 (PDF), Sale of Business Property, for specifics on calculating and reporting the amount of gain.

References:



Q. Is the loss on the sale of your home deductible?

Ans. The loss on the sale of a personal residence is a nondeductible personal loss.

References:


http://www.irs.gov/faqs/faq-kw140.html


Conclusion:
If the principal residence was converted to residential rental property on a date that its market value was greater than the cost basis (i.e. you'd have a gain upon sale) and then if the property appreciates even more while rental property, then all of the gain including all of the depreciation will be taxable upon sale if it was rental property for more than three years.

Conversely - If the principal residence was converted to residential rental property on a date that its market value was greater than the cost basis (i.e. you'd have a gain upon sale) and then if the property declines in value below your cost basis while rental property, then all of the loss net of all of the depreciation, to an extent, will be tax deductible upon sale if it was rental property for more than three years.

If the rental lasts less than three years (meaning that during fully two of the last five years it was your principal residence) then up to $500,000 of any gain would not be recognized for federal income tax purposes.  Similarly all of the loss would not be recognized for federal income tax purposes.


IRS Reg. §1.469-2(f)(6) Self-Rental Rule

Connor v. Comr. (78th Cir. 7/5/2000) Rental income generated by the lease of wife's office building to husband's personal services C corporation during 1993-1994 was not passive activity income and may not offset passive losses from rental of taxpayer's other property.

Income from rental real estate, equipment or other property leased to a business where the taxpayer works - is non-passive.

A taxpayer may lease property to a trade or business in which the taxpayer materially participates and have the income from that lease recharacterized as nonpassive income. For example, an individual can lease equipment to a partnership that owns a restaurant in which the individual materially participates and the net rental income may be recharacterized as nonpassive income, but any loss remains passive.

A taxpayer may avoid a "self-rental trap" by combining rental activity with the operations activity by making a special election to aggregate the activities.  This election can only be made in the initial year the taxpayer reports the activities.  This election requires the attachment of a formal statement to the tax return.

http://www.irs.gov/businesses/small/article/0,,id=146330,00.html

http://www.cpa2biz.com/Content/media/PRODUCER_CONTENT/Newsletters/Articles_2008/CorpTax/rentaltrap.jsp

 

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Taxation of Israel Mozel Tov Bonds:

The total amount of OID on any OID Bond will equal the excess of the bond’s "stated redemption price at maturity" over its "issue price." The stated redemption price at maturity equals the sum of all payments due under the OID Bond, other than any payments of qualified stated interest. The issue price will generally equal the initial public offering price at which a substantial number of bonds are issued in a given offering.

The amount of OID on an OID Bond that a United States Bondholder must include in income during a taxable year is the sum of the "daily portions" of OID for that bond. The daily portions are determined by allocating to each day in an "accrual period" (generally the period between compounding dates) a pro rata portion of the OID attributable to that accrual period. The amount of OID attributable to an accrual period is the product of the "adjusted issue price" of the bond at the beginning of the accrual period and its yield to maturity. The adjusted issue price of a bond is generally equal to the sum of its issue price and all prior accruals of OID. Cash payments on an OID Bond are allocated first to any stated interest then due, then to previously accrued OID (in the order of accrual) to which cash payments have not yet been allocated, and then to principal.

A United States Bondholder generally may make an irrevocable election to include in its income its entire return on an OID Bond (including payments of qualified stated interest) under the constant yield method (also called the effective or scientific method of amortization) applicable to OID.

Any OID included in a United States Bondholder’s income will constitute foreign source income, and generally will be "passive category income" (or in certain cases, as "general category income") for United States foreign tax credit purposes.

Disposition of the Bonds. A United States Bondholder generally will recognize gain or loss on the sale or retirement of a bond equal to the difference between the amount realized on the sale or retirement and the tax basis of the bond. A United States Bondholder’s tax basis in a bond generally will be the purchase price of the bond, increased by any OID previously included in the United States Bondholder’s income and decreased (but not below zero) by any early principal payments. Except to the extent attributable to accrued but unpaid interest or OID, gain or loss recognized on the sale or retirement of a bond will be capital gain or loss, and will be long-term capital gain or loss if the bond was held for more than one year.

Under current law, net capital gains of individuals may be taxed at lower rates than most items of ordinary income. Limitations apply to the ability of United States Bondholders to offset capital losses against ordinary income. Any gain or loss recognized by a United States Bondholder on the sale or retirement of a bond generally will constitute income from, or loss allocable to, sources within the United States for United States federal income tax purposes.


Gallenstein Decision of 1992:

Joint tenancy with right of survivorship is a popular form of property ownership between husband and wife. Possession of an interest in a joint tenancy at death has major estate and income tax implications. The value of the interest is includable in the decedent's estate, and results in an adjustment to the tax cost basis for capital gains tax purposes of the asset held by the surviving joint tenant.

Determining the amount included in the estate and the related basis adjustment depends upon the application of Internal Revenue Code Section 2040 ­ a provision that has undergone considerable change over the years. In a case of first impression in 1992 (975 F.2d 286 (6th Cir. 1992)), the Sixth Circuit in Gallenstein v. United States of America, addressed the issue of valuing certain spousal joint interests created prior to 1977.

Statutory Backdrop

As originally enacted, Section 2040 prescribed that the entire value of jointly held property was included in the estate of the decedent/joint tenant except to the extent that the survivor could show that he or she had acquired an interest for full and adequate consideration.

The Tax Reform Act of 1976 amended Section 2040 to provide that, in the case of a spousal joint tenancy, 50% of the value of the jointly held property would be included in the estate of the first spouse to die, regardless of the actual amount contributed by either joint tenant/spouse. Hence, only 50% of the value of the property would receive a step-up in basis for income tax purposes.

There were a number of subsequent amendments to Section 2040, some of which left open some uncertainty concerning whether to use the so-called "contribution" test or the 50% rule when valuing spousal joint tenancies created prior to 1977 for estates of decedents dying after 1981.

Facts of Gallenstein

In Gallenstein, the taxpayer and her husband purchased real property in Kentucky in 1955. The entire purchase price of $38,500 was derived from the husband's earnings. The couple held the farm property as joint tenants with right of survivorship until the husband died on 12/12/87. In July 1988, the taxpayer sold some of the farm property for approximately $3.6 million. After an amended estate tax return included the entire property in her husband's estate, the taxpayer/wife claimed that $3.6 million was her basis in the property. The Internal Revenue Service, however, took the position that the basis of the property sold should reflect only the step-up in basis for one-half of the property to the fair market value at the date of death, as shown on the original estate tax return.

Holdings of the Courts

In upholding the taxpayer's position, the District Court examined the history of Section 2040. Originally, Section 2040 required a contribution test to determine whether and to what extent the value of jointly held property would be included in the estate of a decedent/joint tenant.

The Service in Gallenstein argued that the legislative history indicated that Congress intended to adopt an easily administered rule for spousal joint interests that would eliminate the burdensome tracing requirements under Section 2040(a).

In rejecting the Service's argument, the District Court first noted that, in general, the doctrine of implied repeal is inappropriate where the plain language of the statutes at issue is not in conflict. The court reasoned that when the language of two statutory provisions is unambiguous, resorting to the legislative history to interpret that language would be unnecessary and improper. In addition, a strong judicial policy disfavors the implied repeal of statutes.

Sixth Circuit's Analysis.

On appeal, the Sixth Circuit affirmed the District Court's holding. Before the appellate court, the Service argued theories of express and implied repeal. The Service contended that by changing the definition of qualified joint interest in Section 2040(b)(2), Congress expressly changed the effective date of Section 2040(b)(1). In rejecting this argument, the Sixth Circuit noted that when Congress wanted to repeal a particular section of the estate tax code (such as subsections (c)-(e) of Section 2040), it did so expressly. Thus, the Court declined to provide by judicial interpretation what Congress did not expressly enact.

Many sophisticated tax observers were, to put it mildly, surprised by the Gallenstein decision, and expected or predicted either that other federal circuits would decline to accept its rationale, leading to a U.S. Supreme Court reversal, or that the Service would prevail upon Congress to "fix" what appeared to be an error or oversight. That has not happened. Instead, other courts have adopted the Gallenstein rationale and conclusion. (See Patten v. United States, 116 F.3d 1029).

And, as time goes by, the frequency of an estate owning property acquired before 1977 continues to diminish, and the Service appears to have turned its attention and resources to more pressing matters.

Tax Planning Considerations

Gallenstein holds promise for a surviving spouse who inherits property held in a spousal joint tenancy that was created before 1977. Based on the result in the case, the surviving spouse can receive a step-up in basis to the full extent of the contribution of the first spouse to die towards the purchase of the property, but there should be no increase in estate tax on the death of the first spouse because of the marital deduction. Under pre-1977 law, 100% of the value of jointly held property was included in the estate of the first spousal joint tenant to die except to the extent that the surviving joint tenant spouse could show that he or she had contributed to the purchase of the property. In most instances, it is likely that the holding in Gallenstein will work to the surviving spouse's advantage as it is typically the older spouse who contributed all of the purchase price and dies first. Thus, the surviving spouse's tax basis in the property should be 100% of the property's fair market value. If the property is sold shortly thereafter, no capital gains should be realized.


Garn-St. Germain Depository Institutions Act of 1982 - Due on Sale clause:

1701j-3. Preemption of due-on-sale prohibitions
(a) Definitions For the purpose of this section-


(1) the term "due-on-sale clause" means a contract provision which authorizes a lender, at its option, to declare due and payable sums secured by the lender’s security instrument if all or any part of the property, or an interest therein, securing the real property loan is sold or transferred without the lender’s prior written consent;
(2) the term "lender" means a person or government agency making a real property loan or any assignee or transferee, in whole or in part, of such a person or agency;
(3) the term "real property loan" means a loan, mortgage, advance, or credit sale secured by a lien on real property, the stock allocated to a dwelling unit in a cooperative housing corporation, or a residential manufactured home, whether real or personal property; and
(4) the term "residential manufactured home" means a manufactured home as defined in section 5402 (6) of title 42 which is used as a residence; and
(5) the term "State" means any State of the United States, the District of Columbia, the Commonwealth of Puerto Rico, the Virgin Islands, Guam, the Northern Mariana Islands, American Samoa, and the Trust Territory of the Pacific Islands.

(b) Loan contract and terms governing execution or enforcement of due-on-sale options and rights and remedies of lenders and borrowers; assumptions of loan rates

(1) Notwithstanding any provision of the constitution or laws (including the judicial decisions) of any State to the contrary, a lender may, subject to subsection (c) of this section, enter into or enforce a contract containing a due-on-sale clause with respect to a real property loan.
(2) Except as otherwise provided in subsection (d) of this section, the exercise by the lender of its option pursuant to such a clause shall be exclusively governed by the terms of the loan contract, and all rights and remedies of the lender and the borrower shall be fixed and governed by the contract.
(3) In the exercise of its option under a due-on-sale clause, a lender is encouraged to permit an assumption of a real property loan at the existing contract rate or at a rate which is at or below the average between the contract and market rates, and nothing in this section shall be interpreted to prohibit any such assumption.

(c) State prohibitions applicable for prescribed period; subsection (b) provisions applicable upon expiration of such period; loans subject to State and Federal regulation or subsection (b) provisions when authorized by State laws or Federal regulations

(1)In the case of a contract involving a real property loan which was made or assumed, including a transfer of the liened property subject to the real property loan, during the period beginning on the date a State adopted a constitutional provision or statute prohibiting the exercise of due-on-sale clauses, or the date on which the highest court of such State has rendered a decision (or if the highest court has not so decided, the date on which the next highest appellate court has rendered a decision resulting in a final judgment if such decision applies State-wide) prohibiting such exercise, and ending on October 15, 1982, the provisions of subsection (b) of this section shall apply only in the case of a transfer which occurs on or after the expiration of 3 years after October 15, 1982, except that-

(A) a State, by a State law enacted by the State legislature prior to the close of such 3-year period, with respect to real property loans originated in the State by lenders other than national banks, Federal savings and loan associations, Federal savings banks, and Federal credit unions, may otherwise regulate such contracts, in which case subsection (b) of this section shall apply only if such State law so provides; and

(B) the Comptroller of the Currency with respect to real property loans originated by national banks or the National Credit Union Administration Board with respect to real
property loans originated by Federal credit unions may, by regulation prescribed prior to the close of such period, otherwise regulate such contracts, in which case subsection (b) of this section shall apply only if such regulation so provides.

(2)

(A) For any contract to which subsection (b) of this section does not apply pursuant to this subsection, a lender may require any successor or transferee of the borrower to meet customary credit standards applied to loans secured by similar property, and the lender may declare the loan due and payable pursuant to the terms of the contract upon transfer to any successor or transferee of the borrower who fails to meet such customary credit standards.

(B) A lender may not exercise its option pursuant to a due-on-sale clause in the case of a transfer of a real property loan which is subject to this subsection where the transfer occurred prior to October 15, 1982.

(C) This subsection does not apply to a loan which was originated by a Federal savings and loan association or Federal savings bank.


(d) Exemption of specified transfers or dispositions

With respect to a real property loan secured by a lien on residential real property containing less than five dwelling units, including a lien on the stock allocated to a dwelling unit in a cooperative housing corporation, or on a residential manufactured home, a lender may not exercise its option pursuant to a due-on-sale clause upon-

(1) the creation of a lien or other encumbrance subordinate to the lender’s security instrument which does not relate to a transfer of rights of occupancy in the property;
(2) the creation of a purchase money security interest for household appliances;
(3) a transfer by devise, descent, or operation of law on the death of a joint tenant or tenant by the entirety;
(4) the granting of a leasehold interest of three years or less not containing an option to purchase;
(5) a transfer to a relative resulting from the death of a borrower;
(6) a transfer where the spouse or children of the borrower become an owner of the property;
(7) a transfer resulting from a decree of a dissolution of marriage, legal separation agreement, or from an incidental property settlement agreement, by which the spouse of the borrower becomes an owner of the property;
(8) a transfer into an inter vivos trust (a/k/a a revocable "living trust") in which the borrower is and remains a beneficiary and which does not relate to a transfer of rights of occupancy in the property; or
(9) any other transfer or disposition described in regulations prescribed by the Federal Home Loan Bank Board.


(e) Rules, regulations, and interpretations; future income bearing loans subject to due-on-sale options

(1) The Federal Home Loan Bank Board, in consultation with the Comptroller of the Currency and the National Credit Union Administration Board, is authorized to issue rules and regulations and to publish interpretations governing the implementation of this section.
(2) Notwithstanding the provisions of subsection (d) of this section, the rules and regulations prescribed under this section may permit a lender to exercise its option pursuant to a due-on-sale clause with respect to a real property loan and any related agreement pursuant to which a borrower obtains the right to receive future income.

(f) Effective date for enforcement of Corporation-owned loans with due-on-sale options

The Federal Home Loan Mortgage Corporation (hereinafter referred to as the "Corporation") shall not, prior to July 1, 1983, implement the change in its policy announced on July 2, 1982, with respect to enforcement of due-on-sale clauses in real property loans which are owned in whole or in part by the Corporation.

(g) Balloon payments

Federal Home Loan Bank Board regulations restricting the use of a balloon payment shall not apply to a loan, mortgage, advance, or credit sale to which this section applies.

http://en.wikipedia.org/wiki/Garn-St._Germain_Depository_Institutions_Act

http://www.newyorkfed.org/research/quarterly_review/1982v7/v7n4article6.pdf

http://www.foreclosureforum.com/mb/messages/17090.html

http://books.google.com/books

http://www.troyinsurancegroup.com/how-to-insure-seller-financed-wrap-arounds-and-properties-taken-subject-to-the-existing-loan/

 

Exemption (8) the Land Trust / or separate LLC "trick"

A land trust is form of a revocable, living trust which is exempted under the Garn Act. A land trust, like a living trust, is create by two legal documents:

1) A trust agreement between the creator (called "grantor" in legal terms) of the trust and the trustee which defines the trust arrangement; and
2) A deed from the creator of the trust to the trustee.

The trustee holds title for the benefit of the grantor (in this case, the grantor is also the "beneficiary"). If you place title to your property into a land trust, you have not violated the due-on-sale (so long as there is no change in occupancy).

Let's say that you come across a seller who is willing to give you title to his property. The only "glitch" is that the loan is not assumable because the mortgage has a due-on-sale clause. Here's the process for getting around it:

STEP 1: Sammy Seller signs a trust agreement with you as trustee of his trust. Sammy is named as the "beneficiary" of the trust.

STEP 2: Sammy Seller transfers title to the trustee (no violation of the due-on-sale clause)

STEP 3: Sammy Seller quietly assigns his interest under the trust to you (similar to a transfer of stock in a corporation). This assignment is not recorded in any public record. Sammy moves out and you move in.

STEP 4: You are now the beneficiary of the trust. Your trustee makes payments to the lender.

Keep in mind that the assignment of Sammy Seller's interest under the trust to you does trigger the due-on-sale, but who is going to tell the lender? In reality, the lender will discover the transfer of an interest in real estate in one of three ways:

1) Change of name on the deed. Not likely, since lenders don't readily have "spies" at the clerk's and recorder's office;

2) Different name on the check received for payment. Not likely, since the bank officers are far removed from the clerical workers who process payments; or

3) Change of hazard insurance beneficiary. This is the most common way a lender discovers a transfer of interest in the borrower's property.

If you notify your insurance carrier of a change in insurance beneficiary, the lender, who is also a named beneficiary, receives a copy of the change. However, if you transferred title into a land trust, the new beneficiary under the insurance policy will be the trustee of the land trust. The lender will probably not object, since it will assume the seller has implemented an estate planning device. If the beneficiary of the trust is assigned, the lender will not be notified since the insurance beneficiary (the trustee) has not changed.

http://www.legalwiz.com/due-on-sale-clause

Worthless Inventory Thor Power Tool Company v. Commissioner:

In this landmark case the IRS challenged Thor's practice of writing down the value of its spare parts inventory which it held to cover future warranty commitments. Thor contended that, although the sales price on the individual parts did not decline over the years, the probability of all the parts being sold decreased as time passed, and thus so did the net realizable value of the inventory as a whole. The IRS contended that a decline in inventory values for tax purposes must await actual decline in the sales price of the individual parts. The Supreme Court indicated that for tax purposes, the lower of cost or market method was to be applied on an individual item basis and that if no decline in sales price occurred, no loss should be permitted. (Intermediate Accounting, Kieso & Weygandt, 4th Edition, John Wiley & Sons, 1983, pp. 392-393)



Rexnord, Inc. v. United States of America
Rexnord reduced its 1977 and 1978 ending inventory by the goods it had sold to S.R. Sales, thus increasing its cost of goods sold and reducing its taxable income. The IRS claimed the reduction in ending inventory was not valid because the sale were not genuine, and the dispute over the $250,000 deficiency ended up in district court.

The Seventh Circuit Court of Appeals said the "sales" were an attempt to get around the U.S. Supreme Court's decision in Thor Power Tool Co. (taxpayer may not write off excess inventory it physically retains) and later cases in which manufacturers tried to write off excess inventory while keeping control over it. Rexnord claimed its sales were real because S.R. Sales had the right to resell the goods.

Result: The district court and the appellate court both held the sales were not bona fide. The economic reality was Rexnord maintained control over the inventory. Thus, the inventory writeoffs were not allowed.



The Tog Shop, Inc. v. United States

For its 1980 and 1981 tax years, Tog elected to use the "lower of cost or market method" and valued the excess inventory at net realizable value, which is the replacement cost of inventory less the direct cost of disposing of it. Tog did not compare cost and market for each individual item in its inventory. Instead, Tog applied a percentage formula to the total inventory, which was classified by age, to determine the value of the merchandise

Although this inventory valuation method met the provisions of GAAP and was consistently applied as required by Treas. Reg. Sec 1.471-2, the IRS argued that the method did not clearly reflect income. Even though GAAP would allow the valuation of classes of items, the court agreed with the IRS. Cited as precedent in Tog was Thor Power Tool Co.

§471 inventory rule under IRS Notice 2001-76 & Rev Proc 2001-10 & Rev Proc 2002-28:

Q: Do the new rules apply to all eligible taxpayers that fall under the $10 million threshold?

A: Yes, although taxpayers with average gross receipts of $1 million or less were already exempt under Rev. Proc. 2001-10. (5) That exemption applies without regard to the nature of the taxpayer's business; the Rev. Proc. 2002-28 exemption contains limits based on the taxpayer's business.

Q: Do the new rules exempt cash-basis taxpayers from the Sec. 471 inventory requirement?

A: Yes (but see the next Q&A). The exemption from Sec. 471 should be particularly beneficial for service businesses that also sell related products. As was discussed, the obligation of these service businesses to account for inventories has triggered extensive litigation.

Q: Does the Sec. 471 exemption mean that a cash-basis taxpayer can expense its merchandise in the tax year of purchase?

A: No. Rev. Proc. 2002-28 makes clear that the treatment of merchandise purchases must follow the treatment prescribed for purchases of significant (nonincidental) materials and supplies. Taxpayers can deduct the cost of such nonincidental items only as they are consumed during the tax year, under Regs. Sec. 1.162-3. Applying this rule to merchandise purchases means that the cost of such items may be deducted in the year of sale to customers. An exception applies when the taxpayer pays for the merchandise in a tax year later than the year in which it sells the items to customers. In this event, the items are deductible in the later tax year.

http://webcache.googleusercontent.com/search?q=cache:66yxAqwtoO4J:goliath.ecnext.com/coms2/gi_0199-1953592/Use-of-cash-method-by.html+Exempt+Rev+Proc+2001-10+%22already+exempt+under+Rev.+Proc.+2001-10%22&cd=1&hl=en&ct=clnk&gl=us


IRS Regs. §1.132-6(a) de minimis rule:

de-minimis - IRS Regs. §1.132-6(a)
A benefit is de minimis when the value of the worker's personal use is so small or insignificant that accounting for it would be unreasonable or administratively impractical. An example of this is an employee who stops for lunch or runs a personal errand while driving a company car on business. De minimis personal use is not treated as taxable income to the employee.

IRS Code §132(d) Working Condition Fringe Defined
For purposes of this section, the term "working condition fringe" means any property or services provided to an employee of the employer to the extent that, if the employee paid for such property or services, such payment would be allowable as a deduction under section 162 or 167.

§132(e) De Minimis Fringe Defined
For purposes of this section--
§132(e)(1) In General - The term "de minimis fringe" means any property or service the value of which is (after taking into account the frequency with which similar fringes are provided by the employer to the employer's employees) so small as to make accounting for it unreasonable or administratively impracticable.

 



Hot Assets under IRS Code §751 are taxable as ordinary (earned) income:

Hot Assets
§751(a) Sale Or Exchange Of Interest In Partnership

The amount of any money, or the fair market value of any property, received by a transferor partner in exchange for all or a part of his interest in the partnership attributable to--

751(a)(1) unrealized receivables of the partnership, or
751(a)(2) inventory items of the partnership,
shall be considered as an amount realized from the sale or exchange of property other than a capital asset.

751(b) Certain Distributions Treated As Sales Or Exchanges
751(b)(1) General Rule   To the extent a partner receives in a distribution--
751(b)(1)(A) partnership property which is--
751(b)(1)(A)(i)  unrealized receivables, or
751(b)(1)(A)(ii)  inventory items which have appreciated substantially in value,
in exchange for all or a part of his interest in other partnership property (including money), or

751(b)(1)(B) partnership property (including money) other than property described in subparagraph (A)(i) or (ii) in exchange for all or a part of his interest in partnership property described in subparagraph (A)(i) or (ii),".
such transactions shall, under regulations prescribed by the Secretary, be considered as a sale or exchange of such property between the distributee and the partnership (as constituted after the distribution).

751(b)(2) Exceptions
Paragraph (1) shall not apply to--
751(b)(2)(A)  A distribution of property which the distributee contributed to the partnership, or
751(b)(2)(B) payments, described in section 736(a), to a retiring partner or successor in interest of a deceased partner.
751(b)(3) Substantial Appreciation.--
For purposes of paragraph (1)--
751(b)(3)(A) In General.--
Inventory items of the partnership shall be considered to have appreciated substantially in value if their fair market value exceeds 120 percent of the adjusted basis to the partnership of such property.

751(b)(3)(B) Certain Property Excluded.--
For purposes of subparagraph (A), there shall be excluded any inventory property if a principal purpose for acquiring such property was to avoid the provisions of this subsection relating to inventory items."

 

Unrealized receivables include:

  • trade accounts receivable of a cash-basis partnership (less the cost of providing the goods or services which under Regs. 1.751-1(c)(2) shall include all costs or expenses attributable thereto paid or accrued but not previously taken into account under the partnership method of accounting.  i.e. some of the accounts payable to the extent that are applicable to the services rendered + members' GPP compensation to the extent they were involved in the rendering of such services. )
  • unbilled services already rendered
  • unbilled services not yet rendered but which must be included as income (less the projected cost of providing the services per Regs. 1.751-1(c)(3))
  • amortization recapture on a disposition of an intangible asset
  • depreciation recapture
  • ordinary gain for trade name, trademarks
  • uncompleted contracts accounted for as long-term contracts
  • others...


Inventory items include:

  • accounts receivable of an accrual-basis partnership
  • sec 1231 property or property that is not a capital asset

 



Hot Stock under IRS Code §355 are taxed as dividend income:

Hot Stock
Defined under §355(a)(3)(B) if the IR Code. The stock of a controlled corporation is treated as boot if it is acquired within 5 years of the distribution in a taxable transaction.

(B) Stock Acquired In Taxable Transactions Within 5 Years Treated As Boot

For purposes of this section (other than paragraph (1)(D) of this subsection) and so much of section 356 as relates to this section, stock of a controlled corporation acquired by the distributing corporation by reason of any transaction--

355(a)(3)(B)(i) which occurs within 5 years of the distribution of such stock, and

355(a)(3)(B)(ii) in which gain or loss was recognized in whole or in part, shall not be treated as stock of such controlled corporation, but as other property.


Also see Private Letter Ruling  PLR-123406-06 dated August 30, 2006
Section 355 of the Code provides that no gain or loss is recognized if (i) a corporation distributes to its shareholders with respect to its stock, stock or securities of a corporation which it controls immediately before the distribution, (ii) the transaction was not used principally as a device for the distribution of earnings and profits and (iii) both the distributing corporation and the controlled corporation have been engaged, throughout the five-year period ending on the date of the distribution, in an active trade or business and are engaged in an active trade or business immediately after the distribution.


 

Rev. Rul. 86-131, 1986-2 C.B. 135.
Since FX1 acquired the stock of FX2 within five years of the distribution of such stock in a transaction in which gain or loss was recognized, the distribution described above will not qualify as a tax-free distribution of stock under section 26 USC 355 of the Code and will be treated as a dividend to the extent provided in sections 26 USC 301 and 26 USC 316. Section 26 USC 355(a)(3)(B).



Hot Interest rule under IRS Code §6621(c) after a 30-day letter:

Hot Interest
In the case of a "large corporate underpayment", the underpayment rate for periods after the applicable date is equal to the federal short-term rate plus five percentage points. This increased rate of interest is known as "hot interest." Hot interest applies only to underpayments made by C corporations 12 when there is a threshold underpayment of tax for a taxable period that exceeds $100,000, computed without regard to interest, penalties, additional amounts, and additions to tax. 13 Underpayments of different types of taxes as well as underpayments relating to different taxable periods are not aggregated for purposes of determining whether the $100,000 threshold is satisfied.

6621(c) Increase In Underpayment Rate For Large Corporate Underpayments
6621(c)(1) In General - For purposes of determining the amount of interest payable under section 6601 on any large corporate underpayment for periods after the applicable date, paragraph (2) of subsection (a) shall be applied by substituting "5 percentage points" for "3 percentage points".

6621(c)(3) Large Corporate Underpayment
For purposes of this subsection--
6621(c)(3)(A) In General The term "large corporate underpayment" means any underpayment of a tax by a C corporation for any taxable period if the amount of such underpayment for such period exceeds $100,000.
6621(c)(3)(B) Taxable Period For purposes of subparagraph (A), the term "taxable period" means--
6621(c)(3)(B)(i) in the case of any tax imposed by subtitle A, the taxable year, or
6621(c)(3)(B)(ii) in the case of any other tax, the period to which the underpayment relates.



Tax Benefit Rule under IRS Code §111 (recoveries or refunds received by taxpayer in a year after the year of payment / year of deduction):

Tax Benefit Rule
An Internal Revenue Service provision stating that amounts received in one period, representing a recovery of an amount deducted in a prior year, are to be included in income to the extent that the prior deduction resulted in a decrease in taxable income in that year.

  1. If a taxpayer recovers an amount that was deducted or credited against tax in a previous year, the recovery must be included in income to the extent that the deduction or credit reduced the tax liability in the earlier year. If no tax benefit was derived from a prior-year deduction or credit, the recovery does not have to be included in income.
  2. If a taxpayer repays an amount that was previously included in taxable income, the repayment can be deducted in the year in which it is repaid.

 

IR Code §111  Recovery of tax benefit items:
(a) Deductions
Gross income does not include income attributable to the recovery during the taxable year of any amount deducted in any prior taxable year to the extent such amount did not reduce the amount of tax imposed by this chapter.

(b) Credits

  1. In general
    If-  (A) a credit was allowable with respect to any amount for any prior taxable year, and
          (B) during the taxable year there is a downward price adjustment or similar adjustment,

    the tax imposed by this chapter for the taxable year shall be increased by the amount of the credit attributable to the adjustment.
     
  2. Exception where credit did not reduce tax
    Paragraph (1) shall not apply to the extent that the credit allowable for the recovered amount did not reduce the amount of tax imposed by this chapter.
     
  3. Exception for investment tax credit and foreign tax credit
    This subsection shall not apply with respect to the credit determined under section 46 and the foreign tax credit.

(c) Treatment of carryovers
For purposes of this section, an increase in a carryover which has not expired before the beginning of the taxable year in which the recovery or adjustment takes place shall be treated as reducing tax imposed by this chapter.

(d) Special rules for accumulated earnings tax and for personal holding company tax
In applying subsection (a) for the purpose of determining the accumulated earnings tax under section 531 or the tax under section 541 (relating to personal holding companies)-

  1. any excluded amount under subsection (a) allowed for the purposes of this subtitle (other than section 531 or section 541) shall be allowed whether or not such amount resulted in a reduction of the tax under section 531 or the tax under section 541 for the prior taxable year; and
  2. where any excluded amount under subsection (a) was not allowable as a deduction for the prior taxable year for purposes of this subtitle other than of section 531 or section 541 but was allowable for the same taxable year under section 531 or section 541, then such excluded amount shall be allowable if it did not result in a reduction of the tax under section 531 or the tax under section 541.


Claim of Right Doctrine under IRS Code §1341 (payments returned from taxpayer in a year after the year of receipt / year of income) :

IR Code §1341 Claim of Right Doctrine:

  1. An item is included in gross income for a prior taxable year (or years) because it appeared that the taxpayer had an unrestricted right to such item;
     
  2. a deduction is allowable for the taxable year because it was established after the close of such prior taxable year (or years) that the taxpayer did not have an unrestricted right to such item or to a portion of such item; and
     
  3. the amount of such deduction exceeds $3,000, then the tax imposed by this chapter for the taxable year shall be the lesser of the following:
  • the tax for the taxable year computed with such deduction; or
  • an amount equal to the tax for the taxable year computed without such deduction, minus the decrease in tax under this chapter (or the corresponding provisions of prior revenue laws) for the prior taxable year (or years) which would result solely from the exclusion of such item (or portion thereof) from gross income for such prior taxable year (or years).

http://www.nysscpa.org/cpajournal/2004/1004/essentials/p42.htm

Where to report:
Enter the amount claimed as a refundable credit on line 68 (or line 71 in 2012) of form 1040. Write "IRC Section 1341" in the space to the right of line 68 (or line 71 in 2012).

Or take as in itemized deduction on line 28 of Schedule A of form 1040 in 2012.  (see IRS Publication 525)


Spiffs & Incentive Payments are not subject to employment taxes:

Spiffs or Special Performance Incentives for Field Force are "kickbacks" or incentives paid by manufacturers or distributors to the retail sales force.
|
Where a salesperson is awarded a payment or bonus for selling selling a manufacturer's product, and the manufacturer is not the salesperson's employer, such performance incentive payments are considered other income not subject to self-employment tax.

These are mostly associated with the auto industry, The reason behind why they became not subject to the SE tax is that auto sales people used to write all their expenses off on Schedule C as opposed to Schedule A and they ended up paying less in taxes.  So this "unfairness" was fixed
by making spiffs not subject to self-employment taxes.

If the manufacturer erroneously puts the amount in box 7 of form 1099-MISC, then you need to put it as revenue on Sch C and the same amount as other expenses with a description like "Manufacturer Incentive Reported on Page 1 Line 21". Then put the amount on line 21. If it is box 3 Other Income then just put it on Line 21 with no SE Tax.

http://www.irs.gov/pub/irs-pdf/p3204.pdf


one-time payments, even if "earned" might not qualify as a "trade or business" and therefore are not subject to S/E taxes
Batok, TC Memo 1992-727


TAM 9423004   TAM 9525003   TAM 9647003
 


Foreign Tax Paid election: to deduct on Schedule A, or to take as a foreign tax credit; - subject to a 10-year SOL for claiming a refund:

Proforma letter to the IRS after receiving rejections of form 1040X :

The above taxpayers have received a denial of our claim for refund for the stated reason that at the time, more than 3 years had passed before filing the claim.
 
I request your reconsideration, because I believe that the Service has erred by inadvertently overlooking the §6511(d)(3) "ten-year rule."
I’d like to bring to your attention Chapter 61. LMSB International Program Audit Guidelines, Section 10. Foreign Tax Credit 4.61.10.7 (05-01-2006) Changes in the Amount of Foreign Taxes Claimed "4. There is a ten-year statute of limitations for filing a refund claim when a U.S. taxpayer pays foreign tax relating to an earlier year."
This is found on the following webpage:
http://www.irs.gov/irm/part4/irm_04-061-010.html
 
 
And pursuant to §6511(d)(3)(A) Special period of limitation with respect to foreign taxes paid or accrued.
If the claim for credit or refund relates to an overpayment attributable to any taxes paid or accrued to any foreign country or to any possession of the United States for which credit is allowed against the tax imposed by subtitle A in accordance with the provisions of section 901 or the provisions of any treaty to which the United States is a party, in lieu of the 3-year period of limitation prescribed in subsection (a), the period shall be 10 years from the date prescribed by law for filing the return for the year in which such taxes were actually paid or accrued.
 
§6511(d)(3)(B)Exception in the case of foreign taxes paid or accrued.-
In the case of a claim described in subparagraph (A), the amount of the credit or refund may exceed the portion of the tax paid within the period provided in subsection (b) or (c), whichever is applicable, to the extent of the amount of the overpayment attributable to the allowance of a credit for the taxes described in subparagraph (A).
 
 
And pursuant to regulation §301.6511(d)-3. Internal Revenue Service, Special rules applicable to credit against income tax for foreign taxes
 
(a)Period in which claim may be filed.-
In the case of an overpayment of income tax resulting from a credit, allowed under the provisions of section 901 or under the provisions of any treaty to which the United States is a party, for taxes paid or accrued to a foreign country or possession of the United States, a claim for credit or refund must be filed by the taxpayer within 10 years from the last date prescribed for filing the return (determined without regard to any extension of time for filing such return) for the taxable year with respect to which the claim is made. Such 10-year period shall be applied in lieu of the 3-year period prescribed in section 6511(a).
 
(b)Limit on amount to be credited or refunded.-
In the case of a claim described in paragraph (a) of this section, the amount of the credit or refund allowed or made may exceed the portion of the tax paid within the period prescribed in section 6511(b) or (c), whichever is applicable, to the extent of the amount of the overpayment attributable to the allowance of a credit against income tax referred to in paragraph (a) of this section [Reg. §301.6511(d)-3.]
 
Please contact the undersigned to discuss. 


Sale of "Personal Goodwill" Martin Ice Cream case:

Martin Ice Cream Co. v. Commissioner, 110 T.C. 189 (1998).

http://www.foxfin.com/articles/personal-goodwill.htm

http://www.mercercapital.com/print/?id=363

http://www.journalofaccountancy.com/Issues/2001/May/AvoidTaxesInLiquidation.htm


Demutualization a life insurance company:

Though generally considered as being "tax-free," litigation may change the position on this from time-to-time:

http://www.demutualization.biz/

http://www.costbasis.com/stocks/demutualizationshares.html

http://www.kpmg.com/us/en/issuesandinsights/articlespublications/taxnewsflash/pages/life-insurance-federal-district-court-grants-taxpayer-refud-claim-sale-shares-received-demutualization-life-company.aspx

 


Sale of life Insurance policy by a terminally ill or chronically ill insured person "Viatical Settlements":

Viatical Settlements Viatication allows a terminally or chronically ill person to sell a life insurance policy to someone who is buying it as an investment (i.e., the buyer receives the life insurance proceeds upon the death of the insured). Amounts received from the sale or assignment of a life insurance contract on the life of a terminally ill individual to a qualified viatical settlement provider are excluded from gross income [IRC Sec. 101(g)(2)]. However, the exclusion does not apply if the payments are paid to someone other than the terminally ill individual if the recipient has a business or financial relationship with the insured [IRC Sec. 101(g)(5)]. (See the Preparation Pointer under "Accelerated Life Insurance Proceeds" for the forms used to report viatical settlement proceeds.) A chronically ill individual (defined later in this key issue) can also exclude amounts received for viatical settlements but only if the payments are used for long-term care services and subject to per day and annual limits [IRC Sec. 101(g)(3)]. (See Key Issue 6G.) The services cannot be compensated by insurance and generally cannot be reimbursable by Medicare. A viatical settlement provider is any person regularly engaged in the trade or business of purchasing or taking assignments of life insurance contracts on the lives of individuals who are terminally or chronically ill. In addition, the viatical settlement provider must generally be licensed in particular states where they do business, or must otherwise meet certain legal requirements [IRC Sec. 101(g)(2)(B)(i)]. See Rev. Rul. 2002-82 for details. An individual need not be terminally or chronically ill to enter into a viatical settlement. However, there is no income exclusion in this situation. Instead, the seller must report income to the extent the sales proceeds exceed his or her adjusted basis in the contract. The adjusted basis, which cannot be less than zero, is equal to (1) the amount of premiums the taxpayer paid up to the time of sale less (2) the amount of any refunded premiums, rebates, dividends, or unrepaid loans that were not included in the policyholder's income (Rev. Rul. 2009-13; Reg. 1.1021-1). Although a life insurance policy is a capital asset in the hands of the policyholder, gain to the extent of the policy's cash surrender value over the adjusted basis is taxed as ordinary income under the assignment of income doctrine (Gallun; Neese). To the extent the gain exceeds that amount, it is treated as capital gain, assuming it is a capital asset in the hands of the taxpayer (Rev. Rul. 2009-13).



Underpayment of withholding and estimated tax payments:

Underpayment of withholding and estimated tax payments - from IRS Publication 505:

General Rule
In general, you may owe a penalty for 2005 if the total of your withholding and estimated tax payments did not equal at least the smaller of:
1. 90% of your 2005 tax, or
2. 100% of your 2004 tax. (Your 2004 tax return must cover a 12-month period.)

Your 2005 tax, for this purpose, is your Total tax for 2005, defined under Exceptions, later.

Amended returns. If you file an amended return by the due date (ed note: is this the original due date or the extended due date? unanswered!) of your original return, use the tax shown on your amended return to figure your required estimated tax payments. If you file an amended return after the due date of the original return, use the tax shown on the original return.

However, if you and your spouse file a joint return after the due date to replace separate returns you originally filed by the due date, use the tax shown on the joint return to figure your required estimated tax payments. This rule applies only if both original separate returns were filed on time.

2004 joint return and 2005 separate returns. If you file a separate return for 2005, but you filed a joint return with your spouse for 2004, your 2004 tax is your share of the tax on the joint return. You filed a separate return if you filed as single, head of household, or married filing separately.


Rev. Rul. 82-208, 1982-2 C.B. 58, the IRS concluded that no deduction would be permitted in year 1 for state income tax estimated tax payments for year 1 that were unreasonably too high for year 1. The ruling involved a taxpayer whose income was salary and for which state income tax withholding was sufficient. Clearly the taxpayer was paying a high estimated state income tax in year 1 in order to benefit from the deduction, even though the payments would either be refunded or credited by the state towards the taxpayer's year 2 state income tax liability.

Where a taxpayer, pursuant to state law authorizing such payment, makes an estimated payment of state income taxes that is reasonably determined in good faith at the time of payment, such payments are deductible under section 164(a)(3) of the Code.  But for this ruling, the IRS held that the taxpayer had no reasonable basis to believe that he owed any additional state income taxes and did not allow the estimated payment to be deducted on the 1981 income tax return.


In Estate of Cohen v. Comr., T.C. Memo 1970-272, the court rejected the IRS attempt to deny a deduction for high estimated state income tax payments made in year 1 towards year 1 state income tax liabilities because the amount of state income tax liability was uncertain at the time.


Employee withholding taxes, form W-4:

Withholding Compliance Questions & Answers

Q1: In the past, as an employer, I was required to submit all Forms W-4 that claimed complete exemption from withholding (when $200 or more in weekly wages were regularly expected) or claimed more than 10 allowances. What Forms W-4 do I now have to submit to the IRS?
A1: Employers are no longer required to routinely submit Forms W-4 to the IRS.  However, in certain circumstances, the IRS may direct you to submit copies of Forms W-4 for certain employees in order to ensure that the employees have adequate withholding. You are now required to submit the Forms W-4 to IRS only if directed to do so in a written notice or pursuant to specified criteria set forth in future published guidance. 


Q2: If an employer no longer has to submit Forms W-4 claiming complete exemption from withholding or claiming more than 10 allowances, how does the IRS determine adequate withholding?
A2: The IRS is making more effective use of information contained in its records along with information reported on Form W-2 wage statements to ensure that employees have enough federal income tax withheld. 


Q3: If the IRS determines that an employee does not have enough federal income tax withheld, what will an employer be asked to do?
A3: If the IRS determines that an employee does not have enough withholding, we will notify you to increase the
amount of withholding tax by issuing a “lock-in” letter that specifies the maximum number of withholding allowances
permitted for the employee. You will also receive a copy for the employee that identifies the maximum number of withholding exemptions permitted and the process by which the employee can provide additional information to the IRS for purposes of determining the appropriate number of withholding exemptions. If the employee still works for you, you must furnish the employee copy to the employee. If the employee no longer works for you, NO ACTION IS REQUIRED AT THIS TIME. However if the employee should return to work within twelve (12) months, you should begin withholding income tax from the employee’s wages based on the withholding rate stated in this letter.The employee will be given a period of time before the lock-in rate is effective to submit for approval to the IRS a new Form W-4 and a statement supporting the claims made on the Form W-4 that would decrease federal income tax
withholding. The employee must send the Form W-4 and statement directly to the IRS office designated on the lock-in letter. You must withhold tax in accordance with the lock-in letter as of the date specified in the lock-in letter, unless otherwise notified by the IRS. You will be required to take this action no sooner than 45 calendar days after the date of the lock-in letter. Once a lock-in rate is effective, an employer can not decrease withholding unless approved by the IRS.


Q4: As an employer, after I lock in withholding on an employee based on a lock-in letter from the IRS, what do I do if I receive a revised Form W-4 from the employee?
A4: After the receipt of a lock-in letter, you must disregard any Form W-4 that decreases the amount of withholding. The employee must submit for approval to the IRS any new Form W-4 and a statement supporting the claims made on the Form W-4 that would decrease federal income tax withholding. The employee should send the Form W-4 and statement directly to the address on the lock-in letter. The IRS will notify you to withhold at a specific rate if the employee’s request is approved. However, if, at any time, the employee furnishes a Form W-4 that claims a number of withholding allowances less than the maximum number specified in the lock-in letter, the employer must increase withholding by withholding tax based on that Form W-4.


Q5: As an employer who has received a modification letter (letter 2808C) from the WHC program, do I wait for another 60 days to change the marital status and/or number of allowances per the modification letter?
A5: No, the modifications to the marital status and/or number of allowances become effective immediately upon receipt of the letter 2808C. 


Q6: I have been directed to lock in an employee’s withholding. What happens if I do not lock in the employee’s withholding as directed?
A6: Those employers who do not follow the IRS lock-in instructions will be liable for paying the additional amount of tax that should have been withheld. 


Q7: Our employees can submit or change their Forms W-4 on line. How can I prevent them from changing their Forms W-4 after they have been locked-in by the IRS?
A7: You will need to block employees who have been locked-in from using an on line Form W-4 system to decrease their withholding.


Q8:  What should I do if an employee submits a valid Form W-4 that appears to be claiming an incorrect withholding amount?
A8: You should withhold federal income tax based on the allowances claimed on the Form W-4.  But, you should advise the employee that the IRS may review withholding to ensure it is adequate, and that the IRS may direct you, as the employer, to withhold income tax for the employee at a certain rate if the review indicates the employee’s withholding is inadequate. Once this occurs the employee will not be allowed to decrease their withholding unless approved by the IRS.


Q9: What do I do if an employee hands me a substitute Form W-4 developed by the employee?
A9:  Employers may refuse to accept a substitute form developed by an employee and the employee submitting such a form will be treated as failing to furnish a Form W-4.  In such case, you should inform the employee that you will not accept this form and offer the employee an opportunity to complete an official Form W-4 or a substitute Form W-4 developed by you. Until the employee furnishes a new Form W-4, the employer must withhold from the employee as from a single person claiming no allowances; if, however, a prior Form W-4 is in effect for the employee, the employer must continue to withhold based on the prior Form W-4.  As an employer, a substitute withholding exemption certificate developed by you can be used in lieu of the official Form W-4, if you provide all the tables, instructions, and worksheets contained in the Form W-4 in effect at that time to the employee.  


Q10: What do I do if an employee hands me an official IRS Form W-4 that is clearly altered?
A10: Any alteration of a Form W-4 (e.g. crossed out penalties of perjury statement above the signature) will cause the Form W-4 to be invalid. If an employer receives an invalid Form W-4, the employee will be treated as failing to furnish a Form W-4; the employer must inform the employee that the Form W-4 is invalid, and must request another Form W-4 from the employee. Until the employee furnishes a new Form W-4, the employer must withhold from the employee as from a single person claiming no allowances. If, however, a prior Form W-4 is in effect for the employee, the employer must continue to withhold based on the prior Form W-4.


Q11: I heard my employer no longer has to routinely submit Forms W-4 to the IRS.  How will this affect me as an employee?
A11: There is no change in the requirement that employees have adequate income tax withholding. The withholding
calculator found on www.irs.gov is available to help employees determine the proper amount of federal income tax
withholding. Another useful resource, Publication 505, “Tax Withholding and Estimated Taxes" is available on the IRS
Web site or can be obtained by calling 1-800-TAX-FORM (829-3676).  Individuals who do not have sufficient income tax
withholding are subject to penalties. The IRS will be making more effective use of information contained in its
records along with information reported on Form W-2 wage statements to ensure that employees have enough federal
income tax withheld. 


Q12: As an employee, what happens if the IRS determines that I do not have adequate withholding?
A12: The IRS may direct your employer to withhold federal income tax at an increased rate to ensure you have adequate withholding by issuing a lock-in letter. At that point, your employer must disregard any Form W-4 that decreases the amount of withholding. You will receive a copy of the lock-in letter. You will be given a period of time before the lock-in rate is put in effect to submit for approval to the IRS a new Form W-4 and a statement supporting the claims made on the Form W-4 that would decrease your federal income tax withholding. You should send the Form W-4 and statement directly to the address on the lock-in letter. Once a lock-in letter is issued, you will not be allowed to decrease your withholding unless approved by the IRS.


Q13: What if I don’t want to submit a Form W-4 to my employer?
A13: Your employer is required to withhold income tax from your wages as if you are single with zero allowances if you do not submit a Form W-4.

Page Last Reviewed or Updated: 30-Oct-2012

 

http://www.irs.gov/Individuals/Withholding-Compliance-Questions-&-Answers

30-day letter, 90-day letter & tax court:

Proposed Individual Tax Assessment (Letter 2566 SC/CG)
  • The Proposed Individual Tax Assessment is also referred to as a 30-day letter.
  • This letter notifies you that we have no record of receiving your Form 1040, U.S. Individual Income Tax Return.
  • It proposes a tax assessment with penalties and interest based on income reported to us by your employers, banks, etc.
  • The letter also states that within 30 days, you must submit one of the following:
    • Your Form 1040 completed and signed, including all schedules and forms with cover letter;
    • The Consent to Assessment and Collection form, signed and dated;
    • A statement explaining why you believe you are not required to file, or information you would like us to consider.

Notice of Deficiency (Letter 3219 SC/CG)

  • A Notice of Deficiency is sometimes referred to as a 90-day letter. The Notice of Deficiency tells you the tax we assess plus the interest and penalties you will owe. A Notice of Deficiency is required by law and is to advise you of your appeal rights to the U.S. Tax Court.
  • The letter also states that within 90 days, you must submit one of the following:
    • Your Form 1040 completed and signed, including all schedules and forms with cover letter;
    • The Consent to Assessment and Collection form, signed and dated;
    • A statement explaining why you believe you are not required to file, or information you would like us to consider.

Do I need to petition tax court?

If you file your return, it is not necessary to petition tax court, as your submitted return will be processed based on your information. This is true whether you file the return prior to the IRS proposed assessment being made or after the IRS assessment has been processed.

However if you do not file a return, and do not agree with the tax proposed by the IRS, you have 90 days from the date on the Notice of Deficiency to dispute the amount the IRS says you owe.

http://www.irs.gov/businesses/small/article/0,,id=171838,00.html


Trick to waive penalties for late filing a partnership tax return:

Under Rev. Proc. 84-35, the following partnerships will qualify for an automatic waiver of the Sec. 6698 late-filing penalty for a partnership return, if:

  • The partnership has 10 or fewer partners, all of whom are natural persons (other than nonresident aliens) or estates;
  • Each partners share of each partnership item is the same as such partners share of every other item;
  • The partnership can establish, if requested by the IRS, that all partners have fully reported their shares of income, deductions and credits on their timely filed returns.

Service Center Advice  (Letter Ruling) SCA 200135029 suggested that taxpayers answer the following six questions:

  • Is the partnership a domestic partnership?
  • Does the partnership have 10 or fewer partners (husband and wife and their estates are treated as one partner)?
  • Are all partners natural persons (other than a nonresident alien) or an estate of a deceased partner?
  • Is each of the partner's shares of each partnership item the same as his share of every other item?
  • Have all of the partners timely filed their income tax returns?
  • Have all of the partners fully reported their share of the partnership's income, deductions and credits on their timely filed income tax returns?

If the taxpayer can answer "yes" to all of the above questions, the Service would abate abate any failure-to-file penalty for partnerships.


Rev. Proc. 84-35, 1984-1 C.B. 509
SECTION 1. PURPOSE
The purpose of this revenue Procedure is to update Rev. Proc. 81-11, 1981-1 C.B. 651, to conform to the small partnership provisions of section 6231(a)(1)(B) of the Internal Revenue Code. Rev. Proc. 81-11 sets forth the procedures under which
partnerships with 10 or fewer partners will not be subject to the penalty imposed by section 6698 for failure to file a partnership return.

SECTION 2. BACKGROUND
.01 Section 6031(a) of the Code provides that every partnership must make a return for each taxable year including all information that the Secretary may by forms and regulations prescribe.
.02 Section 402 of the Tax Equity and Fiscal Responsibility Act of 1982, 1982-2 C.B. 462, 585, added sections 6621 through 6232 to the Code to provide that the tax treatment of partnership items must be determined at the partnership level. For purposes of these sections, section 6231(a)(1)(A) defines "partnership" to mean any partnership required to file a return under section 6031(a) except as provided in section 6231(a)(1)(B).

.03 Section 6231(a)(1)(B) of the Code provides an exception to the definition of "partnership" for small partnerships. In general, the term "partnership" does not include a partnership if the partnership has 10 or fewer partners, each of whom is a natural person (other than a nonresident alien) or an estate, and each partner's share of each partnership item is the same as such partner's share of every other item. A husband and wife, and their estates, are treated as one partner for this purpose.

.04 Section 6698 of the Code imposes a penalty if any partnership required to file a return under section 6031 fails to file a timely return, or files a return that fails to show the information required by that section, unless the failure is due to reasonable cause.

.05 The Conference Committee Report concerning section 6698 of the Code states:
The penalty will not be imposed if the partnership can show reasonable cause for failure to file a complete or timely return. Smaller
partnerships (those with 10 or fewer partners) will not be subject to the penalty under this reasonable cause test so long as each partner fully reports his share of the income, deductions, and credits of the partnership...
H.R. Rep. No. 95-1800 (Conf. Report), 95th Cong., 2d Sess. 221 (1978), 1978-3 C.B. (Vol. 1) 521, 555. See also H.R. Rep. No. 95-1445, 95th Cong., 2d Sess. 75 (1978), 1978-3 C.B. (Vol. 1) 181, 249, and S. Rep. No. 95-1263, 95th Cong., 2d Sess. 106 (1978), 1978-3 C.B. (Vol. 1) 315, 403, which contain similar statements.

SECTION 3. REQUIRED PROCEDURES
.01 A domestic partnership composed of 10 or fewer partners and coming within the exceptions outlined in section 6231(a) (1)(B) of the Code
will be considered to have met the reasonable cause test and will not be subject to the penalty imposed by section 6698 for the failure to file a complete or timely partnership return, provided that the partnership, or any of the partners, establishes, if so requested by the Internal Revenue Service, that all partners have fully reported their shares of the income, deductions, and credits of the partnership on their timely filed income tax returns.

.02 Partnerships having a trust or corporation as a partner, tier partnerships, and partnerships where each partner's interest in the capital and profits are not owned in the same proportion, or where all items of income, deductions, and credits are not allocated in proportion to the pro rata interests, do not come within the exception provisions of section 6231(a)(1)(B) of the Code and, are subject to the penalty imposed by section 6698.

.03 Although a partnership of 10 or fewer partners may not be automatically excepted from the penalty imposed by section 6698 of the Code under section 3.01, the partnership may show other reasonable cause for failure to file a complete or timely partnership return.

.04 In determining whether a partner has fully reported the partner's share of the income, deductions, and credits of the partnership, for purposes of section 3.01, all the relevant facts and circumstances will be taken into account. In making this determination, the nature and materiality of any error or omission will be considered. For example, although an isolated clerical error normally reflects no more than mere inadvertence, such an error may be of such magnitude that the partner will not be considered to have fully reported. If the error or omission results in a de minimis understatement of the net amount payable with respect to any income tax, the penalty will not be asserted. However, if the error or omission results in a material understatement of the net amount payable with respect to any income tax, the partner generally will not be considered to have fully reported and the penalty will be applied.

SECTION 4. EFFECT ON OTHER Revenue Procedures
Rev. Proc. 81-11 is modified and superseded.

SECTION 5. EFFECTIVE DATE
This revenue Procedure is effective for returns required to be filed after June 22, 1984.

IRM Exhibit 20.1.2-1 Revenue Procedure 84-35
http://www.irs.gov/irm/part20/irm_20-001-002-cont01.html#d0e5187

IRM 20.1.2.3.3.1 (04-19-2011) Revenue Procedure 84-35
http://www.irs.gov/irm/part20/irm_20-001-002-cont01.html#d0e4543 

 

IRM 8.19.1.6.3.1 (12-01-2006) Small Partnership Exception
http://www.irs.gov/irm/part8/irm_08-019-001.html#d0e396

IRM 3.11.15.14.10 (1-1-2013) Reasonable Cause for Failing to File a Timely Return
http://www.irs.gov/irm/part3/irm_03-011-015r-cont01.html#d0e8820 


Proforma request for penalty abatement:
Department of the Treasury
Internal Revenue Service Center
Cincinnati, OH 45999-0039

Re: XYZ Associates TIN: XX-XXXXXXX form 1065 penalty

Dear Sirs:

The above taxpayer received a penalty of $195 per month, per partner for allegedly filing their tax return three months late.

The taxpayer respectfully requests abatement of the penalty under the provisions of Rev. Proc. 84-35, 1984-1 C.B. 509.

Under Section 2.05 of that Rev. Proc. A partnership is exempt from the penalty as follows:
The Conference Committee Report concerning section 6698 of the Code states:
The penalty will not be imposed if the partnership can show reasonable cause for failure to file a complete or timely return. Smaller partnerships (those with 10 or fewer partners) will not be subject to the penalty under this reasonable cause test so long as each partner fully reports his share of the income, deductions, and credits of the partnership...

The partnership is comprised of only five partners and each reported on their form 1040 tax return their share of the income, deductions, and credits of the partnership.

Please inform the taxpayer directly of your determination.

Very truly yours,



update: (IRM)
In late 2007 new law passed - late filing penalties for late filed form 1065 will no longer be @ $50 per partner, per month, for up to 5 months or $250/K-1.  Rather effective 12/20/07, for 2007 tax returns a Code §66
98(b)(1) penalty is now $85, per K-1, per month, for up to 12 months, or $1,020/K-1.  S-corp. form 1120S K-1's which were exempt in the past, now have a Code §6699(b)(1) penalty for the same $1,020/K-1. 

update:
For 2008 and 2009 tax returns, the form 1065 and form 1120S penalties were raised to $89 or $90 per K-1,  per month, for up to 12 months or $1,068/K-1 or $1,080/K-1.
(the additional $1 increase was authorized by subsequent passing of The Hokie Act and depend on the beginning date of the taxable year)

update: 11/26/09
For 2010 tax returns, the form 1065 and form 1120S penalties were increased to $195
, per K-1,  per month, for up to a12 months or $2,340/K-1.
(over the fiscal period 2011 to 2019, these penalties are projected to raise $642 million (form 1065 partnership penalties) and $587 million (form 1120S S corporation penalties)

update 6/14/12
TC Summary Opinion 2012-55 determines reasonable cause (and not due to willful neglect) for S-corp for the purposes of the Code §6699(b)(1) penalty by interpreting 26 C.F.R. section 301-6651-1(c)(1) "If the taxpayer exercised ordinary business care and prudence and was nevertheless unable to file the return within the prescribed time, then the delay is due to a reasonable cause."


Potential effects of using IRS form 8893 to make the election pursuant to IRC §6231(a)(1)(B)(ii) to have the provisions of subchapter C of chapter 63 of the IRC apply with respect to a partnership (that files form 1065)

Starting in 2012, the IRS occasionally responds with a 168C or 854C letter to a partnership's request for section 6698 penalty abatement pursuant to Rev. Proc 84-35 by sending IRS LTR 854C to the partnership:
"The partnership does not qualify for a penalty waiver under Revenue Procedure 84-35 because our records indicate that the partnership elected to be subject to the consolidated audit procedures in IRS 6221 through IRC 6233."
"The partnership does not qualify for a waiver under Rev. Proc 84 35 because our records indicate that the partnership elected to be subject to the consolidated audit procedures in IRS 6221 through IRC 6233."

But consider the IRS Nat'l Office Significant Service Center Advice No. 200135029 Memorandum for Associate Area Counsel, Boston Small Business/Self Employed CC:SB:1:BOS which states: "Section 6231(a)(1)(B) was enacted as part of the Tax Equity and Fiscal Responsibility Act (TEFRA) of 1982, Pub L 97-248, in an effort to provide unified partnership audit and litigation procedures.  See generally I.R.C. §6221 through 6233. These provisions, which can be found in Subchapter C of Chapter 63 (governing tax treatment of partnership items) are completely unrelated and have no bearing on the application and scope of section 6698."

See LAW & ANALYSIS here:  200135029 Significant Service Center Advice - August 1, 2001

See Regs §301.6231(a)(1)-1 here:  http://law.justia.com/cfr/title26/26-18.0.1.1.2.3.56.43.html

See Code §6231(a)(1)(B) here: http://www.law.cornell.edu/uscode/text/26/6231 


S-corp late filing penalty waived due to reasonable cause: T.C. Summary Opinion 2012-55

 



Trick to waive penalty for late payment of individual income tax:

Proforma request for penalty abatement:
Department of the Treasury
Internal Revenue Service Center
P.O. Box 9019
Holtsville, NY 11742-9019

Re:  James and Jane Lastname SSN: XXX-XX-XXXX  form 1040 penalty

Dear Sirs:

The above taxpayer received a penalty under Code Section 6651 for paying their 20XX taxes late.

The taxpayer respectfully requests abatement of the penalty due to reasonable cause, which is presumed when ninety percent (90%) or more of the 20XX tax liability was paid by April 15, 20XY and the balance due was remitted with the filing of the tax return. (see Regs. §301.6651-1(c)(3)).

Please inform the taxpayer directly of your determination.

Very truly yours,



Trick to use when form W-2 is missing - new IRS/State crackdown starting 2007:

Were you an "employee" misclassified by your employer as a "self-employed sub-contractor"?
(Caution to businesses / employers:  you need to be aware of these items available to your subcontractors / employees)

When form
W-2 is lost, missing or incorrect or was not even issued to "an employee," then IRS form 4852 can be used as a substitute.


Additional new crackdown on employers "incorrect" reporting of employees:
Starting with 2007 employment as an "employee" - but you were not issued a form W-2 or you were issued a form 1099-MISC instead of a form W-2, then IRS form 8919 may be "required" to be filed.  

To determine if a person is an employee (rather than a subcontractor)  IRS form SS-8 may be needed.


IRS Announcement 2001-64 Voluntary Classification Settlement Program VCSP
is a new program developed by the IRS that allows taxpayers to voluntarily reclassify their workers as employees for future tax periods for employment tax purposes FAQ



Old rules - pre 2007:
IRS Notice 989 (issued March 1999)
When IRS Determines Your Work Status is "Employee" gave the following instructions to these employees:
If you are filing an original Form 1040 return, show the total computed social security and Medicare tax due on form 4137, Social Security and Medicare Tax on Unreported Tip Income. Cross out the word "TIP(S)" and insert the word "WAGE(S)" on the Form 4137 and use wage(s) in place of tip(s) when completing the form. Then enter the social security and Medicare tax total on Form 1040, page 2 in the other taxes section as instructed on the Form 4137. Use the appropriate forms for the tax year you are filing.

Starting with 2007 form 4137 includes the following new instructions: "Use Form 4137
only to figure the social security and Medicare tax owed on tips you did not report to your employer, including any allocated tips shown on your Form(s) W-2 that you must report as income. "  "If you believe you are an employee and you received Form 1099-MISC, Miscellaneous Income, instead of Form W-2, Wage and Tax Statement, because your employer did not consider you an employee, do not use Form 4137. Instead, use Form 8919, Uncollected Social Security and Medicare Taxes on Wages."


What to Do If You Are Missing a W-2
http://www.irs.gov/newsroom/article/0,,id=106470,00.html

   
IRS TAX TIP 2009-28

Did you get your W-2? These documents are essential to filling out most individual tax returns. You should receive a Form W-2, Wage and Tax Statement, from each of your employers each year. Employers have until February 2, 2009 to provide or send you a 2008 W-2 earnings statement either electronically or in paper form. If you haven’t received your W-2, follow these steps:

  1. Contact your employer. If you have not received your Form W-2, contact your employer to inquire if and when the W-2 was mailed.  If it was mailed, it may have been returned to the employer because of an incorrect or incomplete address.  After contacting the employer, allow a reasonable amount of time for them to resend or to issue the W-2.
     
  2. Contact the IRS. If you still do not receive your W-2 by February 17th, contact the IRS for assistance at 800-829-1040. When you call, have the following information:
    • Employer's name, address, city, and state, including zip code;
    • Your name, address, city and state, including zip code, and Social Security number; and
    • An estimate of the wages you earned, the federal income tax withheld, and the period you worked for that employer. The estimate should be based on year-to-date information from your final pay stub or leave-and-earnings statement, if possible.
  3. File your return. You still must file your tax return on time even if you do not receive your Form W-2. If you have not received your Form W-2 by February 17th, and have completed steps 1 and 2 above, you may use Form 4852, Substitute for Form W-2, Wage and Tax Statement. Attach Form 4852 to the return, estimating income and withholding taxes as accurately as possible.  There may be a delay in any refund due while the information is verified. 
     
  4. File a Form 1040X. On occasion, you may receive your missing documents at a later date and some may have conflicting information. You may receive a Form W-2 or W-2C (corrected form) after you filed your return using Form 4852, and the information differs from what you reported on your return. If this happens, you must amend your return by filing a Form 1040X, Amended U.S. Individual Income Tax Return.

Form 4852, Form 1040X, and instructions are available on the IRS Web site, IRS.gov or by calling 800-TAX-FORM (800-829-3676).

Links:

  • Form 4852, Substitute for Form W-2, Wage and Tax Statement (PDF 29K)
  • Form 14157, "E-filing Using Payroll Stub" question 13 page 1 and page 4 (PDF)
  • Form 14039, "Identity Theft Affidavit"  (PDF)
  • Form 1040X, Amended U.S. Individual Income Tax Return (PDF 123K)
  • Instructions for Form 1040X (PDF 43K)  

(Caution to businesses / employers:  you need to be aware of this IRS / State crackdown)

FS-2007-25, November 2007
QETP Definition:  Questionable employment tax practices (QETP) are employment tax schemes or practices that have no objective other than to avoid federal and/or state employment taxes.

Additional information from the IRS on the Questionable Employment Tax Practices (QETP) Memorandum of Understanding (MOU)

IRS Publication 1976 regarding relief available under Section 530 information

IRS offers tips on correcting misclassified employee reporting

IRS site search for updated information

Google search for updated information

Information for newly registered employers:
depositing employees' withholding taxes
small employer tax filings
business.gov - 10 steps to hiring your first employee


(Caution to businesses / employers:  you need to be aware of this 2008 IRS / State crackdown)

IRS will be using a computer matching program to further check on the payees of any business that issues five or more form 1099-MISC to workers in an amount exceeding $25,000 each.  They will then do a search for all 1099's and W-2's to these workers and a listing of prospects for employment tax audits will be generated.  (source: KiplingerTaxLetter 2/22/08)


(Voluntary Classification Settlement Program (VCSP) started by IRS in September 2011)

Employers may file an application using IRS Form 8952 if they consistently treated workers in question as outside contractors and must have issued forms 1099 annually for at least the last three years.  See IRS Announcement 2011-64 for details.     Application-for-Voluntary-Classification-Settlement-Program-(VCSP)


Re: payments as "employee reimbursements" and "independent contractor."

A person who is an employee, generally, may not provide services as an independent contractor (to the same business owner).
It is generally viewed as a form of tax evasion and is routinely reclassified to wages, along with interest and penalty, including as a penalty - the employer must pay the income taxes for the independent contractor/employee.

Employee expense reimbursements are okay only if they are paid pursuant to an "accountable plan" meaning that you reimburse the employee for the exact amount in exchange for appropriate receipts from the employee.  Any "unaccountable plan" such as giving the employee a flat $100 to cover costs for uniforms, mileage or other costs of a business trip, must be added to the employee's W-2 as wages.

You may give one separate check to an employee in the amount of $25 each calendar year as a "gift" and this does not need to be reported on the employee's W-2.



Trick to use when form W-2 is checked as being an active participant in retirement plan:

http://www.irs.gov/pub/irs-pdf/f8275.pdf

For information on the active participant rules, see Notice 87-16, 1987-1 C.B. 446, Notice 98-49, 1998-2 C.B. 365, section 219(g)(5), and Pub. 590, Individual Retirement Arrangements (IRAs).

Notice 87-16

I. DEDUCTIBLE CONTRIBUTIONS TO IRAs

A. ACTIVE PARTICIPANT STATUS

An individual who is not an active participant in a retirement arrangement specified in section 219(g)(5) of the Code may make a deductible IRA contribution for the taxable year of up to the lesser of $2,000 ($2,250 for spousal IRAs) or 100% of compensation. An individual who is married and files a joint federal income tax return will be treated as an active participant if such individual's spouse is an active participant.

Section 219(g) of the Code provides that if an individual is an active participant in such a retirement arrangement for a taxable year, the $2,000 ($2,250 for spousal IRAs) dollar limit on the individual's deduction may be reduced or eliminated for such year. Accordingly, the first step in determining the permissible IRA deduction for a year is to determine active participant status for the taxable year.

For purposes of the IRA deduction rules, an individual shall be an "active participant" for a taxable year if either the individual or the individual's spouse (with whom the individual files a joint tax return) actively participates in any of the following:

1) a qualified plan described in section 401(a) of the Code,

2) an annuity plan described in section 403(a) of the Code,

3) a plan established for its employees by the federal, state or local government or by an agency or instrumentality thereof (other than a plan described in section 457 of the Code),

4) an annuity contract or custodial account described in section 403(b) of the Code,

5) a simplified employee pension described in section 408(k) of the Code, or

6) a trust described in section 501(c)(18) of the Code.

See Questions Al through Al4 for active participant rules that apply to all plans.

In determining when an individual is an active participant in retirement arrangement for a taxable year, different rules are applied, depending upon whether the retirement arrangement is a defined benefit or a defined contribution plan.


Defined Benefit Plan Rule

In the case of a defined benefit plan, an individual who is not excluded under the eligibility provisions of the plan for the plan year ending with or within the individual's taxable year shall be an active participant in the plan, regardless of whethe r such individual has elected to decline participation in the plan, has failed to make a mandatory contribution specified under the plan or has failed to perform the minimum service required to accrue a benefit under the plan. For example:

An individual is a calendar year taxpayer who is not excluded from participation under the provisions of a defined benefit plan with a July 1 to June 30 plan year. The individual separates from service on December 31, 1987. Because the individual is not excluded under the plan's eligibility provisions for the plan year ending in such individual's 1988 taxable year, such individual shall be an active participant for the 1988 taxable year.

See Questions Al5 through Al8 for defined benefit plan active participant rules.


Defined Contribution Plan Rule

Generally, in the case of a defined contribution plan, an individual shall be an active participant if employer or employee contributions or forfeitures are allocated to such individual's account with respect to a plan year ending with or within the individual's taxable year. For example:

Company B sponsors a money purchase pension plan with a plan year ending on June 30. The plan provides that contributions must be allocated as of the last day of the plan year. On December 31, 1987, an individual employed by the Company separates from service. The contribution for the plan year ending on June 30, 1988 is not made until February 15, 1989, when the Company files its corporate return. In this case, the individual is an active participant for such individual's 1988 taxable year.

A special rule applies to certain plans in which it is impossible to determine whether or not an amount (other than earnings) will be allocated to an individual's account for a given plan year. If, with respect to a particular plan year, no amount attributable to forfeitures, employer contributions or employee contributions has been allocated to an individual's account by the last day of the plan year, and contributions to the plan are purely discretionary for the plan year, such individual shall not be an active participant for the taxable year in which such plan year ends. If, however, after the end of such plan year, the employer contributes an amount for such plan year, an individual to whose account an allocation is made shall be an active participant for the taxable year in which the contribution is made.

Contributions shall be treated as purely discretionary for the plan year if, as of the end of the plan year, the employer is not obligated under the law or terms of the plan to make a contribution for the plan year, and whether or not contributions are made to the plan is ultimately dependent upon the employer's decision or factors within the control of the employer. Contributions are not purely discretionary merely because they are dependant on profits.

For example:

An individual covered by a profit-sharing plan separated from service on December 31, 1987. The plan year runs from July 1 to June 30. Under the terms of the plan, employer contributions, if any, shall be made at the complete discretion of the Board of the Directors and shall be contributed to the plan prior to the due date for filing the employer's tax return. Such contributions are allocated as of the last day of the plan year, and allocations are made to the accounts of individuals who have any service during the plan year. As of June 30, 1988, no employer or employee contributions had been made that are allocated to the June 30, 1988 plan year, and no forfeitures had been allocated within the plan year. In addition, as of such date, the employer was not obligated to make a contribution for such plan year and it was impossible to determine whether or not a contribution would be made with respect to the plan year. On December 31, 1988, the Board of Directors agreed to contribute a specified amount to the plan, with respect to the plan year ending June 30, 1988; on February 15, 1989, such contribution was made to the plan. As a result of the amount allocated to such individual,s account as of June 30, 1988, the individual is an active participant in the plan for the 1989 calendar year but not for the 1988 year.

See Questions Al9 through A26 for the defined contribution plan rules.


GENERAL ACTIVE PARTICIPANT QUESTIONS

Al: How will an employer report active participant status for a taxable year?

A: An individual's employer (or former employer) must inform an individual of active participant status for the taxable year of the individual. This status must be reported on a Form W- 2.

A2: If an individual is not an active participant, but such individual's spouse is an active participant, will the individual be treated as an active participant?

A: If the couple files a joint federal income tax return for the applicable year, active participation by either spouse will cause both spouses to be treated as active participants. But see Question A3.

A3: If an individual is married but files a separate tax return, will active participation by his or her spouse affect the individual's active participant status?

HMTZ Note: This answer is no longer the correct answer. Congress changed the law after a year to remove this option.
A: No. Section 219(g)(4) of the Code provides that a married individual who files a separate tax return is considered single for purposes of determining active participant status. Thus, if the individual is not an active participant. the fact that his or her spouse is an active participant will not limit such individual's IRA deduction.

A4: If a married individual obtains a divorce during his or her taxable year (and does not remarry during such year), is the individual considered an active participant merely because the former spouse is an active participant for the year?

A: No. Marital status is determined as of the end of the year. Thus, if the individual is not married at the end of the year, the fact that his or her former spouse is an active participant will not cause the individual to be treated as an active parti cipant. Similarly, if an individual marries during the year, and the individual's new spouse is an active participant, the individual shall be treated as an active participant for the entire year if the couple files a joint tax return.

A5: If a married individual dies during a taxable year and is an active participant for such taxable year, will the survivor be treated as an active participant for purposes of section 219(g) of the Code?

A: Yes. In the taxable year of death, active participation is determined as if the deceased spouse was still alive. Thus, if the deceased spouse was an active participant for the taxable year of death and a joint return is filed for the taxable year of death, the survivor will also be treated as an active participant. In such a case, the applicable dollar limitation for AGI purposes is $40,000. (See I. B., below.) For taxable years following the taxable year of death, the deceased spouse's status as an active participant in the year of death has no effect on the survivor's status as an active participant because the survivor is not treated as married to the deceased spouse for purposes of the active participation rules. However, for AGI purposes, in th ose cases in which the survivor meets the filing status requirements under section 2(a) of the Code, the survivor will use the same $40,000 applicable dollar limitation used by married taxpayers filing jointly.

A6: An individual has an amount deferred for a taxable year in a plan described in section 457 of the Code. Does participation in such a plan cause the individual to be an active participant?

A: No. Section 219(g)(5) of the Code specifically exempts unfunded deferred compensation plans described in section 457 of the Code from the definition of relevant plans for purposes of determining who is an active participant. Participation in any ret irement plan established by a state or local government, other than a plan described in section 457 of the Code, is active participation for purposes of section 219(g)(5) of the Code.

A7: Is an individual who is covered under Social Security or Railroad Retirement (Tier I or Tier II) an active participant?

A: No. Under Section 219(g)(5), neither Social Security nor Railroad Retirement (Tier I and Tier II) is a retirement arrangement for purposes of determining active participant status.

A8: Is a retired individual who is receiving pension annuity payments an active participant?

A: No. An individual will not be treated as an active participant merely because the individual receives benefits under a retirement arrangement described in section 219(g)(5) of the Code.

A9: If an individual